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can be changed to corrected link
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Contact me atrjensen@trinity.eduif
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Accounting History Blast from the Past
Demski, J. S. 1973. The general impossibility of normative accounting
standards. The Accounting Review (October): 718-723. (JSTOR link).
Cushing, B. E. 1977. On the possibility of optimal accounting principles.
The Accounting Review (April): 308-321. (JSTOR
link).
Abstract
Several authors have examined the issue of choice among financial reporting
standards and principles using the framework of rational choice theory.
Their results have been almost uniformly pessimistic in terms of the
possibilities for favorable resolution of this issue. Upon further analysis,
these results are revealed to be an artifact of the way in which the issue
is initially formulated. Several possible methods of reformulating of this
issue within the rational choice framework are proposed and explored in this
paper. The results here support a much more optimistic conclusion and
suggest numerous avenues of further research which could provide
considerable insight into the conditions under which optimal accounting
principles are possible.
Some Recent Advances in theory of Financial Reporting
and Disclosures
by Ronald A. Dye (Northwestern University)
Accounting Horizons: September 2017, Vol. 31, No. 3, pp. 39-54.
https://doi.org/10.2308/acch-51717 \
This is a personal essay that contains my
views on some of the recent history and evolution of theory of financial
accounting and disclosures. The essay starts by discussing how research on
information economics by Hirshleifer and Akerlof combined with Demski's
critique of academic assessments of accounting standards shifted theoretical
research toward emphasizing the role of voluntary disclosures. Grossman's
and Milgrom's “unravelling result” is reviewed, as are recent modeling
efforts that provide a foundation for studying firms' incomplete voluntary
disclosures. The paper also speaks to some contemporary financial reporting
problems, such as fair value accounting, and also to an assessment of some
recent financial innovations, such as so-called flash trading.
I will conclude this section with one more
example of the application of this disclosure framework in the context of
SEC 10b-5 litigation (this is based on
Dye [forthcoming]).
If a firm is caught having withheld material information, then it is liable
for damages, and it has to pay a penalty to investors who purchased the
firm's shares while the firm withheld information. This penalty is a
(possibly fractional) multiple of the difference between the amount
investors paid for the shares and the price the investors would have paid
for the shares had the firm disclosed its information. Calling the (possibly
fractional) multiple of the investors' overpayment used to assess the
penalty “the damages multiplier,” in Dye (forthcoming). I show that, counter
intuitively, an increase in the damages multiplier induces the firm to
disclose the information it receives less often and, also counterintuitively,
that an increase in the probability that the fact finder detects that the
firm withheld information also induces the firm to disclose the information
it receives less often. Since an explanation for these results requires
delving more deeply into the model than I have allotted space for presently,
I will forgo the explanation here and instead encourage the interested
reader to review the paper.
FINAL THOUGHTS
The preceding covers but
a small part of my own research on disclosures and a fortiori an even
smaller part of the contributions of the profession's research on
disclosures. But, I hope it serves to give at least a sense of the evolution
of a portion of the research literature in financial reporting and
disclosures with which I have been associated, and I hope it also serves as
encouragement to readers, particularly young researchers, to develop their
own contributions to the literature. There is still much to be learned about
how disclosures work and what can be done to improve them.
Bob Jensen's Threads on Return on Business
Valuation, Business Combinations, Investment (ROI), and Pro Forma Financial
Reporting ---
http://faculty.trinity.edu/rjensen/roi.htm
Conceptual Framework Controversies
Accounting standard setters cannot even operationally define the calculation of
earnings other than to make it a plug that makes the balance sheet balance.
And
yet this plug remains as an exceedingly important driver of share prices in the
stock markets.
Granulation Obviously correlation is not causation, but don't suggest this too loudly to
referees of The Accounting Review --- An enormous problem with accountics science, and finance in general,
is that these sciences largely confine themselves to databases where it's
only possible to establish correlations and not causes, because zero causal
information is contained in the big databases they purchase rather than
collect themselves --- http://www.cs.trinity.edu/~rjensen/temp/AccounticsGranulationCurrentDraft.pdf
A recent accountics science study
suggests that audit firm scandal with respect to someone else's audit
may be a reason for changing auditors. "Audit Quality and Auditor Reputation: Evidence from Japan," by Douglas
J. Skinner and Suraj Srinivasan, The Accounting Review, September
2012, Vol. 87, No. 5, pp. 1737-1765.
Our conclusions are
subject to two caveats. First, we find that clients switched away from
ChuoAoyama in large numbers in Spring 2006, just after Japanese
regulators announced the two-month suspension and PwC formed Aarata.
While we interpret these events as being a clear and undeniable signal
of audit-quality problems at ChuoAoyama, we cannot know for sure
what drove these switches(emphasis added).
It is possible that the suspension caused firms to switch auditors for
reasons unrelated to audit quality. Second, our analysis presumes that
audit quality is important to Japanese companies. While we believe this
to be the case, especially over the past two decades as Japanese capital
markets have evolved to be more like their Western counterparts, it is possible that audit quality is, in general, less important in
Japan(emphasis added) .
People tend to
study what you know how to study, I mean that makes sense. You have
certain experimental techniques, you have certain level of
understanding, you try to push the envelope -- which is okay, I mean,
it's not a criticism, but people do what you can do. On the other hand,
it's worth thinking whether you're aiming in the right direction. And it
could be that if you take roughly the Marr-Gallistel point of view,
which personally I'm sympathetic to, you would work differently, look
for different kind of experiments.
Continued in article
April 3, 2013 message from Bob
Jensen
Hi Tom,
Although I'm inclined to agree
with you about the decline in quality of financial reporting, but
I'm not as inclined to put as much blame on the accounting standards
setters. Perhaps we've just given standard setters an impossible job.
Much of the blame has to be
placed on the clients themselves along with their lawyers and
accountants who created contracts so filled with contingencies and
incomprehensible clauses that it's impossible to account for them, at
least in our overly simplistic double-entry system of accounting.
There were once thousands and
now ten thousands of types of complicated derivatives contracts,
financial structures, and collateralizations. We require accounting
systems to mark contracts to market when markets are thin and unstable
as morning dew on flower petals in a wind.
I think even you would be
overwhelmed if you were appointed to the IASB or IASB. I know that I
would be dumbfounded in less than a week.
As to externalities, I don't
think we will ever be able to measure the costs and benefits because of
the higher order interactions that befuddle even our best scientists. I
sit up here in the mountains and view first-hand what I think is global
warming. But the scientists who measure temperatures around the world
tell us that temperatures are declining rather than rising. There's ever
so much we don't understand in science, macroeconomics (where we are now
facing complexities we've never seen in the history of the world). and
financial risk contracting that the experts who write the contracts do
not understand.
We bookkeepers clomp around in
worlds where angels fear to tread. We can't even explain why financial
statements lost predictive ability since the 1970s.
Bob Jensen's threads on GAAP comparisons (with
particular stress upon derivative financial
instruments accounting rules) are at
http://faculty.trinity.edu/rjensen/caseans/canada.htm
The above site also links to more general GAAP comparison guides between
nations.
Page 206
Like scientists today in medical and economic and other
sizeless sciences, Pearson mistook a large sample size for the definite,
substantive significance---evidence s Hayek put it, of "wholes." But it was
as Hayek said "just an illusion." Pearson's columns of sparkling asterisks,
though quantitative in appearance and as appealing a is the simple truth of
the sky, signified nothing.
Jensen Comment
Here are some added positives and negatives to consider, especially if you are
currently a practicing accountant considering becoming a professor.
As usual, these AECM threads between you, me, and Paul Williams resolve
nothing to date. TAR still has zero articles without equations unless such
articles are forced upon editors like the Kaplan article was forced upon you
as Senior Editor. TAR still has no commentaries about the papers it
publishes and the authors make no attempt to communicate and have dialog
about their research on the AECM or the AAA Commons.
I do hope that our AECM threads will continue and lead one day to when
the top academic research journals do more to both encourage (1) validation
(usually by speedy replication), (2) alternate methodologies, (3) more
innovative research, and (4) more interactive commentaries.
I remind you that Professor Basu's essay is only one of four essays
bundled together in Accounting Horizons on the topic of how to make
accounting research, especially the so-called Accounting Sciience or
Accountics Science or Cargo Cult science, more innovative.
"Framing the Issue of Research Quality in a Context of Research
Diversity," by Christopher S. Chapman ---
"Accounting Craftspeople versus Accounting Seers: Exploring the
Relevance and Innovation Gaps in Academic Accounting Research," by
William E. McCarthy ---
"Is Accounting Research Stagnant?" by Donald V. Moser ---
Cargo Cult Science "How Can Accounting Researchers Become More
Innovative? by Sudipta Basu ---
I will try to keep drawing attention to these important essays and spend
the rest of my professional life trying to bring accounting research closer
to the accounting profession.
I also want to dispel the myth that accountics research is harder than
making research discoveries without equations. The hardest research I can
imagine (and where I failed) is to make a discovery that has a noteworthy
impact on the accounting profession. I always look but never find such
discoveries reported in TAR.
The easiest research is to purchase a database and beat it with an
econometric stick until something falls out of the clouds. I've searched for
years and find very little that has a noteworthy impact on the accounting
profession. Quite often there is a noteworthy impact on other members of the
Cargo Cult and doctoral students seeking to beat the same data with their
sticks. But try to find a practitioner with an interest in these academic
accounting discoveries?
Our latest thread leads me to such questions as:
Is accounting research of inferior quality relative to other
disciplines like engineering and finance?
Are there serious innovation gaps in academic accounting research?
Is accounting research stagnant?
How can accounting researchers be more innovative?
Is there an "absence of dissent" in academic accounting research?
Is there an absence of diversity in our top academic accounting
research journals and doctoral programs?
Is there a serious disinterest (except among the Cargo Cult) and
lack of validation in findings reported in our academic accounting
research journals, especially TAR?
Is there a huge communications gap between academic accounting
researchers and those who toil teaching accounting and practicing
accounting?
One fall out of this thread is that I've been privately asked to write a
paper about such matters. I hope that others will compete with me in
thinking and writing about these serious challenges to academic accounting
research that never seem to get resolved.
Thank you Steve for sometimes responding in my threads on such issues in
the AECM.
HARRY I. WOLK (editor), Accounting Theory
(London, U.K.: Sage Publications Ltd., 2009, ISBN 978-1-84787-609-6, pp.
xlv, 1,518 in four volumes).
Harry I. Wolk, the compiler of this collection of
74 previously published articles and other essays, died in October 2009 at
age 79. In 1984, he was assisted by two colleagues in writing a thoughtful,
wide-ranging textbook on accounting theory, which is now in its seventh
edition. He has, thus, been a close student of the accounting theory
literature for many years.
Wolk's valedictory contribution is this anthology,
which is divided into ten sections: philosophical background, accounting
concepts, conceptual frameworks, accounting for changing prices, standard
setting, applications of accounting theory to five measurement areas, agency
theory, principles versus rules, international accounting standards, and
accounting issues in East and Southeast Asia. Because he provides only a
two-and-a-half-page general introduction, we cannot know the criteria he
used to make these selections. The earliest of the articles dates from 1958,
and one infers that this collection represents the body of work that, over
his long career, mostly at Drake University, he found to be influential
writings.
Among the major contributors to theory
literature represented in the collection are Devine, Mattessich, Davidson,
Solomons, Sterling, Thomas, Bell, Shillinglaw, Bedford, Ijiri, and Stamp.
Conspicuous omissions are Chambers, Baxter, Staubus, Moonitz, Sorter, and
Vatter. Although many of the earlier pieces have stood the test of time, a
number of the more recent selections would, inevitably, be open to
second-guessing. To be sure, most of these articles can be accessed
electronically, yet it is instructive to know the works that Harry Wolk
believed were worth remembering, and it is handy to have them all in one
collection.
The price tag of £600/$1,050
for the four-volume set will, unfortunately, deter all but the most
enthusiastic purchasers.
But I do thank Harry for providing me with an accounting illustration that
I turned into the most popular Excel illustration that I ever authored (i.e.,
popular in the eyes of my students over the years) ---
www.cs.trinity.edu/~rjensen/Excel/wtdcase2a.xls
One of the more surprising things I
have learned from my experience as Senior Editor of
The Accounting Review
is just how often a
‘‘hot
topic’’
generates multiple
submissions that pursue similar research objectives. Though one might view
such situations as enhancing the credibility of research findings through
the independent efforts of multiple research teams, they often result in
unfavorable reactions from reviewers who question the incremental
contribution of a subsequent study that does not materially advance the
findings already documented in a previous study, even if the two (or more)
efforts were initiated independently and pursued more or less concurrently.
I understand the reason for a high incremental contribution standard in a
top-tier journal that faces capacity constraints and deals with about 500
new submissions per year. Nevertheless, I must admit that I sometimes feel
bad writing a rejection letter on a good study, just because some other
research team beat the authors to press with similar conclusions documented
a few months earlier. Research, it seems, operates in a highly competitive
arena.
Fortunately, from time to time, we
receive related but still distinct submissions that, in combination, capture
synergies (and reviewer support) by viewing a broad research question from
different perspectives. The two articles comprising this issue’s forum are a
classic case in point. Though both studies reach the same basic conclusion
that material weaknesses in internal controls over financial reporting
result in negative repercussions for the cost of debt financing, Dhaliwal et
al. (2011) do so by examining the public market for corporate debt
instruments, whereas Kim et al. (2011) examine private debt contracting with
financial institutions. These different perspectives enable the two research
teams to pursue different secondary analyses, such as Dhaliwal et al.’s
examination of the sensitivity of the reported findings to bank monitoring
and Kim et al.’s examination of debt covenants.
Both studies also overlap with yet a
third recent effort in this arena, recently published in the
Journal of Accounting
Research by Costello and
Wittenberg-Moerman (2011). Although the overall
‘‘punch
line’’
is similar in all three studies (material
internal control weaknesses result in a higher cost of debt), I am intrigued
by a ‘‘mini-debate’’
of sorts on the different conclusions
reache by Costello and Wittenberg-Moerman (2011) and by Kim et al.
(2011) for the effect of material weaknesses on debt covenants.
Specifically, Costello and Wittenberg-Moerman (2011, 116) find that
‘‘serious,
fraud-related weaknesses result in a significant decrease in financial
covenants,’’
presumably because banks substitute more
direct protections in such instances, whereas Kim et al.
Published Online: July 2011
(2011) assert from their cross-sectional
design that company-level material weaknesses are associated with
more
financial covenants in
debt contracting.
In reconciling these conflicting
findings, Costello and Wittenberg-Moerman (2011, 116) attribute the Kim et
al. (2011) result to underlying
‘‘differences
in more fundamental firm characteristics, such as riskiness and information
opacity,’’
given that, cross-sectionally, material
weakness firms have a greater number of financial covenants than do
non-material weakness firms even
before the disclosure of the material
weakness in internal controls. Kim et al. (2011) counter that they control
for risk and opacity characteristics, and that advance leakage of internal
control problems could still result in a debt covenant effect due to
internal controls rather than underlying firm characteristics. Kim et al.
(2011) also report from a supplemental change analysis that, comparing the
pre- and post-SOX 404 periods, the number of debt covenants falls for
companies both with and without
material
weaknesses in internal controls, raising the question of whether the
Costello and Wittenberg-Moerman (2011)
finding reflects a reaction to the disclosures or simply a more general
trend of a declining number of debt covenants affecting all firms around
that time period. I urge readers to take a look at both articles, along with
Dhaliwal et al. (2011), and draw their own conclusions. Indeed, I believe
that these sorts . . .
Continued in article
Jensen Comment
Without admitting to it, I think Steve has been embarrassed, along with many
other accountics researchers, about the virtual absence of validation and
replication of accounting science (accountics) research studies over the past
five decades. For the most part, accountics articles are either ignored or
accepted as truth without validation. Behavioral and capital markets empirical
studies are rarely (ever?) replicated. Analytical studies make tremendous leaps
of faith in terms of underlying assumptions that are rarely challenged (such as
the assumption of equations depicting utility functions of corporations).
Accounting science thereby has become a pseudo
science where highly paid accountics professor referees are protecting each
others' butts ---
"574 Shields Against Validity Challenges in Plato's Cave" ---
http://faculty.trinity.edu/rjensen/TheoryTAR.htm
The above link contains Steve's rejoinders on the replication debate.
In the above editorial he's telling us that there is a middle ground for
validation of accountics studies. When researchers independently come to similar
conclusions using different data sets and different quantitative analyses they
are in a sense validating each others' work without truly replicating each
others' work.
I agree with Steve on this, but I would also argue that these types of
"validation" is too little to late relative to genuine science where replication
and true validation are essential to the very definition of science. The types
independent but related research that Steve is discussing above is too
infrequent and haphazard to fall into the realm of validation and replication.
When's the last time you witnesses a TAR author criticizing the research of
another TAR author (TAR does not publish critical commentaries)?
Are TAR articles really all that above criticism? Even though I admire Steve's scholarship, dedication,
and sacrifice, I hope future TAR editors will work harder at turning accountics
research into real science!
People tend to study what you know how to study, I
mean that makes sense. You have certain experimental techniques, you have
certain level of understanding, you try to push the envelope -- which is
okay, I mean, it's not a criticism, but people do what you can do. On the
other hand, it's worth thinking whether you're aiming in the right
direction. And it could be that if you take roughly the Marr-Gallistel point
of view, which personally I'm sympathetic to, you would work differently,
look for different kind of experiments.
A few weeks ago, TechCrunch published a piece
arguing software is better at investing than 99% of human investment
advisors. That post, titled
Thankfully, Software Is Eating The Personal Investing World,
pointed out the advantages of engineering-driven
software solutions versus emotionally driven human judgment. Perhaps not
surprisingly, some commenters (including some financial advisors) seized the
moment to call into question one of the foundations of software-based
investing, Modern Portfolio Theory.
Given the doubts raised by a small but vocal
chorus, it’s worth spending some time to ask if we need a new investing
paradigm and if so, what it should be. Answering that question helps show
why MPT still is the best investment methodology out there; it enables the
automated, low-cost investment management offered by a new wave of Internet
startups including
Wealthfront
(which I advise),
Personal Capital,
Future Advisor
and SigFig.
The basic questions being raised about MPT run
something like this:
Hasn’t recent experience – i.e., the financial
crisis — shown that diversification doesn’t work?
Shouldn’t we primarily worry about “Black
Swan” events and unforeseen risk?
Don’t these unknown unknowns mean we must
develop a new approach to investing?
Let’s begin by briefly laying out the key insights
of MPT.
MPT is based in part on the assumption that most
investors don’t like risk and need to be compensated for bearing it. That
compensation comes in the form of higher average returns. Historical data
strongly supports this assumption. For example, from 1926 to 2011 the
average (geometric) return on U.S. Treasury Bills was 3.6%. Over the same
period the average return on large company stocks was 9.8%; that on small
company stocks was 11.2% ( See 2012 Ibbotson Stocks, Bonds, Bills and
Inflation (SBBI) Valuation Yearbook, Morningstar, Inc., page 23. ). Stocks,
of course, are much riskier than Treasuries, so we expect them to have
higher average returns — and they do.
One of MPT’s key insights is that while investors
need to be compensated to bear risk, not all risks are rewarded. The market
does not reward risks that can be “diversified away” by holding a bundle of
investments, instead of a single investment. By recognizing that not all
risks are rewarded, MPT helped establish the idea that a diversified
portfolio can help investors earn a higher return for the same amount of
risk.
To understand which risks can be diversified away,
and why, consider Zynga. Zynga hit $14.69 in March and has since dropped to
less than $2 per share. Based on what’s happened over the past few months,
the major risks associated with Zynga’s stock are things such as delays in
new game development, the fickle taste of consumers and changes on Facebook
that affect users’ engagement with Zynga’s games.
For company insiders, who have much of their wealth
tied up in the company, Zynga is clearly a risky investment. Although those
insiders are exposed to huge risks, they aren’t the investors who determine
the “risk premium” for Zynga. (A stock’s risk premium is the extra return
the stock is expected to earn that compensates for the stock’s risk.)
Rather, institutional funds and other large
investors establish the risk premium by deciding what price they’re willing
to pay to hold Zynga in their diversified portfolios. If a Zynga game is
delayed, and Zynga’s stock price drops, that decline has a miniscule effect
on a diversified shareholder’s portfolio returns. Because of this, the
market does not price in that particular risk. Even the overall turbulence
in many Internet stocks won’t be problematic for investors who are well
diversified in their portfolios.
Modern Portfolio Theory focuses on constructing
portfolios that avoid exposing the investor to those kinds of unrewarded
risks. The main lesson is that investors should choose portfolios that lie
on the Efficient Frontier, the mathematically defined curve that describes
the relationship between risk and reward. To be on the frontier, a portfolio
must provide the highest expected return (largest reward) among all
portfolios having the same level of risk. The Internet startups construct
well-diversified portfolios designed to be efficient with the right
combination of risk and return for their clients.
Now let’s ask if anything in the past five years
casts doubt on these basic tenets of Modern Portfolio Theory. The answer is
clearly, “No.” First and foremost, nothing has changed the fact that there
are many unrewarded risks, and that investors should avoid these risks. The
major risks of Zynga stock remain diversifiable risks, and unless you’re
willing to trade illegally on inside information about, say, upcoming
changes to Facebook’s gaming policies, you should avoid holding a
concentrated position in Zynga.
The efficient frontier is still the desirable place
to be, and it makes no sense to follow a policy that puts you in a position
well below that frontier.
Most of the people who say that “diversification
failed” in the financial crisis have in mind not the diversification gains
associated with avoiding concentrated investments in companies like Zynga,
but the diversification gains that come from investing across many different
asset classes, such as domestic stocks, foreign stocks, real estate and
bonds. Those critics aren’t challenging the idea of diversification in
general – probably because such an effort would be nonsensical.
True, diversification across asset classes didn’t
shelter investors from 2008’s turmoil. In that year, the S&P 500 index fell
37%, the MSCI EAFE index (the index of developed markets outside North
America) fell by 43%, the MSCI Emerging Market index fell by 53%, the Dow
Jones Commodities Index fell by 35%, and the Lehman High Yield Bond Index
fell by 26%. The historical record shows that in times of economic distress,
asset class returns tend to move in the same direction and be more highly
correlated. These increased correlations are no doubt due to the increased
importance of macro factors driving corporate cash flows. The increased
correlations limit, but do not eliminate, diversification’s value. It would
be foolish to conclude from this that you should be undiversified. If a seat
belt doesn’t provide perfect protection, it still makes sense to wear one.
Statistics show it’s better to wear a seatbelt than to not wear one.
Similarly, statistics show diversification reduces risk, and that you are
better off diversifying than not.
Timing the market
The obvious question to ask anyone who insists
diversification across asset classes is not effective is: What is the
alternative? Some say “Time the market.” Make sure you hold an asset class
when it is earning good returns, but sell as soon as things are about to go
south. Even better, take short positions when the outlook is negative. With
a trustworthy crystal ball, this is a winning strategy. The potential gains
are huge. If you had perfect foresight and could time the S&P 500
on a daily basis, you could have turned $1,000 on Jan. 1, 2000, into
$120,975,000 on Dec. 31, 2009, just by going in and out of the market. If
you could also short the market when appropriate, the gains would have been
even more spectacular!
Sometimes, it seems someone may have a fairly
reliable crystal ball. Consider John Paulson, who in 2007 and 2008 seemed so
prescient in profiting from the subprime market’s collapse. It appears,
however, that Mr. Paulson’s crystal ball became less reliable after his
stunning success in 2007. His Advantage Plus fund experienced more than a
50% loss in 2011. Separating luck from skill is often difficult.
Some people try to come up with a way to time the
market based on historical data. In fact a large number of strategies will
work well “in the back test.” The question is whether any system is reliable
enough to use for future investing.
There are at least three reasons to be cautious
about substituting a timing system for diversification.
First, a timing system that does not work can
impose significant transaction costs (including avoidable adverse tax
consequences) on the investor for no gain.
Second, an ill-founded timing strategy
generally exposes the investor to risk that is unrewarded. In other
words, it puts the investor below the frontier, which is not a good
place to be.
Third, a timing system’s success may create
the seeds of its own destruction. If too many investors blindly follow
the strategy, prices will be driven to erase any putative gains that
might have been there, turning the strategy into a losing proposition.
Also, a timing strategy designed to “beat the market” must involve
trading into “good” positions and away from “bad” ones. That means there
must be a sucker (or several suckers) available to take on the other
(losing) sides. (No doubt in most cases each party to the trade thinks
the sucker is on the other side.)
Black Swans
What about those Black Swans? Doesn’t MPT ignore
the possibility that we can be surprised by the unexpected? Isn’t it
impossible to measure risk when there are unknown unknowns?
Most people recognize that financial markets are
not like simple games of chance where risk can be quantified precisely. As
we’ve seen (e.g., the “Black Monday” stock market crash of 1987 and the
“flash crash” of 2010), the markets can produce extreme events that hardly
anyone contemplated as a possibility. As opposed to poker, where we always
draw from the same 52-card deck, in financial markets, asset returns are
drawn from changing distributions as the world economy and financial
relationships change.
Some Black Swan events turned out to have limited
effects on investors over the long term. Although the market dropped
precipitously in October 1987, it was close to fully recovered in June 1988.
The flash crash was confined to a single day.
This is not to say that all “surprise” events are transitory. The Great
Depression followed the stock market crash of 1929, and the effects of the
financial crisis in 2007 and 2008 linger on five years later.
The question is, how should we respond to
uncertainties and Black Swans? One sensible way is to be more diligent in
quantifying the risks we can see. For example, since extreme events don’t
happen often, we’re likely to be misled if we base our risk assessment on
what has occurred over short time periods. We shouldn’t conclude that just
because housing prices haven’t gone down over 20 years that a housing
decline is not a meaningful risk. In the case of natural disasters like
earthquakes, tsunamis, asteroid strikes and solar storms, the long run could
be very long indeed. While we can’t capture all risks by looking far back in
time, taking into account long-term data means we’re less likely to be
surprised.
Some people suggest you should respond to the risk
of unknown unknowns by investing very conservatively. This means allocating
most of the portfolio to “safe assets” and significantly reducing exposure
to risky assets, which are likely to be affected by Black Swan surprises.
This response is consistent with MPT. If you worry about Black Swans, you
are, for all intents and purposes, a very risk-averse investor. The MPT
portfolio position for very risk-averse investors is a position on the
efficient frontier that has little risk.
The cost of investing in a low-risk position is a
lower expected return (recall that historically the average return on stocks
was about three times that on U.S. Treasuries), but maybe you think that’s a
price worth paying. Can everyone take extremely conservative positions to
avoid Black Swan risk? This clearly won’t work, because some investors must
hold risky assets. If all investors try to avoid Black Swan events, the
prices of those risky assets will fall to a point where the forecasted
returns become too large to ignore.
Continued in article
Jensen Comment
All quant theories and strategies in finance are based upon some foundational
assumptions that in rare instances turn into the
Achilles'
heel of the entire superstructure. The classic example is the wonderful
theory and arbitrage strategy of Long Term Capital Management (LTCM) formed by
the best quants in finance (two with Nobel Prizes in economics). After
remarkable successes one nickel at a time in a secret global arbitrage strategy
based heavily on the Black-Scholes Model, LTCM placed a trillion dollar bet that
failed dramatically and became the only hedge fund that nearly imploded all of
Wall Street. At a heavy cost, Wall Street investment bankers pooled billions of
dollars to quietly shut down LTCM ---
http://faculty.trinity.edu/rjensen/FraudRotten.htm#LTCM
So what was the Achilles heal of the arbitrage strategy of LTCM? It was an
assumption that a huge portion of the global financial market would not collapse
all at once. Low and behold, the Asian financial markets collapsed all at once
and left LTCM naked and dangling from a speculative cliff.
There is a tremendous (one of the best
videos I've ever seen on the Black-Scholes Model) PBS Nova video called
"Trillion Dollar Bet" explaining why LTCM
collapsed. Go to
http://www.pbs.org/wgbh/nova/stockmarket/
This video is in the media libraries on most college campuses. I highly
recommend showing this video to students. It is extremely well done and
exciting to watch.
The principal
policy issue arising out of the events surrounding the near collapse of LTCM
is how to constrain excessive leverage. By increasing the chance that
problems at one financial institution could be transmitted to other
institutions, excessive leverage can increase the likelihood of a general
breakdown in the functioning of financial markets. This issue is not limited
to hedge funds; other financial institutions are often larger and more
highly leveraged than most hedge funds.
The video and above reports, however, do not delve into the tax shelter
pushed by Myron Scholes and his other LTCM partners. A nice summary of the tax
shelter case with links to other documents can be found at
http://www.cambridgefinance.com/CFP-LTCM.pdf
The above August 27,
2004 ruling by Judge Janet Bond Arterton rounds out the "Trillion Dollar Bet."
The classic and enormous scandal was
Long Term Capital led by Nobel Prize winning Merton and Scholes (actually the
blame is shared with their devoted doctoral students). There is a tremendous
(one of the best videos I've ever seen on the Black-Scholes Model) PBS Nova
video ("Trillion Dollar Bet") explaining why LTC collapsed. Go to
http://www.pbs.org/wgbh/nova/stockmarket/
Another illustration of the Achilles' heel of a popular mathematical theory
and strategy is the 2008 collapse mortgage-backed CDO financial risk bonds based
upon David Li's Gaussian copula function of risk diversification in portfolios.
The Achilles' heel was the assumption that the real estate bubble would not
burst to a point where millions of subprime mortgages would all go into default
at roughly the same time.
"For five years, Li's formula, known as a
Gaussian copula function, looked like an unambiguously positive
breakthrough, a piece of financial technology that allowed hugely
complex risks to be modeled with more ease and accuracy than ever
before. With his brilliant spark of mathematical legerdemain, Li made it
possible for traders to sell vast quantities of new securities,
expanding financial markets to unimaginable levels.
His method was adopted by everybody from bond
investors and Wall Street banks to ratings agencies and regulators. And
it became so deeply entrenched—and was making people so much money—that
warnings about its limitations were largely ignored.
Then the model fell apart." The article goes on to show that correlations
are at the heart of the problem.
"The reason that ratings agencies and investors
felt so safe with the triple-A tranches was that they believed there was
no way hundreds of homeowners would all default on their loans at the
same time. One person might lose his job, another might fall ill. But
those are individual calamities that don't affect the mortgage pool much
as a whole: Everybody else is still making their payments on time.
But not all calamities are individual, and
tranching still hadn't solved all the problems of mortgage-pool risk.
Some things, like falling house prices, affect a large number of people
at once. If home values in your neighborhood decline and you lose some
of your equity, there's a good chance your neighbors will lose theirs as
well. If, as a result, you default on your mortgage, there's a higher
probability they will default, too. That's called correlation—the degree
to which one variable moves in line with another—and measuring it is an
important part of determining how risky mortgage bonds are."
I would highly recommend reading the entire thing that gets much more
involved with the
actual formula etc.
The
“math error” might truly be have been an error or it might have simply been a
gamble with what was perceived as miniscule odds of total market failure.
Something similar happened in the case of the trillion-dollar disastrous 1993
collapse of Long Term Capital Management formed by Nobel Prize winning
economists and their doctoral students who took similar gambles that ignored the
“miniscule odds” of world market collapse -- -
http://faculty.trinity.edu/rjensen/FraudRotten.htm#LTCM
The rhetorical question is whether the failure is ignorance in model building or
risk taking using the model?
ROBERT RUBIN was Bill Clinton’s treasury
secretary. He has worked at the top of Goldman Sachs and Citigroup. But he
made arguably the single most influential decision of his long career in
1983, when as head of risk arbitrage at Goldman he went to the MIT Sloan
School of Management in Cambridge, Massachusetts, to hire an economist
called Fischer Black.
A decade earlier Myron Scholes, Robert
Merton and Black had explained how to use share prices to calculate the
value of derivatives. The Black-Scholes options-pricing model was more than
a piece of geeky mathematics. It was a manifesto, part of a revolution that
put an end to the anti-intellectualism of American finance and transformed
financial markets from bull rings into today’s quantitative powerhouses.
Yet, in a roundabout way, Black’s approach also led to some of the late
boom’s most disastrous lapses.
Derivatives markets are not new, nor are
they an exclusively Western phenomenon. Mr Merton has described how Osaka’s
Dojima rice market offered forward contracts in the 17th century and
organised futures trading by the 18th century. However, the growth of
derivatives in the 36 years since Black’s formula was published has taken
them from the periphery of financial services to the core.
In “The Partnership”, a history of Goldman
Sachs, Charles Ellis records how the derivatives markets took off. The
International Monetary Market opened in 1972; Congress allowed trade in
commodity options in 1976; S&P 500 futures launched in 1982, and options on
those futures a year later. The Chicago Board Options Exchange traded 911
contracts on April 26th 1973, its first day (and only one month before
Black-Scholes appeared in print). In 2007 the CBOE’s volume of contracts
reached almost 1 trillion.
Trading has exploded partly because
derivatives are useful. After America came off the gold standard in 1971,
businesses wanted a way of protecting themselves against the movements in
exchange rates, just as they sought protection against swings in interest
rates after Paul Volcker, Mr Greenspan’s predecessor as chairman of the Fed,
tackled inflation in the 1980s. Equity options enabled investors to lay off
general risk so that they could concentrate on the specific types of
corporate risk they wanted to trade.
The other force behind the explosion in
derivatives trading was the combination of mathematics and computing. Before
Black-Scholes, option prices had been little more than educated guesses. The
new model showed how to work out an option price from the known price-behaviour
of a share and a bond. It is as if you had a formula for working out the
price of a fruit salad from the prices of the apples and oranges that went
into it, explains Emanuel Derman, a physicist who later took Black’s job at
Goldman. Confidence in pricing gave buyers and sellers the courage to pile
into derivatives. The better that real prices correlate with the unknown
option price, the more confidently you can take on any level of risk. “In a
thirsty world filled with hydrogen and oxygen,” Mr Derman has written,
“someone had finally worked out how to synthesise H2O.”
Poetry in Brownian motion Black-Scholes is
just a model, not a complete description of the world. Every model makes
simplifications, but some of the simplifications in Black-Scholes looked as
if they would matter. For instance, the maths it uses to describe how share
prices move comes from the equations in physics that describe the diffusion
of heat. The idea is that share prices follow some gentle random walk away
from an equilibrium, rather like motes of dust jiggling around in Brownian
motion. In fact, share-price movements are more violent than that.
Over the years the “quants” have found
ways to cope with this—better ways to deal with, as it were, quirks in the
prices of fruit and fruit salad. For a start, you can concentrate on the
short-run volatility of prices, which in some ways tends to behave more like
the Brownian motion that Black imagined. The quants can introduce sudden
jumps or tweak their models to match actual share-price movements more
closely. Mr Derman, who is now a professor at New York’s Columbia University
and a partner at Prisma Capital Partners, a fund of hedge funds, did some of
his best-known work modelling what is called the “volatility smile”—an
anomaly in options markets that first appeared after the 1987 stockmarket
crash when investors would pay extra for protection against another imminent
fall in share prices.
The fixes can make models complex and
unwieldy, confusing traders or deterring them from taking up new ideas.
There is a constant danger that behaviour in the market changes, as it did
after the 1987 crash, or that liquidity suddenly dries up, as it has done in
this crisis. But the quants are usually pragmatic enough to cope. They are
not seeking truth or elegance, just a way of capturing the behaviour of a
market and of linking an unobservable or illiquid price to prices in traded
markets. The limit to the quants’ tinkering has been not mathematics but the
speed, power and cost of computers. Nobody has any use for a model which
takes so long to compute that the markets leave it behind.
The idea behind quantitative finance is to
manage risk. You make money by taking known risks and hedging the rest. And
in this crash foreign-exchange, interest-rate and equity derivatives models
have so far behaved roughly as they should.
A muddle of mortgages Yet the idea behind
modelling got garbled when pools of mortgages were bundled up into
collateralised-debt obligations (CDOs). The principle is simple enough.
Imagine a waterfall of mortgage payments: the AAA investors at the top catch
their share, the next in line take their share from what remains, and so on.
At the bottom are the “equity investors” who get nothing if people default
on their mortgage payments and the money runs out.
Despite theory, CDOs were hopeless, at
least with hindsight (doesn’t that phrase come easily?). The cash flowing
from mortgage payments into a single CDO had to filter up through several
layers. Assets were bundled into a pool, securitised, stuffed into a CDO,
bits of that plugged into the next CDO and so on and on. Each source of a
CDO had interminable pages of its own documentation and conditions, and a
typical CDO might receive income from several hundred sources. It was a
lawyer’s paradise.
This baffling complexity could hardly be
more different from an equity or an interest rate. It made CDOs impossible
to model in anything but the most rudimentary way—all the more so because
each one contained a unique combination of underlying assets. Each CDO would
be sold on the basis of its own scenario, using central assumptions about
the future of interest rates and defaults to “demonstrate” the payouts over,
say, the next 30 years. This central scenario would then be “stress-tested”
to show that the CDO was robust—though oddly the tests did not include a 20%
fall in house prices.
This was modelling at its most feeble.
Derivatives model an unknown price from today’s known market prices. By
contrast, modelling from history is dangerous. There was no guarantee that
the future would be like the past, if only because the American housing
market had never before been buoyed up by a frenzy of CDOs. In any case,
there are not enough past housing data to form a rich statistical picture of
the market—especially if you decide not to include the 1930s nationwide fall
in house prices in your sample.
Neither could the models take account of
falling mortgage-underwriting standards. Mr Rajan of the University of
Chicago says academic research suggests mortgage originators, keen to
automate their procedures, stopped giving potential borrowers lengthy
interviews because they could not easily quantify the firmness of someone’s
handshake or the fixity of their gaze. Such things turned out to be better
predictors of default than credit scores or loan-to-value ratios, but the
investors at the end of a long chain of securities could not monitor lending
decisions.
The issuers of CDOs asked rating agencies
to assess their quality. Although the agencies insist that they did a
thorough job, a senior quant at a large bank says that the agencies’ models
were even less sophisticated than the issuers’. For instance, a BBB tranche
in a CDO might pay out in full if the defaults remained below 6%, and not at
all once they went above 6.5%. That is an all-or-nothing sort of return,
quite different from a BBB corporate bond, say. And yet, because both shared
the same BBB rating, they would be modelled in the same way.
Issuers like to have an edge over the
rating agencies. By paying one for rating the CDOs, some may have laid
themselves open to a conflict of interest. With help from companies like
Codefarm, an outfit from Brighton in Britain that knew the agencies’ models
for corporate CDOs, issuers could build securities with any risk profile
they chose, including those made up from lower-quality ingredients that
would nevertheless win AAA ratings. Codefarm has recently applied for
administration.
There is a saying on Wall Street that the
test of a product is whether clients will buy it. Would they have bought
into CDOs had it not been for the dazzling performance of the quants in
foreign-exchange, interest-rate and equity derivatives? There is every sign
that the issuing banks believed their own sales patter. The banks so liked
CDOs that they held on to a lot of their own issues, even when the idea
behind the business had been to sell them on. They also lent buyers much of
the money to bid for CDOs, certain that the securities were a sound
investment. With CDOs in deep trouble, the lenders are now suffering.
Modern finance is supposed to be all about
measuring risks, yet corporate and mortgage-backed CDOs were a leap in the
dark. According to Mr Derman, with Black-Scholes “you know what you are
assuming when you use the model, and you know exactly what has been swept
out of view, and hence you can think clearly about what you may have
overlooked.” By contrast, with CDOs “you don’t quite know what you are
ignoring, so you don’t know how to adjust for its inadequacies.”
Now that the world has moved far beyond
any of the scenarios that the CDO issuers modelled, investors’ quantitative
grasp of the payouts has fizzled into blank uncertainty. That makes it hard
to put any value on them, driving away possible buyers. The trillion-dollar
bet on mortgages has gone disastrously wrong. The hope is that the
trillion-dollar bet on companies does not end up that way too.
Continued in article
Closing Jensen Comment
So is portfolio diversification theory dead? I hardly think so. But if any
lesson is to be learned is that we should question those critical underlying
assumptions in Plato's Cave before worldwide strategies are implemented that
overlook the Achilles' heel of those critical underlying assumptions.
Accounting History Blast from the Past
Demski, J. S. 1973. The general impossibility of normative accounting
standards. The Accounting Review (October): 718-723. (JSTOR link).
Cushing, B. E. 1977. On the possibility of optimal accounting principles.
The Accounting Review (April): 308-321. (JSTOR
link).
Abstract
Several authors have examined the issue of choice among financial reporting
standards and principles using the framework of rational choice theory.
Their results have been almost uniformly pessimistic in terms of the
possibilities for favorable resolution of this issue. Upon further analysis,
these results are revealed to be an artifact of the way in which the issue
is initially formulated. Several possible methods of reformulating of this
issue within the rational choice framework are proposed and explored in this
paper. The results here support a much more optimistic conclusion and
suggest numerous avenues of further research which could provide
considerable insight into the conditions under which optimal accounting
principles are possible.
Purpose of Theory:
Prediction Versus Explanation
"Higgs ahoy! The elusive boson has probably been found. That is a triumph
for the predictive power of physics," The Economist, February 17, 2012 ---
http://www.economist.com/node/21541825
IN PHYSICS, the trick is often to ask a question so
obvious no one else would have thought of posing it. Apples have fallen to
the ground since time immemorial. It took the genius of Sir Isaac Newton to
ask why. Of course, it helps if you have the mental clout to work out the
answer. Fortunately, Newton did.
It was in this spirit, almost 50 years ago, that a
few insightful physicists asked themselves where mass comes from. Like the
tendency of apples to fall to the ground, the existence of mass is so
quotidian that the idea it needs a formal explanation would never occur to
most people. But it did occur to Peter Higgs, then a young researcher at
Edinburgh University, and to five other scientists whom the quirks of
celebrity have not treated so kindly. They, too, had the necessary mental
clout. They got out their pencils and papers and scribbled down equations
whose upshot was a prediction.
The reason that fundamental particles have mass,
the researchers calculated, is their interaction with a previously unknown
field that permeates space. This field came to be named (with no disrespect
to the losers in the celebrity race) the Higgs field. Technically, it is
needed to explain a phenomenon called electroweak symmetry breaking, which
divides two of the fundamental forces of nature, electromagnetism and the
weak nuclear force. When that division happens, a bit of leftover
mathematics manifests itself as a particle. This putative particle has
become known as the Higgs boson, whose possible discovery was announced to
the world on December 13th (see
article).
Physicists demand a level of proof that would in
any other human activity (including other scientific ones) be seen as
ludicrously high—that a result has only one chance in 3.5m of being wrong.
The new results—from experiments done at CERN, the world’s premier
particle-physics laboratory, using its multi-billion-dollar Large Hadron
Collider, the LHC—do not individually come close to that threshold. What has
excited physicists, though, is that they have got essentially identical
results from two experiments attached to the LHC, which work in completely
different ways. This coincidence makes it much more likely that they have
discovered the real deal.
If they have, it would be a wonderful thing, and
not just for science. Though nations no longer tremble at the feet of
particle physicists—the men, and a few women, who once delivered the
destructive power of the atom bomb—physics still has the power to produce
awe in another way, by revealing the basic truths that underpin reality.
Model behaviour
Finding the Higgs would mark the closing of one
chapter in this story. The elusive boson rounds off what has become known as
the Standard Model of physics—an explanation that relies on 17 fundamental
particles and three physical forces (though it stubbornly refuses to
accommodate a fourth force, gravity, which is separately explained by Albert
Einstein’s general theory of relativity). Much more intriguingly, the Higgs
also opens another chapter of physics.
The physicists’ plan is to use the Standard Model
as the foundation of a larger and more beautiful edifice called
Supersymmetry. This predicts a further set of particles, the heavier
partners of those already found. How much heavier, though, depends on how
heavy the Higgs itself is. The results just announced suggest it is light
enough for some of the predicted supersymmetric particles to be made in the
LHC too.
That is a great relief to those at CERN. If the
Higgs had proved much heavier than this week’s announcement implies they
might have found themselves with a lot of redundant kit on their hands. Now
they can start looking for the bricks of Supersymmetry, to see if it, too,
resembles the physicists’ predictions. In particular, in a crossover between
particle physics and cosmology, they will be trying to find out if (as the
maths suggest) the lightest of the supersymmetric partner particles are the
stuff of the hitherto mysterious “dark matter” whose gravity holds galaxies
together.
A critique of pure reason
One of the most extraordinary things about the
universe is this predictability—that it is possible to write down equations
which describe what is seen, and extrapolate from them to the unseen. Newton
was able to go from the behaviour of bodies falling to Earth to the
mechanism that holds planets in orbit. James Clerk Maxwell’s equations of
electromagnetism, derived in the mid-19th century, predicted the existence
of radio waves. The atom bomb began with Einstein’s famous equation,
E=mc{+2}, which was a result derived by asking how objects would behave when
travelling near the speed of light. The search for antimatter, that staple
of science fiction, was the consequence of an equation about electrons which
has two sets of solutions, one positive and one negative.
Eugene Wigner, one of the physicists responsible
for showing, in the 1920s, the importance of symmetry to the universe (and
who was thus a progenitor of Supersymmetry), described this as the
“unreasonable effectiveness of mathematics”. Not all such predictions come
true, of course. But the predictive power of mathematical physics—as opposed
to the after-the-fact explanatory power of maths in other fields—is still
extraordinary.
The book covers two (plus) centuries of economic
history. It starts with the Physiocrats, Adam Smith and theoretical
development of capitalism, and then steams ahead into the 19th century,
covering the Industrial Revolution, the rise of big business and big
finance. Next comes the action packed 20th century: the Great Depression,
the New Deal, the threat from Communism during the Cold War, the tax reforms
of the Reagan era, and eventually the crash of 2008 and Occupy Wall Street.
Along the way,
Goodwin and the illustrator
Dan E. Burr demystify the economic theories of
figures like Ricardo, Marx, Malthus, Keynes, Friedman and Hayek — all in a
substantive but approachable way.
As with most treatments of modern economics, the
book starts with Adam Smith. To get a feel for Goodwin’s approach, you can
dive into the first chapter of Economix,
which grapples with Smith’s theories about the free market, division of
labor and the Invisible Hand. Economix can be purchased
online here.
Jensen Comment
I ordered a used copy of this book from Amazon. This book is a most interesting
way to learn the history of economics succinctly.
One surprise is that the book has a relatively good index. Another surprise
is that the book has some small sections on my special interest --- derivative
financial instruments and hedging, although these play a miniscule role in the
comic book.
A few interesting quotations are shown below:
Page 17and Page 19
Enter Jean-Baptiste Colbert (1619-1683), who became
the finance minister of France in 1665. He thought money was wealth, end of
story. ... French thinking on economics change. Maybe wealth wasn't a
stockpile of silver like Colbert thought. Maybe wealth
circulated, like blood circultes throght a body. Laws,
regulations, tariffs, subsidies, and so on would get in the way of that
natural circulation.
Page 61
Marx's logic applied to the
Ricardo model and we don't live in that model. (Neither does
Greece)
Page 22and Page 23
Bakers didn't work because some Bread Planner told
them to, or because they were saints who wanted people to be well fed. They
worked because it was good for them ... So in Smith's economy, competition
kept everyone honest. Every baker --- saint or greedhead alike --- was led,
"as if by an invisible hand," to sell bread at fair price, high enough
to pay for the baker costs and work, low enough that others didn't steal the
customers.
Page 183
Way back in the 1920s, the Austrian economists Ludwig
von Mises (1881-1973) and Freederick Hayek (1899-1992) saw economic planning
become political dictatorship in country after country. They saw that when
people lose their economic liberty, they lose their political liberty. ...
Haye especially was a formidable thinker; instead of assuming the
market worked, which economists had be doing since Ricardo, Hayek looked to
how it worked --- how interaction of small units (people) creates a complex
intelligence (the market), which responds to shortages, changes in
taste, or new technologies far better than any human planner can ("invisible
brain" might be a better term than "invisible hand.") . . . People who
try to replace this brain with their own systems will fail, and in
the process of failing, they'll do a lot of dmagbe.
Page 184
Like Hayek, Friedman stressed that concentrated power
is threat to freedom. But he didn't seem to see that power cn
concentrate in more than one form.
Page 185
(Market failure) refers to how --- even
textbook-perfect markets--- can give bad results. for instance, with
externalities which are essentially side effects of economic transactions.
Bad externalities are everywhere, because the people mking decisions aren't
the ones getting hurt. (in mathematical models these externalities
are sometimes called non-convexities).
Page 240
By the 1980s, the
IMF was full of neoliberals. Strure adjustment came down to adopting
neoliberalism. Structural adjustment was hard to refuse; The World Bank,
private lenders, business, the US Treasury, even aid donors would all steer
cler of a country that the IMF was unsound (say what?)
Still, people hated structural adjustment, and
the IMF knew it. So part of the program was protected democracy in which the
economic program was protected from democracy.
Continued in a nice summary of Economix
Added Comment
If you want to learn more about controversial Keynesian economics you might
start with this book.
Jensen Comment
Of course the paradox in real life decision making, that takes it out of the
real of the Monty Hall solutions and game theory in general, is that in the real
world the probabilities of finding what's behind closed doors are unknown.
What the Monty Hall Paradox teaches us, at least symbolically, is that
sometimes the most obvious common sense solutions to problems are not
necessarily optimal. The geniuses in life discover better solutions that most of
would consider absurd at the time --- such as that time is relative and not
absolute ---
http://en.wikipedia.org/wiki/Theory_of_relativity
Buried in the 2011Denver presentation by Greg Waymire is a lament about two of
my hot buttons. Greg mentions the lack of replication (shall we call them
reproductions?) in findings (harvests) published in academic accounting
research journals. Secondly, he mentions the lack of commentary and debate
concerning these these findings. It seems that there's not a whole lot of
interest (debate) about those findings among practitioners or in our academy ---
http://commons.aaahq.org/hives/629d926370/summary
At long last we are making progress in finally getting the attention of the
American Accounting Association leaders regarding how to broaden research
methods and topics of study (beyond financial reporting) in academic accounting
research. The AAA Executive Committee now has annual retreats devoted to this
most serious hole that accountics researchers have dug (Steve calls it a "dig"
in the message from Jagdish) us into over the past four decades.
Change in academic accounting research will come very slowly. Paul Williams
blames the slowness of change on the accountics scientist-conspired monopoly.
I'm less inclined to blame the problem of conspiracy. I think the biggest
problem is that accountics research in capital markets studies is so much easier
since the data is provided like manna from heaven from CRSP, Compustat,
AuditAnalytics, etc. No added scientific effort to collect data is required by
accountics scientists. At CERN, however, physics scientists had to collect
new data to cast doubt on prevailing speed of light theory.
Two years ago, at a meeting, I encountered one of my former students who
eventually entered a leading accounting PhD program and was completing his
dissertation. When I asked him why he was doing a traditional accountics-science
dissertation he admitted that this was much easier than having to collect his
own data.
Now more to the point concerning the messaging of Jagdish and Steve is my
message earlier this week about the physics of economics in general.
Three years ago I wrote
an Op-Ed for the New York Times on the need for
radical change in the way economists model whole economies. Today's General
Equilibrium models -- and their slightly more sophisticated cousins, Dynamic
Stochastic General Equilibrium models -- make assumptions with no basis in
reality. For example, there is no financial sector in these model economies.
They generally assume that the diversity of behaviour of all an economy's
many firms and consumers can be ignored and simply included as the average
behaviour of a few "representative" agents.
I argued then that it was about time economists started using far more
sophisticated modeling tools, including agent based models, in which the
diversity of interactions among economic agents can be included along with a
financial sector. The idea is to model the simpler behaviours of agents as
well as you can and let the macro-scale complex behaviour of the economy
emerge naturally out of them, without making any restrictive assumptions
about what kinds of things can or cannot happen in the larger economy. This
kind of work is going forward rapidly. For some detail, I recommend
this talk earlier this month by Doyne Farmer.
After that Op-Ed I received quite a number of emails from economists
defending the General Equilibrium approach. Several of them mentioned Milton
Friedman in their defense, saying that he had shown long ago that one
shouldn't worry about the realism of the assumptions in a theory, but only
about the accuracy of its predictions. I eventually found the paper to which
they were referring, a classic in economic history which has exerted a huge
influence over economists over the past half century. I recently re-read the
paper and wanted to make a few comments on Friedman's main argument. It
rests entirely, I think, on a devious or slippery use of words which makes
it possible to give a sensible sounding argument for what is actually a
ridiculous proposition.
The paper is entitled
The Methodology of Positive Economics and was
first published in 1953. It's an interesting paper and enjoyable to read.
Essentially, it seems, Friedman's aim is to argue for scientific standards
for economics akin to those used in physics. He begins by making a clear
definition of what he means by "positive economics," which aims to be free
from any particular ethical position or normative judgments. As he wrote,
positive economics deals with...
"what is," not with "what ought to be." Its task
is to provide a system of generalizations that can be used to make
correct predictions about the consequences of any change in
circumstances. Its performance is to be judged by the precision, scope,
and conformity with experience of the predictions it yields.
Friedman then asks how one should judge the validity
of a hypothesis, and asserts that...
...the only relevant test of the validity of a
hypothesis is comparison of its predictions with experience. The
hypothesis is rejected if its predictions are contradicted ("frequently"
or more often than predictions from an alternative hypothesis); it is
accepted if its predictions are not contradicted; great confidence is
attached to it if it has survived many opportunities for contradiction.
Factual evidence can never "prove" a hypothesis; it can only fail to
disprove it, which is what we generally mean when we say, somewhat
inexactly, that the hypothesis has been "confirmed" by experience."
So far so good. I think most scientists would see the
above as conforming fairly closely to their own conception of how science
should work (and of course this view is closely linked to views made famous
by Karl Popper).
Next step: Friedman goes on to ask how one chooses between several
hypotheses if they are all equally consistent with the available evidence.
Here too his initial observations seem quite sensible:
...there is general agreement that relevant
considerations are suggested by the criteria "simplicity" and
"fruitfulness," themselves notions that defy completely objective
specification. A theory is "simpler" the less the initial knowledge
needed to make a prediction within a given field of phenomena; it is
more "fruitful" the more precise the resulting prediction, the wider the
area within which theory yields predictions, and the more additional
lines for further research it suggests.
Again, right in tune I think with the practice and
views of most scientists. I especially like the final point that part of the
value of a hypothesis also comes from how well it stimulates creative
thinking about further hypotheses and theories. This point is often
overlooked.
Friedman's essay then shifts direction. He argues that the processes and
practices involved in the initial formation of a hypothesis, and in the
testing of that hypothesis, are not as distinct as people often think,
Indeed, this is obviously so. Many scientists form a hypothesis and try to
test it, then adjust the hypothesis slightly in view of the data. There's an
ongoing evolution of the hypothesis in correspondence with the data and the
kinds of experiments of observations which seem interesting.
To this point, Friedman's essay says nothing that wouldn't fit into any
standard discussion of the generally accepted philosophy of science from the
1950s. But this is where it suddenly veers off wildly and attempts to
support a view that is indeed quite radical. Friedman mentions the
difficulty in the social sciences of getting
new evidence with which to test an hypothesis by looking at its
implications. This difficulty, he suggests,
... makes it tempting to suppose that other, more
readily available, evidence is equally relevant to the validity of the
hypothesis-to suppose that hypotheses have not only "implications" but
also "assumptions" and that the conformity of these "assumptions" to
"reality" is a test of the validity of the hypothesis different from or
additional to the test by implications. This widely held view is
fundamentally wrong and productive of much mischief.
Having raised this idea that assumptions are not part
of what should be tested, Friedman then goes on to attack very strongly the
idea that a theory should strive at all to have realistic assumptions.
Indeed, he suggests, a theory is actually superior insofar as its
assumptions are unrealistic:
In so far as a theory can be said to have
"assumptions" at all, and in so far as their "realism" can be judged
independently of the validity of predictions, the relation between the
significance of a theory and the "realism" of its "assumptions" is
almost the opposite of that suggested by the view under criticism. Truly
important and significant hypotheses will be found to have "assumptions"
that are wildly inaccurate descriptive representations of reality, and,
in general, the more significant theory, the more unrealistic the
assumptions... The reason is simple. A hypothesis is important if it
"explains" much by little,... To be important, therefore, a hypothesis
must be descriptively false in its assumptions...
This is the statement that the economists who wrote to
me used to defend unrealistic assumptions in General Equilibrium theories.
Their point was that having unrealistic assumptions isn't just not a
problem, but is a positive strength for a theory. The more unrealistic the
better, as Friedman argued (and apparently proved, in the eyes of some
economists).
Now, what is wrong with Friedman's argument, if anything? I think the key
issue is his use of the provocative terms such as "unrealistic" and "false"
and "inaccurate" in places where he actually means "simplified,"
"approximate" or "incomplete." He switches without warning between these
two different meanings in order to make the conclusion seem unavoidable, and
profound, when in fact it is simply not true, or something we already
believe and hardly profound at all.
To see the problem, take a simple example in physics. Newtonian dynamics
describes the motions of the planets quite accurately (in many cases) even
if the planets are treated as point masses having no extension, no rotation,
no oceans and tides, mountains, trees and so on. The great triumph of
Newtonian dynamics (including his law of gravitational attraction) is it's
simplicity -- it asserts that out of all the many details that could
conceivably influence planetary motion, two (mass and distance) matter most
by far. The atmosphere of the planet doesn't matter much, nor does the
amount of sunlight it reflects. theory of course goes further to
describe how other details do matter if one considers planetary motion in
more detail -- rotation does matter, for example, because it generates tides
which dissipate energy, taking energy slowly away from orbital motion.
But I don't think anyone would be tempted to say that Newtonian dynamics is
a powerful theory because it is descriptively false in its assumptions. It's
assumptions are actually descriptively simple -- that planets and The Sun
have mass, and that a force acts between any two masses in proportion to the
product of their masses and in inverse proportional to the distance between
them. From these assumptions one can work out predictions for details of
planetary motion, and those details turn out to be close to what we see. The
assumptions are simple and plausible, and this is what makes theory so
powerful when it turns out to make powerful and accurate predictions.
Indeed, if those same predictions came out of a theory with obviously false
assumptions -- all planets are perfect cubes, etc. -- it would be less
powerful by far because it would be less believable. It's ability to make
predictions would be as big a mystery as the original phenomenon of
planetary motion itself -- how can a theory that is so obviously not in tune
with reality still make such accurate predictions?
So whenever Friedman says "descriptively false" I think you can instead
write "descriptively simple", and clarify the meaning by adding a phrase of
the sort "which identify the key factors which matter most." Do that
replacement in Friedman's most provocative phrase from above and you have
something far more sensible:
A hypothesis is important if it "explains" much by
little,... To be important, therefore, a hypothesis must be
descriptively simple in its assumptions. It must identify the key
factors which matter most...
That's not quite so bold, however, and it doesn't create a license for
theorists to make any assumptions they want without being criticized if
those assumptions stray very far from reality.
Continued in article
Jensen Comment
Especially note the comments at the end of this article.
My favorite is the following:
Herbert Simon (1963) countered Friedman by stating the
purpose of scientific theories is not to make predictions, but to explain
things - predictions are then tests of whether the explanations are correct.
Both Friedman and Simon's views are better directed
to a field other than economics. The data
at some point will always expose the frailest of assumptions; while the lack
of repeatable results supports futility in the explanation of heterogeneous
agents.
There are certainly financial theories with patently
false assumptions. For example, the Capital Asset Pricing Model:
> all investors are rational
> all investors have perfect information
> all investors can borrow and lend at the risk-free rate
> all investors can buy and short the market in unlimited quantities
We know none of these assumptions are true. How many of us can borrow at the
risk-free rate? Yet they are some of the assumptions that underlie Nobel
Prize winning theories.
As suggested in the blog, these false assumptions are made because they are
ancillary to the main point of theory, which speaks to asset pricing
being a function of risk vs. return, and how these assets together comprise
portfolios.
For these items the above does not matter.
However, if we were to go about modeling the stock or bond market for a
month to assess our own portfolio, the false assumptions would matter
greatly.
Accounting history builds on content of accounting theory articles in the
published leading academic accounting journals such as TAR between the Years
1925 and 1990. After 1990, I think many accounting theory professors shifted
more toward contemporary accounting theory topics. As a result, most previous
accounting theory textbooks became history.
The older style accounting theory courses were often rooted more in philosophy.
For example, you could cherry pick topics from Harry Wolk's 2009 four-volume
set. If course this set is both too extensive and too expensive to serve as a
textbook for a single course.
Harry I. Wolk, the compiler of this collection of
74 previously published articles and other essays, died in October 2009 at
age 79. In 1984, he was assisted by two colleagues in writing a thoughtful,
wide-ranging textbook on accounting theory, which is now in its seventh
edition. He has, thus, been a close student of the accounting theory
literature for many years.
Wolk's valedictory contribution is this anthology,
which is divided into ten sections: philosophical background, accounting
concepts, conceptual frameworks, accounting for changing prices, standard
setting, applications of accounting theory to five measurement areas, agency
theory, principles versus rules, international accounting standards, and
accounting issues in East and Southeast Asia. Because he provides only a
two-and-a-half-page general introduction, we cannot know the criteria he
used to make these selections. The earliest of the articles dates from 1958,
and one infers that this collection represents the body of work that, over
his long career, mostly at Drake University, he found to be influential
writings.
Among the major contributors to theory
literature represented in the collection are Devine, Mattessich, Davidson,
Solomons, Sterling, Thomas, Bell, Shillinglaw, Bedford, Ijiri, and Stamp.
Conspicuous omissions are Chambers, Baxter, Staubus, Moonitz, Sorter, and
Vatter. Although many of the earlier pieces have stood the test of time, a
number of the more recent selections would, inevitably, be open to
second-guessing. To be sure, most of these articles can be accessed
electronically, yet it is instructive to know the works that Harry Wolk
believed were worth remembering, and it is handy to have them all in one
collection.
The price tag of £600/$1,050
for the four-volume set will, unfortunately, deter all but the most
enthusiastic purchasers.
But I do thank Harry for providing me with an accounting illustration that
I turned into the most popular Excel illustration that I ever authored (i.e.,
popular in the eyes of my students over the years) ---
www.cs.trinity.edu/~rjensen/Excel/wtdcase2a.xls
SECTION I: PHILOSOPHICAL BACKGROUND Accounting - A System of Measurement
Rules Devine, Carl Radical Developments in Accounting Thought Chua, Wai Fong
Accounting as a Discipline for Study and Practice Bell, Philip W. Why Can
Accounting Not Become a Science Like Physics? Stamp, Edward Social Reality
and the Measurement of Its Phenomena Mattessich, Richard Toward a Science of
Accounting Sterling, Robert R. Methodological Problems and Preconditions of
a General Theory of Accounting Mattessich, Richard
SECTION II: INFORMALLY DEVELOPED ACCOUNTING CONCEPTS A. Realization and
Recognition The Critical Event and Recognition of Net Profit Myers, John
Recognition Requirements - Income Earned and Realized Devine, Carl The
Realization Concept Davidson, Sidney B. Matching Cash Movements and Periodic
Income Determination Storey, Reed Some Impossibilities - Including
Allocations Devine, Carl The FASB and the Allocation Fallacy Thomas, Arthur
Conservatism Conservatism in Accounting, Part I: Explanation and
Implications Watts, Ross Conservatism in Accounting, Part II: Evidence and
Research Opportunities Watts, Ross The Changing Time-Series Properties
ofEarnings, Cash Flows, and Accruals: Has Financial Accounting Become Mor
Conservative? Givoly, Dan and Carla Hayn D. Disclosure Information
Disclosure Strategy Lev, Baruch Corporate Reporting and the Accounting
Profession: An Interpretive Paradigm Ogan, Pekin and David Ziebart Financial
Reporting in India: Changes in Disclosure over the Period 1982-1990 Marston,
C. L. and P. Robson Corporate Mandatory Disclosure Practices in Bangladesh
M. Akhtaruddin Corporate Governance and Voluntary Disclosure L.L. Eng and
Y.T. Mak Ownership Structure and Voluntary Disclosure in Hong Kong and
Singapore Chau, Gerald and Sidney Gray E. Uniformity Uniformity Versus
Flexibility: A Review of the Rhetoric Keller, Thomas Differences in
Circumstances!: Fact or Fancy Cadenhead, Gary Toward the Harmonization of
Accounting Standards: An Analytical Framework Wolk, Harry and Patrick
Heaston
SECTION III: CONCEPTUAL FRAMEWORKS FASB's Statements on Objectives and
Elements of Financial Accounting: A Review Dopuch, Nicholas and Shyam Sunder
The FASB's Conceptual Framework: An Evaluation Solomons, David The Evolution
of the Conceptual Framework for Business Enterprises in the United States
Zeff, Stephen Criteria for Choosing an Accounting Model Solomons, David
Objectives of Financial Reporting Walker, R.G. Reliability and Objectivity
of Accounting Methods Ijiri, Yuji and Robert Jaedicke
SECTION IV: ACCOUNTING FOR CHANGING PRICES Replacement Cost: Member of
the Family, Welcome Guest, or Intruder? Zeff, Stephen Costs (Historical
versus Current) versus Exit Values Sterling, Robert R. A Defense for
Historical Cost Accounting Ijiri, Yuji The Case for Financial Capital
Maintenance Carsberg, Bryan Income and Value Determination and Changing
Price Levels: An Essay Towards a Theory Stamp, Edward
SECTION V: ACCOUNTING STANDARDS AND FINANCIAL STATEMENTS Get it off the
Balance Sheet! Dieter, Richard and Arthur Wyatt Political Lobbying on
Proposed Standards: A Challenge to the IASB Zeff, Stephen A Review of the
Earnings Management Literature and Its Implications for Standard Setting
Healy, Paul and James Wahlen Relationships among Income Measurements
Bedford, Norton Some Basic Concepts of Accounting and Their Implications
Lorig, Arthur Economic Impact of Accounting Standards - Implications for the
FASB Rappaport, Alfred An Analysis of Factors Affecting the Adoption of
International Accounting Standards by Developing Countries Zeghal, Daniel
and Kerim Mhedhbi The Relevance of IFRS to a Developing Country: Evidence
from Kazakhstan Tyrrall, David, David Woodward and A. Rakhumbekova Political
Influence and Coexistence of a Uniform Accounting System and Accounting
Standards: Recent Developments in China Xiao, Jason, Pauline Weetman and
Manli Sun
SECTION VI: APPLIED ACCOUNTING THEORY A. Income Tax Allocation
Comprehensive Tax Allocation: Let's Stop Taking Some Misconceptions for
Granted Milburn, Alex Acccelerated Depreciation and the Allocation of Income
Taxes Davidson, Sidney Discounting Deferred Tax Liabilities pp. 655-665
Nurnberg, Hugo B. Leases Lease Capitalization and the Transaction Concept
Rappaport, Alfred Leasing and Financial Statements Shillinglaw, Gordon
Accounting for Leases - A New Framework McGregor, Warren C. Pensions and
Other Postretirement Liabilities Alternative Accounting Treatments for
Pensions Schipper, Katherine and Roman Weil A Conceptual Framework Analysis
of Pension and Other Postretirement Benefit Accounting Wolk, Harry and Terri
Vaughan OPEB: Improved Reporting or the Last Straw Thomas, Paula and Larry
Farmer D. Consolidations An Examination of Financial Reporting Alternatives
for Associated Enterprises King, Thomas and Valdean Lembke Valuation for
Financial Reporting: Intangible Assets, Goodwill, and Impairment Analysis
and SFAS 141 and 142 Mard, Michael, James Hitchner, Steven Hyden and Mark
Zyla Proportionate Consolidation and Financial Analysis Bierman, Harold The
Evolution of Consolidated Financial Reporting in Australia Whittred, Greg
Foreign Currency Translation Research: Review and Synthesis Houston, Carol
The Implementation of SFAS Number 52: Did the Functional Currency Approach
Prevail? Kirsch, Robert and Thomas Evans Financial Accounting Developments
in the European Union: Past Events and Future Prospects Haller, Axel E.
Intangibles Accounting for Research and Development Costs Bierman, Harold
and Roland Dukes The Boundaries of Financial Accounting and How to Extend
Them Lev, Baruch and Paul Zarowin The Capitalization, Amortization, and
Value Added Relevance of R & D Lev, Baruch and Theodore Sougiannis
Accounting for Brands in France and Germany Compared With IAS 38 (Intangible
Assets: An Illustration of the Difficulty of International Harmonization)
Stolowy, Herve, Axel Haller and Volker Klockhaus Accounting for Intangible
Assets in Scandinavia, the U.K., and U.S. and the IASB: Challenges and a
Solution Hoeg-Krohn, Niels and Kjell Knivsfla
SECTION VII: POSITIVE ACCOUNTING THEORY The Methodology of Positive
Accounting Christenson, Charles Positive Accounting Theory: A Ten Year
Perspective Watts, Ross and Jerrold Zimmerman Positive Accounting Theory and
the PA Cult Chambers, Raymond Accounting and Policy Choice and Firm
Characteristics in the Asia-Pacific Region: an International Empirical Test
of Costly Contracting Theory Astami, Emita and Greg Tower
SECTION VIII: THE TRUE AND FAIR VIEW AND PRINCIPLES VERSUS RULES-BASED
STANDARDS Principles Versus Rules-Based Accounting Standards: The FASB's
Standard Setting Strategy Benston, George, Michael Bromwich and Alfred
Wagenhofer The True and Fair View in British Accounting Walton, Peter A
European True and Fair View Alexander, David Rules, Principles, and
Judgments in Accounting Standards Bennett, Bruce, Helen Prangell and Michael
Bradbury
SECTION IX: INTERNATIONAL ACCOUNTING AND CONVERGENCE The Introduction of
International Accounting Standards in Europe: Implications for International
Convergence Schipper, Katherine The Adoption of International Accounting
Standards in the European Union pp. 127-153 Whittington, Geoffrey Trends in
Research on International Accounting Harmonization pp. 272-304 Baker, C.
Richard and Elena Barbou The Quest for International Accounting
Harmonization: A Review of the Standard- Setting Agendas of the IASC, US,
UK, Canada and Australia, 1973-1997 Street, Donna and Kimberly Shaughnessy
From National to Global Accounting and Reporting Standards McKee, David, Don
Garner and Yosra AbuAmara McKee A Statistical Model of International
Accounting Harmonization pp. 1-29 Archer, Simon, Pascal, Delvaille and
Stuart McLeay
SECTION X: OTHER NATIONAL AND REGIONAL ACCOUNTING STUDIES The
Institutional Environment of Financial Reporting Regulation in ASEAN
Countries Saudogaran, Sharokh and J. Diga Corporate Financial Reporting and
Regulation in Japan Benston, George, Michael Bromwich, Robert Litan and
Alfred Wagenhofer Accounting Theory in the Political Economy of China Shuie,
Fujing and Joseph Hilmy Ownership Structure and Earnings Informativeness:
Evidence from Korea Jung, Kooyul and Kwon Soo Young Accounting Developments
in Pakistan Ashraf, Junaid and WaQar Ghani Accounting Theory in the
Political Economy of China Shuie, Fujing and Joseph Hilmy Ownership
Structure and Earnings Informativeness: Evidence from Korea Jung, Kooyul and
Kwon Soo Young Corporate Ownership and Governments in Russia Krivogorsky,
Victoria Accounting Developments in Pakistan
Jensen Comment
I have not yet read this book, although it is on order. The table of contents is
certainly very comprehensive. When I get the book I anticipate some major
strenghts (e.g., history) and some major weaknesses such as superficial coverage
of XBRL and financial instruments accounting, particularly derivative financial
instruments and hedging activities.
One problem with this book is bad timing. It has copyright date of 2009, but
most of the modules were written much earlier before major happenings in
accounting standard setting such as new standards and interpretations (domestic
and international) on leases, revenue recognition, consolidations, fair value
accounting, and hedging.
Jensen Comment
Note that this site includes a long listing of research in accounting, finance,
and economics, much of it based on positivism and financial markets.
2012 AAA Meeting Plenary
Speakers and Response Panel Videos ---
http://commons.aaahq.org/hives/20a292d7e9/summary
I think you have to be a an AAA member and log into the AAA Commons to view
these videos.
Bob Jensen is an obscure speaker following the handsome Rob Bloomfield
in the 1.02 Deirdre McCloskey Follow-up Panel—Video ---
http://commons.aaahq.org/posts/a0be33f7fc
What a wonderful speaker Deidre McCloskey! Reminded
me of JR Hicks who also was a stammerer. For an economist, I was amazed by
her deep and remarkable understanding of statistics.
It was nice to hear about Gossett, perhaps the only
human being who got along well with both Karl Pearson and R.A. Fisher,
getting along with the latter itself a Herculean feat.
Gosset was helped in the mathematical derivation of
small sample theory by Karl Pearson, he did not appreciate its importance,
it was left to his nemesis R.A. Fisher. It is remarkable that he could work
with these two giants who couldn't stand each other.
I remember my father (who designed experiments in
horticulture for a living) telling me the virtues of balanced designs at the
same time my professors in school were extolling the virtues of
randomisation.
In Gosset we also find seeds of Bayesian thinking
in his writings.
While I have always had a great regard for Fisher
(visit to the tree he planted at the Indian Statistical Institute in
Calcutta was for me more of a pilgrimage), I think his influence on the
development of statistics was less than ideal.
Regards,
Jagdish
Jagdish S. Gangolly
Department of Informatics College of Computing & Information
State University of New York at Albany
Harriman Campus, Building 7A, Suite 220
Albany, NY 12222 Phone: 518-956-8251, Fax: 518-956-8247
Hi Jagdish,
You're one of the few people who can really appreciate Deidre's scholarship in
history, economics, and statistics. When she stumbled for what seemed like
forever trying to get a word out, it helped afterwards when trying to remember
that word.
Interestingly, two Nobel economists slugged out the very essence of theory some
years back. Herb Simon insisted that the purpose of theory was to explain.
Milton Friedman went off on the F-Twist tangent saying that it was enough if a
theory merely predicted. I lost some (certainly not all) respect for Friedman
over this. Deidre, who knew Milton, claims that deep in his heart, Milton did
not ultimately believe this to the degree that it is attributed to him. Of
course Deidre herself is not a great admirer of Neyman, Savage, or Fisher.
Friedman's essay
"The
Methodology of Positive Economics" (1953) provided
the
epistemological pattern for his own subsequent
research and to a degree that of the Chicago School. There he argued that
economics as science should be free of value judgments for it to be
objective. Moreover, a useful economic theory should be judged not by its
descriptive realism but by its simplicity and fruitfulness as an engine of
prediction. That is, students should measure the accuracy of its
predictions, rather than the 'soundness of its assumptions'. His argument
was part of an ongoing debate among such statisticians as
Jerzy Neyman,
Leonard Savage, and
Ronald Fisher.
It is widely held that better financial reporting
makes investors more confident in their predictions of future cash flows
and reduces their required risk premia. The logic is that more
information leads necessarily to more certainty, and hence lower
subjective estimates of firm "beta" or covariance with other firms. This
is misleading on both counts. Bayesian
logic shows that the best available information can often leave decision
makers less certain about future events.
And for those cases where information indeed brings great certainty,
conventional mean-variance asset pricing models imply that more certain
estimates of future cash payoffs can sometimes bring a higher cost of
capital. This occurs when new or better information leads to
sufficiently reduced expected firm payoffs. To properly understand the
effect of signal quality on the cost of capital, it is essential to
think of what that information says, rather than considering merely its
"precision", or how strongly it says what it says.
In particular,
a dominant trend in critical theory was the rejection of the concept of
objectivity as something that rests on a more or less naive
epistemology: a simple belief that “facts” exist in some pristine state
untouched by “theory.” To avoid being naive, the dutiful student learned
to insist that, after all, all facts come to us embedded in various
assumptions about the world. Hence (ta da!) “objectivity” exists only
within an agreed-upon framework. It is relative to that framework. So it
isn’t really objective....
What Mohanty
found in his readings of the philosophy of science were much less naïve,
and more robust, conceptions of objectivity than the straw men being
thrashed by young Foucauldians at the time. We are not all prisoners of
our paradigms. Some theoretical frameworks permit the discovery of new
facts and the testing of interpretations or hypotheses. Others do not.
In short, objectivity is a possibility and a goal — not just in the
natural sciences, but for social inquiry and humanistic research as
well.
Mohanty’s major
theoretical statement on PPR arrived in 1997 with Literary Theory and
the Claims of History: Postmodernism, Objectivity, Multicultural
Politics (Cornell University Press). Because poststructurally
inspired notions of cultural relativism are usually understood to be
left wing in intention, there is often a tendency to assume that
hard-edged notions of objectivity must have conservative implications.
But Mohanty’s work went very much against the current.
“Since the
lowest common principle of evaluation is all that I can invoke,” wrote
Mohanty, complaining about certain strains of multicultural relativism,
“I cannot — and consequently need not — think about how your space
impinges on mine or how my history is defined together with yours. If
that is the case, I may have started by declaring a pious political
wish, but I end up denying that I need to take you seriously.”
PPR did
not require throwing out the multicultural baby with the relativist
bathwater, however. It meant developing ways to think about cultural
identity and its discontents. A number of Mohanty’s students and
scholarly colleagues have pursued the implications of postpositive
identity politics.
I’ve written elsewhere
about Moya, an associate professor of English at Stanford University who
has played an important role in developing PPR ideas about identity. And
one academic critic has written
an interesting review essay
on early postpositive scholarship — highly recommended for anyone with a
hankering for more cultural theory right about now.
Not everybody
with a sophisticated epistemological critique manages to turn it into a
functioning think tank — which is what started to happen when people in
the postpositive circle started organizing the first Future of Minority
Studies meetings at Cornell and Stanford in 2000. Others followed at the
University of Michigan and at the University of Wisconsin in Madison.
Two years ago FMS applied for a grant from Mellon Foundation, receiving
$350,000 to create a series of programs for graduate students and junior
faculty from minority backgrounds.
The FMS Summer
Institute, first held in 2005, is a two-week seminar with about a dozen
participants — most of them ABD or just starting their first
tenure-track jobs. The institute is followed by a much larger colloquium
(the part I got to attend last week). As schools of thought in the
humanities go, the postpositivists are remarkably light on the in-group
jargon. Someone emerging from the Institute does not, it seems, need a
translator to be understood by the uninitated. Nor was there a dominant
theme at the various panels I heard.
Rather, the
distinctive quality of FMS discourse seems to derive from a certain very
clear, but largely unstated, assumption: It can be useful for scholars
concerned with issues particular to one group to listen to the research
being done on problems pertaining to other groups.
That sounds
pretty simple. But there is rather more behind it than the belief that
we should all just try to get along. Diversity (of background, of
experience, of disciplinary formation) is not something that exists
alongside or in addition to whatever happens in the “real world.” It is
an inescapable and enabling condition of life in a more or less
democratic society. And anyone who wants it to become more democratic,
rather than less, has an interest in learning to understand both its
inequities and how other people are affected by them.
A case in point
might be the findings discussed by Claude Steele, a professor of
psychology at Stanford, in a panel on Friday. His paper reviewed some of
the research on “identity contingencies,” meaning “things you have to
deal with because of your social identity.” One such contingency is what
he called “stereotype threat” — a situation in which an individual
becomes aware of the risk that what you are doing will confirm some
established negative quality associated with your group. And in keeping
with the threat, there is a tendency to become vigilant and defensive.
Steele did not
just have a string of concepts to put up on PowerPoint. He had research
findings on how stereotype threat can affect education. The most
striking involved results from a puzzle-solving test given to groups of
white and black students. When the test was described as a game, the
scores for the black students were excellent — conspicuously higher, in
fact, than the scores of white students. But in experiments where the
very same puzzle was described as an intelligence test, the results were
reversed. The black kids scores dropped by about half, while the graph
for their white peers spiked.
The only
variable? How the puzzle was framed — with distracting thoughts about
African-American performance on IQ tests creating “stereotype threat” in
a way that game-playing did not.
Steele also
cited an experiment in which white engineering students were given a
mathematics test. Just beforehand, some groups were told that Asian
students usually did really well on this particular test. Others were
simply handed the test without comment. Students who heard about their
Asian competitors tended to get much lower scores than the control
group.
Extrapolate
from the social psychologist’s experiments with the effect of a few
innocent-sounding remarks — and imagine the cumulative effect of more
overt forms of domination. The picture is one of a culture that is
profoundly wasteful, even destructive, of the best abilities of many of
its members.
“It’s not easy
for minority folks to discuss these things,” Satya Mohanty told me on
the final day of the colloquium. “But I don’t think we can afford to
wait until it becomes comfortable to start thinking about them. Our
future depends on it. By ‘our’ I mean everyone’s future. How we enrich
and deepen our democratic society and institutions depends on the
answers we come up with now.”
Earlier this year, Oxford
University Press published a major new work on postpositivist theory,
Visible Identities: Race, Gender, and the Self,by Linda Martin
Alcoff, a professor of philosophy at Syracuse University. Several essays
from the book are available at
the author’s
Web site.
Special Notice:
Accounting Scholarship that Advances Professional Knowledge and Practice
Robert S. Kaplan The Accounting Review, March 2011, Volume 86, Issue 2,
Although all three
speakers provided inspirational presentations, Steve Zeff and I both
concluded that Bob Kaplan’s presentation was possibly the best that we had
ever viewed among all past AAA plenary sessions. And we’ve seen a lot of
plenary sessions in our long professional careers.
Now that Kaplan’s video is
available I cannot overstress the importance that accounting educators and
researchers watch the video of Bob Kaplan's August 4, 2010 plenary
presentation
http://commons.aaahq.org/hives/531d5280c3/posts?postTypeName=session+video
Don’t miss the history map of Africa analogy to academic accounting
research!!!!!
PS
I think Bob Kaplan overstates the value of the academic valuation models in
leading accounting research journals, at least he overvalues their
importance to our practicing profession.
September 9, 2011 reply from Paul Williams
Bob,
I have avoided chiming in on this thread; have gone down this same road and
it is a cul-de-sac. But I want to say that this line of argument is a
clever one. The answer to your rhetorical question is, No, they aren't
more ethical than other "scientists." As you tout the Kaplan
speech I would add the caution that before he raised the issue of practice,
he still had to praise the accomplishments of "accountics" research by
claiming numerous times that this research has led us to greater
understanding about analysts, markets, info. content, contracting, etc.
However, none of that is actually true. As a panelist at the AAA
meeting I juxtaposed Kaplan's praise for what accountics research has taught
us with Paul Krugman's observations about Larry Summer's 1999 observation
that GAAP is what makes US capital markets so stable and efficient. Of
course, as Krugman noted, none of that turned out to be true. And if
that isn't true, then Kaplan's assessment of accountics research isn't
credible, either. If we actually did understand what he claimed we now
understand much better than we did before, the financial crisis of 2008
(still ongoing) would not have happened. The title of my talk was (the
panel was organized by Cheryl McWatters) "The Epistemology of
Ignorance." An obsessive preoccupation with method could be a choice not to
understand certain things-- a choice to rigorously understand things as you
already think they are or want so desperately to continue to believe for
reasons other than scientific ones.
Jensen Comment
Here are some added positives and negatives to consider, especially if you are
currently a practicing accountant considering becoming a professor.
The quick and dirty answer to your question Marc is that the present
dominance of accountics scientists behind a wall of silence on our Commons is
just not sustainable. They cannot continue to monopolize AACSB accounting
doctoral programs by limiting supply so drastically in the face of rising demand
for accounting faculty ---
http://faculty.trinity.edu/rjensen/Theory01.htm#DoctoralPrograms
They cannot continue to monopolize the selection of editors of their favored
journals (especially TAR and AH) in the face of increasing democracy in the AAA.
The Emperor cannot continue to parade without any clothes in the presence of
increasing criticism from AAA Presidents, including criticisms raised by
President Waymire (
who's an accountics
scientist ) in the 2011 Annual Meetings ---
Watch the Video:
http://commons.aaahq.org/posts/b60c7234c6
What we cannot do is expect change to happen overnight. For the past four
decades our doctoral programs have cranked out virtually nothing but accountics
scientists. Something similar happened in the Pentagon in the 1920s when West
Point and Naval Academy graduates dominated the higher command until the 1940s.
We began to see the value of air power, but it took decades to split the Air
Force out from under the Army and to create an Air Force Academy. More
importantly Pentagon budgets began to shift more and more to air power in both
the Air Force and the Naval Air Force.
It's been a long and frustrating fight in the AAA dating back to Bob Anthony
when it was beginning to dawn on genuine accountants that we had created an
accountics scientist monster.
I don't know if you were present when Bob Anthony gave his 1989 Outstanding
Educator Award Address to the American Accounting Association. It was one of the
harshest indictments I've ever heard concerning the sad state of academic
research in serving the accounting profession. Bob never held back on his
punches.
We built the most formidable military in the world by adapting to changes and
innovations. Eventually the Luddite accountics scientists will own up to the
fact they never did become real scientists and that their research methods and
models are just too limited and out of date. His colleague at Harvard, Bob
Kaplan, now carries on the laments of Bob Anthony.
Now that Kaplan’s video is available I cannot overstress the importance that
accounting educators and researchers watch the video of Bob Kaplan's August 4,
2010 plenary presentation
http://commons.aaahq.org/hives/531d5280c3/posts?postTypeName=session+video
Don’t miss the history map of Africa analogy to academic accounting
research!!!!!
The accountics scientist monopoly of our doctoral programs is just not a
sustainable model. But don't expect miracles overnight. For 40 years our
accounting doctoral graduates have never learned any research methods other than
those analytical and inference models favored by accountics scientists.
Respectfully,
Bob Jensen
On September 13, 2010 The Wall Street Journal issued
rankings of the “25 Best” college accounting education programs.
In May 2010 Bloomberg/Business Week issued its
rankings of the “111 Best” college accounting education programs.
In an IAE paper, Wood et al. issues its rankings of
the best college accounting research programs. Issues in Accounting Education, November 2010, Volume 25, Issue 4,
pp. 613-xv
Also see
http://www.byuaccounting.net/rankings/univrank/rankings.php
Although I will not dwell on details here,
practitioners are generally interested in clever discoveries of how to make
computer software, XBRL, Google Wave, cloud computing, computer gadgets, cloud computing, pattern recognition,
data visualization, and many other technology innovations relative to the
practice of accountancy. For example, I've attempted (thus far unsuccessfully)
to discover useful ways of visualizing multi-dimensional accounting variables
(including Chernoff faces) ---
http://faculty.trinity.edu/rjensen/352wpvisual/000datavisualization.htm
Alas, I'm a failure, along with most academic accounting researchers, as an applied researcher thus far in life. My leading journal publications, like
other leading accounting research publications, have mostly been irrelevant "accountics" contributions ---
http://faculty.trinity.edu/rjensen/resume.htm#Published
Not everything that can be counted, counts. And not
everything that counts can be counted. Albert Einstein
For a long time, elite accounting
researchers could find no “empirical evidence” of widespread earnings
management. All they had to do was look up from the computers where their heads
were buried. Bob Jensen ---
http://faculty.trinity.edu/rjensen/395wpTAR/Web/TAR395wp.htm
“Research should be problem driven rather than
methodologically driven," said Lisa Garcia Bedolla, a member of the task force
who teaches at the University of California at Berkeley. Scott Jascik ---
http://www.insidehighered.com/news/2009/09/04/polisci
"I understand your point, Jim." He could not identify one issue that (accountics)
researchers had been able to "put to bed" after
all that effort. P. Kothari, one of the Editors of JAE and a full professor at MIT,
as quoted by Jim Peters below.
Do we forecast? You bet. Do we have
confidence in our forecasts? Never! Confidence about a non-linear chaotic system
can only come in degrees, and even those degrees of confidence are guesses. Not
all hope is lost. There are times when it seems our ability to predict is better
than others. Thus we need to take advantage of it if we see it. Trading ranges,
pivot points, support and resistance, and the like can help, and do help the
trader. Michael Covel, Trading Black Swans,
September 2009 ---
http://www.michaelcovel.com/pdfs/swan.pdf
The second is the comment that Joan Robinson made
about American Keynsians: that their theories were so flimsy that they had to
put math into them. In accounting academia, the shortest path to respectability
seems to be to use math (and statistics), whether meaningful or not. Professor Jagdish Gangolly, SUNY
Albany
American Economist and Nobel Prize Winning Paul Samuelson died on December
13, 2009 ---
http://en.wikipedia.org/wiki/Paul_Samuelson Among many other things, his textbook was perhaps the all-time best selling
economics textbook. Students in my generation were weaned on Samuelson who, in
my viewpoint, was a fence sitter, albeit a scholarly fence sitter, with respect
to economic theory. He was a mathematician with hundreds of scholarly papers in
his craft.
Stanislaw Ulam once challenged Samuelson to name
one theory in all of the social sciences which is both true and nontrivial.
Several years later, Samuelson responded with
David Ricardo's theory of
comparative advantage: That it is logically true
need not be argued before a mathematician; that is not trivial is attested
by the thousands of important and intelligent men who have never been able
to grasp the doctrine for themselves or to believe it after it was explained
to them.
Probably be an accountant. I like to
figure out stuff. In accounting, if you miss one number you get the whole thing
wrong. You have to be perfect --- I'm a perfectionist. Giovani Soto (catcher for the Chicago
Cubs when asked what he'd like to be if he wasn't in professional baseball), as
quoted in an interview with Mary Burns in Sports Illustrated, June
2008
Jensen Comment
If Soto only knew that accountants are second only to economists in terms of
inaccuracies. When accountants total up the numbers on a balance sheet the total
is always accurate, but the numbers being added up can be off by 1000% or more.
Accuracy varies of course. Cash counts are highly accurate. Fixed assets, net of
depreciation, are make-pretend within limits. Intangible asset valuations are
about as accurate as ground eyesight measurements of floating cloud dimensions
on a windy day. Accountants make highly inaccurate estimates of assets,
liabilities, and equities. Then accountants change hats and chairs and add these
estimates up very accurately and pretend that the total must mean something ---
but accountants aren't sure what.
If
Soto wants accuracy perhaps he should become a baseball statistician collecting
up subjective estimates of the umpires. In the business world, accountants are
the statisticians and the umpires. Therein lies the problem. An umpire decides
what's a ball/strike, hit/foul, etc. and then leaves it up to baseball
statisticians to book the numbers. In the world of business, accountants decide
what are current versus deferred revenues, current versus capitalized costs, and
additionally make highly subjective estimates about values of such things as
forward contracts and interest rate swaps. After making their inaccurate
estimates they then put on another hat, change chairs, and record their own
estimates to the nearest penny. They're the business world's umpires and
statisticians who simply change hats and chairs and wait for the investors to
file lawsuits against them.
Warning 1: Many of the links were broken when
the FASB changed all of its links. If a link to a FASB site does not work
, Go to the new FASB link and search for the document. The FASB home page
is at http://www.fasb.org/
Warning 2: The document below has not been updated for the
FASB's Codification Database. Although the database is off to a great (albeit
dumb, dumb, dumb) start, there is
much information in this document and in prior FASB hard copy standards and in the FASB standards that cannot be found
in the Codification Database. You can read the following at
http://asc.fasb.org/asccontent&trid=2273304&nav_type=left_nav
Welcome to the Financial Accounting Standards Board
(FASB) Accounting Standards Codification™ (Codification).
The Codification is the result of a major four-year
project involving over 200 people from multiple entities. The Codification
structure is significantly different from the structure of existing
accounting standards. The Notice to Constituents provides information you
should read to obtain a good understanding of the Codification history,
content, structure, and future consequences.
which
introduces the ASC. This video has potential value at the beginning of the
semester to acquaint students with the ASC. I am thinking about posting the
clip to AAA commons. But, where should it be posted and does this type of
thing get posted in multiple interest group areas?
Any thoughts /
suggestions?
Zane Swanson www.askaref.com
a handheld device source of ASC information
Jensen Comment
A disappointment for colleges and students is that access to the Codification
database is not free. The FASB does offer deeply discounted prices to colleges
but not to individual teachers or students.
This is a great video helper for learning how
to use the FASB.s Codification database.
An enormous disappointment to me is how the
Codification omits many, many illustrations in the
pre-codification pronouncements that are still available
electronically as PDF files. In particular, the best way to
learn a very complicated standard like FAS 133 is to study the
illustrations in the original FAS 133, FAS 138, etc.
The FASB paid a fortune for experts to develop the
illustrations in the pre-codification pronouncements. It's sad that
those investments are wasted in the Codification database.
A nice timeline on the development
of U.S. standards and the evolution of thinking about the income statement
versus the balance sheet is provided at:
"The Evolution of U.S. GAAP: The Political Forces Behind Professional
Standards (1930-1973)," by Stephen A. Zeff, CPA Journal, January
2005 ---
http://www.nysscpa.org/cpajournal/2005/105/infocus/p18.htm
Part II covering years
1974-2003 published in February 2005 ---
http://archives.cpajournal.com/
I think leading academic
researchers avoid applied research for the profession because making
seminal and creative discoveries that practitioners have not already
discovered is enormously difficult.
Accounting academe is
threatened by the twin dangers of fossilization and scholasticism
(of three types: tedium, high tech, and radical chic)
From
http://faculty.trinity.edu/rjensen/395wpTAR/Web/TAR395wp.htm
“Knowledge and competence
increasingly developed out of the internal dynamics of esoteric
disciplines rather than within the context of shared perceptions
of public needs,” writes Bender. “This is not to say that
professionalized disciplines or the modern service professions
that imitated them became socially irresponsible. But their
contributions to society began to flow from their own
self-definitions rather than from a reciprocal engagement with
general public discourse.”
Now, there is a definite note of sadness in Bender’s narrative –
as there always tends to be in accounts
of theshift from Gemeinschaft
to Gesellschaft.Yet it
is also clear that the transformation from civic to disciplinary
professionalism was necessary.
“The new disciplines offered relatively precise subject matter
and procedures,” Bender concedes, “at a time when both were
greatly confused. The new professionalism also promised
guarantees of competence — certification — in an era when
criteria of intellectual authority were vague and professional
performance was unreliable.”
But in the epilogue to Intellect and Public Life,
Bender suggests that the process eventually went too far. “The
risk now is precisely the opposite,” he writes. “Academe is
threatened by the twin dangers of fossilization and
scholasticism (of three types: tedium, high tech, and radical
chic).
The agenda for the next decade, at least as I see it, ought to
be the opening up of the disciplines, the ventilating of
professional communities that have come to share too much and
that have become too self-referential.”
Accountics is the mathematical science of values.
Charles Sprague [1887] as quoted by McMillan [1998, p. 1][NH1]
Bob Jensen's threads on GAAP comparisons (with
particular stress upon derivative financial
instruments accounting rules) are at
http://faculty.trinity.edu/rjensen/caseans/canada.htm
The above site also links to more general GAAP comparison guides between
nations.
It is widely held that better financial reporting
makes investors more confident in their predictions of future cash flows
and reduces their required risk premia. The logic is that more
information leads necessarily to more certainty, and hence lower
subjective estimates of firm "beta" or covariance with other firms. This
is misleading on both counts. Bayesian
logic shows that the best available information can often leave decision
makers less certain about future events.
And for those cases where information indeed brings great certainty,
conventional mean-variance asset pricing models imply that more certain
estimates of future cash payoffs can sometimes bring a higher cost of
capital. This occurs when new or better information leads to
sufficiently reduced expected firm payoffs. To properly understand the
effect of signal quality on the cost of capital, it is essential to
think of what that information says, rather than considering merely its
"precision", or how strongly it says what it says.
August 3, 2014 reply from David Johnstone
The idea is that we never know “true probabilities”, even if they “exist”,
we only have subjective beliefs. These beliefs are the basis on which
actions are chosen (i.e. by maximizing subjective expected utility, if we go
to this next step). Observed frequencies feed into our beliefs, and
sometimes they are the major influence. Similarly, subjective “symmetry”
arguments (we think we see symmetry in a coin) might be a major influence in
saying that “the probability of heads” is 0.5. But a coin does not have a
probability, at least not in the sense that it has weight, metal content,
and other physical attributes.
Big names Bayesian authors with this general philosophy are Kadane (ex
editor of J American Stat Assoc), Lindley, Savage, de Finnetti, Lad, O’Hagen,
Bernardo, and others. The only rule in this world is that your beliefs must
be “coherent” in the sense that they are mutually consistent in terms of the
laws of probability. New evidence must therefore be used via Bayes theorem
to get new probabilities.
One of the more surprising things I
have learned from my experience as Senior Editor of
The Accounting Review
is just how often a
‘‘hot
topic’’
generates multiple
submissions that pursue similar research objectives. Though one might view
such situations as enhancing the credibility of research findings through
the independent efforts of multiple research teams, they often result in
unfavorable reactions from reviewers who question the incremental
contribution of a subsequent study that does not materially advance the
findings already documented in a previous study, even if the two (or more)
efforts were initiated independently and pursued more or less concurrently.
I understand the reason for a high incremental contribution standard in a
top-tier journal that faces capacity constraints and deals with about 500
new submissions per year. Nevertheless, I must admit that I sometimes feel
bad writing a rejection letter on a good study, just because some other
research team beat the authors to press with similar conclusions documented
a few months earlier. Research, it seems, operates in a highly competitive
arena.
Fortunately, from time to time, we
receive related but still distinct submissions that, in combination, capture
synergies (and reviewer support) by viewing a broad research question from
different perspectives. The two articles comprising this issue’s forum are a
classic case in point. Though both studies reach the same basic conclusion
that material weaknesses in internal controls over financial reporting
result in negative repercussions for the cost of debt financing, Dhaliwal et
al. (2011) do so by examining the public market for corporate debt
instruments, whereas Kim et al. (2011) examine private debt contracting with
financial institutions. These different perspectives enable the two research
teams to pursue different secondary analyses, such as Dhaliwal et al.’s
examination of the sensitivity of the reported findings to bank monitoring
and Kim et al.’s examination of debt covenants.
Both studies also overlap with yet a
third recent effort in this arena, recently published in the
Journal of Accounting
Research by Costello and
Wittenberg-Moerman (2011). Although the overall
‘‘punch
line’’
is similar in all three studies (material
internal control weaknesses result in a higher cost of debt), I am intrigued
by a ‘‘mini-debate’’
of sorts on the different conclusions
reache by Costello and Wittenberg-Moerman (2011) and by Kim et al.
(2011) for the effect of material weaknesses on debt covenants.
Specifically, Costello and Wittenberg-Moerman (2011, 116) find that
‘‘serious,
fraud-related weaknesses result in a significant decrease in financial
covenants,’’
presumably because banks substitute more
direct protections in such instances, whereas Kim et al.
Published Online: July 2011
(2011) assert from their cross-sectional
design that company-level material weaknesses are associated with
more
financial covenants in
debt contracting.
In reconciling these conflicting
findings, Costello and Wittenberg-Moerman (2011, 116) attribute the Kim et
al. (2011) result to underlying
‘‘differences
in more fundamental firm characteristics, such as riskiness and information
opacity,’’
given that, cross-sectionally, material
weakness firms have a greater number of financial covenants than do
non-material weakness firms even
before the disclosure of the material
weakness in internal controls. Kim et al. (2011) counter that they control
for risk and opacity characteristics, and that advance leakage of internal
control problems could still result in a debt covenant effect due to
internal controls rather than underlying firm characteristics. Kim et al.
(2011) also report from a supplemental change analysis that, comparing the
pre- and post-SOX 404 periods, the number of debt covenants falls for
companies both with and without
material
weaknesses in internal controls, raising the question of whether the
Costello and Wittenberg-Moerman (2011)
finding reflects a reaction to the disclosures or simply a more general
trend of a declining number of debt covenants affecting all firms around
that time period. I urge readers to take a look at both articles, along with
Dhaliwal et al. (2011), and draw their own conclusions. Indeed, I believe
that these sorts . . .
Continued in article
Jensen Comment
Without admitting to it, I think Steve has been embarrassed, along with many
other accountics researchers, about the virtual absence of validation and
replication of accounting science (accountics) research studies over the past
five decades. For the most part, accountics articles are either ignored or
accepted as truth without validation. Behavioral and capital markets empirical
studies are rarely (ever?) replicated. Analytical studies make tremendous leaps
of faith in terms of underlying assumptions that are rarely challenged (such as
the assumption of equations depicting utility functions of corporations).
Accounting science thereby has become a pseudo
science where highly paid accountics professor referees are protecting each
others' butts ---
"574 Shields Against Validity Challenges in Plato's Cave" ---
http://faculty.trinity.edu/rjensen/TheoryTAR.htm
The above link contains Steve's rejoinders on the replication debate.
In the above editorial he's telling us that there is a middle ground for
validation of accountics studies. When researchers independently come to similar
conclusions using different data sets and different quantitative analyses they
are in a sense validating each others' work without truly replicating each
others' work.
I agree with Steve on this, but I would also argue that these types of
"validation" is too little to late relative to genuine science where replication
and true validation are essential to the very definition of science. The types
independent but related research that Steve is discussing above is too
infrequent and haphazard to fall into the realm of validation and replication.
When's the last time you witnesses a TAR author criticizing the research of
another TAR author (TAR does not publish critical commentaries)?
Are TAR articles really all that above criticism? Even though I admire Steve's scholarship, dedication,
and sacrifice, I hope future TAR editors will work harder at turning accountics
research into real science!
A few weeks ago, TechCrunch published a piece
arguing software is better at investing than 99% of human investment
advisors. That post, titled
Thankfully, Software Is Eating The Personal Investing World,
pointed out the advantages of engineering-driven
software solutions versus emotionally driven human judgment. Perhaps not
surprisingly, some commenters (including some financial advisors) seized the
moment to call into question one of the foundations of software-based
investing, Modern Portfolio Theory.
Given the doubts raised by a small but vocal
chorus, it’s worth spending some time to ask if we need a new investing
paradigm and if so, what it should be. Answering that question helps show
why MPT still is the best investment methodology out there; it enables the
automated, low-cost investment management offered by a new wave of Internet
startups including
Wealthfront
(which I advise),
Personal Capital,
Future Advisor
and SigFig.
The basic questions being raised about MPT run
something like this:
Hasn’t recent experience – i.e., the financial
crisis — shown that diversification doesn’t work?
Shouldn’t we primarily worry about “Black
Swan” events and unforeseen risk?
Don’t these unknown unknowns mean we must
develop a new approach to investing?
Let’s begin by briefly laying out the key insights
of MPT.
MPT is based in part on the assumption that most
investors don’t like risk and need to be compensated for bearing it. That
compensation comes in the form of higher average returns. Historical data
strongly supports this assumption. For example, from 1926 to 2011 the
average (geometric) return on U.S. Treasury Bills was 3.6%. Over the same
period the average return on large company stocks was 9.8%; that on small
company stocks was 11.2% ( See 2012 Ibbotson Stocks, Bonds, Bills and
Inflation (SBBI) Valuation Yearbook, Morningstar, Inc., page 23. ). Stocks,
of course, are much riskier than Treasuries, so we expect them to have
higher average returns — and they do.
One of MPT’s key insights is that while investors
need to be compensated to bear risk, not all risks are rewarded. The market
does not reward risks that can be “diversified away” by holding a bundle of
investments, instead of a single investment. By recognizing that not all
risks are rewarded, MPT helped establish the idea that a diversified
portfolio can help investors earn a higher return for the same amount of
risk.
To understand which risks can be diversified away,
and why, consider Zynga. Zynga hit $14.69 in March and has since dropped to
less than $2 per share. Based on what’s happened over the past few months,
the major risks associated with Zynga’s stock are things such as delays in
new game development, the fickle taste of consumers and changes on Facebook
that affect users’ engagement with Zynga’s games.
For company insiders, who have much of their wealth
tied up in the company, Zynga is clearly a risky investment. Although those
insiders are exposed to huge risks, they aren’t the investors who determine
the “risk premium” for Zynga. (A stock’s risk premium is the extra return
the stock is expected to earn that compensates for the stock’s risk.)
Rather, institutional funds and other large
investors establish the risk premium by deciding what price they’re willing
to pay to hold Zynga in their diversified portfolios. If a Zynga game is
delayed, and Zynga’s stock price drops, that decline has a miniscule effect
on a diversified shareholder’s portfolio returns. Because of this, the
market does not price in that particular risk. Even the overall turbulence
in many Internet stocks won’t be problematic for investors who are well
diversified in their portfolios.
Modern Portfolio Theory focuses on constructing
portfolios that avoid exposing the investor to those kinds of unrewarded
risks. The main lesson is that investors should choose portfolios that lie
on the Efficient Frontier, the mathematically defined curve that describes
the relationship between risk and reward. To be on the frontier, a portfolio
must provide the highest expected return (largest reward) among all
portfolios having the same level of risk. The Internet startups construct
well-diversified portfolios designed to be efficient with the right
combination of risk and return for their clients.
Now let’s ask if anything in the past five years
casts doubt on these basic tenets of Modern Portfolio Theory. The answer is
clearly, “No.” First and foremost, nothing has changed the fact that there
are many unrewarded risks, and that investors should avoid these risks. The
major risks of Zynga stock remain diversifiable risks, and unless you’re
willing to trade illegally on inside information about, say, upcoming
changes to Facebook’s gaming policies, you should avoid holding a
concentrated position in Zynga.
The efficient frontier is still the desirable place
to be, and it makes no sense to follow a policy that puts you in a position
well below that frontier.
Most of the people who say that “diversification
failed” in the financial crisis have in mind not the diversification gains
associated with avoiding concentrated investments in companies like Zynga,
but the diversification gains that come from investing across many different
asset classes, such as domestic stocks, foreign stocks, real estate and
bonds. Those critics aren’t challenging the idea of diversification in
general – probably because such an effort would be nonsensical.
True, diversification across asset classes didn’t
shelter investors from 2008’s turmoil. In that year, the S&P 500 index fell
37%, the MSCI EAFE index (the index of developed markets outside North
America) fell by 43%, the MSCI Emerging Market index fell by 53%, the Dow
Jones Commodities Index fell by 35%, and the Lehman High Yield Bond Index
fell by 26%. The historical record shows that in times of economic distress,
asset class returns tend to move in the same direction and be more highly
correlated. These increased correlations are no doubt due to the increased
importance of macro factors driving corporate cash flows. The increased
correlations limit, but do not eliminate, diversification’s value. It would
be foolish to conclude from this that you should be undiversified. If a seat
belt doesn’t provide perfect protection, it still makes sense to wear one.
Statistics show it’s better to wear a seatbelt than to not wear one.
Similarly, statistics show diversification reduces risk, and that you are
better off diversifying than not.
Timing the market
The obvious question to ask anyone who insists
diversification across asset classes is not effective is: What is the
alternative? Some say “Time the market.” Make sure you hold an asset class
when it is earning good returns, but sell as soon as things are about to go
south. Even better, take short positions when the outlook is negative. With
a trustworthy crystal ball, this is a winning strategy. The potential gains
are huge. If you had perfect foresight and could time the S&P 500
on a daily basis, you could have turned $1,000 on Jan. 1, 2000, into
$120,975,000 on Dec. 31, 2009, just by going in and out of the market. If
you could also short the market when appropriate, the gains would have been
even more spectacular!
Sometimes, it seems someone may have a fairly
reliable crystal ball. Consider John Paulson, who in 2007 and 2008 seemed so
prescient in profiting from the subprime market’s collapse. It appears,
however, that Mr. Paulson’s crystal ball became less reliable after his
stunning success in 2007. His Advantage Plus fund experienced more than a
50% loss in 2011. Separating luck from skill is often difficult.
Some people try to come up with a way to time the
market based on historical data. In fact a large number of strategies will
work well “in the back test.” The question is whether any system is reliable
enough to use for future investing.
There are at least three reasons to be cautious
about substituting a timing system for diversification.
First, a timing system that does not work can
impose significant transaction costs (including avoidable adverse tax
consequences) on the investor for no gain.
Second, an ill-founded timing strategy
generally exposes the investor to risk that is unrewarded. In other
words, it puts the investor below the frontier, which is not a good
place to be.
Third, a timing system’s success may create
the seeds of its own destruction. If too many investors blindly follow
the strategy, prices will be driven to erase any putative gains that
might have been there, turning the strategy into a losing proposition.
Also, a timing strategy designed to “beat the market” must involve
trading into “good” positions and away from “bad” ones. That means there
must be a sucker (or several suckers) available to take on the other
(losing) sides. (No doubt in most cases each party to the trade thinks
the sucker is on the other side.)
Black Swans
What about those Black Swans? Doesn’t MPT ignore
the possibility that we can be surprised by the unexpected? Isn’t it
impossible to measure risk when there are unknown unknowns?
Most people recognize that financial markets are
not like simple games of chance where risk can be quantified precisely. As
we’ve seen (e.g., the “Black Monday” stock market crash of 1987 and the
“flash crash” of 2010), the markets can produce extreme events that hardly
anyone contemplated as a possibility. As opposed to poker, where we always
draw from the same 52-card deck, in financial markets, asset returns are
drawn from changing distributions as the world economy and financial
relationships change.
Some Black Swan events turned out to have limited
effects on investors over the long term. Although the market dropped
precipitously in October 1987, it was close to fully recovered in June 1988.
The flash crash was confined to a single day.
This is not to say that all “surprise” events are transitory. The Great
Depression followed the stock market crash of 1929, and the effects of the
financial crisis in 2007 and 2008 linger on five years later.
The question is, how should we respond to
uncertainties and Black Swans? One sensible way is to be more diligent in
quantifying the risks we can see. For example, since extreme events don’t
happen often, we’re likely to be misled if we base our risk assessment on
what has occurred over short time periods. We shouldn’t conclude that just
because housing prices haven’t gone down over 20 years that a housing
decline is not a meaningful risk. In the case of natural disasters like
earthquakes, tsunamis, asteroid strikes and solar storms, the long run could
be very long indeed. While we can’t capture all risks by looking far back in
time, taking into account long-term data means we’re less likely to be
surprised.
Some people suggest you should respond to the risk
of unknown unknowns by investing very conservatively. This means allocating
most of the portfolio to “safe assets” and significantly reducing exposure
to risky assets, which are likely to be affected by Black Swan surprises.
This response is consistent with MPT. If you worry about Black Swans, you
are, for all intents and purposes, a very risk-averse investor. The MPT
portfolio position for very risk-averse investors is a position on the
efficient frontier that has little risk.
The cost of investing in a low-risk position is a
lower expected return (recall that historically the average return on stocks
was about three times that on U.S. Treasuries), but maybe you think that’s a
price worth paying. Can everyone take extremely conservative positions to
avoid Black Swan risk? This clearly won’t work, because some investors must
hold risky assets. If all investors try to avoid Black Swan events, the
prices of those risky assets will fall to a point where the forecasted
returns become too large to ignore.
Continued in article
Jensen Comment
All quant theories and strategies in finance are based upon some foundational
assumptions that in rare instances turn into the
Achilles'
heel of the entire superstructure. The classic example is the wonderful
theory and arbitrage strategy of Long Term Capital Management (LTCM) formed by
the best quants in finance (two with Nobel Prizes in economics). After
remarkable successes one nickel at a time in a secret global arbitrage strategy
based heavily on the Black-Scholes Model, LTCM placed a trillion dollar bet that
failed dramatically and became the only hedge fund that nearly imploded all of
Wall Street. At a heavy cost, Wall Street investment bankers pooled billions of
dollars to quietly shut down LTCM ---
http://faculty.trinity.edu/rjensen/FraudRotten.htm#LTCM
So what was the Achilles heal of the arbitrage strategy of LTCM? It was an
assumption that a huge portion of the global financial market would not collapse
all at once. Low and behold, the Asian financial markets collapsed all at once
and left LTCM naked and dangling from a speculative cliff.
There is a tremendous (one of the best
videos I've ever seen on the Black-Scholes Model) PBS Nova video called
"Trillion Dollar Bet" explaining why LTCM
collapsed. Go to
http://www.pbs.org/wgbh/nova/stockmarket/
This video is in the media libraries on most college campuses. I highly
recommend showing this video to students. It is extremely well done and
exciting to watch.
The principal
policy issue arising out of the events surrounding the near collapse of LTCM
is how to constrain excessive leverage. By increasing the chance that
problems at one financial institution could be transmitted to other
institutions, excessive leverage can increase the likelihood of a general
breakdown in the functioning of financial markets. This issue is not limited
to hedge funds; other financial institutions are often larger and more
highly leveraged than most hedge funds.
The video and above reports, however, do not delve into the tax shelter
pushed by Myron Scholes and his other LTCM partners. A nice summary of the tax
shelter case with links to other documents can be found at
http://www.cambridgefinance.com/CFP-LTCM.pdf
The above August 27,
2004 ruling by Judge Janet Bond Arterton rounds out the "Trillion Dollar Bet."
The classic and enormous scandal was
Long Term Capital led by Nobel Prize winning Merton and Scholes (actually the
blame is shared with their devoted doctoral students). There is a tremendous
(one of the best videos I've ever seen on the Black-Scholes Model) PBS Nova
video ("Trillion Dollar Bet") explaining why LTC collapsed. Go to
http://www.pbs.org/wgbh/nova/stockmarket/
Another illustration of the Achilles' heel of a popular mathematical theory
and strategy is the 2008 collapse mortgage-backed CDO financial risk bonds based
upon David Li's Gaussian copula function of risk diversification in portfolios.
The Achilles' heel was the assumption that the real estate bubble would not
burst to a point where millions of subprime mortgages would all go into default
at roughly the same time.
"For five years, Li's formula, known as a
Gaussian copula function, looked like an unambiguously positive
breakthrough, a piece of financial technology that allowed hugely
complex risks to be modeled with more ease and accuracy than ever
before. With his brilliant spark of mathematical legerdemain, Li made it
possible for traders to sell vast quantities of new securities,
expanding financial markets to unimaginable levels.
His method was adopted by everybody from bond
investors and Wall Street banks to ratings agencies and regulators. And
it became so deeply entrenched—and was making people so much money—that
warnings about its limitations were largely ignored.
Then the model fell apart." The article goes on to show that correlations
are at the heart of the problem.
"The reason that ratings agencies and investors
felt so safe with the triple-A tranches was that they believed there was
no way hundreds of homeowners would all default on their loans at the
same time. One person might lose his job, another might fall ill. But
those are individual calamities that don't affect the mortgage pool much
as a whole: Everybody else is still making their payments on time.
But not all calamities are individual, and
tranching still hadn't solved all the problems of mortgage-pool risk.
Some things, like falling house prices, affect a large number of people
at once. If home values in your neighborhood decline and you lose some
of your equity, there's a good chance your neighbors will lose theirs as
well. If, as a result, you default on your mortgage, there's a higher
probability they will default, too. That's called correlation—the degree
to which one variable moves in line with another—and measuring it is an
important part of determining how risky mortgage bonds are."
I would highly recommend reading the entire thing that gets much more
involved with the
actual formula etc.
The
“math error” might truly be have been an error or it might have simply been a
gamble with what was perceived as miniscule odds of total market failure.
Something similar happened in the case of the trillion-dollar disastrous 1993
collapse of Long Term Capital Management formed by Nobel Prize winning
economists and their doctoral students who took similar gambles that ignored the
“miniscule odds” of world market collapse -- -
http://faculty.trinity.edu/rjensen/FraudRotten.htm#LTCM
The rhetorical question is whether the failure is ignorance in model building or
risk taking using the model?
ROBERT RUBIN was Bill Clinton’s treasury
secretary. He has worked at the top of Goldman Sachs and Citigroup. But he
made arguably the single most influential decision of his long career in
1983, when as head of risk arbitrage at Goldman he went to the MIT Sloan
School of Management in Cambridge, Massachusetts, to hire an economist
called Fischer Black.
A decade earlier Myron Scholes, Robert
Merton and Black had explained how to use share prices to calculate the
value of derivatives. The Black-Scholes options-pricing model was more than
a piece of geeky mathematics. It was a manifesto, part of a revolution that
put an end to the anti-intellectualism of American finance and transformed
financial markets from bull rings into today’s quantitative powerhouses.
Yet, in a roundabout way, Black’s approach also led to some of the late
boom’s most disastrous lapses.
Derivatives markets are not new, nor are
they an exclusively Western phenomenon. Mr Merton has described how Osaka’s
Dojima rice market offered forward contracts in the 17th century and
organised futures trading by the 18th century. However, the growth of
derivatives in the 36 years since Black’s formula was published has taken
them from the periphery of financial services to the core.
In “The Partnership”, a history of Goldman
Sachs, Charles Ellis records how the derivatives markets took off. The
International Monetary Market opened in 1972; Congress allowed trade in
commodity options in 1976; S&P 500 futures launched in 1982, and options on
those futures a year later. The Chicago Board Options Exchange traded 911
contracts on April 26th 1973, its first day (and only one month before
Black-Scholes appeared in print). In 2007 the CBOE’s volume of contracts
reached almost 1 trillion.
Trading has exploded partly because
derivatives are useful. After America came off the gold standard in 1971,
businesses wanted a way of protecting themselves against the movements in
exchange rates, just as they sought protection against swings in interest
rates after Paul Volcker, Mr Greenspan’s predecessor as chairman of the Fed,
tackled inflation in the 1980s. Equity options enabled investors to lay off
general risk so that they could concentrate on the specific types of
corporate risk they wanted to trade.
The other force behind the explosion in
derivatives trading was the combination of mathematics and computing. Before
Black-Scholes, option prices had been little more than educated guesses. The
new model showed how to work out an option price from the known price-behaviour
of a share and a bond. It is as if you had a formula for working out the
price of a fruit salad from the prices of the apples and oranges that went
into it, explains Emanuel Derman, a physicist who later took Black’s job at
Goldman. Confidence in pricing gave buyers and sellers the courage to pile
into derivatives. The better that real prices correlate with the unknown
option price, the more confidently you can take on any level of risk. “In a
thirsty world filled with hydrogen and oxygen,” Mr Derman has written,
“someone had finally worked out how to synthesise H2O.”
Poetry in Brownian motion Black-Scholes is
just a model, not a complete description of the world. Every model makes
simplifications, but some of the simplifications in Black-Scholes looked as
if they would matter. For instance, the maths it uses to describe how share
prices move comes from the equations in physics that describe the diffusion
of heat. The idea is that share prices follow some gentle random walk away
from an equilibrium, rather like motes of dust jiggling around in Brownian
motion. In fact, share-price movements are more violent than that.
Over the years the “quants” have found
ways to cope with this—better ways to deal with, as it were, quirks in the
prices of fruit and fruit salad. For a start, you can concentrate on the
short-run volatility of prices, which in some ways tends to behave more like
the Brownian motion that Black imagined. The quants can introduce sudden
jumps or tweak their models to match actual share-price movements more
closely. Mr Derman, who is now a professor at New York’s Columbia University
and a partner at Prisma Capital Partners, a fund of hedge funds, did some of
his best-known work modelling what is called the “volatility smile”—an
anomaly in options markets that first appeared after the 1987 stockmarket
crash when investors would pay extra for protection against another imminent
fall in share prices.
The fixes can make models complex and
unwieldy, confusing traders or deterring them from taking up new ideas.
There is a constant danger that behaviour in the market changes, as it did
after the 1987 crash, or that liquidity suddenly dries up, as it has done in
this crisis. But the quants are usually pragmatic enough to cope. They are
not seeking truth or elegance, just a way of capturing the behaviour of a
market and of linking an unobservable or illiquid price to prices in traded
markets. The limit to the quants’ tinkering has been not mathematics but the
speed, power and cost of computers. Nobody has any use for a model which
takes so long to compute that the markets leave it behind.
The idea behind quantitative finance is to
manage risk. You make money by taking known risks and hedging the rest. And
in this crash foreign-exchange, interest-rate and equity derivatives models
have so far behaved roughly as they should.
A muddle of mortgages Yet the idea behind
modelling got garbled when pools of mortgages were bundled up into
collateralised-debt obligations (CDOs). The principle is simple enough.
Imagine a waterfall of mortgage payments: the AAA investors at the top catch
their share, the next in line take their share from what remains, and so on.
At the bottom are the “equity investors” who get nothing if people default
on their mortgage payments and the money runs out.
Despite theory, CDOs were hopeless, at
least with hindsight (doesn’t that phrase come easily?). The cash flowing
from mortgage payments into a single CDO had to filter up through several
layers. Assets were bundled into a pool, securitised, stuffed into a CDO,
bits of that plugged into the next CDO and so on and on. Each source of a
CDO had interminable pages of its own documentation and conditions, and a
typical CDO might receive income from several hundred sources. It was a
lawyer’s paradise.
This baffling complexity could hardly be
more different from an equity or an interest rate. It made CDOs impossible
to model in anything but the most rudimentary way—all the more so because
each one contained a unique combination of underlying assets. Each CDO would
be sold on the basis of its own scenario, using central assumptions about
the future of interest rates and defaults to “demonstrate” the payouts over,
say, the next 30 years. This central scenario would then be “stress-tested”
to show that the CDO was robust—though oddly the tests did not include a 20%
fall in house prices.
This was modelling at its most feeble.
Derivatives model an unknown price from today’s known market prices. By
contrast, modelling from history is dangerous. There was no guarantee that
the future would be like the past, if only because the American housing
market had never before been buoyed up by a frenzy of CDOs. In any case,
there are not enough past housing data to form a rich statistical picture of
the market—especially if you decide not to include the 1930s nationwide fall
in house prices in your sample.
Neither could the models take account of
falling mortgage-underwriting standards. Mr Rajan of the University of
Chicago says academic research suggests mortgage originators, keen to
automate their procedures, stopped giving potential borrowers lengthy
interviews because they could not easily quantify the firmness of someone’s
handshake or the fixity of their gaze. Such things turned out to be better
predictors of default than credit scores or loan-to-value ratios, but the
investors at the end of a long chain of securities could not monitor lending
decisions.
The issuers of CDOs asked rating agencies
to assess their quality. Although the agencies insist that they did a
thorough job, a senior quant at a large bank says that the agencies’ models
were even less sophisticated than the issuers’. For instance, a BBB tranche
in a CDO might pay out in full if the defaults remained below 6%, and not at
all once they went above 6.5%. That is an all-or-nothing sort of return,
quite different from a BBB corporate bond, say. And yet, because both shared
the same BBB rating, they would be modelled in the same way.
Issuers like to have an edge over the
rating agencies. By paying one for rating the CDOs, some may have laid
themselves open to a conflict of interest. With help from companies like
Codefarm, an outfit from Brighton in Britain that knew the agencies’ models
for corporate CDOs, issuers could build securities with any risk profile
they chose, including those made up from lower-quality ingredients that
would nevertheless win AAA ratings. Codefarm has recently applied for
administration.
There is a saying on Wall Street that the
test of a product is whether clients will buy it. Would they have bought
into CDOs had it not been for the dazzling performance of the quants in
foreign-exchange, interest-rate and equity derivatives? There is every sign
that the issuing banks believed their own sales patter. The banks so liked
CDOs that they held on to a lot of their own issues, even when the idea
behind the business had been to sell them on. They also lent buyers much of
the money to bid for CDOs, certain that the securities were a sound
investment. With CDOs in deep trouble, the lenders are now suffering.
Modern finance is supposed to be all about
measuring risks, yet corporate and mortgage-backed CDOs were a leap in the
dark. According to Mr Derman, with Black-Scholes “you know what you are
assuming when you use the model, and you know exactly what has been swept
out of view, and hence you can think clearly about what you may have
overlooked.” By contrast, with CDOs “you don’t quite know what you are
ignoring, so you don’t know how to adjust for its inadequacies.”
Now that the world has moved far beyond
any of the scenarios that the CDO issuers modelled, investors’ quantitative
grasp of the payouts has fizzled into blank uncertainty. That makes it hard
to put any value on them, driving away possible buyers. The trillion-dollar
bet on mortgages has gone disastrously wrong. The hope is that the
trillion-dollar bet on companies does not end up that way too.
Continued in article
Closing Jensen Comment
So is portfolio diversification theory dead? I hardly think so. But if any
lesson is to be learned is that we should question those critical underlying
assumptions in Plato's Cave before worldwide strategies are implemented that
overlook the Achilles' heel of those critical underlying assumptions.
Jonathan Spence came here
to deliver a speech, but don't let that fool you: his address -- the 39th
Annual Jefferson Lecture in the Humanities, which took place Thursday -- in
no way resembled the sort typically associated with D.C.
The Jefferson Lecture is
sponsored by the National Endowment for the Humanities, which describes the
lecture as "the most prestigious honor the federal government bestows for
distinguished intellectual achievement in the humanities." Those
chosen
for the distinction are typically academics or
creative types (or both) -- but, given the setting, the sponsor, and the
nature of the award (which "recognizes an individual... who has the ability
to communicate the knowledge and wisdom of the humanities in a broad,
appealing way"), Jefferson Lecturers have historically taken the opportunity
to make a larger (and sometimes tacitly political) point related to the
humanities. Last year, controversial bioethicist
Leon Kass used his lecture
to criticize the way the humanities are taught and researched at American
universities; in 2007,
Harvey Mansfield argued, with many subtle
political allusions, that the social sciences are in dire need of "the help
of literature and history";
Tom Wolfe's 2006 lecture discussed how the
humanities shed light on modern culture (and lamented the current state of
that culture on campuses); 2005 lecturer Donald Kagan and 2004 lecturer
Helen Vendler offered opposing views on which disciplines of the humanities
are most crucial, and why.
If any of those in the
crowd (noticeably larger than last year's) at the Warner Theater last night
were familiar with the Jefferson Lectures of years prior, they were in for a
surprise.
Spence is Sterling
Professor of History Emeritus at Yale University, whose faculty he joined in
1966. His specialty has always been China -- his 14 books on Chinese history
include 1990's The Search for Modern China, upon whose publication
the New York Times
accurately predicted that it would "undoubtedly
become a standard text on the subject" -- and his lecture was entitled
"When
Minds Met: China and the West in the Seventeenth Century."
Even this relatively specific appellation, however,
conveys a misleading breadth, for Spence's lecture focused almost
exclusively on three men -- Shen Fuzong, an exceptionally learned Chinese
traveler; Thomas Hyde, an English scholar of history and language; and
Robert Boyle, also English, a scientist and philosopher of considerable
renown -- and one year: 1687.
In his lecture, Spence gave
what may (or may not) have been one brief acknowledgment that he'd chosen an
unusually narrow topic of discourse: "It is a commonplace, I think, that the
sources that underpin our concept of the humanities, as a focus for our
thinking, are expected to be broadly inclusive." But, for himself, Spence
dismissed that notion in one more sentence: "...as a historian I have always
been drawn to the apparently small-scale happenings in circumscribed
settings, out of which we can tease a more expansive story."
Thus he dedicated the rest
of his lecture to the story of those three historical figures in the year
1687. Shen had traveled to Europe in the company of one of his teachers, a
Flemish Jesuit priest who was co-editing a book of the sayings of Confucius
from Chinese into Latin. Hyde, librarian at the University of Oxford's
Bodleian Library, invited Shen there to assist him with the cataloging of
some Chinese books -- and also because Hyde, who in that era would have been
called an Orientalist, wanted to learn Chinese himself. After a brief stay
at Oxford, Shen returned to London, bearing a letter of introduction from
Hyde to his friend Boyle; the letter recommended that Boyle meet and
converse with the Chinese scholar. The letter had to be convincing, Spence
explained, because Boyle's reputation was by then widespread, and "he was so
inundated with curious visitors that at times he had to withdraw into
self-enforced seclusion...."
Shen did meet Boyle at
least once; Boyle's work diary mentions their discussion of the Chinese
language and its scholars (a conversation that, like all of those between
Shen and Hyde, must have taken place in Latin: Shen's Latin was excellent,
but he did not, evidently, know English). And Hyde maintained correspondence
not only with his old friend Boyle -- over the years, the two had "discussed
Arabic and Persian texts, Malay grammars... and how to access books from
Tangier, Constantinople and Bombay" as well as "the chemical constituents of
sal ammoniac and amber, the effectiveness of certain Mexican herbs...
current studies of human blood and air, the nature of papyrus, the writings
of Ramon Llull and the use of elixirs and alchemy in the treatment of
illnesses" -- but also with Shen, until around the time of the latter's
departure from England for Portugal in the spring of 1688.The letters
between Shen and Hyde covered such topics as "Chinese vocabulary... China's
units of weights and measurements... the workings of the Chinese examination
system and bureaucracy... [and] the Chinese Buddhist belief in the
transmigration of souls."
"All three men," Spence
ultimately concluded, "though so different, shared certain basic ideas about
human knowledge: these included... the importance of linguistic precision,
the need for broad-based comparative studies, the role of clarity in
argument, the need for thorough scrutiny of philosophical and theological
principles.... Theirs, though brief, had been a real meeting of the minds.
And the values they shared remain, well over three hundred years later, the
kind that we can seek to practice even in our own hurried lives."
That final point was the
closest Spence came to suggesting a particular take-home message for his
audience; however, in an interview with Inside Higher Ed, held that
morning in the lobby of the Willard Hotel, he did mention a few ideas that
he was hoping to convey. For one thing, Spence said, given the current
importance of U.S.-China relations, he hopes this much older, smaller-scale
example of dialogue between the East and West will "give some perspective to
that."
"Historians," he said,
"try to get people away from just focusing on the present; they try to give
them some sort of stronger sense of continuity, human continuity. And I just
like the range of things, these three people that draw together, and they're
writing their letters to each other, and their few meetings... and in that
short time they talk about examination systems, they talk about language,
competition, they talk about medicine, they talk about -- I was fascinated,
they talk about chess..... All these things seemed to me to flow together,
and I think they'd make an interesting -- I hope they'd make an interesting
-- package about cultural contact."
There's a message in that,
Spence said: "to make our range of contact as wide as possible, and to use
our intelligence about how to do this."
Another issue raised in
the lecture, Spence said -- "maybe a small point, but perhaps worth making"
-- has to do with the teaching and learning of languages; Hyde dreamed of
bringing native speakers of various Eastern languages to Oxford, to
establish a college of languages. "Why should everybody else on the planet
speak English?" Spence asked. "I mean, why should they?"
But on the larger
importance of the humanities, and their current status in higher education
and society at large, Spence was reluctant to make a strong argument. "It's
not just a case of encouraging humanities in the abstract; it's having
something to say.... The main search should be for what is the most
meaningful thing you can achieve with the humanities, how can you share some
kind of broader cultural values, or how can you learn things about yourself
or other societies. The challenge is to use the humane intelligence and see
what can be built on that."
And when it comes to
funding, "any government has to put its priorities somewhere, and this does
usually mean cutting something."
His lecture, Spence said,
isn't "meant to be exactly a political speech, you know, I hope people
understand that."
For the most part, those
in attendance seemed more than satisfied. Spence's talk was punctuated
frequently by warm laughter from the audience -- whom he indulged
shamelessly, often departing from his prepared remarks to expound upon
details that interested him, or to make additional jokes whenever the crowd
found one of his remarks especially humorous. When he finished, the applause
was long and loud, and one woman remarked audibly, "That was amazing!"; her
companion replied, "Nice, really nice!"
But at least a few people
reacted with more ambivalence. One group of young attendees, who identified
themselves as fans of Spence, having been students of his as undergraduates
at Yale, said that while they'd enjoyed the lecture, they had been hoping
that Spence would make a more explicit connection between his topic and
issues of current cultural or political relevance. One noted that, in his
introductory remarks that evening, NEH Chairman James Leach had described
the purpose of the Jefferson Lecture as being "to narrow the gap between the
world of academia and public affairs," and had emphasized the Endowment's
goal of "bridging cultures."
There was an "irony," this
young man said, in the fact that Spence's lecture precisely addressed the
bridging of two cultures, but Spence hadn't made a bridge between his own
remarks -- which the audience member interpreted as "a clarion call for
better scholarship" -- and any other realm. "Listeners," he said (possibly
referring to himself), "want something that's cut and dry, that's tweetable."
The possibility of such
complaints about his speech had arisen during Inside Higher Ed'sinterview with Spence that morning; he hadn't seemed concerned. "I'm not
going to sort of over-apologize to the audience... they've chosen to come to
hear about the seventeenth century" -- he chuckled -- "I think we announced
that!"
History of the CMA Examination and Revisions
October 30, 2010 message from James Martin
For an update and history of the CMA program see
VanZante, N. R. 2010. IMA's
professional certification program has changed. Management Accounting
Quarterly (Summer): 48-51.
The information provided in this paper is very similar
to the information
provided by Brausch and Whitney earlier this year. However, VanZante adds a
chronological history of the CMA program and explains why the CFM exam was
discontinued and merged into the new CMA exam.
We didn't get around to putting together our usual
"annual report" this year. We did a fair bit of travel during the 2nd half
of 2010, had a number of family get-togethers, and time got away from us.
But thankfully we are reasonably healthy and well. Our major downsizing was
a pain, but now we are glad we tackled it in 2009. How are you both?
Hopefully you did not have to suffer through the cold, cold winter in the
N.E.
Since you are both quite family oriented, I thought
you might be interested in the completion of my professional biography by
Dale Flesher at Ole Miss. I am very happy with the outcome. So I am enclosed
the flyer about the book in the attachment hereto.
Be well and keep warm! Best greetings and regards,
Gary & Coralie
Jensen Comment
Although the above message from Gary Mueller is somewhat personal, I thought
readers might like to hear from Gary and to know about the recent biography
about Gary that was written by accounting historians Dale
Flesher and Gary Previts:
Although I've known Gary and Coralie for years, we became much closer in the
years that we were both on the Executive Committee of the American Accounting
Association. Because there was significant outside funding for our EC meetings
in those years, we had some wonderful trips with spouses to places like
Amsterdam and
Puerto Rico and Hawaii. When we met outside the U.S., Gary usually had a
purpose. For example, when we met in Amsterdam he organized meetings where we
interacted with leaders of European accounting education. Gary had more global
contacts in accounting education than any person I've ever known other than the
very, very long term serving international accounting professor Paul Garner.
These were exciting times for the Executive Committee because it was a time when
the Big Eight accounting firms gave the AAA $4 million to establish the
Accounting Education Change Commission ---
http://aaahq.org/AECC/history/cover.htm
Gary Mueller was instrumental in organizing the entire AECC Program.
For
36 years when Gary was at the University of Washington he was arguably the
best known international accounting professor in the world. Gary grew up in
Germany and was fluent in several languages (including difficult German
dialects). In addition to his various books on international accounting, Gary
chaired the doctoral dissertations of some outstanding international accounting
students.
In addition to serving a AAA President, Gary was on the FASB for a full five
year appointment before he retired.
Gary served the accounting profession and the Academy very well and was a mover
and shaker in the globalization of accountancy.
My life is much richer for having served with Gary!
The Treviso Arithmetic on December 10,
1578, the first printed mathematics text,
published in Treviso, Italy, as Arte dell'Abbaco by an
unknown author---
https://en.wikipedia.org/wiki/Treviso_Arithmetic
Luca Pacioli: Author of the First Printed Work
(Summa)
in Algebra That Also Featured Algebraic Applications in Accountancy
Luca Pacioli was an Italian mathematician, Franciscan friar, collaborator
with Leonardo da Vinci, and an early contributor to the field now known as
accounting ---
https://en.wikipedia.org/wiki/Luca_Pacioli
Pacioli published several works on
mathematics, including:
·Tractatus
mathematicus ad discipulos perusinos
(Ms. Vatican Library, Lat. 3129), a nearly 600-page textbook dedicated to
his students at the University of Perugia where Pacioli taught from 1477 to
1480. The manuscript was written between December 1477
and 29 April 1478.
It contains 16 sections on merchant arithmetic, such as barter, exchange,
profit, mixing metals, and algebra, though 25 pages from the chapter on
algebra are missing. A modern transcription was published by Calzoni and
Cavazzoni (1996) along with a partial translation of the chapter on
partitioning problems.[7]
·Summa de arithmetica, geometria.
Proportioni et proportionalita
(Venice
1494), a textbook
for use in the schools of Northern Italy. It was a synthesis of the
mathematical knowledge of his time and containedthe first printed work
on algebrawritten in the vernacular (i.e.,
the spoken language of the day). It is also notable for including
one of the first published descriptions of the bookkeeping method that
Venetian merchants used during the Italian Renaissance,
known as the
double-entry accounting system. The
system he published included most of the accounting cycle as we know it
today. He described the use of journals and ledgers and warned that a person
should not go to sleep at night until the debits equalled the credits. His
ledger had accounts for assets (including receivables and inventories),
liabilities, capital, income, and expenses — the account categories that are
reported on an organization's
balance sheet and
income statement, respectively. He
demonstrated year-end closing entries and proposed that a
trial balance be used to prove a
balanced ledger. Additionally, his treatise touches on a wide range of
related topics from
accounting ethics to
cost accounting. He introduced the
Rule of 72, using an approximation of
100*ln 2 more than 100 years before
Napier and Briggs.[8]
·De viribus
quantitatis
(Ms. Università degli Studi di Bologna, 1496–1508), a treatise on
mathematics and magic. Written between 1496 and 1508, it contains the first
reference to card tricks as well as guidance on how to juggle, eat fire, and
make coins dance. It is the first work to note that Leonardo was
left-handed. De viribus quantitatis is divided into three sections:
Mathematical problems, puzzles, and tricks, along with a collection of
proverbs and verses. The book has been described as the "Foundation of
modern magic and numerical puzzles," but it was never published and sat in
the archives of the University of Bologna, where it was seen by only a small
number of scholars during the Middle Ages. The book was rediscovered after
David Singmaster, a mathematician,
came across a reference to it in a 19th-century manuscript. An English
translation was published for the first time in 2007.[9]
·Geometry
(1509),
a Latin translation of
Euclid's
Elements.
·Divina proportione
(written in Milan in 1496–98, published in Venice in
1509). Two
versions of the original manuscript are extant, one in the Biblioteca
Ambrosiana in Milan, the other in the Bibliothèque Publique et Universitaire
in Geneva. The subject was mathematical and artistic proportion, especially
the mathematics of the
golden ratio and its application in
architecture.
Leonardo da Vinci drew the
illustrations of the regular solids in Divina proportione while he
lived with and took mathematics lessons from Pacioli. Leonardo's drawings
are probably the first illustrations of skeletal solids, which allowed an
easy distinction between front and back. The work also discusses the use of
perspective by painters such as
Piero della Francesca,
Melozzo da Forlì, and
Marco Palmezzano.
Accounting History
The September 2011 edition of The Accounting Review has some really
interesting biographical book reviews and tributes to historical scholars ---
Anthony Hopwood (Deceased)
Gerhard G. Mueller
George J. Benston (Deceased)
This collection of essays memorializes the life and
work of Anthony Hopwood, a thought leader in management accounting research
who was renowned for developing communities of accounting scholars. These
essays, written by his students, co-authors, and colleagues, were presented
to Anthony in a conference of international researchers. Thus, they have
benefited from the counsel of the editors, from vigorous discussion among
conference participants, and from reactions by Anthony himself. Consistent
with Anthony’s distinguished career, in what may be his final research
endeavor he contributed to the creation of a collection of serious scholarly
works, worthy of consideration by all accounting researchers.
The volume is comprised of 18 chapters that
collectively cover themes that animated Anthony’s work. Chief among these is
the importance of studying accounting in the organizational and social
contexts in which it operates, with an aim of understanding how accounting
shapes and is shaped by its environment. In the introductory chapter, the
editors delineate a tripartite schema of accounting, organizations, and
institutions that guided their commissioning of pieces for the volume. Given
the title of the journal that Anthony founded and edited for decades,
Accounting, Organizations and Society (AOS), I wondered why the authors
chose ‘‘institutions’’ over ‘‘societies’’ as the third element of the
framework. In particular, I was curious about whether Anthony might in
hindsight have preferred this, acknowledging the growing importance and use
of institutional theory in accounting research. While the authors
acknowledge the limitations of adhering too literally to the framework in
light of indistinct conceptual boundaries (i.e., ‘‘to what extent is
accounting itself an ‘institution’?’’, p. 2), they nonetheless argue
convincingly for the usefulness of the framework in understanding a
significant body of research that has been published in journals such as:
AOS, Critical Perspectives on Accounting, and Accounting, Auditing and
Accountability Journal. In Chapter 1, the editors provide a nice history and
synthesis of these works. Although Anthony clearly played a major part in
the genesis and intellectual development of the literature, the chapter is
not a biographical sketch. It locates Anthony’s contributions in relation to
other management scholars and in the context of current events and
influential practitioner-led studies.
The editors conclude their history by reiterating
Anthony’s concern: that much of the current-day neglect of accounting by
social scientists stems from new modes of accountability in higher education
that have been made operational through simplified, standardized performance
metrics. Their hope is that these essays from ‘‘within and beyond’’ the
discipline of accounting will reinvigorate research on accounting in its
social context, and thereby address Anthony’s apprehension that ‘‘the only
consumers of accounting research are other accounting researchers’’ (p. 22).
Opting for a mix of ‘‘depth’’ strategy and ‘‘breadth’’ strategy for this
review, I have selected one of the 17 contributed chapters for extensive
comment and two others for brief summary.
A biography, the title of which anoints its subject
as the ‘‘Father of International Accounting Education,’’ raises two
immediate questions. First, what exactly is international accounting and,
second, what does it mean to be a ‘‘father’’ of an educational discipline?
The first question arises because it is not obvious
as to what is international about international accounting. After all, the
underlying concepts of accounting, like those of physics, are universal. The
principles of accounting articulated by Fr. Luca Pacioli (often referred to
as the ‘‘father of accounting’’) are no more confined to the boundaries of
Italy than are the principles of physics described by Galileo. Yet it is
doubtful that any academic physicists consider themselves specialists in
‘‘international physics.’’ ‘‘International accounting’’ is, at best, an
ill-defined sub-discipline of accounting. To many—and probably to most U.S.
accountants—international accounting is mainly a description of accounting
practices in countries other than the United States. Needless to say, that
definition would be unlikely to be embraced by our colleagues in those
‘‘other’’ countries. To others, international accounting deals primarily
with measurement and reporting issues involving currency translation and
related issues of consolidation. To still others, it pertains to the unique
problems of controlling and auditing the accounting systems of multinational
enterprises.
In his biography of Gerhard G. Mueller, Professor
Dale L. Flesher never explicitly answers that first question. Yet it is
apparent from the extraordinary length and breadth of Mueller’s publications
that international accounting incorporated almost anything that involved
entities outside of the United States. Indeed, he himself defined
international accounting as ‘‘the producing, exchanging, using, and
interpreting of accounting data across national borders’’ (p. 45).
As for the second question, what it means to be the
‘‘father’’ of international accounting education, Flesher concedes that
Mueller was certainly not its biological father; others both wrote about and
taught international accounting prior to him. But he leaves no doubt that
Mueller adopted the discipline and can take credit for nurturing it up to
adulthood.
. . .
Book review author Mike Granof states the following on Page 1841:
Flesher’s treatise leaves one significant question unanswered: Why has
Gerhard Mueller not yet been elected to the Accounting Hall of Fame?
This volume, which is edited by James D. Rosenfeld,
the late George Benston’s friend and colleague at Emory University, consists
of 16 articles arranged consecutively in two parts: nine accounting articles
and seven finance articles. I will discuss all nine accounting articles in
chronological order. I will then discuss two accounting articles that were
omitted from the volume that were more highly cited than eight of the nine
accounting articles included in the volume (source of citations:
scholar.google.com as of February 10, 2011). Before beginning my discussion
of the 11 articles, I opine that George Benston (hereafter, George) was one
of the few and last Renaissance men of our profession, making numerous
contributions to the accounting, finance, economics, and banking
literatures.1 Indeed, while I focus on his contributions to accounting,
George was best known for his expertise in banking, an area in which he was
often cited by The Economist. As additional evidence of his expertise in
banking, George was an Associate Editor of The Journal of Money, Credit, and
Banking.2
Volume 1 of this two-volume collection covers
George’s contributions to banking and financial services.
Continued in article
Jensen Comment
It saddens me that my friends Tony Hopwood and George Benston passed on. It
thrills me, however, to still correspond with Gary Mueller. I was honored to
serve on the Executive Committee when Gary was President of the American
Accounting Association. The task fell upon Gary's shoulders to set up the
Accounting Education Change Commission that received $4 million from the Big
Eight to fund change in accounting education. We chose Gary's then colleague
Gary Sundem to serve as CEO of the AECC.
More Detailed Differences
(Comparisons) between FASB and IASB Accounting Standards
2011 Update
"IFRS and US GAAP: Similarities and Differences" according to PwC
(2011 Edition)
http://www.pwc.com/us/en/issues/ifrs-reporting/publications/ifrs-and-us-gaap-similarities-and-differences.jhtml
Note the Download button!
Note that warnings are given throughout the document that the similarities and
differences mentioned in the booklet are not comprehensive of all similarities
and differences. The document is, however, a valuable addition to students of
FASB versus IASB standard differences and similarities.
It's not easy keeping track of what's changing and
how, but this publication can help. Changes for 2011 include:
Revised introduction reflecting the current
status, likely next steps, and what companies should be doing now (see page 2);
Updated convergence timeline, including
current proposed timing of exposure drafts, deliberations, comment
periods, and final standards
(see page 7);
More current analysis of the differences
between IFRS and US GAAP -- including an assessment of the impact
embodied within the differences
(starting on page 17); and
Details incorporating authoritative standards
and interpretive guidance issued through July 31, 2011
(throughout).
This continues to be one of PwC's most-read
publications, and we are confident the 2011 edition will further your
understanding of these issues and potential next steps.
For further exploration of the similarities and
differences between IFRS and US GAAP, please also visit our
IFRS Video Learning Center.
To request a hard copy of this publication, please contact your PwC
engagement team or
contact us.
Jensen Comment
My favorite comparison topics (Derivatives and Hedging) begin on Page 158
The booklet does a good job listing differences but, in my opinion, overly
downplays the importance of these differences. It may well be that IFRS is more
restrictive in some areas and less restrictive in other areas to a fault. This
is one topical area where IFRS becomes much too subjective such that comparisons
of derivatives and hedging activities under IFRS can defeat the main purpose of
"standards." The main purpose of an "accounting standard" is to lead to greater
comparability of inter-company financial statements. Boo on IFRS in this topical
area, especially when it comes to testing hedge effectiveness!
One key quotation is on Page 165
IFRS does not specifically discuss the methodology
of applying a critical-terms match in the level of detail included within
U.S. GAAP.
Then it goes yatta, yatta, yatta.
Jensen Comment
This is so typical of when IFRS fails to present the "same level of detail" and
more importantly fails to provide "implementation guidance" comparable with the
FASB's DIG implementation topics and illustrations.
I have a
huge beef with the lack of illustrations in IFRS versus the many illustrations
in U.S. GAAP.
I have a
huge beef with the lack of illustrations in IFRS versus the many illustrations
in U.S. GAAP.
I have a huge beef with the lack of illustrations in
IFRS versus the many illustrations in U.S. GAAP.
"Canadian regulator decides against allowing early adoption of recent
IFRSs by certain entities," IAS Plus, November 1, 2011 ---
http://www.iasplus.com/index.htm
. . .
In making its decision, the OSFI considered a
number of factors such as industry
consistency, OSFI policy positions on
accounting and capital, operational capacity and resource constraints of
Federally Regulated Entities (FREs), the ability to benefit from improved
standards arising from the financial crisis and the
notion of a level playing field with other Canadian
and international financial institutions.
OSFI concluded that FREs should not early adopt the following new or amended
IFRSs, but instead should adhere to their mandatory effective dates:
Continued
Jensen Comment
The clients, auditors, and the AICPA clamoring that U.S. firms should be able to
voluntarily choose IFRS instead of U.S. GAAP even before it has not been decided
that IFRS will ever replace FASB standards seem to ignore the problems that
voluntary choice of IFRS might cause for investors and analysts. The above
reasoning by the OSFI makes sense to me.
But then outfits like the AICPA have a self-serving interest in earning
millions of dollars selling IFRS training courses and materials.
November 2, 2011 reply from Patricia Walters
Does that mean you oppose options to early adopt standards in general,
not just IFRSs?
Pat
November 2, 2011 reply from Bob Jensen
Hi Pat,
It's hard to say regarding early adoption of a particular national or
international standard, because there can be unique circumstances. For
example, FAS 123R simply altered how to make disclosures rather than alter
the disclosures themselves since employee option expenses had to be
disclosed before the FAS 123R adoption date. But even here early adoption of
FAS 123R by Company A versus late adoption by Company B made simple
comparisons of eps and P/E ratios between these companies less easy.
There's a huge difference between early adoption of a particular standard
and early adoption of an entire system of standards like switching from FASB
accounting standards to IFRS.
I think the Canadian position of early adoption of IFRS is probably correct
because of the mess early adoption of IFRS makes with comparisons of
companies using different accounting standards and the added costs of
regulation of more than one set of standards. Also think of the added burden
placed upon the courts to adjudicate disputes when differing sets of
standards are being used.
Even though we allow IFRS for SEC registered foreign companies, I think it
would be a total mess for the SEC, the PCAOB, investors, analysts,
educators, trainers, auditing, and even the IRS (where tax and reporting
treatments must sometimes be reconciled) if our domestic corporations could
choose between FASB versus IASB standards.
There are hundreds of differences between FASB and IASB standards. Allowing
companies domestic companies to cherry pick which system they choose before
it is even known if there will ever be official replacement of FASB
standards by IASB standards would be very, very confusing. What if there
never is a decision to replace FASB standards? Do want to simply allow
companies to choose to bypass FASB standards at their own discretion?
Of course, if information were costless it might be ideal to require
financial reporting where FASB and IASB outcomes are reconciled. But clients
and auditors generally contend that the cost of doing this greatly exceeds
benefits. And teaching financial accounting would become exceedingly
complicated if we had to teach two sets of standards on an equal basis.
I would certainly hate to face a CPA examination that had nearly equal
coverage of both FASB and IASB standards simultaneously. I say this
especially after viewing the hundreds of pages of complicated differences
between the two standards systems.
More Detailed Differences
(Comparisons) between FASB and IASB Accounting Standards
2011 Update
"IFRS and US GAAP: Similarities and Differences" according to PwC
(2011 Edition)
http://www.pwc.com/us/en/issues/ifrs-reporting/publications/ifrs-and-us-gaap-similarities-and-differences.jhtml
Note the Download button!
Note that warnings are given throughout the document that the similarities and
differences mentioned in the booklet are not comprehensive of all similarities
and differences. The document is, however, a valuable addition to students of
FASB versus IASB standard differences and similarities.
It's not easy keeping track of what's changing and
how, but this publication can help. Changes for 2011 include:
Revised introduction reflecting the current
status, likely next steps, and what companies should be doing now (see page 2);
Updated convergence timeline, including
current proposed timing of exposure drafts, deliberations, comment
periods, and final standards
(see page 7);
More current analysis of the differences
between IFRS and US GAAP -- including an assessment of the impact
embodied within the differences
(starting on page 17); and
Details incorporating authoritative standards
and interpretive guidance issued through July 31, 2011
(throughout).
This continues to be one of PwC's most-read
publications, and we are confident the 2011 edition will further your
understanding of these issues and potential next steps.
For further exploration of the similarities and
differences between IFRS and US GAAP, please also visit our
IFRS Video Learning Center.
To request a hard copy of this publication, please contact your PwC
engagement team or
contact us.
Jensen Comment
My favorite comparison topics (Derivatives and Hedging) begin on Page 158
The booklet does a good job listing differences but, in my opinion, overly
downplays the importance of these differences. It may well be that IFRS is more
restrictive in some areas and less restrictive in other areas to a fault. This
is one topical area where IFRS becomes much too subjective such that comparisons
of derivatives and hedging activities under IFRS can defeat the main purpose of
"standards." The main purpose of an "accounting standard" is to lead to greater
comparability of inter-company financial statements. Boo on IFRS in this topical
area, especially when it comes to testing hedge effectiveness!
One key quotation is on Page 165
IFRS does not specifically discuss the methodology
of applying a critical-terms match in the level of detail included within
U.S. GAAP.
Then it goes yatta, yatta, yatta.
Jensen Comment
This is so typical of when IFRS fails to present the "same level of detail" and
more importantly fails to provide "implementation guidance" comparable with the
FASB's DIG implementation topics and illustrations.
I have a
huge beef with the lack of illustrations in IFRS versus the many illustrations
in U.S. GAAP.
I have a
huge beef with the lack of illustrations in IFRS versus the many illustrations
in U.S. GAAP.
I have a huge beef with the lack of illustrations in
IFRS versus the many illustrations in U.S. GAAP.
"Canadian regulator decides against allowing early adoption of recent
IFRSs by certain entities," IAS Plus, November 1, 2011 ---
http://www.iasplus.com/index.htm
. . .
In making its decision, the OSFI considered a
number of factors such as industry
consistency, OSFI policy positions on
accounting and capital, operational capacity and resource constraints of
Federally Regulated Entities (FREs), the ability to benefit from improved
standards arising from the financial crisis and the
notion of a level playing field with other Canadian
and international financial institutions.
OSFI concluded that FREs should not early adopt the following new or amended
IFRSs, but instead should adhere to their mandatory effective dates:
Continued
Jensen Comment
The clients, auditors, and the AICPA clamoring that U.S. firms should be able to
voluntarily choose IFRS instead of U.S. GAAP even before it has not been decided
that IFRS will ever replace FASB standards seem to ignore the problems that
voluntary choice of IFRS might cause for investors and analysts. The above
reasoning by the OSFI makes sense to me.
But then outfits like the AICPA have a self-serving interest in earning
millions of dollars selling IFRS training courses and materials.
November 2, 2011 reply from Patricia Walters
Does that mean you oppose options to early adopt standards in general,
not just IFRSs?
Pat
November 2, 2011 reply from Bob Jensen
Hi Pat,
It's hard to say regarding early adoption of a particular national or
international standard, because there can be unique circumstances. For
example, FAS 123R simply altered how to make disclosures rather than alter
the disclosures themselves since employee option expenses had to be
disclosed before the FAS 123R adoption date. But even here early adoption of
FAS 123R by Company A versus late adoption by Company B made simple
comparisons of eps and P/E ratios between these companies less easy.
There's a huge difference between early adoption of a particular standard
and early adoption of an entire system of standards like switching from FASB
accounting standards to IFRS.
I think the Canadian position of early adoption of IFRS is probably correct
because of the mess early adoption of IFRS makes with comparisons of
companies using different accounting standards and the added costs of
regulation of more than one set of standards. Also think of the added burden
placed upon the courts to adjudicate disputes when differing sets of
standards are being used.
Even though we allow IFRS for SEC registered foreign companies, I think it
would be a total mess for the SEC, the PCAOB, investors, analysts,
educators, trainers, auditing, and even the IRS (where tax and reporting
treatments must sometimes be reconciled) if our domestic corporations could
choose between FASB versus IASB standards.
There are hundreds of differences between FASB and IASB standards. Allowing
companies domestic companies to cherry pick which system they choose before
it is even known if there will ever be official replacement of FASB
standards by IASB standards would be very, very confusing. What if there
never is a decision to replace FASB standards? Do want to simply allow
companies to choose to bypass FASB standards at their own discretion?
Of course, if information were costless it might be ideal to require
financial reporting where FASB and IASB outcomes are reconciled. But clients
and auditors generally contend that the cost of doing this greatly exceeds
benefits. And teaching financial accounting would become exceedingly
complicated if we had to teach two sets of standards on an equal basis.
I would certainly hate to face a CPA examination that had nearly equal
coverage of both FASB and IASB standards simultaneously. I say this
especially after viewing the hundreds of pages of complicated differences
between the two standards systems.
There is a clamor of voices
demanding the rebooting of capitalism, from academics (such as Michael
Porter) and politicians (like Al Gore) to investors (such as CalPERS)
and Occupy's street activists.
The common thread is
that today's model of capitalism overemphasizes short-term financial
data and neglects information that gets at the true sources of
sustainable value creation — things like innovation, brand equity,
customer loyalty, and key stakeholder relationships. Corporate reporting
today emphasizes compliance, boilerplate and legalese. As a result, we
have a massive glut of filings, press releases, analyst reports and
articles focused on financial data. The system has lost sight of the
point of reporting: to give companies access to financial capital by
communicating their value to investors.
The consequence of the
systemic failure of this lopsided model is that companies focus on
short-term financial performance — because that is what they believe
investors are interested in — to the detriment of long-term value
creation. Investors, meanwhile, compensate for the lack of knowledge
about issues central to longer term value by pricing in a risk premium.
This can result in market valuations that do not reflect the fundamental
performance or prospects of the business, leading to a misallocation of
capital and reduced visibility for investors, reinforcing short-term
decision-making. And it is business that pays the price through more
expensive capital, while furthering a flawed model of capitalism.
Fortunately, there is a
better way to communicate about the sources of value creation:
integrated reporting. Such reporting integrates material information
about a firm's financial performance with information on sustainability
performance and intangibles such as intellectual and human capital.
From the investor
standpoint, integrated reporting provides insights about a firm's
business model, strategy, risk, performance and prospects that are
simply not available under the current reporting model. It therefore
supports investor decision-making by providing a more complete basis for
dialogue with the company's board and an assessment of present and
future value. This benefits not only the investor, but also investors'
beneficiaries and the broader economy by providing a platform that
encourages financial stability. Companies such as Danone, SAP, AkzoNobel
and Unilever are already pushing the boundaries on their corporate
reporting in this direction.
This week, the
International Integrated Reporting Council (of which I am the chief
executive) launched the
consulting draft of integrated reporting framework.
Over the next ninety days, the IIRC is seeking
feedback on the draft from companies, investor groups, reporting
standards organizations, accounting bodies and regulators — anybody who
has a stake in seeing the transformation of corporate reporting.
The framework differs
from standard financial reporting in a number of ways:
It provides
guidance on reporting that goes beyond simply conveying past
performance in order to help investors understand how value is
created (or destroyed) in the company, given its business model and
its strategies, risks and opportunities.
It acknowledges
that financial capital is not the only asset in a business that
drives value creation; instead, a business must report on the
interaction of six different types of capital: financial,
manufactured, intellectual, human, social and relationship, and
natural.
It demands that
reporting go beyond being simply a mash-up of a firm's existing
reports, or a forced combination of the financial and sustainability
reports. Instead, it is a concise report that concentrates on
material issues — those relevant to investors — that affect the
firm's strategy and future orientation.
Despite the evidence of
green shoots representing a new pathway for corporate reporting, I don't
believe that true integrated reporting exists anywhere just yet.
However, the new framework gets us closer to that goal.
While all this makes me
hopeful for the future of corporate reporting, one dark cloud hangs over
my outlook: US companies are lagging their European, Asian and Latin
American counterparts in moving towards an integrated reporting model.
Of course, we have great examples of US companies, such as Coca Cola,
Prudential Finance and Clorox, joining around ninety global companies in
IIRC's pilot program right now, alongside dozens of investors. But my
concern is that there are deep-rooted reasons why the US environment may
stifle innovation in corporate reporting.
One is that companies
hesitate to make statements about anticipated future performance because
they fear litigation. But there are other reasons too. Many see
reporting as a compliance issue — if it's not legislated, then don't
bother. And some will only move on this when they believe the majority
of investors want this sort of information.
The danger for US firms
who lag in adopting integrated reporting is twofold: not only will their
investors lack complete information about their performance, but they
also will lose out on the integrated thinking that integrated reporting
drives: it reduces barriers between functional silos, aligns data
systems and processes, and encourages a culture that focuses on the full
spectrum of value drivers. This is all about innovation, and I am
saddened to think that US companies, some of the world's most innovative
businesses in their own right, might be held back because they are stuck
in an out-of-date reporting model.
If integrated reporting
can play its role in better corporate performance, holistic investor
engagement and the proliferation of a longer-term model of capitalism,
it will not have come a moment too soon.
Jensen Comment
I really hate being a luddite, but if corporate reporting is to be expanded to
cover the entire ballpark as suggested in the above article, then don't look for
the accounting profession to carry the ball into the new territories of
corporate reporting.
In fairness, Paul Druckman did not propose that the accounting profession
expand to cover these new corporate reporting territories. But in this era of
rebranding of PwC and other multinational CPA firms to offer expertise in
non-accounting areas it's tempting to think CPA firms can rebrand in corporate
reporting of "brand equity, customer loyalty, and key
stakeholder relationships."
In the accounting profession we've been through this before. The AICPA even
proposed a new professional designation that became the joke of the 20th Century
---- the professional certification of a Cognitor (later changed to XYZ).
http://www.journalofaccountancy.com/Issues/2001/Oct/TheXyzCredential
Also see
http://www.journalofaccountancy.com/Issues/2001/May/CpasSpeakUpOnNewGlobalCredential
Accountants are educated and trained to do what they learn in accounting
education programs. They are generally not trained to become experts in "innovation,
brand equity, customer loyalty, and key stakeholder relationships."
Unless they have a lot more education and training outside accountancy they are
not IT experts or valuation experts.
This takes me
back to the days when Bob Elliott, eventually as President of the AICPA, was
proposing great changes in the profession, including SysTrust, WebTrust,
Eldercare Assurance, etc. For years I used Bob’s AICPA/KPMG videos as starting
points for discussion in my accounting theory course. Bob relied heavily on the
analogy of why the railroads that did not adapt to innovations in transportation
such as Interstate Highways and Jet Airliners went downhill and not uphill. The
railroads simply gave up new opportunities to startup professions rather than
adapt from railroading to transportation.
Bob’s underlying
assumption was that CPA firms could extend assurance services to non-traditional
areas (where they were not experts but could hire new kinds of experts) by
leveraging the public image of accountants as having high integrity and
professional responsibility. That public image was destroyed by the many
auditing scandals, notably Enron and the implosion of Andersen, that surfaced in
the late 1990s and beyond ---
http://faculty.trinity.edu/rjensen/Fraud001.htm
The AICPA
commenced initiatives on such things as Systrust. To my knowledge most of these
initiatives bit the dust, although some CPA firms might be making money by
assuring Eldercare services.
The counter
argument to Bob Elliot’s initiatives is that CPA firms had no comparative
advantages in expertise in their new ventures just as railroads had few
comparative advantages in trucking and airline transportation industries,
although the concept of piggy backing of truck trailers eventually caught on.
I still have
copies of Bob’s great VCR tapes, but I doubt that these have ever been
digitized. Bob could sell refrigerators to Eskimos.
Should Double Entry Accounting be Abandoned?
It would seem that, if the constraint of double-entry bookkeeping is removed
as a basis of financial reporting, the operational definitions of the major
performance indicator of "profit" for for-profit businesses will have to become
much more precise and operational than "profit" is presently defined as a
residual phenomenon in a double-entry bookkeeping system.
In recent communications Tom Selling suggested that accounting might be
improved by deleting the historic constraint of double entry bookkeeping for
financial reporting.
An earlier advocate of this was Cox Bonita in the following reference:
This paper discusses the need for modern accounting
systems to meet the criteria of both ‘accountability’ and ‘usefulness’ and
argues that the traditional double entry book keeping system serves as a
constraint on the achievement of system usefulness. We look at the problems
associated with the double entry book keeping system and argue for its
replacement with an events accounting system (EAS) model which is more
appropriate to current business requirements. We also consider the need to
extend the EAS model to more adequately meet the criterion of system
usefulness. It is suggested that the integration of an EAS approach with
that of a strategic information systems planning approach, facilitates the
meeting of this objective.
Jensen Comment
Due to tradition, functional fixation (and whatever else) financial
analysts and investors want a primary index for tracking performance a company's
performance over time and to compare inter-company performances. Net profit
throughout accounting history since the days before Pacioli serves this purpose.
Net profit became the most-tracked index of business performance without ever
being formally defined. Before
Other Comprehensive Income (OCI) was invented in FAS 130 net profit
was the change in equity that's left (a positive or negative residual) after
changes in defined components of liabilities and equities other than retained
earnings are eliminated under a double entry system.
In my opinion OCI was initially invented in anticipation of FAS 133 so that
changes in value of derivative contracts serving as cash flow and FX hedges do
not impact net profit to the extent that the hedges
are effective. Of course some other items are also posted to OCI (or AOCI)
---
https://en.wikipedia.org/wiki/Accumulated_other_comprehensive_profit#Other_comprehensive_profit
Tom Selling is so critical of the OCI concept I suspect that he'd like to take
this "quagmire" back out of accounting standards when defining net profit.
Tom Selling would like to define profit in terms of changes in values of
assets and liabilities along Hicksian lines, but this is not an operational
definition without more precise definitions of assets, liabilities, and values.
The standard setters (IASB and FASB) define profit in terms of revenues minus
expenses, but this is not an operational definition without precise definitions
of revenues and expenses.
Accounting standard setters readily admit that they do not have an
operational definition of profit and other important financial definitions.
The IASB just undertook a five-year effort to define profit more operationally.
From the CFO Journal's Morning Ledger on May 8, 201
The largest U.S. companies are booking their strongest
quarterly profits in five years,
as firms reap the benefits of years of belt tightening and finally see a
pickup in demand. But part of the improvement has come from keeping a lid on
spending, and many CEOs remain reluctant to change and open their wallets
for new projects, plants and people, Thomas Gryta and Theo Francis write.
Profits at S&P 500 companies jumped an estimated 13.9% in the first quarter,
growing nearly twice as fast as revenue. The gains stretched across
industries, from Wall Street’s banks to Silicon Valley’s web giants, and
were helped by a rebound in the battered energy sector. The picture was a
marked improvement from a year ago, when profits fell 5%, and was the best
performance since the third quarter of 2011.
ensen Comment
Accounting standard setters cannot even operationally define the calculation of
earnings other than to make it a plug that makes the balance sheet balance. And
yet this plug remains as an exceedingly important driver of share prices in the
stock markets.
The Double-Entry Bookkeeping Model is Crucial for Being Able to Calculate
Some Items That Can Only Be Defined as Plug Amounts That Make Balance Sheets
Balance
1.
Net income is defined by both the FASB and IASB as a plug figure that makes
balance sheets balance under double-entry bookkeeping. In some ways computing
the net income plug amount is like the Hicksian economic concept of income,
although it really is not Hicksian income due to the many ways of measuring
various balance-sheet components of assets and liabilities in modern-day
mixed-model measuring systems. Also there are "assets" and "liabilities" in the
Hicksian model that accountants cannot measure for balance sheet accounts such
as some intangibles (think the value of human resources and business
reputations), contingent liabilities, etc.
2.
Purchasing power gains or losses on monetary items are computed as a
double-entry-based plug amounts.
https://en.wikipedia.org/wiki/Constant_purchasing_power_accounting
Suppose all balance sheet items are partitioned into monetary versus
non-monetary items. Non-monetary items are those items having value changes that
move with general price levels (think inflation). Examples include real estate,
equipment, variable rate investments, and variable rate debt.
Monetary items include cash on hand, fixed rate receivables/investments, and
fixed rate debt. Some derivative financial items on the balance sheet are
monetary items and some are non-monetary. Interest rate swaps are commonly used
to hedge monetary gains and losses. Monetary items are subject to purchasing
power gains and losses. Firms minimize holdings of monetary assets in highly
inflationary economies like Venezuela where monetary holdings are a disaster.
Firms often experience some monetary asset losses in mildly inflationary
economies. They also experience purchasing power gains on monetary liabilities
such as long-term fixed-rate mortgages.
In my theory courses I used a tabbed Excel workbook to illustrate the
calculation of monetary-item gains and losses as plug figures ---
www.cs.trinity.edu/~rjensen/Excel/wtdcase2a.xls
Especially note the Answers tab.
In some ways computing exit value
net income plug amount is like the Hicksian economic concept of income (a plug
calculation), although it really is not Hicksian income due to the many ways of
measuring various balance-sheet components of assets and liabilities in
modern-day mixed-model measuring systems. Also there are "assets" and
"liabilities" in the Hicksian model that accountants cannot measure for balance
sheet accounts such as some intangibles (think the value of human resources and
business reputations), contingent liabilities, etc.
In my theory courses I used a tabbed Excel workbook to illustrate the
calculation of exit value net earnings as a plug vfubure. ---
www.cs.trinity.edu/~rjensen/Excel/wtdcase2a.xls
Especially note the Answers tab.
In some ways computing exit value
net income plug amount is like the Hicksian economic concept of income (a plug
calculation) , although it really is not Hicksian income due to the many ways of
measuring various balance-sheet components of assets and liabilities in
modern-day mixed-model measuring systems. Also there are "assets" and
"liabilities" in the Hicksian model that accountants cannot measure for balance
sheet accounts such as some intangibles (think the value of human resources and
business reputations), contingent liabilities, etc.
Unlike exit values, entry (replacement costs) are not really "values" since
entry value accounting is subject to arbitrary accrual adjustments (think
depreciation) just like historical costs.
In my theory courses I used a tabbed Excel workbook to illustrate the
calculation of exit value net earnings as a plug vfubure. ---
www.cs.trinity.edu/~rjensen/Excel/wtdcase2a.xls
Especially note the Answers tab.
From the CFO Journal's Morning Ledger on May 5, 2017
Avon under pressure
Avon Products Inc.
Chief Executive Sheri McCoy faces new pressure following a surprise loss
that sent the cosmetics seller’s stock tumbling
Thursday.
Jensen Comment
Accounting standard setters cannot even operationally define the calculation of
earnings other than to make it a plug that makes the balance sheet balance. And
yet this plug remains as an exceedingly important driver of share prices in the
stock markets.
May 9, 2017 Question from Tom Selling
I’d like to brush up on the shortcomings of
Hicksian “income” for measuring the earnings of a business entity. Do
you (or anyone else on AECM, of course) have a reference (e.g., an article
or book chapter) to help me out?
Here is one of references that I recommend that are in the accounting
literature. The main take away here is that fair value accounting takes us
closer to the Hicksian concept of income at the expense of reliability. I
might note that Professor Schipper over the years is a proponent of falr
value accounting. This is not a defense of historical cost accounting as
might have been written by AC Littleton or Yuji Ijiri.
Especially note the references at the end of the commentary.
The main problem is that Hicksian Income in theory assumes all changes is
"wealth" or "well offness" where wealth includes much more than accountants
put on balance sheets. Examples include the many intangibles and contingent
liabilities that are left off balance sheets due to inability to measure
reliably such as the value of human resources and changes thereof. Also
accountants have never figured out how to measure the requisite "value in
use: as opposed to disposal value in a yard sale.
Bob Jensen
It would seem that, if the constraint of double-entry bookkeeping is removed as
a basis of financial reporting, the operational definitions of the major
performance indicator of "profit" for for-profit businesses will have to become
much more precise and operational than "profit" is presently defined as a
residual phenomenon in a double-entry bookkeeping system.
Some alternative approaches to income suggested by
Hicks and by other writers and their relevance to conceptual frameworks for
accounting
"Hicksian Income in the Conceptual Framework" ---
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1576611
Michael Bromwich London School of Economics
Richard H. Macve London School of Economics & Political Science (LSE) -
Department of Accounting and Finance
Shyam Sunder Yale School of Management
March 22, 2010
Abstract:
In seeking to replace accounting ‘conventions’ by ‘concepts’ in the pursuit
of principles-based standards, the FASB/IASB joint project on the conceptual
framework has grounded its approach on a well-known definition of ‘income’
by Hicks. We welcome the use of theories by accounting standard setters and
practitioners, if theories are considered in their entirety.
‘Cherry-picking’ parts of a theory to serve the immediate aims of standard
setters risks distortion. Misunderstanding and misinterpretation of the
selected elements of a theory increase the distortion even more. We argue
that the Boards have selectively picked from, misquoted, misunderstood, and
misapplied Hicksian concepts of income. We explore some alternative
approaches to income suggested by Hicks and by other writers, and their
relevance to current debates over the Boards’ conceptual framework and
standards. Our conclusions about how accounting concepts and conventions
should be related differ from those of the Boards. Executive stock options (ESOs)
provide an illustrative case study.
The International
Accounting Standards Board, or IASB, which sets reporting standards in more
than 120 countries, said Wednesday it would look at providing new
definitions of common financial terms such as earnings before interest and
taxes, or ebit.
The new definitions
will be introduced over the next five years, in order to provide sufficient
time for suggestions and comment from market participants.
The changes will not
result in new standards but will require the board to overhaul existing
ones.
At the moment, terms
like operating profit are not defined by the IASB. The aim is to help market
participants judge the suitability of a particular investment.
“We want to give
investors the right handles to look at a balance sheet,” said IASB chairman
Hans Hoogervorst.
Up until now,
International Financial Reporting Standards, known as IFRS, leave companies
too much flexibility in defining such terms, which often makes it difficult
to compare financials, Mr. Hoogervorst said.
“Even within sectors,
there is a lack of comparability,” Mr. Hoogervorst said. This affects both
investors and companies, he added.
It is too early to tell
what the changes will mean for companies reporting under IFRS, according to
Mr. Hoogervorst. “They should be less revolutionary than the introduction of
new standards but every change results in work”, he said.
Some firms might find
that they have less latitude when reporting financial results, he said. That
could mean more work.
Firms that decide
against adopting the new IASB definition for ebit, for example, could be
required to reconcile their own ebit calculation into one based on the
IASB’s definition.
The IASB in 2017 also
plans to finalize a single accounting model that would be applied to all
forms of insurance contracts.
Besides that, the board
will work on updating the system through which filers add disclosures to the
electronic versions of their financial statements. The system is updated on
a regular basis and the IASB produces an annual compilation of all changes
each year.
Jensen Comment
It would seem that, if the constraint of double-entry bookkeeping is removed as
a basis of financial reporting, the operational definitions of the major
performance indicator of "profit" for for-profit businesses will have to become
much more precise and operational than "profit" is presently defined as a
residual phenomenon in a double-entry bookkeeping system.
History of Women in Accounting and Other Women in the World
Among the AICPA-donated volumes at Ole Miss
are two binders containing photographs of individuals appearing in the
JofA or at accounting conventions from 1887 to 1979. Of the 446
individuals featured, eight are women—Christine Ross, Ellen Libby Eastman,
Miriam Donnelly, Mary E. Murphy, Helen Lord, Helen H. Fortune, Mary E. Lewis
and Beth M. Thompson. In a time when the profession was the
all-but-exclusive domain of men, they stood out not only because of their
gender but in many cases because of their accomplishments and contributions
to accounting. Consider that in 1933, slightly more than 100 CPA
certificates had been issued to women. By 1946, World War II had changed
traditional notions of gender in the workplace, and female CPAs had more
than tripled to 360—still a small contingent but, as information gleaned
from the AICPA Library indicates, one capable of exerting a strong and
beneficial influence on the profession.
Christine Ross
Born about 1873 in Nova Scotia, Ross took New York by storm in the late
1890s. New York state enacted licensure legislation in 1896 and gave its
inaugural CPA exam in December 1896. Ross sat for the exam in June 1898,
scoring second or third in her group. Six to 18 months elapsed while her
certificate was delayed by state regents because of her gender. But she had
completed the requirements and became the first woman CPA in the United
States, receiving certificate no. 143 on Dec. 21, 1899.
Ross began practicing accounting around
1889. For several years, she worked for Manning’s Yacht Agency in New York.
Her clients included women’s organizations, wealthy women and those in
fashion and business.
Helen Lord
Lord received her CPA certificate from New York in 1934 and in 1935 joined
the American Society of Certified Public Accountants, which merged with the
American Institute of Accountants (later AICPA) the following year. In 1937,
she was a partner with her father in the New York firm of Lord & Lord and a
member of the AIA. She served in the late 1940s as business manager of
The Woman CPA, published by the American Woman’s Society of Certified
Public Accountants–American Society of Women Accountants. Lord reported the
journal then had a circulation of more than 2,200.
Helen Hifner Fortune
Fortune, one of the first women CPAs in Kentucky, received certificate no.
174 in 1935 and was admitted to the AIA the following year. She became a
member of an AIA committee in 1942 and by 1947 was a partner in the
Lexington, Ky., firm of Hifner and Fortune.
Ellen Libby Eastman
Eastman began her career as a clerk in a Maine lumber company, eventually
becoming chief accountant. She studied for the CPA exam at night and became
the first woman CPA in Maine, receiving certificate no. 37 dated 1918. She
was also the first woman to establish a public accounting practice in New
England. Arriving in New York in 1920, Eastman focused on tax work and
audited the accounts of the American Women’s Hospital in Greece. In 1925,
she was a member of the ASCPA. In 1940, Eastman began working with the law
firm of Hawkins, Delafield & Longfellow in New York.
She was outspoken and eloquent regarding a
woman’s ability to succeed in accounting. In a 1929 article in The
Certified Public Accountant, Eastman recounted her adventures:
One must be willing and able to endure
long and irregular hours, unusual working arrangements and difficult travel
conditions. I have worked eighteen out of the twenty-four hours of a day
with time for but one meal; I have worked in the office of a bank president
with its mahogany furnishings and oriental rugs and I have worked in the
corner of a grain mill with a grain bin for a desk and a salt box for a
chair; I have been accorded the courtesy of the private car and chauffeur of
my client and have also walked two miles over the top of a mountain to a
lumber camp inaccessible even with a Ford car. I have ridden from ten to
fifteen miles into the country after leaving the railroad, the only
conveyance being a horse and traverse runners—and this in the severity of a
New England winter. I have done it with a thermometer registering fourteen
degrees below zero and a twenty-five mile per hour gale blowing. I have
chilled my feet and frozen my nose for the sake of success in a job which I
love. I have been snowbound in railroad stations and have been stranded five
miles from a garage with both rear tires of my car flat. I have ridden into
and out of open culvert ditches with the workmen shouting warnings to me.
And always one must keep the appointment; “how” is not the client’s concern.
Mary E. Murphy
A long-lived pioneer, Murphy (1905–1985) lectured, researched and taught in
the United States and abroad, retiring in 1973. The Iowa native earned her
bachelor of commerce degree with a major in accounting from the University
of Iowa in 1927, then obtained a master’s in accountancy in 1928 from
Columbia University Business School. In 1938, she received a doctorate in
accountancy—only the second woman in the United States to do so—from the
London School of Economics.
In 1928, Murphy began working in the New York office of Lybrand, Ross Bros.
& Montgomery. Two years later, she took the CPA exam in Iowa and received
certificate no. 67, to become the first woman CPA in Iowa. She joined the
AIA in 1937.
Following her public accounting stint, she
served for three years as the chair of the Department of Commerce at St.
Mary’s College in Notre Dame, Ind. Murphy also was an assistant professor of
economics at Hunter College of the City University of New York until 1951.
In 1952, she received the first Fulbright professorship of accounting, with
assignments in Australia and New Zealand. In 1957, she was appointed as the
first director of research of the Institute of Chartered Accountants in
Australia. Murphy retired in 1973 from the accounting faculty at California
State University.
She published or collaborated on more than
20 books and 100 journal articles and many book reviews and scholarly
papers. From 1946 to 1965 she was the most frequently published author in
The Accounting Review. Murphy investigated the role of accounting
in the economy, made the case for accounting education improvements and
paved the way for other aspiring women accountants to prosper. More than
half her publications explored international accounting, often advocating
standardization. She also emphasized accounting history and biographies.
Mary E. Lewis
Lewis received California CPA certificate no. 1404 in 1939. She was admitted
to the AIA that year and by 1947 had her own firm in Los Angeles.
Beth M. Thompson
Thompson worked as the office manager in the Kentucky Automobile Agency she
and her husband, Charles R. Thompson, owned. After closing the car business,
they moved to Florida, where she worked for an accounting firm. She passed
the CPA exam in 1951 with the encouragement of her husband and opened her
own accounting business in Miami. In 1955, Thompson was one of only 900
women CPAs and the only female president of a state association chapter—the
Dade County chapter of the Florida Institute of CPAs.
Miriam Donnelly
From 1949 to 1955, Donnelly was head librarian of the AIA library. (In 1957,
the AIA was renamed the AICPA.) She began her career with the library as
assistant librarian and cataloger in 1927, after working for two
governmental libraries and the New York Public Library.
Accounting History Libraries at the University of Mississippi (Ole Miss) ---
http://www.olemiss.edu/depts/accountancy/libraries.html There are many items pertaining to accounting women in history, especially
in the Accounting Historians Journal
The first issue below is related to the one
addressed by Bennis and O'Toole. According to Hopwood, research in
business schools is becoming increasingly distanced from the reality of
business. The worlds of practice and research have become ever more
separated. More and more accounting and finance researchers know less and
less about accounting and finance practice. Other professions such as
medicine have avoided this problem so it is not an inevitable development.
Another issue has to do with the status of
management accounting. Hopwood tells us that the term management accountant
is no longer popular and virtually no one in the U.S. refers to themselves
as a management accountant. The body of knowledge formally associated with
the term is now linked to a variety of other concepts and job titles. In
addition, management accounting is no longer an attractive subject to
students in business schools. This is in spite of the fact that many
students will be working in positions where a knowledge of management
control and systems design issues will be needed. Unfortunately, the present
positioning and image of management accounting does not make this known.
Continued in article
June 29, 2013 reply from Zane Swanson
Hi Bob,
A key word of incentive comes up as it relates to
the practitioner motivator of the nature of accounting and financing
research. The AICPA does give an educator award at the AAA convention and so
it isn't as though the practitioners don't care about accounting
professorship activity.
Maybe, the "right"' type of incentive needs to be
designed. For example, it was not so many years ago that firms developed
stock options to align interests of management and investors. Perhaps, a
similar option oriented award could be designed to align the interests of
research professors and practitioners. Theoretically, practitioners could
vest a set of professors for research publications in a pool for a
particular year and then grant the exercise of the option several years
later with the attainment of a practitioner selected goal level (like HR
performance share awards). This approach could meet your calls to get
researchers to write "real world" papers and to have follow up replications
to prove the point.
However, there are 2 road blocks to this approach.
1 is money for the awards. 2 is determining what the practitioner
performance features would be.
You probably would have to determine what
practitioners want in terms of research or this whole line of discussion is
moot.
The point of this post is: Determining research
demand solely by professors choices does not look like it is addressing your
"real world" complaints.
Respectfully,
Zane
June 29, 2013 reply from Bob Jensen
Hi Zane,
I had a very close friend (now dead) in the Engineering Sciences
Department at Trinity University. I asked him why engineering professors
seemed to be much closer to their profession than many other departments in
the University. He said he thought it was primarily that doctoral students
chose engineering because they perhaps were more interested in being problem
solvers --- and their profession provided them with an unlimited number of
professional problems to be solved. Indeed the majority of Ph.D. graduates
in engineering do not even join our Academy. The ones that do are not a
whole lot different from the Ph.D. engineers who chose to go into industry
except that engineering professors do more teaching.
When they take up research projects, engineering professors tend to be
working with government (e.g., the EPA) and and industry (e.g., Boeing) to
help solve problems. In many instances they work on grants, but many
engineering professors are working on industry problems without grants.
In contrast, accounting faculty don't like to work with practitioners to
solve problems. In fact accounting faculty don't like to leave the campus to
explore new problems and collect data. The capital markets accounting
researchers purchase their databases and them mine the data. The behavioral
accounting researchers study their students as surrogates for real world
decision makers knowing full well that students are almost always poor
surrogates. The analytical accounting researchers simply assume the world
away. They don't set foot off campus except to go home at night. I know
because I was one of them for nearly all of my career.
Academic accounting researchers submit very little original research work
to journals that practitioners read. Even worse a hit in an accounting
practitioner journal counts very little for promotion and tenure especially
when the submission itself may be too technical to interest any of our AAA
journal editors, e.g., an editor told me that the AAA membership was just
not interested in technical articles on valuing interest rate swaps, I had
to get two very technical papers on accounting for derivative financial
instruments published in a practitioner journal (Derivatives Reports)
because I was told that these papers were just too technical for AAA journal
readers.
Our leading accountics science researchers have one goal in mind ---
getting a hit in TAR, JAR, or JAE or one of the secondary academic
accounting research journals that will publish accountics research. They
give little or no priority to finding and helping to solve problems that
practitioners want solved. They have little interest in leaving the ivory
tower to collect their own messy real-world data.
Awards and even research grants aren't the answer to making accounting
professors more like engineering, medical, and law professors. We need to
change the priorities of TAR, JAR, JAE, and other top academic accounting
research journals where referees ask hard questions about how the practice
of the profession is really helped by the research findings of virtually all
submitted articles.
In short, we need to become better problem solvers in a way like
engineering, medical, and law professors are problem solvers on the major
problems of their professions. A great start would be to change the
admissions criteria of our top accounting research journals.
Sue Haka, former AAA President, commenced a thread on the AAA Commons
entitled "Saving Management Accounting in the Academy,"
---
http://commons.aaahq.org/posts/98949b972d
A succession of comments followed.
The latest comment (from James Gong) may be of special interest to some of
you.
Ken Merchant is a former faculty member from Harvard University who form many
years now has been on the faculty at the University of Southern California.
Here are my two cents. First, on the teaching side,
the management accounting textbooks fail to cover new topics or issues. For
instance, few textbooks cover real options based capital budgeting, product
life cycle management, risk management, and revenue driver analysis. While
other disciplines invade management accounting, we need to invade their
domains too. About five or six years ago, Ken Merchant had written a few
critical comments on Garrison/Noreen textbook for its lack of breadth. Ken's
comments are still valid. Second, on the research and publication side,
management accounting researchers have disadvantage in getting data and
publishing papers compared with financial peers. Again, Ken Merchant has an
excellent discussion on this topic at an AAA annual conference.
Hi Bob,
You have expressed your concerns articulately and passionately. However,
in terms of creating value to society in general, your "action plan" of
getting the "top" of the profession (editors) to take steps appears
unlikely. As you pointed out, the professors who create articles do it with
resources immediately under their control in the most expeditious fashion in
order to get tenure, promotion and annual raises. The editors take what
submissions are given. Thus, it is an endless cycle (a closed loop, a
complete circle). As you noted the engineering profession has different
culture with a "make it happen" objective real world. In comparison with
accounting, the prospect of "only" accounting editors from the top dictating
research seems questionable. Your critique suggests that the "entire"
accounting research culture needs a paradigm shift of real world action
consequences in order to do what you want. The required big data shift is
probably huge and is a reason that I suggested starting an options alignment
mechanism of interests of practitioners and researchers.
Respectfully,
Zane
June 30, 2013 reply from Bob Jensen
Hi Zane,
You may be correct that a paradigm
shift in accountics research is just not feasible given the
generations of econometrics, psychometrics. and mathematical
accountics researchers that virtually all of the North American
doctoral programs have produced.
I think Anthony Hopwood, Paul Williams, and
others agree with you that it will take a paradigm shift that just is
not going to happen in our leading journals like TAR, JAR, JAE, CAR,
etc. Paul, however, thinks we are making some traction, especially since
virtually all AAA presidents since Judy Rayburn have made appeals fro a
paradigm shift plus the strong conclusions of the Pathways Commission
Report. However, that report seems to have fallen on deaf ears as far as
accountics scientists are concerned.
Other historical scholars like Steve Zeff, Mike
Granfof, Bob Kaplan, Judy Rayburn, Sudipta Basu, and think that we can wedge
these top journals to just be a bit more open to alternative research
methods like were used in the past when practitioners took a keen interest
in TAR and even submitted papers to be published in TAR --- alternative
methods like case studies, field studies, and normative studies without
equations.
"We fervently
hope that the research pendulum will soon swing back from the narrow lines
of inquiry that dominate today's leading journals to a rediscovery of the
richness of what accounting research can be. For that to occur, deans and
the current generation of academic accountants must
give it a push."
Granof and Zeff ---
http://www.trinity.edu/rjensen/TheoryTAR.htm#Appendix01
Michael H. Granof is a professor of accounting at the McCombs School of
Business at the University of Texas at Austin. Stephen A. Zeff is a
professor of accounting at the Jesse H. Jones Graduate School of Management
at Rice University.
Accounting Scholarship that
Advances Professional Knowledge and Practice
Robert S. Kaplan The Accounting Review, March 2011, Volume 86, Issue 2,
Separately and independently, both
Steve Kachelmeier (Texas) and Bob Kaplan (Harvard) singled out
the Hunton and Gold (2010) TAR article as being an excellent
paradigm shift model in the sense that the data supposedly was
captured by practitioners with the intent of jointly working
with academic experts in collecting and analyzing the data
---
If that data had subsequently not been
challenged for integrity (by whom is secret) that Hunton and Gold
(2010) research us the type of thing we definitely would like to see
more of in accountics research.
Unfortunately, this excellent example may
have been a bit like Lance Armstrong being such a winner because he did
not playing within the rules.
For Jim Hunton maybe the world did
end on December 21, 2012
James E. Hunton, a
prominent accounting professor at Bentley University, has resigned
amid an investigation of the retraction of an article of which he
was the co-author, The Boston Globe reported. A spokeswoman cited
"family and health reasons" for the departure, but it follows the
retraction of an article he co-wrote in the journal Accounting
Review. The university is investigating the circumstances that led
to the journal's decision to retract the piece.
Retraction: A Field
Experiment Comparing the Outcomes of Three Fraud Brainstorming
Procedures: Nominal Group, Round Robin, and Open Discussion
James E. Hunton,
Anna Gold Bentley University and Erasmus University Erasmus
University This article was originally published in 2010 in The
Accounting Review 85 (3) 911–935; DOI:
10/2308/accr.2010.85.3.911
The authors
confirmed a misstatement in the article and were unable to provide
supporting information requested by the editor and publisher.
Accordingly, the article has been retracted.
Jensen Comment
The TAR article retraction in no way detracts from this study being a
model to shoot for in order to get accountics researchers more involved
with the accounting profession and using their comparative advantages to
analyze real world data that is more granulated that the usual practice
of beating purchased databases like Compustat with econometric sticks
and settling for correlations rather than causes.
The objective of the conceptual framework project
is to develop an improved conceptual framework that provides a sound
foundation for developing future accounting standards. Such a framework is
essential to fulfilling the Board’s goal of developing standards that are
principles based, internally consistent, and that lead to financial
reporting that provides the information capital providers need to make
decisions in their capacity as capital providers. The new FASB framework
will build on the existing framework.
The Conceptual Framework sets out the concepts that
underlie the preparation and presentation of financial statements. It is a
practical tool that assists the IASB when developing and revising IFRSs. The
objective of the Conceptual Framework project is to improve financial
reporting by providing the IASB with a complete and updated set of concepts
to use when it develops or revises standards.
This I've got to see
The standard setters' (IASB and FASB) balance sheet priority over the income
statement totally destroyed the concepts of "income" and "earnings."
I'm anxiously awaiting to see the IASB's operational definition of "earnings"
underlying the forthcoming definition of EBIT, etc.
One of my main concerns in this definition is the jumbling of legally earned
revenues with unrealized value changes.
From the CFO Journal's Morning Ledger on May 8, 201
The largest U.S. companies are booking their strongest
quarterly profits in five years,
as firms reap the benefits of years of belt tightening and finally see a
pickup in demand. But part of the improvement has come from keeping a lid on
spending, and many CEOs remain reluctant to change and open their wallets
for new projects, plants and people, Thomas Gryta and Theo Francis write.
Profits at S&P 500 companies jumped an estimated 13.9% in the first quarter,
growing nearly twice as fast as revenue. The gains stretched across
industries, from Wall Street’s banks to Silicon Valley’s web giants, and
were helped by a rebound in the battered energy sector. The picture was a
marked improvement from a year ago, when profits fell 5%, and was the best
performance since the third quarter of 2011.
ensen Comment
Accounting standard setters cannot even operationally define the calculation of
earnings other than to make it a plug that makes the balance sheet balance. And
yet this plug remains as an exceedingly important driver of share prices in the
stock markets.
From the CFO Journal's Morning Ledger on May 5, 2017
Avon under pressure
Avon Products Inc.
Chief Executive Sheri McCoy faces new pressure following a surprise loss
that sent the cosmetics seller’s stock tumbling
Thursday.
Jensen Comment
Accounting standard setters cannot even operationally define the calculation of
earnings other than to make it a plug that makes the balance sheet balance. And
yet this plug remains as an exceedingly important driver of share prices in the
stock markets.
May 9, 2017 Question from Tom Selling
I’d like to brush up on the shortcomings of
Hicksian “income” for measuring the earnings of a business entity. Do
you (or anyone else on AECM, of course) have a reference (e.g., an article
or book chapter) to help me out?
Here is one of references that I recommend that are in the accounting
literature. The main take away here is that fair value accounting takes us
closer to the Hicksian concept of income at the expense of reliability. I
might note that Professor Schipper over the years is a proponent of falr
value accounting. This is not a defense of historical cost accounting as
might have been written by AC Littleton or Yuji Ijiri.
Especially note the references at the end of the commentary.
The main problem is that Hicksian Income in theory assumes all changes is
"wealth" or "well offness" where wealth includes much more than accountants
put on balance sheets. Examples include the many intangibles and contingent
liabilities that are left off balance sheets due to inability to measure
reliably such as the value of human resources and changes thereof. Also
accountants have never figured out how to measure the requisite "value in
use: as opposed to disposal value in a yard sale.
Bob Jensen
It would seem that, if the constraint of double-entry bookkeeping is removed as
a basis of financial reporting, the operational definitions of the major
performance indicator of "profit" for for-profit businesses will have to become
much more precise and operational than "profit" is presently defined as a
residual phenomenon in a double-entry bookkeeping system.
Some alternative approaches to income suggested by
Hicks and by other writers and their relevance to conceptual frameworks for
accounting
"Hicksian Income in the Conceptual Framework" ---
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1576611
Michael Bromwich London School of Economics
Richard H. Macve London School of Economics & Political Science (LSE) -
Department of Accounting and Finance
Shyam Sunder Yale School of Management
March 22, 2010
Abstract:
In seeking to replace accounting ‘conventions’ by ‘concepts’ in the pursuit
of principles-based standards, the FASB/IASB joint project on the conceptual
framework has grounded its approach on a well-known definition of ‘income’
by Hicks. We welcome the use of theories by accounting standard setters and
practitioners, if theories are considered in their entirety.
‘Cherry-picking’ parts of a theory to serve the immediate aims of standard
setters risks distortion. Misunderstanding and misinterpretation of the
selected elements of a theory increase the distortion even more. We argue
that the Boards have selectively picked from, misquoted, misunderstood, and
misapplied Hicksian concepts of income. We explore some alternative
approaches to income suggested by Hicks and by other writers, and their
relevance to current debates over the Boards’ conceptual framework and
standards. Our conclusions about how accounting concepts and conventions
should be related differ from those of the Boards. Executive stock options (ESOs)
provide an illustrative case study.
The International
Accounting Standards Board, or IASB, which sets reporting standards in more
than 120 countries, said Wednesday it would look at providing new
definitions of common financial terms such as earnings before interest and
taxes, or ebit.
The new definitions
will be introduced over the next five years, in order to provide sufficient
time for suggestions and comment from market participants.
The changes will not
result in new standards but will require the board to overhaul existing
ones.
At the moment, terms
like operating profit are not defined by the IASB. The aim is to help market
participants judge the suitability of a particular investment.
“We want to give
investors the right handles to look at a balance sheet,” said IASB chairman
Hans Hoogervorst.
Up until now,
International Financial Reporting Standards, known as IFRS, leave companies
too much flexibility in defining such terms, which often makes it difficult
to compare financials, Mr. Hoogervorst said.
“Even within sectors,
there is a lack of comparability,” Mr. Hoogervorst said. This affects both
investors and companies, he added.
It is too early to tell
what the changes will mean for companies reporting under IFRS, according to
Mr. Hoogervorst. “They should be less revolutionary than the introduction of
new standards but every change results in work”, he said.
Some firms might find
that they have less latitude when reporting financial results, he said. That
could mean more work.
Firms that decide
against adopting the new IASB definition for ebit, for example, could be
required to reconcile their own ebit calculation into one based on the
IASB’s definition.
The IASB in 2017 also
plans to finalize a single accounting model that would be applied to all
forms of insurance contracts.
Besides that, the board
will work on updating the system through which filers add disclosures to the
electronic versions of their financial statements. The system is updated on
a regular basis and the IASB produces an annual compilation of all changes
each year.
Jensen Comment
It would seem that, if the constraint of double-entry bookkeeping is removed as
a basis of financial reporting, the operational definitions of the major
performance indicator of "profit" for for-profit businesses will have to become
much more precise and operational than "profit" is presently defined as a
residual phenomenon in a double-entry bookkeeping system.
From the CFO Journal's Morning Ledger
on November 3, 2016
IASB evaluating EBIT
The International Accounting Standards Board said
Wednesday it would look at providing new
definitions of common financial terms such as earnings before interest and
taxes, or ebit. The new definitions will be introduced over the next five
years, in order to provide sufficient time for suggestions and comment from
market participants, Nina Trentmann reports.
The International Accounting Standards Board, or
IASB, which sets reporting standards in more than 120 countries, said
Wednesday it would look at providing new definitions of common financial
terms such as earnings before interest and taxes, or ebit.
The new definitions will be introduced over the
next five years, in order to provide sufficient time for suggestions and
comment from market participants.
The changes will not result in new standards but
will require the board to overhaul existing ones.
At the moment, terms like operating profit are not
defined by the IASB. The aim is to help market participants judge the
suitability of a particular investment.
“We want to give investors the right handles to
look at a balance sheet,” said IASB chairman Hans Hoogervorst.
Up until now, International Financial Reporting
Standards, known as IFRS, leave companies too much flexibility in defining
such terms, which often makes it difficult to compare financials, Mr.
Hoogervorst said.
“Even within sectors, there is a lack of
comparability,” Mr. Hoogervorst said. This affects both investors and
companies, he added.
It is too early to tell what the changes will mean
for companies reporting under IFRS, according to Mr. Hoogervorst. “They
should be less revolutionary than the introduction of new standards but
every change results in work”, he said.
Some firms might find that they have less latitude
when reporting financial results, he said. That could mean more work.
Firms that decide against adopting the new IASB
definition for ebit, for example, could be required to reconcile their own
ebit calculation into one based on the IASB’s definition.
The IASB in 2017 also plans to finalize a single
accounting model that would be applied to all forms of insurance contracts.
Besides that, the board will work on updating the
system through which filers add disclosures to the electronic versions of
their financial statements. The system is updated on a regular basis and the
IASB produces an annual compilation of all changes each year.
"The IASB and ASBJ Conceptual Frameworks: Same Objective, Different
Financial Performance Concepts," by Carien van Mourik and Yuko Katsuo,
Accounting Horizons, Volume 29, Issue 1 (March 2015) ---
http://aaajournals.org/doi/full/10.2308/acch-50902
This paper illustrates that, despite their general
agreement on the decision-usefulness objective of general purpose financial
reporting, the Accounting Standard Board of Japan (ASBJ) and the
International Accounting Standards Board (IASB)'s conceptual frameworks are
based on two different concepts of financial performance. By identifying and
contrasting the two financial performance concepts and their impact on the
rest of the frameworks and by explaining the thinking that underpins the
ASBJ's chosen financial performance concept, it contributes to a debate
about the role of financial performance concepts in fulfilling the
decision-usefulness objective. Such a debate is pertinent to the revision of
the IASB's Conceptual Framework, which is scheduled for completion in 2015.
. . .
The revision of the International Accounting
Standards Board (IASB)'s Conceptual Framework is scheduled for completion in
2015. This commentary is motivated by the fact that neither the 2010 IASB
Conceptual Framework nor the IASB's 2013 Discussion Paper explains in detail
how the particular concept of financial performance underpinning the IASB
Conceptual Framework leads to financial reporting standards and financial
accounting information that best fulfill the objective of general purpose
financial reporting.
This commentary contrasts the 2010 IASB Conceptual
Framework with the Accounting Standard Board of Japan (ASBJ)'s 2006
Conceptual Framework Discussion Paper (DP). Both conceptual frameworks are
developed from the Financial Accounting Standards Board (FASB) Framework,
but despite their agreement on the decision-usefulness objective of general
purpose financial reporting, the IASB and the ASBJ arrive at different
concepts of financial performance. After identifying and contrasting the
IASB's and the ASBJ's financial performance concepts and their impact on the
rest of the two frameworks, this commentary explains the ASBJ's arguments
for its choice of financial performance concept. The aim is to stimulate and
contribute to an international academic debate about how different concepts
of financial performance are thought to best fulfill the same
decision-usefulness objective.
In this commentary, the term “financial performance
concept” refers to the logic and principles underlying the definition,
recognition, measurement, presentation, and disclosure of the elements of
the statement of financial performance. A system of articulated financial
statements (where the flow statements reconcile with items in the stock
statement at two points in time) requires that the logic and principles be
the same as that underlying the definition, recognition, measurement,
presentation, and disclosure of the elements of the statement of financial
position, the cash flow statement, and the statement of changes in equity.
In contrast, under the non-articulated view, the logic and principles for
the stock statement and the flow statements may be different and therefore
the financial statements cannot directly be reconciled, either within a
period or across time.1 Both the 2010 IASB Framework and the 2006 ASBJ
Framework (which, as will be explained later, is still a discussion paper
[DP]) adhere to the articulated view.2
The 2010 IASB Framework adopts an “all-inclusive
realisable changes in net assets” concept of financial performance. This
means that it recognizes changes in assets and liabilities as income or
expenses when they are realizable (i.e., measurable and reasonably certain
to be realized). On the other hand, the 2006 ASBJ Framework DP adopts a
“released-from-risk net income” concept of financial performance. It
recognizes changes in assets and liabilities as revenues/gains and
expenses/losses in the profit or loss section of the statement of financial
performance when they have either been realized through the receipt or
payment of cash or assets convertible into cash, or released from risk by
virtue of deriving from a financial investment in an asset for which the
exit price equals the entry price.
This commentary consists of four further sections.
First, we present a brief comparative overview of the contexts in which the
2010 IASB Framework and 2006 ASBJ Framework DP were developed, and discuss
their objectives, statuses, and structures. Second, we contrast the
objective of general purpose financial reporting, the qualitative
characteristics, and the financial performance concepts in both frameworks.
Third, we describe how the ASBJ decided on the released-from-risk net income
concept of financial performance and discuss the accounting thought
underpinning this financial performance concept. The fourth and final
section summarizes and concludes.
CONTEXTS, STATUSES, AND STRUCTURES Context and
Status of the 2010 IASB Framework
The International Accounting Standards Committee (IASC)
was established in 1973 by 14 accountancy bodies in seven countries (Camfferman
and Zeff 2007, 48–49). In the early years, the IASC took decisions on a
pragmatic rather than a conceptual basis with the result that its early
standards included numerous, not necessarily theoretically consistent,
options (Camfferman and Zeff 2007, 253). After the FASB completed its
conceptual framework, the IASC established its own conceptual framework in
1989. Framework for the Preparation and Presentation of Financial Statements
“was strongly reminiscent of the FASB's Statements of Financial Accounting
Concepts No. 1, 2, 3, and 5 (1978–1984)” (Camfferman and Zeff 2007, 260).
The 1989 IASC Framework had been established
following a due process that was in essence the same as that set out in the
1973 IASC Constitution (Camfferman and Zeff 2007, 352). In 2001 the IASB
adopted the 1989 Framework without any critical review of its philosophical
and theoretical foundations. In October 2004, the IASB and the FASB decided
to start a joint project to work on a common conceptual framework, which
resulted in Chapters 1 and 3 of the 2010 IASB Framework. The objective of
the project was not to fundamentally review the old 1989 IASC Framework or
the existing FASB Framework, but rather to iron out differences between the
two frameworks. In 2012 the IASB announced that it would recommence its work
on revising Chapter 4 (the remainder of the 1989 IASC Framework) on its own
and in July 2013 issued a DP (IASB 2013). An exposure draft is expected in
early 2015. Context and Status of the 2006 ASBJ Framework DP
Until 2001, the Business Accounting Deliberation
Council (BADC) was the public accounting standard setter in Japan.3 The
Japanese “Accounting Big Bang” started with the establishment of the
Financial Supervisory Agency in 1998, renamed the Financial Services Agency
(FSA) in 2000, with responsibility for ensuring the stability of the
Japanese financial system and the regulation and transparency of the
Japanese financial and securities markets.4 On July 26, 2001 the Financial
Accounting Standards Foundation was established consisting of a board of
directors, trustees, the ASBJ, and an advisory council. Since then, the ASBJ
has been Japan's private sector accounting standard setter.
In January 2003, a Concepts Working Group,
organized by the ASBJ and consisting of nine accounting academics5 and the
seven ASBJ members, started the task of drafting a conceptual framework for
the ASBJ. The Concepts Working Group issued its first full draft of a DP on
June 22, 2004, which was revised in September 2004. By 2005 however, the
IASB and FASB had started their joint convergence project that included
convergence of their conceptual frameworks. Furthermore, in 2005 the IASB
and ASBJ had started meetings on the convergence of financial accounting
standards, and in 2006 the FASB and ASBJ did the same. Around the same time,
Japan was being considered in the equivalence assessment by the EU
(Nishikawa 2011, 4). For these reasons, the ASBJ chose to issue the
Conceptual Framework again as a DP rather than as an exposure draft, which
it did in December 2006 (Saito 2007, 3). The ASBJ believed that the DP would
further evolve through participation in international discussions,
particularly with the IASB and the FASB (ASBJ 2006, Preface). In spite of
its unofficial status, the 2006 ASBJ Framework DP did have an impact on
Japanese accounting standards, for example in the area of accounting for
pensions.6 Structures of the Frameworks
The 2006 ASBJ Conceptual Framework follows the
structure of the 1989 IASC/2001 IASB Conceptual Framework as the ASBJ
thought that this would facilitate communication and mutual understanding (ASBJ
2006, Preface). The 2010 IASB Conceptual Framework has a slightly different
structure, but it also consists of an introduction and four chapters. As
yet, Chapter 2 on the reporting entity has no content, while Chapter 4 is
the remainder of the 1989 IASC/2001 IASB Conceptual Framework. Table 1 shows
the comparative structures of the two frameworks.
Continued in article
"Developing a Conceptual Framework to
Appraise the Corporate Social Responsibility Performance of Islamic Banking and
Finance Institutions," by M. Mansoor Khan, Accounting and the
Public Interest, American Accounting Association, Volume 13, Issue 1
(December 2013) ---
http://aaajournals.org/doi/abs/10.2308/apin-10375
Abstract
This paper fills some of theoretical and empirical deficiencies
regarding Corporate Social Responsibility (CSR) dimensions in Islamic
Banking and Financial Institutions (IBFIs). The firms' CSR initiatives are
the key to secure success in modern business and society, and there is a
scope to develop a broader understanding of CSR in globally integrated
business and financial markets. This paper provides the Islamic perspective
of CSR, which is etho-religious based and, thus, more meaningful and
intensified. It proposes a CSR framework for IBFIs based on principles of
Islamic economics and society. The proposed framework urges IBFIs to engage
in community-based banking, work toward the betterment of the poor, ensure
the most efficient and socially desirable utilization of financial
resources, develop their institutional frameworks, infrastructures, and
innovative products to facilitate the wider circulation of wealth and
sustainable development in the world. This paper observes that IBFIs have
failed to deal with underlying CSR challenges due to lack of commitment and
expertise in the field. The CSR-based outlook of IBFIs can only ensure their
legitimacy, sustainability, and long-term success.
Jensen Comment
All accounting standard setters destroyed the concept of net income by giving
priority to balance sheet concepts and fair value accounting where unrealized
changes in transitory fair value are combined with realized net income. As a
result there is no longer a concept of net income since the days of historical
cost accounting standards ala Paton and Littleton ---
http://faculty.trinity.edu/rjensen/Theory01.htm#Paton
Accounting History Corner
"SPROUSE’S WHAT-YOU-MAY-CALL-ITS: FUNDAMENTAL INSIGHT OR MONUMENTAL MISTAKE?"
by Sudipta Basu and Gegory B. Waymire Accounting Historians Journal, 2010, Vol. 37, no. 1 ---
http://umiss.lib.olemiss.edu:82/articles/1038402.7233/1.PDF
Hi Glen,
I have some troubles with the link as well. For me, the PDF will run in
my Windows 7 laptop but not my newer Windows 10 laptop, although this
morning the link I gave you is not working on either laptop.
It may be that you have to route to the article as described below.
Then scroll down to 2010 Volume 37 Number 1 and click on the line that
says to View Searchable PDF Text File
Then scroll down to the article page numbers may not exactly coincide with
the table of contents depending upon the resolution of your browser.
Abstract
We critically evaluate Sprouse’s 1966 Journal of Accountancyarticle, which
prodded the FASB towards a balance-sheet approach. We highlight three errors
in this article.
First,
Sprouse confuses necessary and sufficient conditions by arguing that
good accounting systems must satisfy the balance-sheet equation. Second, Sprouse’s insinuation that financial analysts rely on
balance-sheet analysis is contradicted by contemporary and current
security-analysis textbooks, analysts’ written reports, and interviews
with analysts. Third,
and most crucially, Sprouse does not recognize that the primary role
of accounting systems is to help managers discover and exploit profit
able exchange opportunities, without which firms cannot survive
CONCLUDING OBSERVATIONS ON THE LEGACY OF THE
ASSET-LIABILITY APPROACH
Sprouse [1966] is important neither because of its
conceptual insights nor because of its unpersuasive evidence. Rather, the
article matters mainly because it shaped the FASB’s rhetoric and subsequent
standard-setting approach and today’s international standard-setting agenda.
Sprouse’s misinterpretation of Graham and Dodd’s Security Analysis
foreshadows the FASB and IASB misinterpretation of Hicks [1939]. Sprouse and
the two Boards are equally culpable in ignoring actual security-analyst
behavior when advocating their preferences, relying instead on made-up
“users” [Young 2006]. Thus, the current FASB/IASB Conceptual Framework [FASB,
2006] is justifiably seen as a direct descen dant of Sprouse [1966].
Sprouse and the two Boards ignore the implications
(or are unaware) of one of the major stylized facts of U.S. financial
reporting history – the shift from a balance-sheet approach to an
income-statement approach during 1900-1930. The shift to an income-statement
approach is usually attributed to the information needs of a massive influx
of individual investors into U.S. equity markets during this era [e.g.,
Hendriksen, 1970, pp. 51-55]. If individual equity investors are
primarily interested in balance-sheet information, then this shift should
not have occurred when it did. Sprouse and the two Boards never address this
salient historical evidence that contradicts their core as assumption of
investor information needs. More broadly, Sprouse and the two Boards ignore
the historical development of the revenue-expense approach, both in theory
and practice, which we survey in this paper. If financial accounting has
emerged over many generations to maintain consilience with the biologically
evolved human brain [Dickhaut et al., 2010], then an abrupt change to a
fair-value-based, asset-liability approach might well make financial reports
less useful to actual human readers.
Contrary to theoretical ruminations of Sprouse,
security analysts to this day rely primarily on earnings forecasts in
valuing firms. However, today’s analysts can construct their earnings
forecasts only after adjusting for many more non-recurring items that the
FASB has introduced into the income statement. Although SFAS 130 [FASB,
1997] introduced a broader, comprehensive income concept that includes even
more non-recurring items, analysts show no interest in forecasting it or
using it in their analyses. We believe that the FASB’s shift in focus to the
balance sheet has created bigger problems than merely whether financial
analysts have to adjust for new income statement “thingamajigs” instead of
balance sheet “what-you-may-call-its.”
We claim that the lack of analyst interest in the
FASB-mandated, non-recurring items is symptomatic of a monumental mistake in
the asset-liability approach; specifically, it is misaligned with the
reasons that firms exist and the resulting demand for causaldouble-entry
accounting as an economic institution. In other words, while the
asset-liability approach is constructively rational, i.e. deduced from
assumptions that work in a theoretical model, it is unlikely to be
ecologically rational in the sense of improving firms’ survival prospects in
the complex real world [Sargent, 2008; Smith, 2008].
Net earnings and EBITDA cannot be defined since
the FASB and IASB elected to give the balance sheet priority over the income
statement in financial reporting --- "The Asset-Liability Approach: Primacy does not mean Priority,"
by Robert Bloomfield, FASRI Financial Accounting Standards Research
Initiative, October 6, 2009 ---
http://www.fasri.net/index.php/2009/10/the-asset-liability-approach-primacy-does-not-mean-priority/
This I've got to see
The standard setters' (IASB and FASB) balance sheet priority over the income
statement totally destroyed the concepts of "income" and "earnings."
I'm anxiously awaiting to see the IASB's operational definition of "earnings"
underlying the forthcoming definition of EBIT, etc.
One of my main concerns in this definition is the jumbling of legally earned
revenues with unrealized value changes.
From the CFO Journal's Morning Ledger
on November 3, 2016
IASB evaluating EBIT
The International Accounting Standards Board said
Wednesday it would look at providing new
definitions of common financial terms such as earnings before interest and
taxes, or ebit. The new definitions will be introduced over the next five
years, in order to provide sufficient time for suggestions and comment from
market participants, Nina Trentmann reports.
The International Accounting Standards Board, or
IASB, which sets reporting standards in more than 120 countries, said
Wednesday it would look at providing new definitions of common financial
terms such as earnings before interest and taxes, or ebit.
The new definitions will be introduced over the
next five years, in order to provide sufficient time for suggestions and
comment from market participants.
The changes will not result in new standards but
will require the board to overhaul existing ones.
At the moment, terms like operating profit are not
defined by the IASB. The aim is to help market participants judge the
suitability of a particular investment.
“We want to give investors the right handles to
look at a balance sheet,” said IASB chairman Hans Hoogervorst.
Up until now, International Financial Reporting
Standards, known as IFRS, leave companies too much flexibility in defining
such terms, which often makes it difficult to compare financials, Mr.
Hoogervorst said.
“Even within sectors, there is a lack of
comparability,” Mr. Hoogervorst said. This affects both investors and
companies, he added.
It is too early to tell what the changes will mean
for companies reporting under IFRS, according to Mr. Hoogervorst. “They
should be less revolutionary than the introduction of new standards but
every change results in work”, he said.
Some firms might find that they have less latitude
when reporting financial results, he said. That could mean more work.
Firms that decide against adopting the new IASB
definition for ebit, for example, could be required to reconcile their own
ebit calculation into one based on the IASB’s definition.
The IASB in 2017 also plans to finalize a single
accounting model that would be applied to all forms of insurance contracts.
Besides that, the board will work on updating the
system through which filers add disclosures to the electronic versions of
their financial statements. The system is updated on a regular basis and the
IASB produces an annual compilation of all changes each year.
Abstract:
Since the 1970s, the decision-usefulness has taken center stage and our
attention has been concentrated on valuation of assets and liabilities
instead of income measurement. The concept of income, once considered the
gravitational center of accounting has lost its primacy and become a
byproduct of the balance sheet derived from the measurement of assets and
liabilities.
However, we have not been equipped with robust
conceptual foundation supporting theoretically reasoned accounting
measurement. It is not only theoretically but also practically important to
renew our seemingly waned interest in the concept of income because ongoing
reforms of accounting standards cannot be successfully implemented without a
sound understanding of the concept of income.
Be that as it may, net earnings and EBITDA are all-important because
investors change their portfolios based on net earnings and its derivatives more
than anything in the balance sheet.
"Accounting Alchemy," by Robert E. Verrecchia, Accounting Horizons,
September 2013, pp. 603-618.
Verrecchia alleges that it's not that managers have a functional fixation for
earnings metrics as it is that they believe that other managers and investors
are so fixated with earnings that it because of monumental importance not
because it is inherently a great metric but because they believe deeply that the
market itself makes this index of vital importance.
. . .
In summary, my thesis is that managers project that
others are fixated on earnings—independent of any evidence in support
of, or contrary to, this phenomenon. This leads to managers resisting the
inclusion in earnings items that fail to enhance performance, such as the
amortization of Goodwill, or measures that make future performance more
volatile, such as those based on fair value. In the absence of acknowledging
PEF and attempting to grapple with it, I continue to see confrontations over
accounting regulation along the lines of recent debates about fair value
accounting, in addition to further impediments along the path to greater
transparency in financial statements.
It's a bit like requiring calculus for undergraduate accounting courses.
Calculus probably is not essential in any undergraduate accounting course in the
curriculum, but faculty are fixated that the best accounting majors are the ones
do well in calculus. Similarly, investors change their portfolios based on
earnings, eps, EBITDA, and P/E ratios when in fact those metrics are not defined
and may have a lot of misleading noise and secret manipulation
That’s the question facing the accounting
profession, as it advances through a period of unprecedented change: Which
of the many issues that cry out for attention should the profession address
first?
The short answer is: All of them.
In trying to solve this riddle, we reached out to
the leaders in accounting — the regulators, association chiefs, thought
leaders, trailblazing firm owners, software developers, consultants and so
on — and asked them what they thought were the most important issues facing
the field. Their answers covered the wide range that you would expect, but
as we dug through them, three broad categories of concern emerged, each of
which subsumed a number of individual issues. What’s more, all three broad
categories were related in ways that both multiplied their difficulty, and
also pointed toward possible solutions.
Call them the Three Nightmares of the Accounting
Profession, and read on to see what the field’s leaders think can be done to
wake up from them.
THE NIGHTMARE OF IRRELEVANCE
The most-cited concern was the worry that the
profession is dropping behind not just its clients, but the world as a
whole, seeing its core services rendered obsolete by technology, their value
to clients plummeting.
Technology thought leader and educator Doug Sleeter
described it very simply: “The profession is struggling to maintain its
relevance in the eyes of clients. As a whole, the focus is still too much on
compliance services and not enough on going deeper with client engagements.”
September 4, 2015 Message from Gerald Trites in Canada
Hi Bob,
Is there any material in our website
on the Future of the Profession? In particular I am researching possible
initiatives that could be taken that are new and not presently being
done that will be needed to adapt to our changing world. I have found
numerous articles on the future of the profession but there is not much
real innovation out there.
Jerry
Jensen Comment
There are predictions all over the place, many of which vary with parts of
what we call accountancy. For example, technology will increasingly replace
bookkeepers in capturing transactions, journalizing, posting, closing the
books, and preparing financial statements --- all without human beings.
Technology will also increasingly replace human auditors, although this
happening is further down the road.
But the "future of accounting" can be viewed even without
focusing on human accountants. Even if robots determine what data is
captured and eventually put on financial statements those robots will have
to be guided by accounting policies, standards, and operational rules. Here
futurists are widely divided by traditional and historic differences such as
preferences for historical cost (price-level adjusted), entry values, exit
values, economic values, etc. Robots are no better than humans in measuring
and disclosing intangibles than human accountants. What we really would like
is a robot that can measure "value in use," but that robot if it exists at
all still resides in other galaxies.
In terms of financial accounting standards most of us
thought that it would soon be a done deal to give the IASB a monopoly on
setting the standards and principles that guide operational decisions. But
it looks like, gratefully in my opinion, that the IASB is going to have to
wait decades for monopoly powers.
The future of accounting is conditioned upon the future of
world economics. Most advances in accounting have assumed some form of
capitalism with heavy financial and managerial accounting advances for
business enterprises. The state of accountancy for socialism and
governmental accounting in general is still in the dark ages. We only have
to compare Soviet accounting advances in the 20th Century with accounting
advances in the West to appreciate that as imperfect as accounting is in the
West it is well ahead of Soviet accounting that amounted to writing of
fiction.
You might take a look at the following article in
Forbes.
Software was a frequently cited villain in the
case. “Technology is moving so fast that all the bean-counting that has been
the heart and soul of the industry is disappearing fast,” warned 2020 Group
chairman Chris Frederiksen, describing how staples of accounting like
recording purchases, writing checks, invoicing and others have disappeared
in the face of automation. “Some firms have moved swiftly to give clients
what they want: accurate, timely information and meaningful advice.”
I do have a
PwC Direct password, but I really doubt that the Switzerland link is using a
cookie.
In any case
the home page of PwC does not require any login ---
http://www.pwc.com/
The video is now on this home page.
This takes
me back to the days when Bob Eliott, eventually as President of the AICPA,
was proposing great changes in the profession, including SysTrust, WebTrust,
Eldercare Assurance, etc. For years I used Bob’s AICPA/KPMG videos as
starting points for discussion in my accounting theory course. Bob relied
heavily on the analogy of why the railroads that did not adapt to
innovations in transportation such as Interstate Highways and Jet Airliners
went downhill and not uphill. The railroads simply gave up new opportunities
to startup professions rather than adapt from railroading to transportation.
Bob’s
underlying assumption was that CPA firms could extend assurance services to
non-traditional areas (where they were not experts but could hire new kinds
of experts) by leveraging the public image of accountants as having high
integrity and professional responsibility. That public image was destroyed
by the many auditing scandals, notably Enron and the implosion of Andersen,
that surfaced in the late 1990s and beyond ---
http://faculty.trinity.edu/rjensen/Fraud001.htm
The AICPA
commenced initiatives on such things as Systrust. To my knowledge most of
these initiatives bit the dust, although some CPA firms might be making
money by assuring Eldercare services.
The counter
argument to Bob Elliot’s initiatives is that CPA firms had no comparative
advantages in expertise in their new ventures just as railroads had few
comparative advantages in trucking and airline transportation industries,
although the concept of piggy backing of truck trailers eventually caught
on.
I still have
copies of Bob’s great VCR tapes, but I doubt that these have ever been
digitized. Bob could sell refrigerators to Eskimos.
Isn't interesting that the pwc video has nothing at
all to say about protection of the investor or maintenance of the public
interest. It is all about value for the client. The client gets mentioned at
least a dozen times -- investors and the public, zero times.
If these are truly the internalized values of the
firm, we're sure to have more audit failures in coming years.
Sarbox (Sarbanes,
SOX) revived the profitability of financial audits but possibly not for long
as worldwide lawsuits commence to take their toll on the auditing firms.
http://faculty.trinity.edu/rjensen/Fraud001.htm
A key point made
by Bob Elliott is that expansion of assurance services (e.g., SysTrust and
Eldercare) is levered on the public image of CPA firms’ high integrity and
professional responsibility. After this shining public image of CPA firms’
integrity and professional responsibility was tarnished since the turn of
the Century, the question becomes what comparative advantages do CPA firms
have that gives them comparative advantage. If you believe Francine, there’s
not much left for the largest auditing firms aside from an existing global
network of offices, infrastructures, vast teams of lawyers, and whatever is
left of a once-shining public image
Bob, it's all about branding. If you look at what
Deloitte now says on their new boilerplate legal language- they recently
converted from Swiss Verein to UK private firm structure - you'll see that
brand is king. "Deloitte is a brand..." It begins.
Deloitte has a consulting firm they never shed, PwC
wants one bad and is counting on it to grow to pull the rest if the firm up.
KPMG is trying to get back in. They were advertising their presence at
Oracle Open World user conf. EY seems the only one laying low, but then
again I predicted that. Time and money is being spent on lots of litigation
and they have the whopper of the day-Lehman. Yes, we are back pre-2000 and
no one is doing anything to stop it. In the UK the regulators and media are
rattling sabers but in the US nada but me and a few others like Jim
Peterson. The PCAOB has no powers to stop acquisitions like BearingPoint and
Diamond by PwC that distract them and waste resources that should be spent
on training and quality assurance.
Accountics
is the mathematical science of values.
Charles Sprague [1887] as quoted by McMillan [1998, p. 1][NH1]
Hi Pat,
Interestingly, the term
“accountics” was coined by a Civil War veteran (badly wounded) who practiced
accounting in the 19th Century in New York City. He also taught
accounting at both Columbia College (now Columbia University) and New York
University.
But accounting history buffs should note that the term
“accountics” was a big deal between 1887 and 1925. In particular, heated debates
arose regarding whether The Accounting Review should commence in 1925 as
an accountics journal for mathematical economists or as a journal for accounting
teachers and practitioners.
Accountics
is the mathematical science of values.
Charles Sprague [1887] as quoted by McMillan [1998, p. 1][NH1]
Accounting professor Charles
Sprague of Columbia University (then called Columbia College) coined the word
"accountics" in 1887. The word is not used today in accounting and has some
alternative meanings outside our discipline. However, in the early 20th
century, accountics was the centerpiece of some unpublished lectures by Sprague.
McMillan [1998, p. 11] stated the following:
These claims were
not a pragmatic strategy to legitimize the development of sophisticated
bookkeeping theories. Rather, this development of a science was seen as
revealing long-hidden realities within the economic environment and the
double-entry bookkeeping system itself. The science of accounts, through
systematic mathematical analysis, could discover hidden thrust of the reality of
economic value. The term “accountics” captured the imagination of the members of
the IA, connoting advances in bookkeeping that all these men were experiencing.
By 1900, there was a journal called Accountics
[Forrester, 2003]. Both the journal and the term “accountics” had short lives,
but the belief that mathematical analysis and empirical research can “discover
hidden thrust of the reality of economic value” (see above) underlies much of
what has been published in TAR over the past three decades. Hence, we propose
reviving the term “accountics” to describe the research methods and quantitative
analysis tools that have become popular in TAR and other leading accounting
research journals. We essentially define accountics as equivalent to the
scientific study of values in what Zimmerman [2001, p. 414] called “agency
problems, corporate governance, capital asset pricing, capital budgeting,
decision analysis, risk management, queuing theory, and statistical audit
analysis.”
The American Association of
University Instructors of Accounting, which in December 1935 became the American
Accounting Association, commenced unofficially in 1915 [Zeff, 1966, p. 5]. It
was proposed in October of 1919 that the Association publish a Quarterly
Journal of Accountics. This
proposed accountics journal never got off the ground as leaders in the
Association argued heatedly and fruitlessly about whether accountancy was a
science. A quarterly journal called The Accounting Review was
subsequently born in 1925, with its first issue being published in March of
1926. Its accountics-like attributes did not commence in earnest until the
1960s.
Practitioner involvement, in a large measure, was the reason for changing the
name of the Association by removing the words “of University Instructors.”
Practitioners interested in accounting education participated actively in AAA
meetings. TAR articles in the first several decades were devoted heavily to
education issues and accounting issues in particular industries and trade
groups. Research methodologies were mainly normative (without mathematics), case
study, and archival (history) methods. Anecdotal evidence and hypothetical
illustrations ruled the day. The longest serving editor of TAR was a
practitioner named Eric
Kohler,
who determined what was published in TAR between 1929 and 1943. In those years,
when the AAA leadership mandated that TAR focus on the development of accounting
principles, publications were oriented to both practitioners and educators,
Chatfield [1975, p. 4].
Following World War II, practitioners outnumbered educators in the AAA
[Chatfield 1975, p. 4]. Leading partners from accounting firms took pride in
publishing papers and books intended to inspire scholarship among professors and
students. Over the years, some practitioners, particularly those with scholarly
publications, were admitted into the Accounting Hall of Fame founded by The Ohio
State University. Prior to the 1960s, accounting educators were generally long
on practical experience and short on academic credentials such as doctoral
degrees.
A major catalyst for change in
accounting research occurred when the Ford Foundation poured millions of dollars
into the study of collegiate business schools and the funding of doctoral
programs and students in business studies. Gordon and Howell [1959] reported
that business faculty in colleges lacked research skills and academic esteem
when compared to their colleagues in the sciences. The Ford Foundation
thereafter provided funding for doctoral programs and for top quality graduate
students to pursue doctoral degrees in business and accountancy. The Foundation
even funded publication of selected doctoral dissertations to give doctoral
studies in business more visibility. Great pressures were also brought to bear
on academic associations like the AAA to increase the scientific standards for
publications in journals like TAR.
TAR BETWEEN 1956
AND 1985: NURTURING OF ACCOUNTICS
A perfect storm for change in
accounting research arose in the late 1950s and early1960s. First came the
critical Pierson Carnegie Report [1959] and the Gordon and Howell Ford
Foundation Report [1959]. Shortly thereafter, the AACSB introduced a requirement
requiring that a certain percentage of faculty possess doctoral degrees for
business education programs seeking accreditation [Bricker
and Previts, 1990]. Soon
afterwards, both a doctorate and publication in top accounting research journals
became necessary for tenure [Langenderfer, 1987].
A second component of this
perfect storm for change was the proliferation of mainframe computers, the
development of analytical software (e.g., early SPSS for mainframes), and the
dawning of management and decision “sciences.” The third huge stimulus for
changed research is rooted in portfolio theory discovered by Harry Markowitz
in1952 that became the core of his dissertation at Princeton University, which
was published in book form in 1959. This theory eventually gave birth to the
Nobel Prize winning Capital Asset Pricing Model (CAPM) and a new era of capital
market research. A fourth stimulus was when the CRSP stock price tapes became
available from the University of Chicago. The availability of CRSP led to a high
number of TAR articles on capital market event studies (e.g., earnings
announcements on trading prices and volumes) covering a period of nearly 40
years.
This “perfect storm” roared into
nearly all accounting and finance research and turned academic accounting
research into an accountics-centered science of values and
mathematical/statistical analysis. After 1960, there was a shift in TAR, albeit
slow at first, toward preferences for quantitative model building ---
econometric models in capital market studies, time series models in forecasting,
advanced calculus information science, information economics, analytical models,
and psychometric behavioral models. Chatfield [1975, p. 6] wrote the following:
Beginning in the
1960s the Review published many more articles by non-accountants, whose
contribution involved showing how ideas or methods from their own discipline
could be used to solve particular accounting problems. The more successful
adaptations included matrix theory, mathematical model building, organization
theory, linear programming, and Bayesian analysis.
TAR was not alone in moving
toward a more quantitative focus. Accountics methodologies accompanied similar
quantitative model building preferences in finance, marketing, management
science, decision science, operations research, information economics, computer
science, and information systems. Early changes along these lines began to
appear in other leading research journals between 1956-1965, with some
mathematical modeling papers noted by Dyckman and Zeff [1984, p. 229]. Fleming,
Graci and Thompson [2000, p. 43] documented additional emphasis on quantitative
methodology between 1966 and 1985. In particular, they note how tenure
requirements began to change and asserted the following:
The Accounting
Review evolved into a
journal with demanding acceptance standards whose leading authors were highly
educated accounting academics who, to a large degree, brought methods and tools
from other disciplines to bear upon accounting issues.
A number of new academic
accountancy journals were launched in the early 1960s, including the Journal
of Accounting Research (1963), Abacus (1965) and The International
Journal of Accounting Education and Research (1965). Clinging to its
traditional normative roots and trade-article style would have made TAR appear
to be a journal for academic luddites. Actually, many of the new mathematical
approaches to theory development were fundamentally normative, but they were
couched in the formidable language and rigors of mathematics. Publication of
papers in traditional normative theory, history, and systems slowly ground to
almost zero in the new age of accountics.
These new spearheads in
accountics were not without problems. It is both humorous and sad to go back and
discover how naïve and misleading some of TAR’s bold and high risk thrusts were
in quantitative methods. Statistical models were employed without regard to
underlying assumptions of independence, temporal stationarity, multicollinearity,
homoscedasticity, missing variables, and departures from the normal
distribution. Mathematical applications were proposed for real-world systems
that failed to meet continuity and non-convexity assumptions inherent in models
such as linear programming and calculus optimizations. Some proposed
applications of finite mathematics and discrete (integer) programming failed
because the fastest computers in the world, then and now, could not solve most
realistic integer programming problems in less than 100 years.
After financial databases
provided a beta covariance of each security in a portfolio with the market
portfolio, many capital market events studies were published by TAR and other
leading accounting journals. In the early years, accounting researchers did not
challenge the CAPM’s assumptions and limitations --- limitations that, in
retrospect, cast doubt upon many of the findings based upon any single index of
market risk [Fama and French, 1992].
Leading accounting professors
lamented TAR’s preference for rigor over relevancy [Zeff, 1978; Lee, 1997; and
Williams, 1985 and 2003]. Sundem [1987] provides revealing information about the
changed perceptions of authors, almost entirely from academe, who submitted
manuscripts for review between June 1982 and May 1986. Among the 1,148
submissions, only 39 used archival (history) methods; 34 of those submissions
were rejected. Another 34 submissions used survey methods; 33 of those were
rejected. And 100 submissions used traditional normative (deductive) methods
with 85 of those being rejected. Except for a small set of 28 manuscripts
classified as using “other” methods (mainly descriptive empirical according to
Sundem), the remaining larger subset of submitted manuscripts used methods that
Sundem [1987, p. 199] classified these as follows:
292 General Empirical
172 Behavioral
135 Analytical modeling
119 Capital Market
97 Economic modeling
40 Statistical modeling
29 Simulation
It is clear that by 1982, accounting researchers realized that
having mathematical or statistical analysis in TAR submissions made accountics
virtually a necessary, albeit not sufficient, condition for acceptance for
publication. It became increasingly difficult for a single editor to have
expertise in all of the above methods. In the late 1960s, editorial decisions on
publication shifted from the TAR editor alone to the TAR editor in conjunction
with specialized referees and eventually associate editors [Flesher, 1991, p.
167]. Fleming et al. [2000, p. 45] wrote the following:
The big change
was in research methods. Modeling and empirical methods became prominent during
1966-1985, with analytical modeling and general empirical methods leading the
way. Although used to a surprising extent, deductive-type methods declined in
popularity, especially in the second half of the 1966-1985 period.
We were surprised that there was
no reduction in accountics dominance in TAR since 1986 in spite of changes in
the environment such as the explosion of communications networking, interacting
relational databases, and sophisticated accounting information systems (AIS).Virtually
no AIS papers were published in TAR between 1986 and 2005. This practice was
changed in 2006 by the appointment of a new AIS associate editor to encourage
publication of some AIS papers that often do not fit neatly into the accountics
mold. In an interesting aside, we note that the AAA has become a leading
international association of accounting educators. Sundem [1987] reported
that about 12 percent of the manuscripts submitted came from outside of North
America. The American Accounting Association is an international association
that provides publication opportunities to all members, and manuscripts are
submitted from many parts of the world. In our opinion, this contributed
significantly to the rise in accountics studies worldwide.
A major change at TAR took place
in the 1980s with the creation of new AAA journals to relieve TAR of publishing
articles that were less accountics-oriented. Prior to 1983, TAR was the leading
academic journal for teachers of accounting as well as practitioners. Numerous
TAR papers appeared on how to improve accounting education and teaching. In an
effort to better serve educators, the AAA created a specialty journal called
Issues in Accounting Education, first published in 1983. A journal aimed
more at issues facing practitioners was inaugurated in 1987 under the name
Accounting Horizons. Around this time, the AAA also granted permission for
specialty “sections” to be formed for sub-disciplines of accounting, which
resulted in additional new journals. These new journals allowed TAR to focus
more heavily on quantitative papers that became increasingly difficult for
practitioners and many teachers of accounting to comprehend.
Fleming et al. [2000, p. 48]
report that education articles in TAR declined from 21 percent in 1946-1965 to 8
percent in 1966-1985. Issues in Accounting Education began to publish the
education articles in 1983. Garcha, Harwood, and Hermanson [1983] reported on
the readership of TAR before any new specialty journals commenced in the AAA.
They found that among their AAA membership respondents, only 41.7 percent would
subscribe to TAR if it became unbundled in terms of dollar savings from AAA
membership dues. This suggests that TAR was not meeting the AAA membership’s
needs. Based heavily upon the written comments of respondents, the authors’
conclusions were, in part, as follows by Garcha, Harwood, and Hermanson [1983,
p. 37]:
The findings of the survey reveal that opinions vary regarding
TAR and that emotions run high. At one extreme some respondents seem to believe
that TAR is performing its intended function very well. Those sharing this view
may believe that its mission is to provide a high-quality outlet for those at
the cutting-edge of accounting research. The pay-off for this approach may be
recognition by peers, achieving tenure and promotion, and gaining mobility
should one care to move. This group may also believe that trying to affect
current practice is futile anyway, so why even try?
At the other extreme are those who believe that TAR is not
serving its intended purpose. This group may believe TAR should serve the
readership interests of the audiences identified by the Moonitz Committee. Many
in the intended audience cannot write for, cannot read, or are not interested in
reading the Main Articles which have been published during approximately the
last decade. As a result there is the suggestion that this group believes that a
change in editorial policy is needed.
After a study by Abdel-khalik [1976]
revealed complaints about the difficulties of following the increased
quantitative terminology in TAR, editors did introduce abstracts at the
beginning of the articles to summarize major findings with less jargon [Flesher,
1991, p. 169]. However,
the problem was simultaneously exacerbated when TAR stopped publishing
commentaries and rebuttals that sometimes aided comprehension of complicated
research. Science journals often are much better about encouraging commentaries,
replications, and rebuttals.
TAR BETWEEN 1986
AND 2005: MATURATION OF ACCOUNTICS
We pointed out earlier in Table
2 how the numbers of authors having five or more appearances in twenty-year time
spans has markedly declined over the entire 80-year life of TAR. Table 4 lists
the most recent top authors for the 1986-2005 period. In contrast to Heck and
Bremser [1986] findings, the likelihood that any single author will have more
than five appearances is greatly reduced in more recent times.
Jensen Comment
Note that this site includes a long listing of research in accounting, finance,
and economics, much of it based on positivism and financial markets.
So how did this “the last shall come first” thinking become established?
You can blame it all on economists, specifically Harvard Business
School’s Michael Jensen. In other words, this idea did not come out of
legal analysis, changes in regulation, or court decisions. It was simply
an academic theory that went mainstream. And to add insult to injury,
the version of the Jensen formula that became popular was its worst
possible embodiment.
In the 1970s, there was a great deal of hand-wringing in America as
Japanese and German manufacturers were eating American’s lunch. That led
to renewed examination of how US companies were managed, with lots of
theorizing about what went wrong and what the remedies might be. In
1976, Jensen and William Meckling asserted that the problem was that
corporate executives served their own interests rather than those of
shareholders, in other words, that there was an agency problem.
Executives wanted to build empires while shareholders wanted profits to
be maximized.
I strongly suspect that if Jensen and Meckling had not come out with
this line of thinking, you would have gotten something similar to
justify the actions of the leveraged buyout kings, who were just getting
started in the 1970s and were reshaping the corporate landscape by the
mid-1980s. They were doing many of the things Jensen and Meckling
recommended: breaking up multi-business companies, thinning out
corporate centers, and selling corporate assets (some of which were
clearly excess, like corporate art and jet collection, while other sales
were simply to increase leverage, like selling corporate office
buildings and leasing them back). In other words, a likely reason that
Jensen and Meckling’s theory gained traction was it appeared to validate
a fundamental challenge to incumbent managements. (Dobbin and Jung
attribute this trend, as pretty much everyone does, to Jensen because he
continued to develop it. What really put it on the map was a 1990
Harvard Business Review article, “It’s
Not What You Pay CEOs, but How,” that led to an explosion in the use
of option-based pay and resulted in a huge increase in CEO pay relative
to that of average workers.)
To forestall takeovers, many companies implemented the measures an
LBO artist might take before his invading army arrived: sell off
non-core divisions, borrow more, shed staff.
The problem was to the extent that the Jensen/Meckling prescription
had merit, only the parts that helped company executives were adopted.
Jensen didn’t just call on executives to become less ministerial and
more entrepreneurial; they also called for more independent and engaged
boards to oversee and discipline top managers, and more equity-driven
pay, both options and other equity-linked compensation, to make
management more sensitive to both upside and downside risks.
Over the next two decades, companies levered up, became more
short-term oriented, and executive pay levels exploded. As Dobbin and
Jung put it, “The result of the changes promoted by agency theory was
that by the late 1990s, corporate America’s leaders were drag racing
without the brakes.”
The paper proceeds to analyze in considerable detail how three of the
major prescriptions of “agency theory” aka “executives and boards should
maximize value,” namely, pay for (mythical) performance,
dediversification, and greater reliance on debt all increased risk. And
the authors also detail how efforts to improve oversight were
ineffective.
But the paper also makes clear that this vision of how companies
should be run was simply a new management fashion, as opposed to any
sort of legal requirement:
Organizational institutionalists have long argued that new
management practices diffuse through networks of firms like fads
spread through high schools….In their models, new paradigms are
socially constructed as appropriate solutions to perceived problems
or crises….Expert groups that stand to gain from having their
preferred strategies adopted by firms then enter the void, competing
to have their model adopted….
And as Dobbin and Jung point out, the parts of the Jensen formula
that got adopted were the one that had constituents. The ones that
promoted looting and short-termism had obvious followings. The ones for
prudent management didn’t.
And consider the implications of Jensen’s prescriptions, of pushing
companies to favor shareholders, when they actually stand at the back of
the line from a legal perspective. The result is that various agents
(board compensation consultants, management consultants, and cronyistic
boards themselves) have put incentives in place for CEOs to favor
shareholders over parties that otherwise should get better treatment. So
is it any surprise that companies treat employees like toilet paper,
squeeze vendors, lobby hard for tax breaks and to weaken regulations,
and worse, like fudge their financial reports? Jensen himself, in 2005,
repudiated his earlier prescription precisely because it led to fraud.
From
an interview with the New York Times:
Q. So the maximum stock price is the holy grail?
A. Absolutely not. Warren Buffett says he worries as much when
one of his companies becomes overvalued as undervalued. I agree.
Overvalued equity is managerial heroin – it feels really great when
you start out; you’re feted on television; investment bankers vie to
float new issues.
But it doesn’t take long before the elation and ecstasy turn into
enormous pain. The market starts demanding increased earnings and
revenues, and the managers begin to say: “Holy Moley! How are we
going to generate the returns?” They look for legal loopholes in the
accounting, and when those don’t work, even basically honest people
move around the corner to outright fraud.
If they hold a lot of stock or options themselves, it is like
pouring gasoline on a fire. They fudge the numbers and hope they can
sell the stock or exercise the options before anything hits the fan.
Q. Are you suggesting that executives be rewarded for driving
down the price of the stock?
A. I’m saying they should be rewarded for being honest. A C.E.O.
should be able to tell investors, “Listen, this company isn’t worth
its $70 billion market cap; it’s really worth $30 billion, and
here’s why.”
But the board would fire that executive immediately. I guess it
has to be preventative – if executives would present the market with
realistic numbers rather than overoptimistic expectations, the stock
price would stay realistic. But I admit, we scholars don’t yet know
the real answer to how to make this happen.
So having led Corporate America in the wrong direction, Jensen
‘fesses up no one knows the way out. But if executives weren’t
incentivized to take such a topsy-turvey shareholder-driven view of the
world, they’d weigh their obligations to other constituencies, including
the community at large, along with earning shareholders a decent return.
But it’s now become so institutionalized it’s hard to see how to move to
a more sensible regime. For instance, analysts regularly try pressuring
Costco to pay its workers less, wanting fatter margins. But the
comparatively high wages are
an integral part of Costco’s formula: it reduces costly staff
turnover and employee pilferage. And Costco’s upscale members report
they prefer to patronize a store they know treats workers better than
Walmart and other discounters. If managers with an established,
successful formulas still encounter pressure from the Street to strip
mine their companies, imagine how hard it is for struggling companies or
less secure top executives to implement strategies that will take a
while to reap rewards. I’ve been getting reports from McKinsey from the
better part of a decade that they simply can’t get their clients to
implement new initiatives if they’ll dent quarterly returns.
This governance system is actually in crisis, but the extraordinary
profit share that companies have managed to achieve by squeezing workers
and the asset-goosing success of post-crisis financial policies have
produced an illusion of health. But porcine maquillage only improves
appearances; it doesn’t mask the stench of gangrene. Nevertheless,
executives have successfully hidden the generally unhealthy state of
their companies. As long as they have cheerleading analysts, complacent
boards and the Fed protecting their back, they can likely continue to
inflict more damage, using “maximizing shareholder value” canard as the
cover for continuing rent extraction.
So how did this “the last shall come first” thinking become established?
You can blame it all on economists, specifically Harvard Business
School’s Michael Jensen. In other words, this idea did not come out of
legal analysis, changes in regulation, or court decisions. It was simply
an academic theory that went mainstream. And to add insult to injury,
the version of the Jensen formula that became popular was its worst
possible embodiment.
In the 1970s, there was a great deal of hand-wringing in America as
Japanese and German manufacturers were eating American’s lunch. That led
to renewed examination of how US companies were managed, with lots of
theorizing about what went wrong and what the remedies might be. In
1976, Jensen and William Meckling asserted that the problem was that
corporate executives served their own interests rather than those of
shareholders, in other words, that there was an agency problem.
Executives wanted to build empires while shareholders wanted profits to
be maximized.
I strongly suspect that if Jensen and Meckling had not come out with
this line of thinking, you would have gotten something similar to
justify the actions of the leveraged buyout kings, who were just getting
started in the 1970s and were reshaping the corporate landscape by the
mid-1980s. They were doing many of the things Jensen and Meckling
recommended: breaking up multi-business companies, thinning out
corporate centers, and selling corporate assets (some of which were
clearly excess, like corporate art and jet collection, while other sales
were simply to increase leverage, like selling corporate office
buildings and leasing them back). In other words, a likely reason that
Jensen and Meckling’s theory gained traction was it appeared to validate
a fundamental challenge to incumbent managements. (Dobbin and Jung
attribute this trend, as pretty much everyone does, to Jensen because he
continued to develop it. What really put it on the map was a 1990
Harvard Business Review article, “It’s
Not What You Pay CEOs, but How,” that led to an explosion in the use
of option-based pay and resulted in a huge increase in CEO pay relative
to that of average workers.)
To forestall takeovers, many companies implemented the measures an
LBO artist might take before his invading army arrived: sell off
non-core divisions, borrow more, shed staff.
The problem was to the extent that the Jensen/Meckling prescription
had merit, only the parts that helped company executives were adopted.
Jensen didn’t just call on executives to become less ministerial and
more entrepreneurial; they also called for more independent and engaged
boards to oversee and discipline top managers, and more equity-driven
pay, both options and other equity-linked compensation, to make
management more sensitive to both upside and downside risks.
Over the next two decades, companies levered up, became more
short-term oriented, and executive pay levels exploded. As Dobbin and
Jung put it, “The result of the changes promoted by agency theory was
that by the late 1990s, corporate America’s leaders were drag racing
without the brakes.”
The paper proceeds to analyze in considerable detail how three of the
major prescriptions of “agency theory” aka “executives and boards should
maximize value,” namely, pay for (mythical) performance,
dediversification, and greater reliance on debt all increased risk. And
the authors also detail how efforts to improve oversight were
ineffective.
But the paper also makes clear that this vision of how companies
should be run was simply a new management fashion, as opposed to any
sort of legal requirement:
Organizational institutionalists have long argued that new
management practices diffuse through networks of firms like fads
spread through high schools….In their models, new paradigms are
socially constructed as appropriate solutions to perceived problems
or crises….Expert groups that stand to gain from having their
preferred strategies adopted by firms then enter the void, competing
to have their model adopted….
And as Dobbin and Jung point out, the parts of the Jensen formula
that got adopted were the one that had constituents. The ones that
promoted looting and short-termism had obvious followings. The ones for
prudent management didn’t.
And consider the implications of Jensen’s prescriptions, of pushing
companies to favor shareholders, when they actually stand at the back of
the line from a legal perspective. The result is that various agents
(board compensation consultants, management consultants, and cronyistic
boards themselves) have put incentives in place for CEOs to favor
shareholders over parties that otherwise should get better treatment. So
is it any surprise that companies treat employees like toilet paper,
squeeze vendors, lobby hard for tax breaks and to weaken regulations,
and worse, like fudge their financial reports? Jensen himself, in 2005,
repudiated his earlier prescription precisely because it led to fraud.
From
an interview with the New York Times:
Q. So the maximum stock price is the holy grail?
A. Absolutely not. Warren Buffett says he worries as much when
one of his companies becomes overvalued as undervalued. I agree.
Overvalued equity is managerial heroin – it feels really great when
you start out; you’re feted on television; investment bankers vie to
float new issues.
But it doesn’t take long before the elation and ecstasy turn into
enormous pain. The market starts demanding increased earnings and
revenues, and the managers begin to say: “Holy Moley! How are we
going to generate the returns?” They look for legal loopholes in the
accounting, and when those don’t work, even basically honest people
move around the corner to outright fraud.
If they hold a lot of stock or options themselves, it is like
pouring gasoline on a fire. They fudge the numbers and hope they can
sell the stock or exercise the options before anything hits the fan.
Q. Are you suggesting that executives be rewarded for driving
down the price of the stock?
A. I’m saying they should be rewarded for being honest. A C.E.O.
should be able to tell investors, “Listen, this company isn’t worth
its $70 billion market cap; it’s really worth $30 billion, and
here’s why.”
But the board would fire that executive immediately. I guess it
has to be preventative – if executives would present the market with
realistic numbers rather than overoptimistic expectations, the stock
price would stay realistic. But I admit, we scholars don’t yet know
the real answer to how to make this happen.
So having led Corporate America in the wrong direction, Jensen
‘fesses up no one knows the way out. But if executives weren’t
incentivized to take such a topsy-turvey shareholder-driven view of the
world, they’d weigh their obligations to other constituencies, including
the community at large, along with earning shareholders a decent return.
But it’s now become so institutionalized it’s hard to see how to move to
a more sensible regime. For instance, analysts regularly try pressuring
Costco to pay its workers less, wanting fatter margins. But the
comparatively high wages are
an integral part of Costco’s formula: it reduces costly staff
turnover and employee pilferage. And Costco’s upscale members report
they prefer to patronize a store they know treats workers better than
Walmart and other discounters. If managers with an established,
successful formulas still encounter pressure from the Street to strip
mine their companies, imagine how hard it is for struggling companies or
less secure top executives to implement strategies that will take a
while to reap rewards. I’ve been getting reports from McKinsey from the
better part of a decade that they simply can’t get their clients to
implement new initiatives if they’ll dent quarterly returns.
This governance system is actually in crisis, but the extraordinary
profit share that companies have managed to achieve by squeezing workers
and the asset-goosing success of post-crisis financial policies have
produced an illusion of health. But porcine maquillage only improves
appearances; it doesn’t mask the stench of gangrene. Nevertheless,
executives have successfully hidden the generally unhealthy state of
their companies. As long as they have cheerleading analysts, complacent
boards and the Fed protecting their back, they can likely continue to
inflict more damage, using “maximizing shareholder value” canard as the
cover for continuing rent extraction.
So how did this “the last shall come first” thinking become established?
You can blame it all on economists, specifically Harvard Business
School’s Michael Jensen. In other words, this idea did not come out of
legal analysis, changes in regulation, or court decisions. It was simply
an academic theory that went mainstream. And to add insult to injury,
the version of the Jensen formula that became popular was its worst
possible embodiment.
In the 1970s, there was a great deal of hand-wringing in America as
Japanese and German manufacturers were eating American’s lunch. That led
to renewed examination of how US companies were managed, with lots of
theorizing about what went wrong and what the remedies might be. In
1976, Jensen and William Meckling asserted that the problem was that
corporate executives served their own interests rather than those of
shareholders, in other words, that there was an agency problem.
Executives wanted to build empires while shareholders wanted profits to
be maximized.
I strongly suspect that if Jensen and Meckling had not come out with
this line of thinking, you would have gotten something similar to
justify the actions of the leveraged buyout kings, who were just getting
started in the 1970s and were reshaping the corporate landscape by the
mid-1980s. They were doing many of the things Jensen and Meckling
recommended: breaking up multi-business companies, thinning out
corporate centers, and selling corporate assets (some of which were
clearly excess, like corporate art and jet collection, while other sales
were simply to increase leverage, like selling corporate office
buildings and leasing them back). In other words, a likely reason that
Jensen and Meckling’s theory gained traction was it appeared to validate
a fundamental challenge to incumbent managements. (Dobbin and Jung
attribute this trend, as pretty much everyone does, to Jensen because he
continued to develop it. What really put it on the map was a 1990
Harvard Business Review article, “It’s
Not What You Pay CEOs, but How,” that led to an explosion in the use
of option-based pay and resulted in a huge increase in CEO pay relative
to that of average workers.)
To forestall takeovers, many companies implemented the measures an
LBO artist might take before his invading army arrived: sell off
non-core divisions, borrow more, shed staff.
The problem was to the extent that the Jensen/Meckling prescription
had merit, only the parts that helped company executives were adopted.
Jensen didn’t just call on executives to become less ministerial and
more entrepreneurial; they also called for more independent and engaged
boards to oversee and discipline top managers, and more equity-driven
pay, both options and other equity-linked compensation, to make
management more sensitive to both upside and downside risks.
Over the next two decades, companies levered up, became more
short-term oriented, and executive pay levels exploded. As Dobbin and
Jung put it, “The result of the changes promoted by agency theory was
that by the late 1990s, corporate America’s leaders were drag racing
without the brakes.”
The paper proceeds to analyze in considerable detail how three of the
major prescriptions of “agency theory” aka “executives and boards should
maximize value,” namely, pay for (mythical) performance,
dediversification, and greater reliance on debt all increased risk. And
the authors also detail how efforts to improve oversight were
ineffective.
But the paper also makes clear that this vision of how companies
should be run was simply a new management fashion, as opposed to any
sort of legal requirement:
Organizational institutionalists have long argued that new
management practices diffuse through networks of firms like fads
spread through high schools….In their models, new paradigms are
socially constructed as appropriate solutions to perceived problems
or crises….Expert groups that stand to gain from having their
preferred strategies adopted by firms then enter the void, competing
to have their model adopted….
And as Dobbin and Jung point out, the parts of the Jensen formula
that got adopted were the one that had constituents. The ones that
promoted looting and short-termism had obvious followings. The ones for
prudent management didn’t.
And consider the implications of Jensen’s prescriptions, of pushing
companies to favor shareholders, when they actually stand at the back of
the line from a legal perspective. The result is that various agents
(board compensation consultants, management consultants, and cronyistic
boards themselves) have put incentives in place for CEOs to favor
shareholders over parties that otherwise should get better treatment. So
is it any surprise that companies treat employees like toilet paper,
squeeze vendors, lobby hard for tax breaks and to weaken regulations,
and worse, like fudge their financial reports? Jensen himself, in 2005,
repudiated his earlier prescription precisely because it led to fraud.
From
an interview with the New York Times:
Q. So the maximum stock price is the holy grail?
A. Absolutely not. Warren Buffett says he worries as much when
one of his companies becomes overvalued as undervalued. I agree.
Overvalued equity is managerial heroin – it feels really great when
you start out; you’re feted on television; investment bankers vie to
float new issues.
But it doesn’t take long before the elation and ecstasy turn into
enormous pain. The market starts demanding increased earnings and
revenues, and the managers begin to say: “Holy Moley! How are we
going to generate the returns?” They look for legal loopholes in the
accounting, and when those don’t work, even basically honest people
move around the corner to outright fraud.
If they hold a lot of stock or options themselves, it is like
pouring gasoline on a fire. They fudge the numbers and hope they can
sell the stock or exercise the options before anything hits the fan.
Q. Are you suggesting that executives be rewarded for driving
down the price of the stock?
A. I’m saying they should be rewarded for being honest. A C.E.O.
should be able to tell investors, “Listen, this company isn’t worth
its $70 billion market cap; it’s really worth $30 billion, and
here’s why.”
But the board would fire that executive immediately. I guess it
has to be preventative – if executives would present the market with
realistic numbers rather than overoptimistic expectations, the stock
price would stay realistic. But I admit, we scholars don’t yet know
the real answer to how to make this happen.
So having led Corporate America in the wrong direction, Jensen
‘fesses up no one knows the way out. But if executives weren’t
incentivized to take such a topsy-turvey shareholder-driven view of the
world, they’d weigh their obligations to other constituencies, including
the community at large, along with earning shareholders a decent return.
But it’s now become so institutionalized it’s hard to see how to move to
a more sensible regime. For instance, analysts regularly try pressuring
Costco to pay its workers less, wanting fatter margins. But the
comparatively high wages are
an integral part of Costco’s formula: it reduces costly staff
turnover and employee pilferage. And Costco’s upscale members report
they prefer to patronize a store they know treats workers better than
Walmart and other discounters. If managers with an established,
successful formulas still encounter pressure from the Street to strip
mine their companies, imagine how hard it is for struggling companies or
less secure top executives to implement strategies that will take a
while to reap rewards. I’ve been getting reports from McKinsey from the
better part of a decade that they simply can’t get their clients to
implement new initiatives if they’ll dent quarterly returns.
This governance system is actually in crisis, but the extraordinary
profit share that companies have managed to achieve by squeezing workers
and the asset-goosing success of post-crisis financial policies have
produced an illusion of health. But porcine maquillage only improves
appearances; it doesn’t mask the stench of gangrene. Nevertheless,
executives have successfully hidden the generally unhealthy state of
their companies. As long as they have cheerleading analysts, complacent
boards and the Fed protecting their back, they can likely continue to
inflict more damage, using “maximizing shareholder value” canard as the
cover for continuing rent extraction.
So how did this “the last shall come first” thinking become established? You
can blame it all on economists, specifically Harvard Business School’s
Michael Jensen. In other words, this idea did not come out of legal
analysis, changes in regulation, or court decisions. It was simply an
academic theory that went mainstream. And to add insult to injury, the
version of the Jensen formula that became popular was its worst possible
embodiment.
In the 1970s, there was a great deal of hand-wringing in America as Japanese
and German manufacturers were eating American’s lunch. That led to renewed
examination of how US companies were managed, with lots of theorizing about
what went wrong and what the remedies might be. In 1976, Jensen and William
Meckling asserted that the problem was that corporate executives served
their own interests rather than those of shareholders, in other words, that
there was an agency problem. Executives wanted to build empires while
shareholders wanted profits to be maximized.
I
strongly suspect that if Jensen and Meckling had not come out with this line
of thinking, you would have gotten something similar to justify the actions
of the leveraged buyout kings, who were just getting started in the 1970s
and were reshaping the corporate landscape by the mid-1980s. They were doing
many of the things Jensen and Meckling recommended: breaking up
multi-business companies, thinning out corporate centers, and selling
corporate assets (some of which were clearly excess, like corporate art and
jet collection, while other sales were simply to increase leverage, like
selling corporate office buildings and leasing them back). In other words, a
likely reason that Jensen and Meckling’s theory gained traction was it
appeared to validate a fundamental challenge to incumbent managements.
(Dobbin and Jung attribute this trend, as pretty much everyone does, to
Jensen because he continued to develop it. What really put it on the map was
a 1990 Harvard Business Review article,
“It’s
Not What You Pay CEOs, but How,” that
led to an explosion in the use of option-based pay and resulted in a huge
increase in CEO pay relative to that of average workers.)
To forestall takeovers, many companies implemented the measures an LBO
artist might take before his invading army arrived: sell off non-core
divisions, borrow more, shed staff.
The problem was to the extent that the Jensen/Meckling prescription had
merit, only the parts that helped company executives were adopted. Jensen
didn’t just call on executives to become less ministerial and more
entrepreneurial; they also called for more independent and engaged boards to
oversee and discipline top managers, and more equity-driven pay, both
options and other equity-linked compensation, to make management more
sensitive to both upside and downside risks.
Over the next two decades, companies levered up, became more short-term
oriented, and executive pay levels exploded. As Dobbin and Jung put it, “The
result of the changes promoted by agency theory was that by the late 1990s,
corporate America’s leaders were drag racing without the brakes.”
The paper proceeds to analyze in considerable detail how three of the major
prescriptions of “agency theory” aka “executives and boards should maximize
value,” namely, pay for (mythical) performance, dediversification, and
greater reliance on debt all increased risk. And the authors also detail how
efforts to improve oversight were ineffective.
But the paper also makes clear that this vision of how companies should be
run was simply a new management fashion, as opposed to any sort of legal
requirement:
Organizational institutionalists have long argued that new management
practices diffuse through networks of firms like fads spread through high
schools….In their models, new paradigms are socially constructed as
appropriate solutions to perceived problems or crises….Expert groups that
stand to gain from having their preferred strategies adopted by firms then
enter the void, competing to have their model adopted….
And as Dobbin and Jung point out, the parts of the Jensen formula that got
adopted were the one that had constituents. The ones that promoted looting
and short-termism had obvious followings. The ones for prudent management
didn’t.
And
consider the implications of Jensen’s prescriptions, of pushing companies to
favor shareholders, when they actually stand at the back of the line from a
legal perspective. The result is that various agents (board compensation
consultants, management consultants, and cronyistic boards themselves) have
put incentives in place for CEOs to favor shareholders over parties that
otherwise should get better treatment. So is it any surprise that companies
treat employees like toilet paper, squeeze vendors, lobby hard for tax
breaks and to weaken regulations, and worse, like fudge their financial
reports? Jensen himself, in 2005, repudiated his earlier prescription
precisely because it led to fraud. Froman interview with the New York Times:
Q. So the maximum stock price is the holy grail?
A. Absolutely not. Warren Buffett says he worries as much when one of his
companies becomes overvalued as undervalued. I agree. Overvalued equity is
managerial heroin – it feels really great when you start out; you’re feted
on television; investment bankers vie to float new issues.
But it doesn’t take long before the elation and ecstasy turn into enormous
pain. The market starts demanding increased earnings and revenues, and the
managers begin to say: “Holy Moley! How are we going to generate the
returns?” They look for legal loopholes in the accounting, and when those
don’t work, even basically honest people move around the corner to outright
fraud.
If they hold a lot of stock or options themselves, it is like pouring
gasoline on a fire. They fudge the numbers and hope they can sell the stock
or exercise the options before anything hits the fan.
Q. Are you suggesting that executives be rewarded for driving down the price
of the stock?
A. I’m saying they should be rewarded for being honest. A C.E.O. should be
able to tell investors, “Listen, this company isn’t worth its $70 billion
market cap; it’s really worth $30 billion, and here’s why.”
But the board would fire that executive immediately. I guess it has to be
preventative – if executives would present the market with realistic numbers
rather than overoptimistic expectations, the stock price would stay
realistic. But I admit, we scholars don’t yet know the real answer to how to
make this happen.
So
having led Corporate America in the wrong direction, Jensen ‘fesses up no
one knows the way out. But if executives weren’t incentivized to take such a
topsy-turvey shareholder-driven view of the world, they’d weigh their
obligations to other constituencies, including the community at large, along
with earning shareholders a decent return. But it’s now become so
institutionalized it’s hard to see how to move to a more sensible regime.
For instance, analysts regularly try pressuring Costco to pay its workers
less, wanting fatter margins. But thecomparatively high wages are an integral part of
Costco’s formula: it
reduces costly staff turnover and employee pilferage. And Costco’s upscale
members report they prefer to patronize a store they know treats workers
better than Walmart and other discounters. If managers with an established,
successful formulas still encounter pressure from the Street to strip mine
their companies, imagine how hard it is for struggling companies or less
secure top executives to implement strategies that will take a while to reap
rewards. I’ve been getting reports from McKinsey from the better part of a
decade that they simply can’t get their clients to implement new initiatives
if they’ll dent quarterly returns.
This governance system is actually in crisis, but the extraordinary profit
share that companies have managed to achieve by squeezing workers and the
asset-goosing success of post-crisis financial policies have produced an
illusion of health. But porcine maquillage only improves appearances; it
doesn’t mask the stench of gangrene. Nevertheless, executives have
successfully hidden the generally unhealthy state of their companies. As
long as they have cheerleading analysts, complacent boards and the Fed
protecting their back, they can likely continue to inflict more damage,
using “maximizing shareholder value” canard as the cover for continuing rent
extraction.
Jensen Comment
Mike Jensen was the headliner at the 2013 American Accounting Association Annual
Meetings. AAA members can watch various videos by him and about him at the AAA
Commons Website.
Actually Al Rappaport at Northwestern may have been more influential in
spreading the word about creating shareholder value --- Rappaport, Alfred
(1998).
Creating Shareholder Value: A guide for managers and investors. New
York: The Free Press. pp. 13–29.
It would be interesting if Mike Jensen and/or Al
Rappaport wrote rebuttals to this article.
A recent accountics science study suggests
that audit firm scandal with respect to someone else's audit may be a reason
for changing auditors.
"Audit Quality and Auditor Reputation: Evidence from Japan," by Douglas J.
Skinner and Suraj Srinivasan, The Accounting Review, September 2012,
Vol. 87, No. 5, pp. 1737-1765.
Our conclusions are subject
to two caveats. First, we find that clients switched away from ChuoAoyama in
large numbers in Spring 2006, just after Japanese regulators announced the
two-month suspension and PwC formed Aarata. While we interpret these events
as being a clear and undeniable signal of audit-quality problems at
ChuoAoyama, we cannot know for sure what drove these switches(emphasis added).
It is possible that the suspension caused firms to switch auditors for
reasons unrelated to audit quality. Second, our analysis presumes that audit
quality is important to Japanese companies. While we believe this to be the
case, especially over the past two decades as Japanese capital markets have
evolved to be more like their Western counterparts, it is possible
that audit quality is, in general, less important in Japan(emphasis added) .
Replication Paranoia: Can you imagine anything like this happening
in accountics science?
If you’re a psychologist, the news has to make you
a little nervous—particularly if you’re a psychologist who published an
article in 2008 in any of these three journals: Psychological Science,
the Journal of Personality and Social Psychology, or the
Journal of Experimental Psychology: Learning, Memory, and Cognition.
Because, if you did, someone is going to check your
work. A group of researchers have already begun what they’ve dubbed
the Reproducibility Project, which aims to
replicate every study from those three journals for that one year. The
project is part of Open Science Framework, a group interested in scientific
values, and its stated mission is to “estimate the reproducibility of a
sample of studies from the scientific literature.” This is a more polite way
of saying “We want to see how much of what gets published turns out to be
bunk.”
For decades, literally, there has been talk about
whether what makes it into the pages of psychology journals—or the journals
of other disciplines, for that matter—is actually, you know, true.
Researchers anxious for novel, significant, career-making findings have an
incentive to publish their successes while neglecting to mention their
failures. It’s what the psychologist Robert Rosenthal named “the file drawer
effect.” So if an experiment is run ten times but pans out only once you
trumpet the exception rather than the rule. Or perhaps a researcher is
unconsciously biasing a study somehow. Or maybe he or she is flat-out faking
results, which is not unheard of.
Diederik Stapel, we’re looking at you.
So why not check? Well, for a lot of reasons. It’s
time-consuming and doesn’t do much for your career to replicate other
researchers’ findings. Journal editors aren’t exactly jazzed about
publishing replications. And potentially undermining someone else’s research
is not a good way to make friends.
Brian Nosek
knows all that and he’s doing it anyway. Nosek, a
professor of psychology at the University of Virginia, is one of the
coordinators of the project. He’s careful not to make it sound as if he’s
attacking his own field. “The project does not aim to single out anybody,”
he says. He notes that being unable to replicate a finding is not the same
as discovering that the finding is false. It’s not always possible to match
research methods precisely, and researchers performing replications can make
mistakes, too.
But still. If it turns out that a sizable
percentage (a quarter? half?) of the results published in these three top
psychology journals can’t be replicated, it’s not going to reflect well on
the field or on the researchers whose papers didn’t pass the test. In the
long run, coming to grips with the scope of the problem is almost certainly
beneficial for everyone. In the short run, it might get ugly.
Nosek told Science that a senior colleague
warned him not to take this on “because psychology is under threat and this
could make us look bad.” In a Google discussion group, one of the
researchers involved in the project wrote that it was important to stay “on
message” and portray the effort to the news media as “protecting our
science, not tearing it down.”
The researchers point out, fairly, that it’s not
just social psychology that has to deal with this issue. Recently, a
scientist named C. Glenn Begley attempted to replicate 53 cancer studies he
deemed landmark publications. He could only replicate six. Six! Last
December
I interviewed Christopher Chabris about his paper
titled “Most Reported Genetic Associations with General Intelligence Are
Probably False Positives.” Most!
A related new endeavour called
Psych File Drawer
allows psychologists to upload their attempts to
replicate studies. So far nine studies have been uploaded and only three of
them were successes.
Both Psych File Drawer and the Reproducibility
Project were started in part because it’s hard to get a replication
published even when a study cries out for one. For instance, Daryl J. Bem’s
2011 study that seemed to prove that extra-sensory perception is real — that
subjects could, in a limited sense, predict the future —
got no shortage of attention and seemed to turn
everything we know about the world upside-down.
Yet when Stuart Ritchie, a doctoral student in
psychology at the University of Edinburgh, and two colleagues failed to
replicate his findings, they had
a heck of a time
getting the results into print (they finally did, just recently, after
months of trying). It may not be a coincidence that the journal that
published Bem’s findings, the Journal of Personality and Social
Psychology, is one of the three selected for scrutiny.
Continued in article
Jensen Comment
Scale Risk
In accountics science such a "Reproducibility Project" would be much more
problematic except in behavioral accounting research. This is because accountics
scientists generally buy rather than generate their own data (Zoe-Vonna Palmrose
is an exception). The problem with purchased data from such as CRSP data,
Compustat data, and AuditAnalytics data is that it's virtually impossible to
generate alternate data sets, and if there are hidden serious errors in the data
it can unknowingly wipe out thousands of accountics science publications all at
one --- what we might call a "scale risk."
Assumptions Risk
A second problem in accounting and finance research is that researchers tend to
rely upon the same models over and over again. And when serious flaws were
discovered in a model like CAPM it not only raised doubts about thousands of
past studies, it made accountics and finance researchers make choices about
whether or not to change their CAPM habits in the future. Accountics researchers
that generally look for an easy way out blindly continued to use CAPM in
conspiracy with journal referees and editors who silently agreed to ignore CAPM
problems and limitations of assumptions about efficiency in capital markets---
http://faculty.trinity.edu/rjensen/Theory01.htm#EMH
We might call this an "assumptions risk."
Hence I do not anticipate that there will ever be a Reproducibility Project
in accountics science. Horrors. Accountics scientists might not continue to be
the highest paid faculty on their respected campuses and accounting doctoral
programs would not know how to proceed if they had to start focusing on
accounting rather than econometrics.
Scientists, philosophers and skeptics alike are
familiar with the idea of Ockham’s razor, an epistemological principle
formulated in a number of ways by the English Franciscan friar and
scholastic
philosopher William of Ockham (1288-1348).
Here is one version of it, from the pen of its originator:
Frustra fit per plura quod potest
fieri per pauciora. [It is futile to do with more things that which can
be done with fewer] (Summa Totius Logicae)
Philosophers often refer to this as
the principle of economy, while scientists tend to call it parsimony.
Skeptics invoke it every time they wish to dismiss out of hand claims of
unusual phenomena (after all, to invoke the “unusual” is by definition
unparsimonious, so there).
There is a problem with all of this, however, of
which I was reminded recently while reading an old paper by my colleague
Elliot Sober, one of the most prominent contemporary philosophers of
biology. Sober’s article is provocatively entitled “Let’s razor Ockham’s
razor” and it is available for download from
his web site.
Let me begin by reassuring you that Sober didn’t
throw the razor in the trash. However, he cut it down to size, so to
speak. The obvious question to ask about Ockham’s razor is: why? On what
basis are we justified to think that, as a matter of general practice,
the simplest hypothesis is the most likely one to be true? Setting aside
the surprisingly difficult task of operationally defining “simpler” in
the context of scientific hypotheses (it can be done, but only
in certain domains,
and it ain’t straightforward), there doesn’t seem
to be any particular logical or metaphysical reason to believe that the
universe is a simple as it could be.
Indeed, we know it’s not. The history
of science is replete with examples of simpler (“more elegant,” if you
are aesthetically inclined) hypotheses that had to yield to more clumsy
and complicated ones. The Keplerian idea of elliptical planetary orbits
is demonstrably more complicated than the Copernican one of circular
orbits (because it takes more parameters to define an ellipse than a
circle), and yet, planets do in fact run around the gravitational center
of the solar system in ellipses, not circles.
Lee Smolin (in his delightful
The Trouble with Physics)
gives us a good history of 20th century physics,
replete with a veritable cemetery of hypotheses that people thought
“must” have been right because they were so simple and beautiful, and
yet turned out to be wrong because the data stubbornly contradicted
them.
In Sober’s paper you will find a
discussion of two uses of Ockham’s razor in biology, George Williams’
famous critique of group selection, and “cladistic” phylogenetic
analyses. In the first case, Williams argued that individual- or
gene-level selective explanations are preferable to group-selective
explanations because they are more parsimonious. In the second case,
modern systematists use parsimony to reconstruct the most likely
phylogenetic relationships among species, assuming that a smaller number
of independent evolutionary changes is more likely than a larger number.
Part of the problem is that we do
have examples of both group selection (not many, but they are there),
and of non-parsimonious evolutionary paths, which means that at best
Ockham’s razor can be used as a first approximation heuristic, not as a
sound principle of scientific inference.
And it gets worse before it gets
better. Sober cites Aristotle, who chided Plato for hypostatizing The
Good. You see, Plato was always running around asking what makes for a
Good Musician, or a Good General. By using the word Good in all these
inquiries, he came to believe that all these activities have something
fundamental in common, that there is a general concept of Good that gets
instantiated in being a good musician, general, etc. But that, of
course, is nonsense on stilts, since what makes for a good musician has
nothing whatsoever to do with what makes for a good general.
Analogously, suggests Sober, the
various uses of Ockham’s razor have no metaphysical or logical universal
principle in common — despite what many scientists, skeptics and even
philosophers seem to think. Williams was correct, group selection is
less likely than individual selection (though not impossible), and the
cladists are correct too that parsimony is usually a good way to
evaluate competitive phylogenetic hypotheses. But the two cases (and
many others) do not share any universal property in common.
What’s going on, then? Sober’s solution is to
invoke the famous
Duhem thesis.**
Pierre Duhem suggested in 1908 that, as Sober puts
it: “it is wrong to think that hypothesis H makes predictions about
observation O; it is the conjunction of H&A [where A is a set of
auxiliary hypotheses] that issues in testable consequences.”
This means that, for instance, when astronomer
Arthur Eddington “tested”
Einstein’s General Theory of Relativity during a
famous 1919 total eclipse of the Sun — by showing that the Sun’s
gravitational mass was indeed deflecting starlight by exactly the amount
predicted by Einstein — he was not, strictly speaking doing any such
thing. Eddington was testing Einstein’s theory given a set of
auxiliary hypotheses, a set that included independent estimates of
the mass of the sun, the laws of optics that allowed the telescopes to
work, the precision of measurement of stellar positions, and even the
technical processing of the resulting photographs. Had Eddington failed
to confirm the hypotheses this would not (necessarily) have spelled the
death of Einstein’s theory (since confirmed
in many other ways).
The failure could have resulted from the failure
of any of the auxiliary hypotheses instead.
This is both why there is no such
thing as a “crucial” experiment in science (you always need to repeat
them under a variety of conditions), and why naive Popperian
falsificationism is wrong (you can never falsify a hypothesis directly,
only the H&A complex can be falsified).
What does this have to do with
Ockham’s razor? The Duhem thesis explains why Sober is right, I think,
in maintaining that the razor works (when it does) given certain
background assumptions that are bound to be discipline- and
problem-specific. So, for instance, Williams’ reasoning about group
selection isn’t correct because of some generic logical property of
parsimony (as Williams himself apparently thought), but because — given
the sorts of things that living organisms and populations are, how
natural selection works, and a host of other biological details — it is
indeed much more likely than not that individual and not group selective
explanations will do the work in most specific instances. But that set
of biological reasons is quite different from the set that
cladists use in justifying their use of parsimony to reconstruct
organismal phylogenies. And needless to say, neither of these two sets
of auxiliary assumptions has anything to do with the instances of
successful deployment of the razor by physicists, for example.
Continued in article
Note the comments that follow
August 21, 2012 message from Amy Dunbar
Jensen Quotation
"Of course you, Amy, know this since you prepare technical tax learning
Camtasia videos for your tax students. I suspect you also prepare technical
software learning videos (such as how to run a GLM model in SAS)."
Actually I record Stata videos. I much prefer Stata
to SAS. ;-)
Amy
Jensen Comment
Here are some added positives and negatives to consider, especially if you are
currently a practicing accountant considering becoming a professor.
One of the more surprising things I
have learned from my experience as Senior Editor of
The Accounting Review
is just how often a
‘‘hot
topic’’
generates multiple
submissions that pursue similar research objectives. Though one might view
such situations as enhancing the credibility of research findings through
the independent efforts of multiple research teams, they often result in
unfavorable reactions from reviewers who question the incremental
contribution of a subsequent study that does not materially advance the
findings already documented in a previous study, even if the two (or more)
efforts were initiated independently and pursued more or less concurrently.
I understand the reason for a high incremental contribution standard in a
top-tier journal that faces capacity constraints and deals with about 500
new submissions per year. Nevertheless, I must admit that I sometimes feel
bad writing a rejection letter on a good study, just because some other
research team beat the authors to press with similar conclusions documented
a few months earlier. Research, it seems, operates in a highly competitive
arena.
Fortunately, from time to time, we
receive related but still distinct submissions that, in combination, capture
synergies (and reviewer support) by viewing a broad research question from
different perspectives. The two articles comprising this issue’s forum are a
classic case in point. Though both studies reach the same basic conclusion
that material weaknesses in internal controls over financial reporting
result in negative repercussions for the cost of debt financing, Dhaliwal et
al. (2011) do so by examining the public market for corporate debt
instruments, whereas Kim et al. (2011) examine private debt contracting with
financial institutions. These different perspectives enable the two research
teams to pursue different secondary analyses, such as Dhaliwal et al.’s
examination of the sensitivity of the reported findings to bank monitoring
and Kim et al.’s examination of debt covenants.
Both studies also overlap with yet a
third recent effort in this arena, recently published in the
Journal of Accounting
Research by Costello and
Wittenberg-Moerman (2011). Although the overall
‘‘punch
line’’
is similar in all three studies (material
internal control weaknesses result in a higher cost of debt), I am intrigued
by a ‘‘mini-debate’’
of sorts on the different conclusions
reache by Costello and Wittenberg-Moerman (2011) and by Kim et al.
(2011) for the effect of material weaknesses on debt covenants.
Specifically, Costello and Wittenberg-Moerman (2011, 116) find that
‘‘serious,
fraud-related weaknesses result in a significant decrease in financial
covenants,’’
presumably because banks substitute more
direct protections in such instances, whereas Kim et al.
Published Online: July 2011
(2011) assert from their cross-sectional
design that company-level material weaknesses are associated with
more
financial covenants in
debt contracting.
In reconciling these conflicting
findings, Costello and Wittenberg-Moerman (2011, 116) attribute the Kim et
al. (2011) result to underlying
‘‘differences
in more fundamental firm characteristics, such as riskiness and information
opacity,’’
given that, cross-sectionally, material
weakness firms have a greater number of financial covenants than do
non-material weakness firms even
before the disclosure of the material
weakness in internal controls. Kim et al. (2011) counter that they control
for risk and opacity characteristics, and that advance leakage of internal
control problems could still result in a debt covenant effect due to
internal controls rather than underlying firm characteristics. Kim et al.
(2011) also report from a supplemental change analysis that, comparing the
pre- and post-SOX 404 periods, the number of debt covenants falls for
companies both with and without
material
weaknesses in internal controls, raising the question of whether the
Costello and Wittenberg-Moerman (2011)
finding reflects a reaction to the disclosures or simply a more general
trend of a declining number of debt covenants affecting all firms around
that time period. I urge readers to take a look at both articles, along with
Dhaliwal et al. (2011), and draw their own conclusions. Indeed, I believe
that these sorts . . .
Continued in article
Jensen Comment
Without admitting to it, I think Steve has been embarrassed, along with many
other accountics researchers, about the virtual absence of validation and
replication of accounting science (accountics) research studies over the past
five decades. For the most part, accountics articles are either ignored or
accepted as truth without validation. Behavioral and capital markets empirical
studies are rarely (ever?) replicated. Analytical studies make tremendous leaps
of faith in terms of underlying assumptions that are rarely challenged (such as
the assumption of equations depicting utility functions of corporations).
Accounting science thereby has become a pseudo
science where highly paid accountics professor referees are protecting each
others' butts ---
"574 Shields Against Validity Challenges in Plato's Cave" ---
http://faculty.trinity.edu/rjensen/TheoryTAR.htm
The above link contains Steve's rejoinders on the replication debate.
In the above editorial he's telling us that there is a middle ground for
validation of accountics studies. When researchers independently come to similar
conclusions using different data sets and different quantitative analyses they
are in a sense validating each others' work without truly replicating each
others' work.
I agree with Steve on this, but I would also argue that these types of
"validation" is too little to late relative to genuine science where replication
and true validation are essential to the very definition of science. The types
independent but related research that Steve is discussing above is too
infrequent and haphazard to fall into the realm of validation and replication.
When's the last time you witnesses a TAR author criticizing the research of
another TAR author (TAR does not publish critical commentaries)?
Are TAR articles really all that above criticism? Even though I admire Steve's scholarship, dedication,
and sacrifice, I hope future TAR editors will work harder at turning accountics
research into real science!
Accounting theory courses seem to vary across the board
as do AIS courses in comparison to most other accounting courses that are
structured largely by the CPA examination and relatively uniform textbooks in
basic, intermediate, and advanced accounting courses.
Some programs gave up teaching accounting theory, in
part because there really aren't any good new textbooks in accounting theory,
and the older textbooks are outdated.
There are many bases from which accounting theory might
be taught;
Suggestions below are broad categories having considerable overlap:
I would also like to develop an accounting theory course
on the interaction of accounting controls, stewardship accounting, and the
evolution of fraud. The focus would be upon theory of preventing fraud:
More Detailed
Differences
(Comparisons) between FASB and IASB Accounting Standards
2011 Update
"IFRS and US GAAP: Similarities and Differences" according to PwC
(2011 Edition)
http://www.pwc.com/us/en/issues/ifrs-reporting/publications/ifrs-and-us-gaap-similarities-and-differences.jhtml
Note the Download button!
Note that warnings are given throughout the document that the similarities and
differences mentioned in the booklet are not comprehensive of all similarities
and differences. The document is, however, a valuable addition to students of
FASB versus IASB standard differences and similarities.
It's not easy keeping track of what's changing and
how, but this publication can help. Changes for 2011 include:
Revised introduction reflecting the current
status, likely next steps, and what companies should be doing now (see page 2);
Updated convergence timeline, including
current proposed timing of exposure drafts, deliberations, comment
periods, and final standards
(see page 7);
More current analysis of the differences
between IFRS and US GAAP -- including an assessment of the impact
embodied within the differences
(starting on page 17); and
Details incorporating authoritative standards
and interpretive guidance issued through July 31, 2011
(throughout).
This continues to be one of PwC's most-read
publications, and we are confident the 2011 edition will further your
understanding of these issues and potential next steps.
For further exploration of the similarities and
differences between IFRS and US GAAP, please also visit our
IFRS Video Learning Center.
To request a hard copy of this publication, please contact your PwC
engagement team or
contact us.
Jensen Comment
My favorite comparison topics (Derivatives and Hedging) begin on Page 158
The booklet does a good job listing differences but, in my opinion, overly
downplays the importance of these differences. It may well be that IFRS is more
restrictive in some areas and less restrictive in other areas to a fault. This
is one topical area where IFRS becomes much too subjective such that comparisons
of derivatives and hedging activities under IFRS can defeat the main purpose of
"standards." The main purpose of an "accounting standard" is to lead to greater
comparability of inter-company financial statements. Boo on IFRS in this topical
area, especially when it comes to testing hedge effectiveness!
One key quotation is on Page 165
IFRS does not specifically discuss the methodology
of applying a critical-terms match in the level of detail included within
U.S. GAAP.
Then it goes yatta, yatta, yatta.
Jensen Comment
This is so typical of when IFRS fails to present the "same level of detail" and
more importantly fails to provide "implementation guidance" comparable with the
FASB's DIG implementation topics and illustrations.
I have a
huge beef with the lack of illustrations in IFRS versus the many illustrations
in U.S. GAAP.
I have a
huge beef with the lack of illustrations in IFRS versus the many illustrations
in U.S. GAAP.
I have a huge beef with the lack of illustrations in
IFRS versus the many illustrations in U.S. GAAP.
"Canadian regulator decides against allowing early adoption of recent IFRSs
by certain entities," IAS Plus, November 1, 2011 ---
http://www.iasplus.com/index.htm
. . .
In making its decision, the OSFI considered a
number of factors such as industry
consistency, OSFI policy positions on
accounting and capital, operational capacity and resource constraints of
Federally Regulated Entities (FREs), the ability to benefit from improved
standards arising from the financial crisis and the
notion of a level playing field with other Canadian
and international financial institutions.
OSFI concluded that FREs should not early adopt the following new or amended
IFRSs, but instead should adhere to their mandatory effective dates:
Continued
Jensen Comment
The clients, auditors, and the AICPA clamoring that U.S. firms should be able to
voluntarily choose IFRS instead of U.S. GAAP even before it has not been decided
that IFRS will ever replace FASB standards seem to ignore the problems that
voluntary choice of IFRS might cause for investors and analysts. The above
reasoning by the OSFI makes sense to me.
But then outfits like the AICPA have a self-serving interest in earning
millions of dollars selling IFRS training courses and materials.
November 2, 2011 reply from Patricia Walters
Does that mean you oppose options to early adopt standards in general,
not just IFRSs?
Pat
November 2, 2011 reply from Bob Jensen
Hi Pat,
It's hard to say regarding early adoption of a particular national or
international standard, because there can be unique circumstances. For
example, FAS 123R simply altered how to make disclosures rather than alter
the disclosures themselves since employee option expenses had to be
disclosed before the FAS 123R adoption date. But even here early adoption of
FAS 123R by Company A versus late adoption by Company B made simple
comparisons of eps and P/E ratios between these companies less easy.
There's a huge difference between early adoption of a particular standard
and early adoption of an entire system of standards like switching from FASB
accounting standards to IFRS.
I think the Canadian position of early adoption of IFRS is probably correct
because of the mess early adoption of IFRS makes with comparisons of
companies using different accounting standards and the added costs of
regulation of more than one set of standards. Also think of the added burden
placed upon the courts to adjudicate disputes when differing sets of
standards are being used.
Even though we allow IFRS for SEC registered foreign companies, I think it
would be a total mess for the SEC, the PCAOB, investors, analysts,
educators, trainers, auditing, and even the IRS (where tax and reporting
treatments must sometimes be reconciled) if our domestic corporations could
choose between FASB versus IASB standards.
There are hundreds of differences between FASB and IASB standards. Allowing
companies domestic companies to cherry pick which system they choose before
it is even known if there will ever be official replacement of FASB
standards by IASB standards would be very, very confusing. What if there
never is a decision to replace FASB standards? Do want to simply allow
companies to choose to bypass FASB standards at their own discretion?
Of course, if information were costless it might be ideal to require
financial reporting where FASB and IASB outcomes are reconciled. But clients
and auditors generally contend that the cost of doing this greatly exceeds
benefits. And teaching financial accounting would become exceedingly
complicated if we had to teach two sets of standards on an equal basis.
I would certainly hate to face a CPA examination that had nearly equal
coverage of both FASB and IASB standards simultaneously. I say this
especially after viewing the hundreds of pages of complicated differences
between the two standards systems.
I’ve just uploaded the first 8 lectures in my Behavioral Finance class
for 2012. The first few lectures are very similar to last year’s, but the
content changes substantially by about lecture 5 when I start to focus more
on Schumpeter’s approach to endogenous money ---
http://www.debtdeflation.com/blogs/2012/09/23/behavioral-finance-lectures/
Jonathan Spence came here
to deliver a speech, but don't let that fool you: his address -- the 39th
Annual Jefferson Lecture in the Humanities, which took place Thursday -- in
no way resembled the sort typically associated with D.C.
The Jefferson Lecture is
sponsored by the National Endowment for the Humanities, which describes the
lecture as "the most prestigious honor the federal government bestows for
distinguished intellectual achievement in the humanities." Those
chosen
for the distinction are typically academics or
creative types (or both) -- but, given the setting, the sponsor, and the
nature of the award (which "recognizes an individual... who has the ability
to communicate the knowledge and wisdom of the humanities in a broad,
appealing way"), Jefferson Lecturers have historically taken the opportunity
to make a larger (and sometimes tacitly political) point related to the
humanities. Last year, controversial bioethicist
Leon Kass used his lecture
to criticize the way the humanities are taught and researched at American
universities; in 2007,
Harvey Mansfield argued, with many subtle
political allusions, that the social sciences are in dire need of "the help
of literature and history";
Tom Wolfe's 2006 lecture discussed how the
humanities shed light on modern culture (and lamented the current state of
that culture on campuses); 2005 lecturer Donald Kagan and 2004 lecturer
Helen Vendler offered opposing views on which disciplines of the humanities
are most crucial, and why.
If any of those in the
crowd (noticeably larger than last year's) at the Warner Theater last night
were familiar with the Jefferson Lectures of years prior, they were in for a
surprise.
Spence is Sterling
Professor of History Emeritus at Yale University, whose faculty he joined in
1966. His specialty has always been China -- his 14 books on Chinese history
include 1990's The Search for Modern China, upon whose publication
the New York Times
accurately predicted that it would "undoubtedly
become a standard text on the subject" -- and his lecture was entitled
"When
Minds Met: China and the West in the Seventeenth Century."
Even this relatively specific appellation, however,
conveys a misleading breadth, for Spence's lecture focused almost
exclusively on three men -- Shen Fuzong, an exceptionally learned Chinese
traveler; Thomas Hyde, an English scholar of history and language; and
Robert Boyle, also English, a scientist and philosopher of considerable
renown -- and one year: 1687.
In his lecture, Spence gave
what may (or may not) have been one brief acknowledgment that he'd chosen an
unusually narrow topic of discourse: "It is a commonplace, I think, that the
sources that underpin our concept of the humanities, as a focus for our
thinking, are expected to be broadly inclusive." But, for himself, Spence
dismissed that notion in one more sentence: "...as a historian I have always
been drawn to the apparently small-scale happenings in circumscribed
settings, out of which we can tease a more expansive story."
Thus he dedicated the rest
of his lecture to the story of those three historical figures in the year
1687. Shen had traveled to Europe in the company of one of his teachers, a
Flemish Jesuit priest who was co-editing a book of the sayings of Confucius
from Chinese into Latin. Hyde, librarian at the University of Oxford's
Bodleian Library, invited Shen there to assist him with the cataloging of
some Chinese books -- and also because Hyde, who in that era would have been
called an Orientalist, wanted to learn Chinese himself. After a brief stay
at Oxford, Shen returned to London, bearing a letter of introduction from
Hyde to his friend Boyle; the letter recommended that Boyle meet and
converse with the Chinese scholar. The letter had to be convincing, Spence
explained, because Boyle's reputation was by then widespread, and "he was so
inundated with curious visitors that at times he had to withdraw into
self-enforced seclusion...."
Shen did meet Boyle at
least once; Boyle's work diary mentions their discussion of the Chinese
language and its scholars (a conversation that, like all of those between
Shen and Hyde, must have taken place in Latin: Shen's Latin was excellent,
but he did not, evidently, know English). And Hyde maintained correspondence
not only with his old friend Boyle -- over the years, the two had "discussed
Arabic and Persian texts, Malay grammars... and how to access books from
Tangier, Constantinople and Bombay" as well as "the chemical constituents of
sal ammoniac and amber, the effectiveness of certain Mexican herbs...
current studies of human blood and air, the nature of papyrus, the writings
of Ramon Llull and the use of elixirs and alchemy in the treatment of
illnesses" -- but also with Shen, until around the time of the latter's
departure from England for Portugal in the spring of 1688.The letters
between Shen and Hyde covered such topics as "Chinese vocabulary... China's
units of weights and measurements... the workings of the Chinese examination
system and bureaucracy... [and] the Chinese Buddhist belief in the
transmigration of souls."
"All three men," Spence
ultimately concluded, "though so different, shared certain basic ideas about
human knowledge: these included... the importance of linguistic precision,
the need for broad-based comparative studies, the role of clarity in
argument, the need for thorough scrutiny of philosophical and theological
principles.... Theirs, though brief, had been a real meeting of the minds.
And the values they shared remain, well over three hundred years later, the
kind that we can seek to practice even in our own hurried lives."
That final point was the
closest Spence came to suggesting a particular take-home message for his
audience; however, in an interview with Inside Higher Ed, held that
morning in the lobby of the Willard Hotel, he did mention a few ideas that
he was hoping to convey. For one thing, Spence said, given the current
importance of U.S.-China relations, he hopes this much older, smaller-scale
example of dialogue between the East and West will "give some perspective to
that."
"Historians," he said,
"try to get people away from just focusing on the present; they try to give
them some sort of stronger sense of continuity, human continuity. And I just
like the range of things, these three people that draw together, and they're
writing their letters to each other, and their few meetings... and in that
short time they talk about examination systems, they talk about language,
competition, they talk about medicine, they talk about -- I was fascinated,
they talk about chess..... All these things seemed to me to flow together,
and I think they'd make an interesting -- I hope they'd make an interesting
-- package about cultural contact."
There's a message in that,
Spence said: "to make our range of contact as wide as possible, and to use
our intelligence about how to do this."
Another issue raised in
the lecture, Spence said -- "maybe a small point, but perhaps worth making"
-- has to do with the teaching and learning of languages; Hyde dreamed of
bringing native speakers of various Eastern languages to Oxford, to
establish a college of languages. "Why should everybody else on the planet
speak English?" Spence asked. "I mean, why should they?"
But on the larger
importance of the humanities, and their current status in higher education
and society at large, Spence was reluctant to make a strong argument. "It's
not just a case of encouraging humanities in the abstract; it's having
something to say.... The main search should be for what is the most
meaningful thing you can achieve with the humanities, how can you share some
kind of broader cultural values, or how can you learn things about yourself
or other societies. The challenge is to use the humane intelligence and see
what can be built on that."
And when it comes to
funding, "any government has to put its priorities somewhere, and this does
usually mean cutting something."
His lecture, Spence said,
isn't "meant to be exactly a political speech, you know, I hope people
understand that."
For the most part, those
in attendance seemed more than satisfied. Spence's talk was punctuated
frequently by warm laughter from the audience -- whom he indulged
shamelessly, often departing from his prepared remarks to expound upon
details that interested him, or to make additional jokes whenever the crowd
found one of his remarks especially humorous. When he finished, the applause
was long and loud, and one woman remarked audibly, "That was amazing!"; her
companion replied, "Nice, really nice!"
But at least a few people
reacted with more ambivalence. One group of young attendees, who identified
themselves as fans of Spence, having been students of his as undergraduates
at Yale, said that while they'd enjoyed the lecture, they had been hoping
that Spence would make a more explicit connection between his topic and
issues of current cultural or political relevance. One noted that, in his
introductory remarks that evening, NEH Chairman James Leach had described
the purpose of the Jefferson Lecture as being "to narrow the gap between the
world of academia and public affairs," and had emphasized the Endowment's
goal of "bridging cultures."
There was an "irony," this
young man said, in the fact that Spence's lecture precisely addressed the
bridging of two cultures, but Spence hadn't made a bridge between his own
remarks -- which the audience member interpreted as "a clarion call for
better scholarship" -- and any other realm. "Listeners," he said (possibly
referring to himself), "want something that's cut and dry, that's tweetable."
The possibility of such
complaints about his speech had arisen during Inside Higher Ed'sinterview with Spence that morning; he hadn't seemed concerned. "I'm not
going to sort of over-apologize to the audience... they've chosen to come to
hear about the seventeenth century" -- he chuckled -- "I think we announced
that!"
Robert Walker in New Zealand
and I have been corresponding about how much of the core of an accounting theory
course should be devoted to the main works of Professor Ijiri, especially his
AAA Monographs ---
http://aaahq.org/market/display.cfm?catID=5
However, given the tradeoffs
of the many topics that are important to accounting theory education, I think I
would devote less time to Yuji’s works than would Robert Walker since I don’t
think Yuji addressed many of our current theoretical problems. Robert Walker
would pretty much begin and end an accounting theory course with the Ijiri
monographs.
Robert Walker is a fine
accounting historian and theorist who asked me to share the following with you.
I admit that my own interest
in theory are probably wider. I’m also inclined with respect to accounting
theory to also focus on issues of operations and implementation. We can always
assume non-existent worlds filled with idealized inhabitants that we program.
Andy way we like But that’s probably theory best left to economists.
From: Robert
Bruce Walker [mailto:walkerrb@actrix.co.nz]
Sent: Wednesday, March 31, 2010 9:42 PM
To: Jensen, Robert
Subject: RE: Accounting Theory Courses
I am not trying to
operationalise ‘triple entry’ bookkeeping. This is ijiri’s ‘bridge too far’
(even a genius, for that is what he is, can be mistaken). Knowing the flaws
of historical cost, he attempted to introduce a third element which
accommodated the future (‘momentum’). In doing so he violated the beauty of
the algebraic formulation that double entry is
I have attempted to
express ‘momentum’ in double entry form – that is, I don’t look to the AAA
study on ‘triple entry bookkeeping’ (which, frankly, is nonsense and an
abject failure) but to the alternative valuation analysis in Theory of
Accounting Measurement. The idea of ‘momentum’ is to try to predict the
future from the past. That is not possible because it pre-supposes that
there is an essential continuity. It cannot take account of what is now
referred to as the ‘black swan’ phenomenon – the wholly unpredictable and
unexpected event. At best the accountant can only lay out the value
propositions that are an attempt to predict the future and adjust them for
discontinuities. The arrival of the black swan is, hopefully, not so
momentous an event as to over-whelm the entity whose accounting is being
carried out. The equity buffer is there for that purpose – to accommodate
the unexpected.
For instance, even in the
example of life insurance where actuarial practice is (a) most precise and
(b) most certain (everybody dies) the actuary cannot take account of events
that have not arisen before. They cannot predict a plague which would
fundamentally alter the stochastic data. All they can do is introduce a
prudential margin (see IAS36.30). Even then it may not be enough and even
then a dangerous thing to do as it under-states equity.
I would go so far as to
say that concepts such as irrationality are not amenable to any real or
sensible mathematical formulation. If it cannot be expressed in that form
it cannot be expressed in accounting notation. It is therefore not the
business of accounting. Perhaps my theory of accounting, if it is a theory
at all, ultimately teaches this – accounting needs to be much more modest in
its ambition. It deals only in money and money’s worth. If it cannot, it
is not practical to express it in money then it shouldn’t be expressed.
Take your concern with
contingent liability (or better provisional liability) it is simply absurd
to predict the outcome of the judicial process when dealing in matters of
tort (as you know these days that is how I make my living and I wouldn’t
even attempt to quantify my future ‘winnings’). A written narrative is all
that you can hope to achieve in such matters. If that understates
liabilities, so be it. As I say that is what equity (ownership interest) is
for.
It might not surprise for
me to claim that my theories are based in Friedrich Nietzsche. Consider
this:
I walk among men as among fragments of the
future; of that future which I scan.
And it is all my
art and aim, to compose into one and bring together that which is fragment, and
riddle and dreadful chance.
For how could I
endure to be a man; if man were not poet and reader of riddles and the redeemer
of chance!
To redeem the
past; to turn every ‘it was’ into ‘I wanted it thus’. That alone would I call
redemption.
Friedrich
Nietzsche Thus Spoke Zarathustra.
You wish to read the
‘fragments of the future’. A Promethean task I think. You cannot ever deal
with ‘dreadful chance’ until it is upon you. Then all you can do is redeem
it. It is foolhardy even an act of hubris to think otherwise. Accounting
can never do what you want it to do. In the end it is about limits, limits
to ambition.
Robert (jensen)
PS I hope your wife is
OK. It is illness, on a human scale, that is ‘dreadful chance’.
PSS Your colleagues might
consider, along with Ijiri, Nietzsche as the foundation to a course of
theory. His book Beyond Good and Evil has a sub-title ‘Towards a Philosophy
of the Future’.
From: Jensen, Robert [mailto:rjensen@trinity.edu]
Sent: Thursday, 1 April 2010 10:26 a.m.
To: Robert Bruce Walker
Subject: RE: Accounting Theory Courses
Hi Robert (Walker),
I think I understand the
swap, but I cannot connect to Ijiri with this illustration. The revaluations
are given, but they do not relate to force or momentum. That would take a
mathematical model of the future valuations, but this cannot be predicted.
If it could there would be no swap. The party and the counterparty have
different predictions of the future
New Essay Site by Robert Bruce Walker, Practitioner in New Zealand ---
walkerrb@actrix.co.nz
I have begun to go back over all my many writings
on the matter of accounting. I have decided to start publishing this
material on my website and I will do so progressively over the next few
weeks and months.
The first offering is an essay I wrote as a
submission to what is now NZICA on the occasion of a restructure in about
1992.
For those of you who have read my messages over the
last decade or so you will see that I am a musician with a single score in
my repertoire. Or less self deprecatingly I have had a consistent message
for what is now becoming decades rather than years.
Was I listened to back then? I doubt it. Was I
right in what I said? My answer to that may surprise.
Please read it and circulate it. I am slightly
uneasy about pushing people to read what I write. It seems so egotistical.
But then that would be true of all writers or would-be writers.
Jensen Comment
In Ijiri's mathematics the momentum lies in the first derivative. In accounting
practice the first derivative is not easily measured and audited. The momentum
for momentum accounting dies for lack of real world applications.
PS Yuji was one of my Ph.D. studies advisors
His writings on triple-entry accounting are listed in the above link.
Yuji is one of the best-known defenders of historical cost accounting.
Brush up your Shakespeare:
Medieval manuscripts to hit Internet Stanford University
Libraries, the University of Cambridge and
Corpus Christi College, Cambridge, will make
hundreds of medieval manuscripts, dating
from the sixth through the 16th centuries,
accessible on the Internet.
"Medieval manuscripts to hit Internet,"
Stanford Report, July 13, 2005 ---
http://news-service.stanford.edu/news/2005/july13/parker-071305.html
Thank you for the notice about the availability of
the medieval manuscripts on the Internet through the project Parker on the
Web at Stanford University. Two manuscripts are currently available, and on
page 11 of the English translation of Matthew Paris's "English History From
1235 to 1273" I have already found references to accounting (see below).
Accountants are still using the principle "under
whatever name it may be called" and entities are still making up new names
for inconvenient economic events in the hopes of avoiding full disclosure.
At this Catholic liberal arts university
Shakespeare is modern, and the medieval world is revered, so I'm interested
in gaining some insight into the medieval worldview.
Barbara W. Scofield, PhD, CPA
Associate Professor of Accounting
University of Dallas
1845 E. Northgate Irving, TX 75062
Braniff 262
scofield@gsm.udallas.edu
Here’s an expanded view of questions raised about
which constituencies credit rating agencies (and by analogy auditing firms)
really serve.
A
message forwarded by my anonymous friend Larry on October 18, 2009
How Moody's sold its ratings -- and sold out investors | McClatchy
---
http://www.mcclatchydc.com/politics/story/77244.html Instead, Moody's promoted executives who
headed its "structured finance" division, which assisted Wall Street in
packaging loans into securities for sale to investors. It also stacked
its compliance department with the people who awarded the highest
ratings to pools of mortgages that soon were downgraded to junk. Such
products have another name now: "toxic assets."
"In 2001, Moody's had revenues of $800.7 million; in 2005, they were
up to $1.73 billion; and in 2006, $2.037 billion. The exploding profits
were fees from packaging . . . and for granting the top-class AAA
ratings, which were supposed to mean they were as safe as U.S.
government securities," said Lawrence McDonald in his recent book, "A
Colossal Failure of Common Sense."
Nobody cared about due diligence so long as
the money kept pouring in during the housing boom. Moody's stock peaked
in February 2007 at more than $72 a share.
Billionaire investor Warren Buffett's
firm Berkshire Hathaway owned 15 percent of
Moody's stock by the end of 2001, company reports show. That stake,
largely still intact, meant that the Oracle from Omaha reaped huge
financial rewards while Moody's overlooked the glaring problems in pools
of subprime mortgages.
A Berkshire spokeswoman had no comment.
Moody's wasn't alone in ignoring the mounting problems. It wasn't
even first among competitors. The financial industry newsletter
Asset-Backed Alert found that Standard & Poor's participated in 1,962
deals in 2006 involving pools of loans, while Moody's did 1,697. In
2005, Standard & Poor's did 1,754 deals to Moody's 1,120. Fitch was well
behind both.
Jensen Comment
I’m frantically searching the writings of my very technical hero, Janet
Tavakoli, to discover that all this is not true about my other hero, Warren
Buffett. Of course there are huge unknowns, at this point in time, and
varying degrees of culpability.
Janet is pretty rough on the ratings agencies in her
writings. However, she’s always kind to Warren. One of my all-time favorite
books is her Dear Mr. Buffet book. On Page 107, Janet writes as
follows:
At the end of 2007, Berkshire Hathaway owned 78 million shares of Moody’s
Corporation, one of the top three rating agencies (the same shares owned
when I first met Warren Buffett in 2005), representing just over 19 percent
of the capital stock. The cot basis of the shares is $499 million. At the
end of 200, the value was just under $1 billion. By the end of 2006, the
value was around $3.3 billion, but it dropped to $1.7 billion at the end of
2007. The sharp increase in revenues is due chiefly to revenues generated
from rating structured financial products, and the sharp decrease was due to
the disillusionment of the market with the integrity of the ratings.
On Page 109, Janet continues to berate the rating
agency cartel (where I think it might be possible to substitute auditors for
rating agencies interchangeably):
The rating agencies seem to not care about the market’s forgiveness
since not only have they not apologized --- a necessary but not sufficient
condition --- they seem to feel the market should change.
Specifically, the market should change its point of view about what it
expects from the rating agencies. Yet it seems that the market has the right
to expect rating agencies to follow the basic principles of statistics.
The tactic has mainly been successful because the rating agencies act as a
cartel, leveraging their joint power to have fees magically converge and
have ratings so similar that they have participated overrating AAA
structured products backed by dodgy loans in 2007 that took substantial
principal losses. Meanwhile, many market professionals, including me,
pointed out in print that the AAA ratings were maeaningless. The rating
agencies presented a farily united front in defending their methods (except
for Fitch, which also participated on overrated CDOs and later seemed more
responsive to downgrading structured products.
. . .
“Ma and pa” retail investors found that AAA product ended up in their
pension funds and mutual funds because their money managers gave too much
credence to an AAA rating.
But nowhere have I yet found where Janet alludes to any
insider profiteering on the part of Warren Buffett who also lost billions of
dollars in the crash The difference between “ma and pa” and Mr. Buffet is
that a billion dollars is pocket change to Warren Buffet. He can easily
recoup his losses legitimately in trades with stupid hedge fund managers and
bankers that rely too much on fallible models (at least that’s what
mathematician Janet Tavakoli tells us in a very enlightening way).
Expert Financial Predictions (Jon Stewart's hindsight video
scrapbook) ---
http://www.technologyreview.com/blog/post.aspx?bid=354&bpid=23077&nlid=1840 You have to watch the first third of this video before it gets into the
scrapbook itself The problem unmentioned here is one faced by auditors and credit rating agencies
of risky clients every day: Predictions are often self fulfilling If an auditor issues going concern exceptions in audit reports, the exceptions
themselves will probably contribute to the downfall of the clients The same can be said by financial analysts who elect to trash a company's
financial outlook Hence we have the age-old conflict between holding back on what you really
secretly predict versus pulling the fire alarm on a troubled company There are no easy answers here except to conclude that it auditors and
credit rating agencies appeared to not reveal many of their inner secret
predictions in 2008 Auditing firms and credit rating agencies lost a lot of credibility in this
economic crisis, but they've survived many such stains on their reputations in
the past By now we're used to the fact that the public is generally aware of the fire
before the auditors and credit rating agencies pull the alarm lever On the other hand, financial wizards who pull the alarm lever on nearly every
company all the time lose their credibility in a hurry
FASB Codification Database Supersedes All FASB Standards
Countdown to Codification Alert: FASB Alert #4, 5-22-09
What happens to U.S. GAAP literature when the Codification went live on July 1,
2009? All
existing standards that were used to create the Codification will become
superseded upon the adoption of the Codification. The FASB will no longer
update and maintain the superseded standards. Also, upon adoption of the
Codification, the U.S. GAAP hierarchy will flatten from five levels to
twoauthoritative and non-authoritative. The following table illustrates the
result:
DON’T BE CAUGHT OFF GUARD! GET READY FOR THE CODIFICATION!
The FASB instituted a major change in the way accounting standards
are organized. The FASB Accounting Standards CodificationTM is
expected to become the single official source of authoritative, nongovernmental
U.S. generally accepted accounting principles (GAAP).After final
approval by the FASB only one level of authoritative GAAP will exist, other than
guidance issued by the Securities and Exchange Commission (SEC). All other
literature will be non-authoritative. While the FASB Codification is designed to make it much easier to research
accounting issues, the transition to use of the Codification will require some
advance training. These weekly “Countdown to Codification” alerts are designed
to provide tips to make that transition easier. The FASB offers a free online tutorial at
http://asc.fasb.org. A recorded instructional webcastThe Move to
Codification of US GAAP, first presented live on March 13, 2008also is
available at
http://www.fasb.org/fasb_webcast_series/index.shtml. In addition,
Codification training opportunities are offered through professional accounting
organizations such as the American Institute of Certified Public Accountants (AICPA).
which
introduces the ASC. This video has potential value at the beginning of the
semester to acquaint students with the ASC. I am thinking about posting the
clip to AAA commons. But, where should it be posted and does this type of
thing get posted in multiple interest group areas?
Any thoughts /
suggestions?
Zane Swanson www.askaref.com
a handheld device source of ASC information
Jensen Comment
A disappointment for colleges and students is that access to the Codification
database is not free. The FASB does offer deeply discounted prices to colleges
but not to individual teachers or students.
This is a great video helper for learning how
to use the FASB.s Codification database.
An enormous disappointment to me is how the
Codification omits many, many illustrations in the
pre-codification pronouncements that are still available
electronically as PDF files. In particular, the best way to
learn a very complicated standard like FAS 133 is to study the
illustrations in the original FAS 133, FAS 138, etc.
The FASB paid a fortune for experts to develop the
illustrations in the pre-codification pronouncements. It's sad that
those investments are wasted in the Codification database.
The following message was
forwarded by David Albrecht on June 16, 2009
From: "Tracey E. Sutherland" <traceysutherland@aaahq.org>
Organization: American Accounting Association
Date: Tue, 16 Jun 2009 17:25:23 -0400
FAF and AAA to Provide FASB Codification to Faculty and Students
On July 1, 2009, the Financial Accounting Standards Board (FASB) is
instituting a major change in the way accounting standards are organized. On
that date, the FASB Accounting Standards Codification™ (FASB Codification)
will become the single official source of authoritative, nongovernmental
U.S. generally accepted accounting principles (U.S. GAAP). After that date,
only one level of authoritative U.S. GAAP will exist, other than guidance
issued by the Securities and Exchange Commission (SEC). All other
literature will be non-authoritative.
As part of its educational mission, the Financial Accounting Foundation (FAF),
the oversight and administrative body of the FASB, in a joint initiative
with the American Accounting Association (AAA), will provide faculty and
students in accounting programs at post-secondary academic institutions with
the Professional View of the online FASB Codification.
Accounting Program Access—No Cost to Individual Faculty or Students
The Professional View of the FASB Codification will be accessible at no cost
to individual faculty and students, through the AAA’s Academic Access
program, available to Registered Accounting Programs. The Professional View
will provide advanced search functions with special utilities to assist in
the navigation of content, representing the fully functional view of the
FASB Codification that will be used by auditors, financial analysts,
investors, and preparers of financial statements. All of the features that
have been available with the verification version currently at
http://asc.fasb.org are included with the Professional View.
AAA Academic Access
The AAA will provide direct services to accounting departments through its
Academic Access program; issuing authentication credentials for faculty and
students through Registered Accounting Programs, at a low annual
institutional fee of $150. Information about this program will be
forthcoming directly from AAA and on the AAA website at
http://aaahq.org/FASB/Access.cfm.
Transitional Access—From July 1 through August 31, 2009
The AAA will provide credentials to individual faculty and students, at no
charge, during the transition period before the beginning of the fall
semester when faculty and students will receive credentials for access
through their Registered Accounting Programs.
The FAF, FASB, and AAA are enthusiastic about this new initiative and
understand the value of this program to accounting education and
scholarship, in addition to its benefit to faculty and students to have
access to the advanced view of U.S. GAAP that will be used by accounting
professionals.
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June 24, 2009 Update There was some doubt initially about whether the free or discounted faculty
and student access version of the FASB Codification database would be the
"Professional" version (that includes searching and cross-referencing at an $850
single user license per year).
The AAA registration site for the discounted ($150 annual discount price)
version makes it clear that accounting education departments or schools will get
the full "Professional" version at a discount, thereby saving each academic
program $700 per year savings per license. What is not yet perfectly clear is
whether this is a single-user access license. My reading is that multiple users
within a department or school can use the Codification database at the same
time. I could be wrong.
Since all future financial statements will no longer reference hard copy
sources like FAS 166 or EITF 98-1 or FIN 48, it is vital for students and
teachers and researchers to have access to the Codification database for
financial statement analysis.
All users will
have free access to the Codification database, but not the free access to the
$850 “Professional” searching and cross-referencing services.
Part Behavioral finance, part cycling, and part a
study in how the brain works, the following "Test" is eye opening at least.
We all get so caught up in seeing what we want to
see that we sometimes miss the obvious. This effects us in many ways: In
finance, if bullish (optimistic), we are more apt to see the good news, if
bearish (pessimistic) you see only bad news.
That is one reason why big break throughs happen
from those outside the field. It is one reason why sabbaticals and vacations
are important. But it can also have important implications in many other
ways.
Go ahead, take the test. It takes about a minute
---
Click Here
You can order back issues or relevant links management and accounting
books and journals from MAAW --- http://maaw.info/
Investors and analysts can now search the full
text of every SEC document filed by companies within the last two years.
They'll also be able to retrieve mutual fund filings by fund or share
class.
The company filing search engine enables
real-time, full-text searches of filings on the entirety of the SEC's
EDGAR (Electronic Document, Gathering, Analysis and Retrieval) database
of company filings for the last two years. The tool can be found at
http://www.sec.gov/edgar/searchedgar/webusers.htm.
SEC Chairman Christopher Cox, a strong
proponent of using the Internet to post dynamic financial reports and to
serve as a tool for investors and analysts made the announcement in his
opening remarks at the SEC's Interactive Data Roundtable in Washington,
D.C.
"This new full-text search capability will give
investors and analysts instant access to the specific information they
want," said Cox.
The new mutual fund search capability was made
possible when the SEC recently required that filings contain a unique
numerical identifier for each fund and share class. Investors will be
able to find relevant filings by searching for the name of their own
fund. In the past, searching for information on particular funds and
particular share classes within funds was very difficult, because a
single prospectus might contain information about many mutual funds and
share classes.
The SEC is asking users of this Web site
feature to supply feedback, including suggestions for additional
functions, so that further improvements to the site can be considered
and implemented.
Paul Pacter has been working hard to both maintain his international
accounting site and to produce a comparison guide between international and
Chinese GAAP. He states the following on May 26, 2005 at
http://www.iasplus.com/index.htm
May 26, 2005: Deloitte (China) has published
a comparison of accounting standards in the People's Republic of China and
International Financial Reporting Standards as of March 2005. The comparison
is available in both English and Chinese. China has different levels of
accounting standards that apply to different classes of entities. The
comparison relates to the standards applicable to the largest companies
(including all non-financial listed and foreign-invested enterprises) and
identifies major accounting recognition and measurement differences. Click
to download:
I think a case can be made that the IASB is becoming more Bayesian as tests
of credit risk of cash flow impairments become weighted by subjective
probability distributions. Hence we have to dredge up more of the old Bayesian
theory for students if the IASB heads full bore into using subjective
probability distributions for credit impairment, fair value, etc. Reverend Bayes
may be smiling down on the FASB. I am not so enthusiastic about how it will help
investors to add this subjectivity to financial reporting --- http://www.iasplus.com/dttletr/1007amortcost.pdf
"Group Audits, Group-Level Controls, and Component Materiality: How Much
Auditing Is Enough?" by Trevor R. Stewart and William R. Kinney, Jr., The
Accounting Review, March 2013 ---
http://aaajournals.org/doi/full/10.2308/accr-50314
Auditing standards now mandate that group auditors
determine and implement appropriate component materiality amounts, which
ultimately affect group audit scope, reliability, and value. However,
standards are silent about how these amounts should be determined and
methods being used in practice vary widely, lack theoretical support, and
may either fail to meet the audit objective or do so at excessive cost.
We develop a Bayesian group audit model
that generalizes and extends the
single-component audit risk model to aggregate assurance across multiple
components. The model formally incorporates group auditor knowledge of
group-level structure, controls, and context as well as component-level
constraints imposed by statutory audit or other requirements. Application of
the model yields component materiality amounts that achieve the group
auditor's overall assurance objective by finding the optimal solution on an
efficient materiality frontier. Numerical results suggest group-level
controls and structured subgroups of components are central to efficient
group audits.
A draft paper by Harvard graduate student James Lee
(student of Steve Pinker; I'd love to post the paper here but don't know yet
if that's OK) got me interested in the work of statistical learning pioneer
Judea Pearl.
I found the essay
Bayesianism and Causality, or, why I am only a half-Bayesian
(excerpted below) a concise, and provocative,
introduction to his ideas.
Pearl is correct to say that humans think in terms of
causal models, rather than in terms of correlation. Our brains favor simple,
linear narratives. The effectiveness of physics is a consequence of the fact
that descriptions of natural phenomena are compressible into simple causal
models. (Or, perhaps it just looks that way to us ;-)
Judea Pearl: I
turned Bayesian in 1971, as soon as I began reading Savage’s monograph
The Foundations of Statistical Inference [Savage, 1962]. The arguments
were unassailable: (i) It is plain silly to ignore what we know, (ii) It
is natural and useful to cast what we know in the language of
probabilities, and (iii) If our subjective probabilities are erroneous,
their impact will get washed out in due time, as the number of
observations increases.
Thirty years later, I am still a devout Bayesian in the sense of (i),
but I now doubt the wisdom of (ii) and I know that, in general, (iii) is
false. Like most Bayesians, I believe that the knowledge we carry in our
skulls, be its origin experience, schooling or hearsay, is an invaluable
resource in all human activity, and that combining this knowledge with
empirical data is the key to scientific enquiry and intelligent
behavior. Thus, in this broad sense, I am a still Bayesian. However, in
order to be combined with data, our knowledge must first be cast in some
formal language, and what I have come to realize in the past ten years
is that the language of probability is not suitable for the task; the
bulk of human knowledge is organized around causal, not probabilistic
relationships, and the grammar of probability calculus is insufficient
for capturing those relationships. Specifically, the building blocks of
our scientific and everyday knowledge are elementary facts such as “mud
does not cause rain” and “symptoms do not cause disease” and those
facts, strangely enough, cannot be expressed in the vocabulary of
probability calculus. It is for this reason that I consider myself only
a half-Bayesian. ...
"An Intuitive Explanation of Bayes': Theorem: Bayes' Theorem
for the curious and bewildered; an excruciatingly gentle introduction," by
Eliezer S., Yudkowsky, August 2009 ---
http://yudkowsky.net/rational/bayes
I think a case can be made that the IASB is becoming more Bayesian as tests
of credit risk of cash flow impairments become weighted by subjective
probability distributions. Hence we have to dredge up more of the old Bayesian
theory for students if the IASB heads full bore into using subjective
probability distributions for credit impairment, fair value, etc. Reverend Bayes
may be smiling down on the FASB. I am not so enthusiastic about how it will help
investors to add this subjectivity to financial reporting --- http://www.iasplus.com/dttletr/1007amortcost.pdf
A draft paper by Harvard graduate student James Lee
(student of Steve Pinker; I'd love to post the paper here but don't know yet
if that's OK) got me interested in the work of statistical learning pioneer
Judea Pearl.
I found the essay
Bayesianism and Causality, or, why I am only a half-Bayesian
(excerpted below) a concise, and provocative,
introduction to his ideas.
Pearl is correct to say that humans think in terms of
causal models, rather than in terms of correlation. Our brains favor simple,
linear narratives. The effectiveness of physics is a consequence of the fact
that descriptions of natural phenomena are compressible into simple causal
models. (Or, perhaps it just looks that way to us ;-)
Judea Pearl: I
turned Bayesian in 1971, as soon as I began reading Savage’s monograph
The Foundations of Statistical Inference [Savage, 1962]. The arguments
were unassailable: (i) It is plain silly to ignore what we know, (ii) It
is natural and useful to cast what we know in the language of
probabilities, and (iii) If our subjective probabilities are erroneous,
their impact will get washed out in due time, as the number of
observations increases.
Thirty years later, I am still a devout Bayesian in the sense of (i),
but I now doubt the wisdom of (ii) and I know that, in general, (iii) is
false. Like most Bayesians, I believe that the knowledge we carry in our
skulls, be its origin experience, schooling or hearsay, is an invaluable
resource in all human activity, and that combining this knowledge with
empirical data is the key to scientific enquiry and intelligent
behavior. Thus, in this broad sense, I am a still Bayesian. However, in
order to be combined with data, our knowledge must first be cast in some
formal language, and what I have come to realize in the past ten years
is that the language of probability is not suitable for the task; the
bulk of human knowledge is organized around causal, not probabilistic
relationships, and the grammar of probability calculus is insufficient
for capturing those relationships. Specifically, the building blocks of
our scientific and everyday knowledge are elementary facts such as “mud
does not cause rain” and “symptoms do not cause disease” and those
facts, strangely enough, cannot be expressed in the vocabulary of
probability calculus. It is for this reason that I consider myself only
a half-Bayesian. ...
Statistics Lesson: Spanking is a cause of lower IQ?
U.S. children who were spanked had lower IQs four years
later than those not spanked, researchers found. University of New Hampshire
Professor Murray Straus, who is presenting the findings Friday at the
14th International Conference on Violence, Abuse
and Trauma, in San Diego, called the study
"groundbreaking." "The results of this research have major implications for the
well being of children across the globe," Straus said in a statement. "It is
time for psychologists to recognize the need to help parents end the use of
corporal punishment and incorporate that objective into their teaching and
clinical practice." "How often parents spanked
made a difference. The more spanking the, the slower the development of the
child's mental ability," Straus said. "But even small amounts of spanking made a
difference."
"Study: Spanking linked to lower IQ," Breitbart, September
25, 2009 ---
http://www.breitbart.com/article.php?id=upiUPI-20090925-121520-9596&show_article=1&catnum=0
Jensen Comment
I think Straus was frequently spanked as a child. Could it be that lower IQ
students get more frustrated and are inclined toward greater degrees of misbehavior?
In recent weeks, editors at a respected
psychology journal have been taking heat from
fellow scientists for deciding to accept a research report that claims to
show the existence of extrasensory perception.
The report, to be published this year in
The Journal of Personality and Social Psychology,
is not likely to change many minds. And the scientific critiques of the
research methods and data analysis of its author, Daryl J. Bem (and the peer
reviewers who urged that his paper be accepted), are not winning over many
hearts.
Yet
the episode has
inflamed one of the longest-running debates in science. For decades, some
statisticians have argued that the standard technique used to analyze data
in much of social science and medicine overstates many study findings —
often by a lot. As a result, these experts say, the literature is littered
with positive findings that do not pan out: “effective” therapies that are
no better than a placebo; slight biases that do not affect behavior;
brain-imaging correlations that are meaningless.
By incorporating statistical techniques that are
now widely used in other sciences —
genetics, economic modeling, even wildlife
monitoring — social scientists can correct for such problems, saving
themselves (and, ahem, science reporters) time, effort and embarrassment.
“I was delighted that this ESP paper was accepted
in a mainstream science journal, because it brought this whole subject up
again,” said James Berger, a statistician at
Duke University. “I was on a mini-crusade about
this 20 years ago and realized that I could devote my entire life to it and
never make a dent in the problem.”
In recent weeks, editors at a respected
psychology journal have been taking heat from
fellow scientists for deciding to accept a research report that claims to
show the existence of extrasensory perception.
The report, to be published this year in
The Journal of Personality and Social Psychology,
is not likely to change many minds. And the scientific critiques of the
research methods and data analysis of its author, Daryl J. Bem (and the peer
reviewers who urged that his paper be accepted), are not winning over many
hearts.
Yet
the episode has inflamed one of the
longest-running debates in science. For decades, some statisticians have
argued that the standard technique used to analyze data in much of social
science and medicine overstates many study findings — often by a lot. As a
result, these experts say, the literature is littered with positive findings
that do not pan out: “effective” therapies that are no better than a
placebo; slight biases that do not affect behavior; brain-imaging
correlations that are meaningless.
By incorporating statistical techniques that are
now widely used in other sciences —
genetics, economic modeling, even wildlife
monitoring — social scientists can correct for such problems, saving
themselves (and, ahem, science reporters) time, effort and embarrassment.
“I was delighted that this ESP paper was accepted
in a mainstream science journal, because it brought this whole subject up
again,” said James Berger, a statistician at
Duke University. “I was on a mini-crusade about
this 20 years ago and realized that I could devote my entire life to it and
never make a dent in the problem.”
The statistical approach that has dominated the
social sciences for almost a century is called significance testing. The
idea is straightforward. A finding from any well-designed study — say, a
correlation between a personality trait and the risk of depression — is
considered “significant” if its probability of occurring by chance is less
than 5 percent.
This arbitrary cutoff makes sense when the effect
being studied is a large one — for example, when measuring the so-called
Stroop effect. This effect predicts that naming the color of a word is
faster and more accurate when the word and color match (“red” in red
letters) than when they do not (“red” in blue letters), and is very strong
in almost everyone.
“But if the true effect of what you are measuring
is small,” said Andrew Gelman, a professor of statistics and political
science at
Columbia University, “then by necessity anything
you discover is going to be an overestimate” of that effect.
Consider the following experiment. Suppose there
was reason to believe that a coin was slightly weighted toward heads. In a
test, the coin comes up heads 527 times out of 1,000.
Is this significant evidence that the coin is
weighted?
Classical analysis says yes. With a fair coin, the
chances of getting 527 or more heads in 1,000 flips is less than 1 in 20, or
5 percent, the conventional cutoff. To put it another way: the experiment
finds evidence of a weighted coin “with 95 percent confidence.”
Yet many statisticians do not buy it. One in 20 is
the probability of getting any number of heads above 526 in 1,000 throws.
That is, it is the sum of the probability of flipping 527, the probability
of flipping 528, 529 and so on.
But the experiment did not find all of the numbers
in that range; it found just one — 527. It is thus more accurate, these
experts say, to calculate the probability of getting that one number — 527 —
if the coin is weighted, and compare it with the probability of getting the
same number if the coin is fair.
Statisticians can show that this ratio cannot be
higher than about 4 to 1, according to Paul Speckman, a statistician, who,
with Jeff Rouder, a psychologist, provided the example. Both are at the
University of Missouri and said that the simple
experiment represented a rough demonstration of how classical analysis
differs from an alternative approach, which emphasizes the importance of
comparing the odds of a study finding to something that is known.
The point here, said Dr. Rouder, is that 4-to-1
odds “just aren’t that convincing; it’s not strong evidence.”
And yet classical significance testing “has been
saying for at least 80 years that this is strong evidence,” Dr. Speckman
said in an e-mail.
The critics have been crying foul for half that
time. In the 1960s, a team of statisticians led by Leonard Savage at the
University of Michigan showed that the classical
approach could overstate the significance of the finding by a factor of 10
or more. By that time, a growing number of statisticians were developing
methods based on the ideas of the
18th-century English mathematician Thomas Bayes.
Bayes devised a way to update the probability for a
hypothesis as new evidence comes in.
So in evaluating the strength of a given finding,
Bayesian (pronounced BAYZ-ee-un) analysis incorporates known probabilities,
if available, from outside the study.
It might be called the “Yeah, right” effect. If a
study finds that kumquats reduce the risk of heart disease by 90 percent,
that a treatment cures alcohol addiction in a week, that sensitive parents
are twice as likely to give birth to a girl as to a boy, the Bayesian
response matches that of the native skeptic: Yeah, right. The study findings
are weighed against what is observable out in the world.
In at least one area of medicine — diagnostic
screening tests — researchers already use known probabilities to evaluate
new findings. For instance, a new lie-detection test may be 90 percent
accurate, correctly flagging 9 out of 10 liars. But if it is given to a
population of 100 people already known to include 10 liars, the test is a
lot less impressive.
It correctly identifies 9 of the 10 liars and
misses one; but it incorrectly identifies 9 of the other 90 as lying.
Dividing the so-called true positives (9) by the total number of people the
test flagged (18) gives an accuracy rate of 50 percent. The “false
positives” and “false negatives” depend on the known rates in the
population.
Skills and knowledge should be required as part of the pre-certification
education of CPAs Prompted by New York’s forthcoming adoption of the
150-hour requirement to sit for the CPA exam, the NYSSCPA’s Quality Enhancement
Policy Committee drafted a white paper to encourage discussion on what skills
and knowledge should be required as part of the pre-certification education of
CPAs. This white paper, which was approved by the Society’s Board of Directors,
is presented here, along with additional commentary from the NYSSCPA’s Higher
Education Committee.
Quality Enhancement Policy Committee Sharon Sabba Fierstein, Chair, August 2008
---
http://www.nysscpa.org/cpajournal/2008/808/infocus/p26.htm
Specific requirements for becoming a CPA, and the rights and obligations of a
licensed CPA, are set forth in the laws and regulations of 54 United States
jurisdictions ---
http://www.cpa-exam.org/global/boards.html
Every year, we track the Securities and Exchange
Commission (SEC) staff’s comments on public company filings to provide you
with insights on the SEC staff’s concerns and areas of focus. Although each
registrant’s facts and circumstances are different, the economic conditions
in which they operate and their financial reporting challenges are often
similar. Understanding the comments and trends discussed in this publication
can help as you head into the year-end reporting season.
In its comments, the SEC staff questions
disclosures that may conflict with SEC rules or accounting principles, as
well as disclosures the SEC staff believes could be enhanced or clarified.
The resolutions vary. In some cases, registrants sufficiently support their
existing accounting or disclosures, and in others they agree to expand
disclosures in future filings or amend previous filings. Appendix C of this
publication provides an overview of the SEC staff filing review process, as
well as best practices for responding to staff comments. While the SEC staff
continues to comment on familiar topics such as significant estimates,
revenue recognition, impairment and financial instruments, it has increased
its focus in other areas, including:
• Nonperformance covenants contained in lease
agreements and how these contractual provisions affect the classification of
leases
• Pro forma financial information disclosed in
registration statements and Form 8-Ks reporting a significant acquisition,
including how the requirements of Article 11 of Regulation S-X have been met
for various pro forma adjustments
• The presentation of guarantor condensed
consolidating information pursuant to the relief provided in Rule 3-10 of
Regulation S-X
Segment reporting continues to be a common area of
focus in SEC comment letters. The SEC staff often considers disaggregated
information to be better for users of financial statements. As a result, the
staff frequently questions registrants’ conclusions about operating segments
being economically similar and their aggregation into a reportable segment.
The SEC staff also requests that registrants provide more robust analysis of
their segments in their MD&A.
The number of SEC staff comments on loss
contingency disclosure requirements has stabilized over the past year. While
the SEC staff has said that it has seen improvement in the disclosure of
loss contingencies, it is expected to continue to focus on evaluating and
enforcing compliance with ASC 450 in its filing reviews.
The SEC staff continues to focus on disclosures for
registrants with foreign operations. In particular, the SEC staff has been
questioning the tax effects of operating in foreign jurisdictions, including
the effects on liquidity of indefinitely reinvesting foreign earnings. The
SEC staff also has been asking registrants to provide more detailed
disclosures about any exposure they may have to European debt. To help
companies determine what to disclose about their exposures to countries
experiencing significant economic, fiscal or political challenges, the SEC
staff issued
CF
Disclosure Guidance: Topic No. 4: European Sovereign Debt Exposures
in January 2012. CF disclosure
guidance is a new type of interpretive guidance that the SEC staff has been
using to provide observations and views about disclosures required by
existing SEC rules and regulations.
Management’s discussion and analysis (MD&A)
....................................... 1
Guarantor financial information
.................................................................... 16
Internal control over financial reporting and
disclosure controls and procedures
..................................................................................
19
Where I Made My Money
Consulting and How
If you think I’m a great fan of historical cost, Pat, you’re nuts.
Pat Walters at Fordham University asked how I
found the time to make so many Camtasia videos on top of other things I do like
send out AECM messages by the thousands.
My first answer is that the time I spent making most of my
Camtasia videos actually saved me much more time, especially boring time at
having to repeat demos to confused students who lined up outside may office all
day long on many days. My second answer is that Camtasia videos, one in
particular, led to a lot of consulting opportunities around the world.
First I should note that my teaching style has always been
costly in terms of my time. When I taught any course I insisted on my students
learning technical details. For example, when I taught Accounting Information
Systems (AIS), I did not just teach theory of relational databases. I
insisted that my students learn relational database software, which happened to
be MS Access because that’s the only relational database software that Trinity
University would provide for my students.
I did not want to take up much class time demonstrating use
of software. Instead, each week I passed out a list of Possible Quiz Questions (PQQs)
where each PQQ had a recipe for doing a task in MS Access, usually by focusing
on the Northwind Database that used to be available from Microsoft. In class
each student had a computer in an electronic classroom. I randomly picked a few
PQQs with changed inputs and gave a quiz in every class throughout the semester
--- even if we were no longer even discussing database theory in class.
Invariably students or usually pairs of students could not
get my PQQ recipes to fully work. I found myself spending a typical day
repeatedly demonstrating the same thing over and over again to different pairs
of students. So I commenced to make Camtasia videos that cut down over 95% of
the student traffic regarding PQQ issues. You can sample one or more of my PQQ
videos at
http://www.cs.trinity.edu/~rjensen/video/acct5342/
When I taught AIS I made my students learn how to use the
Excel pivot tables provided with each of the Microsoft annual financial
statements. These are a bit tricky to use, so I made the helper videos linked at
http://www.cs.trinity.edu/~rjensen/video/acct5342/MicrosoftPivots/
When I taught Accounting Theory, I made my students do XBRL
financial statement analysis of a number of companies that the Korean KOSDAQ
stock exchange marked up with XBRL tags. KOSDAQ provided reader software to
analyze those tags. My students had great difficulty on these assignments --- so
I made the XBRLdemos2005.wmv video file listed at
http://www.cs.trinity.edu/~rjensen/video/windowsmedia/
Now let’s talk about the most important video that I
ever made ---
a video that helped me pay for my house up here in the mountains.
When I taught Accounting Theory, about a third of the course was spent on
technical details in FAS 133 and IAS 39 and much of this time was spent on
teaching the first 10 examples in Appendix B of FAS 133 for which my main
teaching guides are the 133ex Excel Workbooks listed at
http://www.cs.trinity.edu/~rjensen/
These files still are being downloaded by thousands of strangers around the
world.
But FAS 133 sometimes was not sufficiently detailed to suit
me. For example, in Example 5 of FAS 133 the FASB simply provides the interest
rate swap values out of thin air. I made my students learn how to value interest
rate swaps. For this purpose I created the wonder video 133ex05a.wmv video file
listed at
http://www.cs.trinity.edu/~rjensen/video/acct5341/
Supporting documentation can be found in the following two
files listed at
133ex05a.xls (the Effective spreadsheet within this Excel
workbook)
133ex05.htm file of a paper that Carl Hubbard and I published about swap
valuation
Also see
http://faculty.trinity.edu/rjensen/acct5341/speakers/133swapvalue.htm
Much of what I learned about swap valuation I learned from Carl.
Largely due to the 133ex05.htm paper that Carl and I
published, I have received over 1,000 inquiries by telephone or email from
investment bankers, Big Four auditors, and accounting professors around the
world asking me about swap valuation. Rather than repeat myself over and over, I
request that each of them watch my 133ex05a.wmv video from beginning to end.
That’s sometimes all they wanted to know, although on many occasions I get more
complicated questions afterwards, some of which I cannot answer and some of
which I can answer.
That one 133ex05a.wmv video plus my other free derivatives
accounting files have led to many consulting trips in the U.S., Canada, Mexico,
China, and Europe. It also led to invited lectures in those places plus New
Zealand. The lecture visits are listed at
http://faculty.trinity.edu/rjensen/resume.htm#Presentations
Consulting fees ranged from $8,000 per day at GE Capital to $0 for folks that
really needed help in developing nations. A colleague professor of finance, Phil
Cooley, always said I sold myself too cheap. I think I usually was
overpaid.
If you think I’m a great fan of historical cost, Pat,
you’re nuts.
In retirement with my wife in ill health, I’ve cut back greatly on travel and
even turned down an offer of two lucrative years in a think tank in Australia.
But a few companies have since beat a path to my door up here in the White
Mountains where I spend usually a day with them consulting on FAS 133 and in
particular derivative financial instruments valuation. If you think I’m a
great fan of historical cost, Pat, you’re nuts.
Now, Pat, when you ask me where I found the time to make
all those Camtasia videos, my answer is that I made the time on a lot of
Saturdays and Sundays in my office at Trinity University. And these videos saved
me tenfold that amount of time with students. And they helped me buy a rather
expensive home up here in the White Mountains.
My philosophy is that it’s
better to give than receive, and I found that in the process I received more
than I gave. I would not have learned nearly as much about FAS 133 and IAS 39
had I not given most of what I know away for free!
And the funny thing about consulting is that I often do not
know the technical answers raised by finance experts who literally beat a path
to my door. But I find that if we interactively begin to work through their
problems they usually ending up paying me for answers they reason out by
themselves from my ad hoc version of the Socratic process.
Dah
I think professors who do not open share extensively on the Web
miss the boat. Selfishness has its own punishments, and generosity has its own rewards.
Scroll most of the way down in this message for an example from XXXXX
Will Yancey was a pioneer in open sharing on the Web ---
http://faculty.trinity.edu/rjensen/Yancey.htm
Will made a very good living consulting and found that open sharing pays
back enormously, much better in his case than any kind of paid advertising.
But if you would’ve known Will you would’ve also discovered that he shared
openly out of the kindness of his big heart. I doubt that he even thought
about payback when he commenced to open share so generously.
I was also
an early-on open sharing professor and never once did so with the thought of
payback in mind. However, I am forwarding the message below to show that
once of the benefits of open sharing is payback ---
http://faculty.trinity.edu/rjensen/threads.htm
Once again, however, I stress that I would open share if there
was not a penny of monetary payback. I open share because it makes me feel
good to make a difference in the academy of professors and students.
When you do open share technical content, potential clients find
your work using Google, Bing, and other Web crawlers.
I think professors who do not open share extensively miss the boat. Selfishness has its own punishments, and generosity has its own rewards.
From:
XXXXX Sent: Wednesday, March 24, 2010 4:26 PM To: Jensen, Robert Subject: Interest Rate Swap Valuation?
Hi Bob,
I found you on the internet. We are doing a Dec 31 2009
audit and our client obtained a mortgage loan in 2009, and entered into a
fixed rate mortgage rate swap on the loans interest. I would like to get a
fair value quote for the swap at Dec. 31,2009. Would you be available to
consult with us on this valuation? Please advise interest and your fee?
Many thanks,
harry
XXXXX
Accounting for Derivative Financial Instruments and Hedging Activities
Hi Patricia,
The bottom line is that accounting authors, like intermediate textbook
authors, provide lousy coverage of FAS 133 and IAS 39 because they just do not
understand the 1,000+ types of contracts that are being accounted for in those
standards. Some finance authors understand the contracts but have never shown an
inclination to study the complexities of FAS 133 and IAS 39 (which started out
as a virtual clone of FAS 133).
There are some great textbooks on derivatives and hedging written by finance
professors, but those professors never delved into the complexities of FAS 133
and IAS 39. My favorite book may be out of print at the moment, but this was a
required book in my theory course: Derivatives: An Introduction by Robert A
Strong, Edition 2 (Thomson South-Western, 2005, ISBN 0-324-27302-9)
Professor Strong's book provides zero about FAS 133 and IAS 39, but my
students were first required to understand the contracts that they later had to
account for in my course. Strong's coverage is concise and relatively simple.
When first learning about hedging, my Trinity University graduate students
and CPE course participants loved an Excel workbook that I made them study at
www.cs.trinity.edu/~rjensen/Calgary/CD/Graphing.xls
Note the tabs on the bottom that take you to different spreadsheets.
There are some really superficial books written by accounting professors who
really never understood derivatives and hedging in finance.
Sadly, much of my tutorial material is spread over hundreds of different
links.
However, my dog and pony CD that I used to take on the road such as a
training course that I gave for a commodities trading outfit in Calgary can be
found at
http://www.cs.trinity.edu/~rjensen/Calgary/CD/ T
his was taken off of the CD that I distributed to each participant in each CPE
course, and now I realize that a copyrighted item on the CD should be removed
from the Web.
Note that some of the illustrations and exam answers have changed over time.
For example, the exam material on embedded derivatives is still relevant under
FASB rules whereas the IASB just waved a magic wand and said that clients no
longer have to search for embedded derivatives even though they're not "clearly
and closely related" to the underlyings in their host contracts. I think this is
a cop out by the IASB.
But the core of what I taught about derivatives and hedge accounting in my
accounting theory course can be found in the FAS 133 Excel spreadsheets listed
near the top of the document at
http://www.cs.trinity.edu/~rjensen/
The bottom line is that accounting authors like intermediate textbook authors
provide lousy coverage of FAS 133 and IAS 39 because they just do not understand
the 1,000+ types of contracts that are being accounted for in those standards.
Some finance authors understand the contracts but have never shown an
inclination to delve into the complexities of FAS 133 and IAS 39 (which started
out as a virtual clone of FAS 133).
CPA Journal
Editors’ Note: Published this past June, Baruch Lev and Fang Gu’s The End
of Accounting and the Path Forward for Investors and Managers (Wiley)
has generated a great deal of controversy within the profession. The CPA
Journal presents two contrasting perspectives on this thought-provoking
book: Arthur J. Radin questions whether the authors are right about the
conclusions they draw from the data, and Thomas I. Selling agrees with some
of their recommendations but disagrees about the linkages to value creation.
Jensen Comment 1
This is my Comment 1 since I want to reflect more on the Radin and Selling
review of the Lev and Gu arguments. Let me say that I really like parts Radin
and Selling review. I've always been disappointed in Baruch Lev's many writings
on intangibles. Lev is great at finding fault but offers nothing (as far as I
can tell it's zero) to find a better way to reliably measure or even disclose
intangibles. Lev writes so much, and for me Lev's attempted positive
contributions are always a huge disappointment.
If Lev's proposals (actually unrealistic dreams) really lowered
cost of capital more firms would be routinely applying Lev's proposals.
Like Ijiri's "Force Accounting" Lev is reaching into the clouds
to touch the angels.
The title "The End of Accounting" seems to be an attempt to
attract attention with an absurd title just like political economist Francis
Fukuyama tried to attract attention with his book "The End of History."
Obviously neither accounting nor history will come to an "end." Accounting will
come to an end when audited financial statements no longer impact portfolio
decisions of investors and employment decisions of business firms such as the
firing of a CEO who fails to meet "earnings" targets. Fukuyama later wrote that
history did not end after all. I wish Lev and Gu would write an article that
admits accounting did not end after all (no thanks to them).
Let me come back to
Comment 2 on these matters once I have more time to think about Comment
2.
Comment 2
Added on December 19, 2017
Comment 2
Accountancy evolved over thousands of years to become what it is rather than
what some academic theorists would like it to be. The best example is the most
popular index used by financial analysts and investors, namely the accounting
net income of a business or some variation thereof such as earnings-per-share (eps)
or other comprehensive income (OCI). Economic theorists would prefer economic
income defined as the amount of discounted net cash flows of a business over all
future time. But neither economists nor accountants have ever been able to
measure economic income reliably because only soothsayers estimate all future
net cash flows, and those soothsayers never agree on the numbers appearing in
their fortune-telling crystal balls.
Traditional for-profit (business) and not-for-profit (e.g., governmental)
accountancy now guided by either national standard setters (e.g., the FASB and
GASB in the USA) or international accounting standard setters (e.g., the
IASB) survived Darwinian-styled evolution over thousands of years because
multiple stakeholders find it to have utility for predicting financial futures
of an organization, stewardship and inputs into macroeconomic analyses. Today
accounting traditions and rules are rooted in the past (e.g. historical cost
book values), present (e.g., market values of derivatives and other marketable
securities), and future (e.g., discounted values of pension obligations).
Baruch Lev's many writings suggest that the biggest controversy in
accountancy is how intangibles are measured and disclosed. See the many books
and papers cited at his home page at
http://www.stern.nyu.edu/faculty/bio/baruch-lev
Baruch writes very well when it comes to emphasizing the importance of
intangibles in predicting a firm's financial future and laying out criticisms of
the present accounting traditions and standards in measuring and otherwise
disclosing such standards. But the world pretty much ignores his soothsayer
suggestions for intangibles measurement and disclosure.
Question:
Where were Enron's intangible assets? In particular, what was
its main intangible asset that has been overlooked in terms of
accounting for intangibles?
Lev's answer essentially was that since he could not find Enron's intangibles
there weren't any intangible assets. My answer is that there were highly
significant intangible assets that could neither be measured in any meaningful
way nor even disclosed without self-incrimination since many of them arose from
illegal bribes and other crimes that gave Enron power around the world and most
importantly inside USA government. Most of Enron's future revenues derived
from the intangible asset of political power. To the extent this intangible
asset arises from shady political activities Enron could not disclose, let alone
measure, the massive value of its political power intangible asset.
Tom Selling leans toward replacement cost valuation of intangible and
tangible assets. I would contend that only soothsayers can measure the
replacement cost of political power.
However, as Radin and Selling suggest not being able to disclose and measure
all important intangibles does not destroy the utility of accountancy or cause
the "end of accountancy" as we know it today. Just because the medical
profession cannot prevent cancer or even save the majority of Stage 4 cancer
patients does not destroy the utility of what the medical profession can do for
such patents. Accountancy is what it is and I do not
think it will "end" because of things it cannot yet do and probably will never
be able to do such as measure and disclose the intangible asset of political
power of a multinational company.
Software that was first put to work writing news
reports has now found another career option: drafting reports for financial
giants and U.S. intelligence agencies.
The writing software, called Quill, was developed
by
Narrative Science, a Chicago company set up in
2010 to commercialize technology developed at Northwestern University that
turns numerical data into a written story. It wasn’t long before Quill was
being used to report on baseball games for TV and online sports outlets, and
company earnings statements for
clients such as Forbes.
Quill’s early career success generated headlines of
its own, and the software was seen by some as evidence that intelligent
software might displace human workers. Narrative Science CEO Stuart Frankel
says that the publicity, even if some of it was negative, was a blessing. “A
lot of people felt threatened by what we were doing, and we got a lot of
coverage,” he says. “It led to a lot of inquiries from all different
industries and to the evolution to a different business.”
Narrative Science is now renting out Quill’s
writing skills to financial customers such as T. Rowe Price, Credit Suisse,
and USAA to write up more in-depth, lengthy reports on the performance of
mutual funds that are then distributed to investors or regulators.
“It goes from the job of a small army of people
over weeks to just a few seconds,” says Frankel. “We do 10- to 15-page
documents for some financial clients.”
An investment from In-Q-Tel, the CIA’s investment
division, led the company to work from multiple U.S. intelligence agencies.
Asked about that work, Frankel says only that “The communication challenges
of the U.S. intelligence community are very similar to those of our other
customers.” Altogether, Quill now churns out millions of words per day.
The software’s output can be impressive for
software, but it can’t write without some numerical data for inspiration. It
performs statistical analysis on that data, looking for significant events
or trends, and it draws on knowledge about key concepts such as bankruptcy,
profit, and revenue, and how such concepts are related.
The following paragraph, from an investment report,
shows that Quill can write passable text for such a document, but it can
still feel as if it were written by a computer.
“The energy sector was the main contributor to
relative performance, led by stock selection in energy equipment and
services companies. In terms of individual contributors, a position in
energy equipment and services company Oceaneering International was the
largest contributor to returns. Stock selection also contributed to
relative results in the health care sector. Positioning in health care
equipment and supplies industry helped most.”
Quill is programmed with rules of writing that it
uses to structure sentences, paragraphs, and pages, says
Kristian Hammond, a
computer science professor at Northwestern University and chief scientist at
Narrative Science. “We know how to introduce an idea, how not to repeat
ourselves, how to get shorter,” he says.
Companies can also tune Quill’s style and use of
language based on what they need it to write. It can accentuate the positive
in marketing copy, or go for exhaustive detail in a regulatory filing, for
example.
Continued in article
Jensen Comment
One problem of with financial data versus scientific data is that financial data
possibly has much higher variation in quality and standardization. For example,
the FASB cannot even define concepts of "earnings" and derivations from earnings
measures like P/E ratios. This makes comparisons of one company's "net earnings"
over multiple years dubious. Even more dubious are comparisons of "net
earnings," eps, and P/E ratios of different companies doubtful no matter how
good the Quill software is for generating narratives out of financial data.
Accounting History Corner
"SPROUSE’S WHAT-YOU-MAY-CALL-ITS: FUNDAMENTAL INSIGHT OR MONUMENTAL MISTAKE?"
by Sudipta Basu and Gegory B. Waymire Accounting Historians Journal, 2010, Vol. 37, no. 1 ---
http://umiss.lib.olemiss.edu:82/articles/1038402.7233/1.PDF
Hi Glen,
I have some troubles with the link as well. For me, the PDF will run in
my Windows 7 laptop but not my newer Windows 10 laptop, although this
morning the link I gave you is not working on either laptop.
It may be that you have to route to the article as described below.
Then scroll down to 2010 Volume 37 Number 1 and click on the line that
says to View Searchable PDF Text File
Then scroll down to the article page numbers may not exactly coincide with
the table of contents depending upon the resolution of your browser.
Abstract
We critically evaluate Sprouse’s 1966 Journal of Accountancyarticle, which
prodded the FASB towards a balance-sheet approach. We highlight three errors
in this article.
First,
Sprouse confuses necessary and sufficient conditions by arguing that
good accounting systems must satisfy the balance-sheet equation. Second, Sprouse’s insinuation that financial analysts rely on
balance-sheet analysis is contradicted by contemporary and current
security-analysis textbooks, analysts’ written reports, and interviews
with analysts. Third,
and most crucially, Sprouse does not recognize that the primary role
of accounting systems is to help managers discover and exploit profit
able exchange opportunities, without which firms cannot survive
CONCLUDING OBSERVATIONS ON THE LEGACY OF THE
ASSET-LIABILITY APPROACH
Sprouse [1966] is important neither because of its
conceptual insights nor because of its unpersuasive evidence. Rather, the
article matters mainly because it shaped the FASB’s rhetoric and subsequent
standard-setting approach and today’s international standard-setting agenda.
Sprouse’s misinterpretation of Graham and Dodd’s Security Analysis
foreshadows the FASB and IASB misinterpretation of Hicks [1939]. Sprouse and
the two Boards are equally culpable in ignoring actual security-analyst
behavior when advocating their preferences, relying instead on made-up
“users” [Young 2006]. Thus, the current FASB/IASB Conceptual Framework [FASB,
2006] is justifiably seen as a direct descen dant of Sprouse [1966].
Sprouse and the two Boards ignore the implications
(or are unaware) of one of the major stylized facts of U.S. financial
reporting history – the shift from a balance-sheet approach to an
income-statement approach during 1900-1930. The shift to an income-statement
approach is usually attributed to the information needs of a massive influx
of individual investors into U.S. equity markets during this era [e.g.,
Hendriksen, 1970, pp. 51-55]. If individual equity investors are
primarily interested in balance-sheet information, then this shift should
not have occurred when it did. Sprouse and the two Boards never address this
salient historical evidence that contradicts their core as assumption of
investor information needs. More broadly, Sprouse and the two Boards ignore
the historical development of the revenue-expense approach, both in theory
and practice, which we survey in this paper. If financial accounting has
emerged over many generations to maintain consilience with the biologically
evolved human brain [Dickhaut et al., 2010], then an abrupt change to a
fair-value-based, asset-liability approach might well make financial reports
less useful to actual human readers.
Contrary to theoretical ruminations of Sprouse,
security analysts to this day rely primarily on earnings forecasts in
valuing firms. However, today’s analysts can construct their earnings
forecasts only after adjusting for many more non-recurring items that the
FASB has introduced into the income statement. Although SFAS 130 [FASB,
1997] introduced a broader, comprehensive income concept that includes even
more non-recurring items, analysts show no interest in forecasting it or
using it in their analyses. We believe that the FASB’s shift in focus to the
balance sheet has created bigger problems than merely whether financial
analysts have to adjust for new income statement “thingamajigs” instead of
balance sheet “what-you-may-call-its.”
We claim that the lack of analyst interest in the
FASB-mandated, non-recurring items is symptomatic of a monumental mistake in
the asset-liability approach; specifically, it is misaligned with the
reasons that firms exist and the resulting demand for causaldouble-entry
accounting as an economic institution. In other words, while the
asset-liability approach is constructively rational, i.e. deduced from
assumptions that work in a theoretical model, it is unlikely to be
ecologically rational in the sense of improving firms’ survival prospects in
the complex real world [Sargent, 2008; Smith, 2008].
Net earnings and EBITDA cannot be defined since
the FASB and IASB elected to give the balance sheet priority over the income
statement in financial reporting --- "The Asset-Liability Approach: Primacy does not mean Priority,"
by Robert Bloomfield, FASRI Financial Accounting Standards Research
Initiative, October 6, 2009 ---
http://www.fasri.net/index.php/2009/10/the-asset-liability-approach-primacy-does-not-mean-priority/
Similar problems arise with variations in quality and standardization of
components of balance sheets. For example, measures of cash might be relatively
accurate in terms of error variations, whereas variations in goodwill and other
intangibles is subject to high error variations.
Abstract:
Since the 1970s, the decision-usefulness has taken center stage and our
attention has been concentrated on valuation of assets and liabilities
instead of income measurement. The concept of income, once considered the
gravitational center of accounting has lost its primacy and become a
byproduct of the balance sheet derived from the measurement of assets and
liabilities.
However, we have not been equipped with robust
conceptual foundation supporting theoretically reasoned accounting
measurement. It is not only theoretically but also practically important to
renew our seemingly waned interest in the concept of income because ongoing
reforms of accounting standards cannot be successfully implemented without a
sound understanding of the concept of income.
Be that as it may, net earnings and EBITDA are all-important because
investors change their portfolios based on net earnings and its derivatives more
than anything in the balance sheet.
"Accounting Alchemy," by Robert E. Verrecchia, Accounting Horizons,
September 2013, pp. 603-618.
Verrecchia alleges that it's not that managers have a functional fixation for
earnings metrics as it is that they believe that other managers and investors
are so fixated with earnings that it because of monumental importance not
because it is inherently a great metric but because they believe deeply that the
market itself makes this index of vital importance.
. . .
In summary, my thesis is that managers project that
others are fixated on earnings—independent of any evidence in support
of, or contrary to, this phenomenon. This leads to managers resisting the
inclusion in earnings items that fail to enhance performance, such as the
amortization of Goodwill, or measures that make future performance more
volatile, such as those based on fair value. In the absence of acknowledging
PEF and attempting to grapple with it, I continue to see confrontations over
accounting regulation along the lines of recent debates about fair value
accounting, in addition to further impediments along the path to greater
transparency in financial statements.
It's a bit like requiring calculus for undergraduate accounting courses.
Calculus probably is not essential in any undergraduate accounting course in the
curriculum, but faculty are fixated that the best accounting majors are the ones
do well in calculus. Similarly, investors change their portfolios based on
earnings, eps, EBITDA, and P/E ratios when in fact those metrics are not defined
and may have a lot of misleading noise and secret manipulation
From the CFO Journal's Morning Ledger on May 8, 201
The largest U.S. companies are booking their strongest
quarterly profits in five years,
as firms reap the benefits of years of belt tightening and finally see a
pickup in demand. But part of the improvement has come from keeping a lid on
spending, and many CEOs remain reluctant to change and open their wallets
for new projects, plants and people, Thomas Gryta and Theo Francis write.
Profits at S&P 500 companies jumped an estimated 13.9% in the first quarter,
growing nearly twice as fast as revenue. The gains stretched across
industries, from Wall Street’s banks to Silicon Valley’s web giants, and
were helped by a rebound in the battered energy sector. The picture was a
marked improvement from a year ago, when profits fell 5%, and was the best
performance since the third quarter of 2011.
ensen Comment
Accounting standard setters cannot even operationally define the calculation of
earnings other than to make it a plug that makes the balance sheet balance. And
yet this plug remains as an exceedingly important driver of share prices in the
stock markets.
From the CFO Journal's Morning Ledger on May 5, 2017
Avon under pressure
Avon Products Inc.
Chief Executive Sheri McCoy faces new pressure following a surprise loss
that sent the cosmetics seller’s stock tumbling
Thursday.
Jensen Comment
Accounting standard setters cannot even operationally define the calculation of
earnings other than to make it a plug that makes the balance sheet balance. And
yet this plug remains as an exceedingly important driver of share prices in the
stock markets.
May 9, 2017 Question from Tom Selling
I’d like to brush up on the shortcomings of
Hicksian “income” for measuring the earnings of a business entity. Do
you (or anyone else on AECM, of course) have a reference (e.g., an article
or book chapter) to help me out?
Here is one of references that I recommend that are in the accounting
literature. The main take away here is that fair value accounting takes us
closer to the Hicksian concept of income at the expense of reliability. I
might note that Professor Schipper over the years is a proponent of falr
value accounting. This is not a defense of historical cost accounting as
might have been written by AC Littleton or Yuji Ijiri.
Especially note the references at the end of the commentary.
The main problem is that Hicksian Income in theory assumes all changes is
"wealth" or "well offness" where wealth includes much more than accountants
put on balance sheets. Examples include the many intangibles and contingent
liabilities that are left off balance sheets due to inability to measure
reliably such as the value of human resources and changes thereof. Also
accountants have never figured out how to measure the requisite "value in
use: as opposed to disposal value in a yard sale.
Bob Jensen
It would seem that, if the constraint of double-entry bookkeeping is removed as
a basis of financial reporting, the operational definitions of the major
performance indicator of "profit" for for-profit businesses will have to become
much more precise and operational than "profit" is presently defined as a
residual phenomenon in a double-entry bookkeeping system.
Some alternative approaches to income suggested by
Hicks and by other writers and their relevance to conceptual frameworks for
accounting
"Hicksian Income in the Conceptual Framework" ---
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1576611
Michael Bromwich London School of Economics
Richard H. Macve London School of Economics & Political Science (LSE) -
Department of Accounting and Finance
Shyam Sunder Yale School of Management
March 22, 2010
Abstract:
In seeking to replace accounting ‘conventions’ by ‘concepts’ in the pursuit
of principles-based standards, the FASB/IASB joint project on the conceptual
framework has grounded its approach on a well-known definition of ‘income’
by Hicks. We welcome the use of theories by accounting standard setters and
practitioners, if theories are considered in their entirety.
‘Cherry-picking’ parts of a theory to serve the immediate aims of standard
setters risks distortion. Misunderstanding and misinterpretation of the
selected elements of a theory increase the distortion even more. We argue
that the Boards have selectively picked from, misquoted, misunderstood, and
misapplied Hicksian concepts of income. We explore some alternative
approaches to income suggested by Hicks and by other writers, and their
relevance to current debates over the Boards’ conceptual framework and
standards. Our conclusions about how accounting concepts and conventions
should be related differ from those of the Boards. Executive stock options (ESOs)
provide an illustrative case study.
The International
Accounting Standards Board, or IASB, which sets reporting standards in more
than 120 countries, said Wednesday it would look at providing new
definitions of common financial terms such as earnings before interest and
taxes, or ebit.
The new definitions
will be introduced over the next five years, in order to provide sufficient
time for suggestions and comment from market participants.
The changes will not
result in new standards but will require the board to overhaul existing
ones.
At the moment, terms
like operating profit are not defined by the IASB. The aim is to help market
participants judge the suitability of a particular investment.
“We want to give
investors the right handles to look at a balance sheet,” said IASB chairman
Hans Hoogervorst.
Up until now,
International Financial Reporting Standards, known as IFRS, leave companies
too much flexibility in defining such terms, which often makes it difficult
to compare financials, Mr. Hoogervorst said.
“Even within sectors,
there is a lack of comparability,” Mr. Hoogervorst said. This affects both
investors and companies, he added.
It is too early to tell
what the changes will mean for companies reporting under IFRS, according to
Mr. Hoogervorst. “They should be less revolutionary than the introduction of
new standards but every change results in work”, he said.
Some firms might find
that they have less latitude when reporting financial results, he said. That
could mean more work.
Firms that decide
against adopting the new IASB definition for ebit, for example, could be
required to reconcile their own ebit calculation into one based on the
IASB’s definition.
The IASB in 2017 also
plans to finalize a single accounting model that would be applied to all
forms of insurance contracts.
Besides that, the board
will work on updating the system through which filers add disclosures to the
electronic versions of their financial statements. The system is updated on
a regular basis and the IASB produces an annual compilation of all changes
each year.
Jensen Comment
It would seem that, if the constraint of double-entry bookkeeping is removed as
a basis of financial reporting, the operational definitions of the major
performance indicator of "profit" for for-profit businesses will have to become
much more precise and operational than "profit" is presently defined as a
residual phenomenon in a double-entry bookkeeping system.
It’s telling that the most interesting
presenter during MIT Technology Review’s
EmTech session on big data last week was not
really about big data at all. It was about
Amazon’s
Mechanical Turk, and the experiments it makes
possible.
Like many
other researchers,
sociologist and Microsoft researcher
Duncan Watts performs experiments using Mechanical
Turk, an online marketplace that allows users to pay others to complete
tasks. Used largely to fill in gaps in applications where human intelligence
is required, social scientists are increasingly turning to the platform to
test their hypotheses.
The point Watts made at EmTech was that, from his perspective, the
data revolution has less to do with the amount of data available and more to
do with the newly lowered cost of running online experiments.
Compare that to Facebook data scientists
Eytan Bakshy and Andrew Fiore, who presented right before Watts. Facebook,
of course, generates a massive amount of data, and the two
spoke of the experiments they perform to inform
the design of its products.
But what might have
looked like two competing visions for the future of data and hypothesis
testing are really two sides of the big data coin. That’s because data on
its own isn’t enough. Even the kind of experiment Bakshy and Fiore
discussed—essentially an elaborate A/B test—has its limits.
This is a point political forecaster and author Nate Silver discusses in his
recent book
The Signal and the Noise. After
discussing economic forecasters who simply gather as much data as possible
and then make inferences without respect for theory, he writes:
This kind of statement is becoming more common in
the age of Big Data. Who needs theory when you have so much information?
But this is categorically the wrong attitude to take toward forecasting,
especially in a field like economics, where the data is so noisy.
Statistical inferences are much stronger when backed up by theory or at
least some deeper thinking about their root causes.
Bakshy and Fiore no doubt understand
this, as they cited plenty of theory in their presentation. But Silver’s
point is an important one. Data on its own won’t spit out answers; theory
needs to progress as well. That’s where Watts’s work comes in.
A recent accountics science study suggests
that audit firm scandal with respect to someone else's audit may be a reason
for changing auditors.
"Audit Quality and Auditor Reputation: Evidence from Japan," by Douglas
J. Skinner and Suraj Srinivasan, The Accounting Review, September
2012, Vol. 87, No. 5, pp. 1737-1765.
Our conclusions are subject
to two caveats. First, we find that clients switched away from ChuoAoyama in
large numbers in Spring 2006, just after Japanese regulators announced the
two-month suspension and PwC formed Aarata. While we interpret these events
as being a clear and undeniable signal of audit-quality problems at
ChuoAoyama, we cannot know for sure what drove these switches
(emphasis added). It
is possible that the suspension caused firms to switch auditors for reasons
unrelated to audit quality. Second, our analysis presumes that audit quality
is important to Japanese companies. While we believe this to be the case,
especially over the past two decades as Japanese capital markets have
evolved to be more like their Western counterparts, it is possible that
audit quality is, in general, less important in Japan(emphasis added).
Financial Statements Loss of Quality and
Predictive Power
"Stock Prices and Earnings: A History of Research," by Patricia M.
Dechow, Richard G. Sloan, and Jenny Zha, SSRN
(no longer available free as a download from SSRN), Annual Review of Financial Economics, Vol. 6, pp. 343-363, 2014
December 2014 ($32 unless accessed free via your university's library
subscription)
http://www.annualreviews.org/doi/full/10.1146/annurev-financial-110613-034522
Abstract:
Accounting earnings summarize periodic corporate financial performance and
are key determinants of stock prices. We review research on the usefulness
of accounting earnings, including research on the link between accounting
earnings and firm value and research on the usefulness of accounting
earnings relative to other accounting and nonaccounting information. We also
review research on the features of accounting earnings that make them useful
to investors, including the accrual accounting process, fair value
accounting, and the conservatism convention. We finish by summarizing
research that identifies situations in which investors appear to
misinterpret earnings and other accounting information, leading to security
mispricing.
Jensen Comment
AAA Members may want to accompany this paper with Bill Beaver's recollections of
his own pioneering research on stock prices and earnings --- recollections given
at the American Accounting Association Annual Meetings as the 2014 Presidential
Scholar.
Video (free to AAA members who are subscribed to the AAA Commons) ---
http://commons.aaahq.org/hives/8d320fc4aa/summary
It is somewhat surprising that a predictor variable its
extended versions (e.g., earnings per share) that cannot be defined by the FASB
and IASB can be an effective predictor after it no longer can be defined.
By not being definable, there is little assurance that earnings, eps, etc. are
consistently measured over time for a single firm and across firms at a point in
time.
Accounting History Corner
"SPROUSE’S WHAT-YOU-MAY-CALL-ITS: FUNDAMENTAL INSIGHT OR MONUMENTAL MISTAKE?"
by Sudipta Basu and Gegory B. Waymire Accounting Historians Journal, 2010, Vol. 37, no. 1 ---
http://umiss.lib.olemiss.edu:82/articles/1038402.7233/1.PDF
Hi Glen,
I have some troubles with the link as well. For me, the PDF will run in
my Windows 7 laptop but not my newer Windows 10 laptop, although this
morning the link I gave you is not working on either laptop.
It may be that you have to route to the article as described below.
Then scroll down to 2010 Volume 37 Number 1 and click on the line that
says to View Searchable PDF Text File
Then scroll down to the article page numbers may not exactly coincide with
the table of contents depending upon the resolution of your browser.
Abstract
We critically evaluate Sprouse’s 1966 Journal of Accountancyarticle, which
prodded the FASB towards a balance-sheet approach. We highlight three errors
in this article.
First,
Sprouse confuses necessary and sufficient conditions by arguing that
good accounting systems must satisfy the balance-sheet equation. Second, Sprouse’s insinuation that financial analysts rely on
balance-sheet analysis is contradicted by contemporary and current
security-analysis textbooks, analysts’ written reports, and interviews
with analysts. Third,
and most crucially, Sprouse does not recognize that the primary role
of accounting systems is to help managers discover and exploit profit
able exchange opportunities, without which firms cannot survive
CONCLUDING OBSERVATIONS ON THE LEGACY OF THE
ASSET-LIABILITY APPROACH
Sprouse [1966] is important neither because of its
conceptual insights nor because of its unpersuasive evidence. Rather, the
article matters mainly because it shaped the FASB’s rhetoric and subsequent
standard-setting approach and today’s international standard-setting agenda.
Sprouse’s misinterpretation of Graham and Dodd’s Security Analysis
foreshadows the FASB and IASB misinterpretation of Hicks [1939]. Sprouse and
the two Boards are equally culpable in ignoring actual security-analyst
behavior when advocating their preferences, relying instead on made-up
“users” [Young 2006]. Thus, the current FASB/IASB Conceptual Framework [FASB,
2006] is justifiably seen as a direct descen dant of Sprouse [1966].
Sprouse and the two Boards ignore the implications
(or are unaware) of one of the major stylized facts of U.S. financial
reporting history – the shift from a balance-sheet approach to an
income-statement approach during 1900-1930. The shift to an income-statement
approach is usually attributed to the information needs of a massive influx
of individual investors into U.S. equity markets during this era [e.g.,
Hendriksen, 1970, pp. 51-55]. If individual equity investors are
primarily interested in balance-sheet information, then this shift should
not have occurred when it did. Sprouse and the two Boards never address this
salient historical evidence that contradicts their core as assumption of
investor information needs. More broadly, Sprouse and the two Boards ignore
the historical development of the revenue-expense approach, both in theory
and practice, which we survey in this paper. If financial accounting has
emerged over many generations to maintain consilience with the biologically
evolved human brain [Dickhaut et al., 2010], then an abrupt change to a
fair-value-based, asset-liability approach might well make financial reports
less useful to actual human readers.
Contrary to theoretical ruminations of Sprouse,
security analysts to this day rely primarily on earnings forecasts in
valuing firms. However, today’s analysts can construct their earnings
forecasts only after adjusting for many more non-recurring items that the
FASB has introduced into the income statement. Although SFAS 130 [FASB,
1997] introduced a broader, comprehensive income concept that includes even
more non-recurring items, analysts show no interest in forecasting it or
using it in their analyses. We believe that the FASB’s shift in focus to the
balance sheet has created bigger problems than merely whether financial
analysts have to adjust for new income statement “thingamajigs” instead of
balance sheet “what-you-may-call-its.”
We claim that the lack of analyst interest in the
FASB-mandated, non-recurring items is symptomatic of a monumental mistake in
the asset-liability approach; specifically, it is misaligned with the
reasons that firms exist and the resulting demand for causaldouble-entry
accounting as an economic institution. In other words, while the
asset-liability approach is constructively rational, i.e. deduced from
assumptions that work in a theoretical model, it is unlikely to be
ecologically rational in the sense of improving firms’ survival prospects in
the complex real world [Sargent, 2008; Smith, 2008].
Net earnings and EBITDA cannot be defined since the FASB and IASB elected to
give the balance sheet priority over the income statement in financial reporting
--- "The Asset-Liability Approach: Primacy does not mean Priority,"
by Robert Bloomfield, FASRI Financial Accounting Standards Research
Initiative, October 6, 2009 ---
http://www.fasri.net/index.php/2009/10/the-asset-liability-approach-primacy-does-not-mean-priority/
Abstract:
Since the 1970s, the decision-usefulness has taken center stage and our
attention has been concentrated on valuation of assets and liabilities
instead of income measurement. The concept of income, once considered the
gravitational center of accounting has lost its primacy and become a
byproduct of the balance sheet derived from the measurement of assets and
liabilities.
However, we have not been equipped with robust
conceptual foundation supporting theoretically reasoned accounting
measurement. It is not only theoretically but also practically important to
renew our seemingly waned interest in the concept of income because ongoing
reforms of accounting standards cannot be successfully implemented without a
sound understanding of the concept of income.
Be that as it may, net earnings and EBITDA are all-important because
investors change their portfolios based on net earnings and its derivatives more
than anything in the balance sheet.
"Accounting Alchemy," by Robert E. Verrecchia, Accounting Horizons,
September 2013, pp. 603-618.
Verrecchia alleges that it's not that managers have a functional fixation for
earnings metrics as it is that they believe that other managers and investors
are so fixated with earnings that it because of monumental importance not
because it is inherently a great metric but because they believe deeply that the
market itself makes this index of vital importance.
. . .
In summary, my thesis is that managers project that
others are fixated on earnings—independent of any evidence in support
of, or contrary to, this phenomenon. This leads to managers resisting the
inclusion in earnings items that fail to enhance performance, such as the
amortization of Goodwill, or measures that make future performance more
volatile, such as those based on fair value. In the absence of acknowledging
PEF and attempting to grapple with it, I continue to see confrontations over
accounting regulation along the lines of recent debates about fair value
accounting, in addition to further impediments along the path to greater
transparency in financial statements.
It's a bit like requiring calculus for undergraduate accounting courses.
Calculus probably is not essential in any undergraduate accounting course in the
curriculum, but faculty are fixated that the best accounting majors are the ones
do well in calculus. Similarly, investors change their portfolios based on
earnings, eps, EBITDA, and P/E ratios when in fact those metrics are not defined
and may have a lot of misleading noise and secret manipulation
Financial Statements Loss of Quality and
Predictive Power
Jensen Comment
I don't think the "The EBITDA Epidemic Takes Its Cue from Standard Setters."
Like Professor Verrecchia currently and my accounting Professor Bob
Jaedicke decades earlier I think the "EBITDA Epidemic" takes its cue from
investors and managers that have a "functional fixation" for earnings, eps,
EBITDA, and P/E ratios --- when in fact those metrics are no longer defined by
the FASB/IASB and may have a lot of misleading noise and secret manipulations.
Jensen Comment
If the FASB cannot define net earnings then it follows from cold logic that they
cannot define measures derived from net earnings like EBITDA.
However, virtually all private sector business firms compute net earnings and
some measures derived from net earnings like eps, EBITDA, and P/E ratios.
It's doubtful whether net earnings for two different companies or even one
company over two time intervals are really comparable.
But all that does not matter when it comes to adjudicating an insider trading
case in court even if the accused may not really be an insider.
I'm reminded of why billionaire Martha Stewart went to prison because she
acted on inside information about a company --- inside information passed on to
her by the CEO of that company. It doesn't matter that the amount of loss saved
by the inside tip involved is insignificant compared to her billion-dollar
portfolio. Evidence in the case made it clear that she did exploit other
investors by acting on the inside tip no matter how insignificant the value of
that tip to her. She was hauled off the clink in handcuffs and was released in
less than five months. But her good name and reputation were tarnished forever
---
http://en.wikipedia.org/wiki/Martha_Stewart
Flamboyant billionaire Mark Cuban is now in trial for very similar reasons,
although the alleged insider tip and the value of the alleged tip is more
obscure than in the Martha Stewart case. Like in the case of Martha Stewart the
loss avoided is pocket change ($750,000) relative to Cuban's billion-dollar
portfolio.
Accounting History Corner
"SPROUSE’S WHAT-YOU-MAY-CALL-ITS: FUNDAMENTAL INSIGHT OR MONUMENTAL MISTAKE?"
by Sudipta Basu and Gegory B. Waymire Accounting Historians Journal, 2010, Vol. 37, no. 1 ---
http://umiss.lib.olemiss.edu:82/articles/1038402.7233/1.PDF
Hi Glen,
I have some troubles with the link as well. For me, the PDF will run in
my Windows 7 laptop but not my newer Windows 10 laptop, although this
morning the link I gave you is not working on either laptop.
It may be that you have to route to the article as described below.
Then scroll down to 2010 Volume 37 Number 1 and click on the line that
says to View Searchable PDF Text File
Then scroll down to the article page numbers may not exactly coincide with
the table of contents depending upon the resolution of your browser.
Abstract
We critically evaluate Sprouse’s 1966 Journal of Accountancyarticle, which
prodded the FASB towards a balance-sheet approach. We highlight three errors
in this article.
First,
Sprouse confuses necessary and sufficient conditions by arguing that
good accounting systems must satisfy the balance-sheet equation. Second, Sprouse’s insinuation that financial analysts rely on
balance-sheet analysis is contradicted by contemporary and current
security-analysis textbooks, analysts’ written reports, and interviews
with analysts. Third,
and most crucially, Sprouse does not recognize that the primary role
of accounting systems is to help managers discover and exploit profit
able exchange opportunities, without which firms cannot survive
CONCLUDING OBSERVATIONS ON THE LEGACY OF THE
ASSET-LIABILITY APPROACH
Sprouse [1966] is important neither because of its
conceptual insights nor because of its unpersuasive evidence. Rather, the
article matters mainly because it shaped the FASB’s rhetoric and subsequent
standard-setting approach and today’s international standard-setting agenda.
Sprouse’s misinterpretation of Graham and Dodd’s Security Analysis
foreshadows the FASB and IASB misinterpretation of Hicks [1939]. Sprouse and
the two Boards are equally culpable in ignoring actual security-analyst
behavior when advocating their preferences, relying instead on made-up
“users” [Young 2006]. Thus, the current FASB/IASB Conceptual Framework [FASB,
2006] is justifiably seen as a direct descen dant of Sprouse [1966].
Sprouse and the two Boards ignore the implications
(or are unaware) of one of the major stylized facts of U.S. financial
reporting history – the shift from a balance-sheet approach to an
income-statement approach during 1900-1930. The shift to an income-statement
approach is usually attributed to the information needs of a massive influx
of individual investors into U.S. equity markets during this era [e.g.,
Hendriksen, 1970, pp. 51-55]. If individual equity investors are
primarily interested in balance-sheet information, then this shift should
not have occurred when it did. Sprouse and the two Boards never address this
salient historical evidence that contradicts their core as assumption of
investor information needs. More broadly, Sprouse and the two Boards ignore
the historical development of the revenue-expense approach, both in theory
and practice, which we survey in this paper. If financial accounting has
emerged over many generations to maintain consilience with the biologically
evolved human brain [Dickhaut et al., 2010], then an abrupt change to a
fair-value-based, asset-liability approach might well make financial reports
less useful to actual human readers.
Contrary to theoretical ruminations of Sprouse,
security analysts to this day rely primarily on earnings forecasts in
valuing firms. However, today’s analysts can construct their earnings
forecasts only after adjusting for many more non-recurring items that the
FASB has introduced into the income statement. Although SFAS 130 [FASB,
1997] introduced a broader, comprehensive income concept that includes even
more non-recurring items, analysts show no interest in forecasting it or
using it in their analyses. We believe that the FASB’s shift in focus to the
balance sheet has created bigger problems than merely whether financial
analysts have to adjust for new income statement “thingamajigs” instead of
balance sheet “what-you-may-call-its.”
We claim that the lack of analyst interest in the
FASB-mandated, non-recurring items is symptomatic of a monumental mistake in
the asset-liability approach; specifically, it is misaligned with the
reasons that firms exist and the resulting demand for causaldouble-entry
accounting as an economic institution. In other words, while the
asset-liability approach is constructively rational, i.e. deduced from
assumptions that work in a theoretical model, it is unlikely to be
ecologically rational in the sense of improving firms’ survival prospects in
the complex real world [Sargent, 2008; Smith, 2008].
What Cuban failed to mention to the jury is that net earnings and EBITDA
cannot be defined since the FASB elected to give the balance sheet priority over
the income statement in financial reporting --- "The Asset-Liability Approach: Primacy does not mean Priority,"
by Robert Bloomfield, FASRI Financial Accounting Standards Research
Initiative, October 6, 2009 ---
http://www.fasri.net/index.php/2009/10/the-asset-liability-approach-primacy-does-not-mean-priority/
Abstract:
Since the 1970s, the decision-usefulness has taken center stage and our
attention has been concentrated on valuation of assets and liabilities
instead of income measurement. The concept of income, once considered the
gravitational center of accounting has lost its primacy and become a
byproduct of the balance sheet derived from the measurement of assets and
liabilities.
However, we have not been equipped with robust
conceptual foundation supporting theoretically reasoned accounting
measurement. It is not only theoretically but also practically important to
renew our seemingly waned interest in the concept of income because ongoing
reforms of accounting standards cannot be successfully implemented without a
sound understanding of the concept of income.
Jensen Comment
Worth and value can be defined in various ways depending a lot upon how
intangibles are valued relative to tangible assets and whether the valuation is
based upon aggregation of values of net assets versus stock market valuation of
equity shares. Certainly Walmart is worth a lot more than Amazon in terms of
tangible assets like stores, warehouses, and delivery trucks. Amazon is now
worth slightly more in terms of stock market valuation of equity shares that are
based on a whole lot of technology intangibles in the case of Amazon.
Walmart employs many more workers, and this carries with it a lot of unbooked
financial obligations for such things as future payroll and employee benefit
costs, especially medical insurance costs. Add to this the constant costs
of labor disputes and costs of fending off unions. Walmart also has much higher
inventory costs since Amazon tends to pass many inventory costs upstream
to suppliers. Amazon has more robotics and is positioned for replacement of
labor with even more robotics and other technologies.
Amazon is more vulnerable to risks of outsourcing such as the risks supplier
pricing disputes and labor disputes in UPS/USPS and price gouging by UPS or the
USPS. My point is that a whole lot of important
risks in Amazon's operations are outside the control of Amazon due to
outsourcing.
Our current managerial accounting courses and textbooks do a poor job of
analyzing financial risks when comparing companies like Amazon versus Walmart.
Hi Marc,
This does not operationally define how Net Earnings differs
from "Other Comprehensive Income." For example, some revenue and expense
items go to OCI and not net earnings whereas others go to net earnings and
not OCI.
Net earnings are derived from "revenues, expenses, gains and
loses."
OCI is derived in large part is derived from "revenues,
expenses, gains and loses."
The concept of "net earnings" in the CF will have to be more
precise on on how the partitions of are defined for
"revenues, expenses, gains and loses." It's impossible to put those
partitioning rules into concise definitions.
More problematic is that those partitions are often subjective and/or
arbitrary such as the subjective partition between a gain on an interest
rate swap is "effective" and goes into OCI versus what part is "ineffective"
and goes into "Net Earnings."
One of the best statements of the lack of a concept for net
earnings is was given by Bloomfield. -
Abstract:
Since the 1970s, the decision-usefulness has taken center stage and our
attention has been concentrated on valuation of assets and liabilities
instead of income measurement. The concept of income, once considered the
gravitational center of accounting has lost its primacy and become a
byproduct of the balance sheet derived from the measurement of assets and
liabilities.
However, we have not been equipped with robust
conceptual foundation supporting theoretically reasoned accounting
measurement. It is not only theoretically but also practically important to
renew our seemingly waned interest in the concept of income because ongoing
reforms of accounting standards cannot be successfully implemented without a
sound understanding of the concept of income.
Be that as it may, net earnings and EBITDA are all-important because
investors change their portfolios based on net earnings and its derivatives more
than anything in the balance sheet.
"Accounting Alchemy," by Robert E. Verrecchia, Accounting Horizons,
September 2013, pp. 603-618.
Verrecchia alleges that it's not that managers have a functional fixation for
earnings metrics as it is that they believe that other managers and investors
are so fixated with earnings that it because of monumental importance not
because it is inherently a great metric but because they believe deeply that the
market itself makes this index of vital importance.
. . .
In summary, my thesis is that managers project that
others are fixated on earnings—independent of any evidence in support
of, or contrary to, this phenomenon. This leads to managers resisting the
inclusion in earnings items that fail to enhance performance, such as the
amortization of Goodwill, or measures that make future performance more
volatile, such as those based on fair value. In the absence of acknowledging
PEF and attempting to grapple with it, I continue to see confrontations over
accounting regulation along the lines of recent debates about fair value
accounting, in addition to further impediments along the path to greater
transparency in financial statements.
It's a bit like requiring calculus for undergraduate accounting courses.
Calculus probably is not essential in any undergraduate accounting course in the
curriculum, but faculty are fixated that the best accounting majors are the ones
do well in calculus. Similarly, investors change their portfolios based on
earnings, eps, EBITDA, and P/E ratios when in fact those metrics are not defined
and may have a lot of misleading noise and secret manipulation
Getting accountants and auditors to follow the
rules, as well as their spirit, isn’t easy—keeping them honest has been an
uphill battle for going on 80 years.
In a
Fortune article three weeks ago, former SEC
Chief Accountant Lynn Turner told me that the current accounting and
auditing systems we all rely on need wholesale reform.
Since then, there has been a flurry of activity
from regulators, who have issued proposals to shore up weaknesses in U.S.
corporate accounting and auditing. The Securities and Exchange Commission
(SEC) issued a concept release on potential new audit committee disclosures,
including possible new requirements for information about how the audit
committee actually oversees the company’s auditor. And the Public Company
Accounting Oversight Board (PCAOB) issued two new proposals. One could
require disclosure of the partner and others involved in a company audit.
The second relates to the potential creation and disclosure of what the
PCAOB calls “measures that may provide new insights into audit quality.”
Since audits have been required of public companies
for 80 years, you’d think that measures of audit quality would already be
clear, well established, and tracked. So why is this just now in the works?
Given the choice between the stricter accountability of clear metrics and
the greater freedom of none, companies, their auditors, and regulators have
chosen flexibility.
Coninued in article
"Financial Engineering and the Arms Race Between Accounting Standard Setters
and Preparers," by Ronald A. Dye, Jonathan C. Glover, and Shyam
Sunder, Accounting Horizons, Volume 29, Issue 2 (June 2015) ---
http://aaapubs.org/doi/full/10.2308/acch-50992
This article is free only to AAA members.
Abstract
This essay analyzes some problems that accounting standard setters confront
in erecting barriers to managers bent on boosting their firms' financial
reports through financial engineering (FE) activities. It also poses some
unsolved research questions regarding interactions between preparers and
standard setters. It starts by discussing the history of lease accounting to
illustrate the institutional disadvantage of standard setters relative to
preparers in their speeds of response. Then, the essay presents a general
theorem that shows that, independent of how accounting standards are
written, it is impossible to eliminate all FE efforts of preparers. It also
discusses the desirability of choosing accounting standards on the basis of
the FE efforts the standards induce preparers to engage in. Then, the essay
turns to accounting boards' concepts statements; it points out that no
concept statement recognizes the general lack of goal congruence between
preparers and standard setters in their desires to produce informative
financial statements. We also point out the relative lack of concern in
recent concept statements for the representational faithfulness of the
financial reporting of transactions. The essay asserts that these oversights
may be responsible, in part, for standard setters promulgating recent
standards that result in difficult-to-audit financial reports. The essay
also discusses factors other than accounting standards that contribute to
FE, including the high-powered incentives of managers, the limited
disclosures and/or information sources outside the face of firms' financial
statements about a firm's FE efforts, firms' principal sources of financing,
the increasing complexity of transactions, the difficulties in auditing
certain transactions, and the roles of the courts and culture. The essay
ends by proposing some other recommendations on how standards can be written
to reduce FE.
Jensen Comment
The analytics of this Accounting Horizons article, rooted heavily in
Blackwell's Theorem, add academic elegance to the accountics science of the
article but do not carry over well in the real world --- largely because of the
limiting Plato's Cave assumptions of Blackwell's Theorem, However, the article
lives up to the fine academic reputations of its authors in other respects that
make it important to consider when pitting financial engineering against
regulation.
What needs to be extended is how financial engineering is not something that can
be reduced per se. Changes in regulation are more apt to impact some
firms positively (i.e., opportunity) and other firms negatively (i.e.,
cost) simultaneously. And there are always considerations of direct impacts
versus externalities. For example, eliminating coal as an energy source cleans
the air and water but puts generations of miners and entire towns out of work as
well as increasing the cost of electric power.
The FASB requirement to book employee stock options when vested makes
employee compensation more transparent to investors while making startups more
costly to operate. And with each significant increase in financial reporting and
compliance regulations businesses are increasingly mummified in red tape. As the
saying goes: "The road to Hell is paved with good intentions."
The above article features lease accounting standards but ignores the positives
and negatives of alternative details in setting such standards and the virtual
impossibility of reliably measuring some liabilities such as estimating
operating lease renewals ad infinitum.
Accounting History Corner
"SPROUSE’S WHAT-YOU-MAY-CALL-ITS: FUNDAMENTAL INSIGHT OR MONUMENTAL MISTAKE?"
by Sudipta Basu and Gegory B. Waymire Accounting Historians Journal, 2010, Vol. 37, no. 1 ---
http://umiss.lib.olemiss.edu:82/articles/1038402.7233/1.PDF
Hi Glen,
I have some troubles with the link as well. For me, the PDF will run in
my Windows 7 laptop but not my newer Windows 10 laptop, although this
morning the link I gave you is not working on either laptop.
It may be that you have to route to the article as described below.
Then scroll down to 2010 Volume 37 Number 1 and click on the line that
says to View Searchable PDF Text File
Then scroll down to the article page numbers may not exactly coincide with
the table of contents depending upon the resolution of your browser.
Abstract
We critically evaluate Sprouse’s 1966 Journal of Accountancyarticle, which
prodded the FASB towards a balance-sheet approach. We highlight three errors
in this article.
First,
Sprouse confuses necessary and sufficient conditions by arguing that
good accounting systems must satisfy the balance-sheet equation. Second, Sprouse’s insinuation that financial analysts rely on
balance-sheet analysis is contradicted by contemporary and current
security-analysis textbooks, analysts’ written reports, and interviews
with analysts. Third,
and most crucially, Sprouse does not recognize that the primary role
of accounting systems is to help managers discover and exploit profit
able exchange opportunities, without which firms cannot survive
CONCLUDING OBSERVATIONS ON THE LEGACY OF THE
ASSET-LIABILITY APPROACH
Sprouse [1966] is important neither because of its
conceptual insights nor because of its unpersuasive evidence. Rather, the
article matters mainly because it shaped the FASB’s rhetoric and subsequent
standard-setting approach and today’s international standard-setting agenda.
Sprouse’s misinterpretation of Graham and Dodd’s Security Analysis
foreshadows the FASB and IASB misinterpretation of Hicks [1939]. Sprouse and
the two Boards are equally culpable in ignoring actual security-analyst
behavior when advocating their preferences, relying instead on made-up
“users” [Young 2006]. Thus, the current FASB/IASB Conceptual Framework [FASB,
2006] is justifiably seen as a direct descen dant of Sprouse [1966].
Sprouse and the two Boards ignore the implications
(or are unaware) of one of the major stylized facts of U.S. financial
reporting history – the shift from a balance-sheet approach to an
income-statement approach during 1900-1930. The shift to an income-statement
approach is usually attributed to the information needs of a massive influx
of individual investors into U.S. equity markets during this era [e.g.,
Hendriksen, 1970, pp. 51-55]. If individual equity investors are
primarily interested in balance-sheet information, then this shift should
not have occurred when it did. Sprouse and the two Boards never address this
salient historical evidence that contradicts their core as assumption of
investor information needs. More broadly, Sprouse and the two Boards ignore
the historical development of the revenue-expense approach, both in theory
and practice, which we survey in this paper. If financial accounting has
emerged over many generations to maintain consilience with the biologically
evolved human brain [Dickhaut et al., 2010], then an abrupt change to a
fair-value-based, asset-liability approach might well make financial reports
less useful to actual human readers.
Contrary to theoretical ruminations of Sprouse,
security analysts to this day rely primarily on earnings forecasts in
valuing firms. However, today’s analysts can construct their earnings
forecasts only after adjusting for many more non-recurring items that the
FASB has introduced into the income statement. Although SFAS 130 [FASB,
1997] introduced a broader, comprehensive income concept that includes even
more non-recurring items, analysts show no interest in forecasting it or
using it in their analyses. We believe that the FASB’s shift in focus to the
balance sheet has created bigger problems than merely whether financial
analysts have to adjust for new income statement “thingamajigs” instead of
balance sheet “what-you-may-call-its.”
We claim that the lack of analyst interest in the
FASB-mandated, non-recurring items is symptomatic of a monumental mistake in
the asset-liability approach; specifically, it is misaligned with the
reasons that firms exist and the resulting demand for causaldouble-entry
accounting as an economic institution. In other words, while the
asset-liability approach is constructively rational, i.e. deduced from
assumptions that work in a theoretical model, it is unlikely to be
ecologically rational in the sense of improving firms’ survival prospects in
the complex real world [Sargent, 2008; Smith, 2008].
Net earnings and EBITDA cannot be defined since
the FASB and IASB elected to give the balance sheet priority over the income
statement in financial reporting --- "The Asset-Liability Approach: Primacy does not mean Priority,"
by Robert Bloomfield, FASRI Financial Accounting Standards Research
Initiative, October 6, 2009 ---
http://www.fasri.net/index.php/2009/10/the-asset-liability-approach-primacy-does-not-mean-priority/
Abstract:
Since the 1970s, the decision-usefulness has taken center stage and our
attention has been concentrated on valuation of assets and liabilities
instead of income measurement. The concept of income, once considered the
gravitational center of accounting has lost its primacy and become a
byproduct of the balance sheet derived from the measurement of assets and
liabilities.
However, we have not been equipped with robust
conceptual foundation supporting theoretically reasoned accounting
measurement. It is not only theoretically but also practically important to
renew our seemingly waned interest in the concept of income because ongoing
reforms of accounting standards cannot be successfully implemented without a
sound understanding of the concept of income.
From the CFO Journal's Morning Ledger on July 24, 2015
Amazon posts surprising profit
http://www.wsj.com/articles/amazon-posts-surprising-profit-1437682791?mod=djemCFO_h
For just the second time, Amazon.com
Inc. shared sales figures
Thursday for its cloud-computing division
Thursday. Amazon Web Services sales rose to $1.82 billion from $1 billion a
year earlier, and operating profit increased to $391 million from $77
million. Some believe the unit could operate on a stand-alone basis and,
because of its growth, is a primary reason to invest in Amazon. Amazon
posted a profit of $92 million for the third quarter, helped by sales which
rose a better-than-expected 20% to $23.18 billion.
Jensen Comment
"Surprising profits" and "record profits" make us wish that someday the
accounting standard setters (think FASB and IASB) would someday be able to
operationally define "profit" and make "profit" measures more comparable between
business firms.
Net earnings and EBITDA are all-important because
investors change their portfolios based on net earnings and its derivatives more
than anything in the balance sheet.
"Accounting Alchemy," by Robert E. Verrecchia, Accounting Horizons,
September 2013, pp. 603-618.
Verrecchia alleges that it's not that managers have a functional fixation for
earnings metrics as it is that they believe that other managers and investors
are so fixated with earnings that it because of monumental importance not
because it is inherently a great metric but because they believe deeply that the
market itself makes this index of vital importance.
. . .
In summary, my thesis is that managers project that
others are fixated on earnings—independent of any evidence in support
of, or contrary to, this phenomenon. This leads to managers resisting the
inclusion in earnings items that fail to enhance performance, such as the
amortization of Goodwill, or measures that make future performance more
volatile, such as those based on fair value. In the absence of acknowledging
PEF and attempting to grapple with it, I continue to see confrontations over
accounting regulation along the lines of recent debates about fair value
accounting, in addition to further impediments along the path to greater
transparency in financial statements.
Investors change their portfolios based on
earnings, eps, EBITDA, and P/E ratios when in fact those metrics are not defined
and may have a lot of misleading noise and secret manipulation
Question
If you presented the following article in class how would you approach the
analysis of this article and/or evaluate student reactions to this article?
Considerations
First consider the fact that neither the FASB nor the IASB has a working
definition of net earnings, and it's quite dangerous to compare earnings numbers
of a company over time.
Second consider the classical debate over whether accrual financial
statements or cash flow financial statements are more important when analyzing
the future of a company --- realizing that both may be important at the same
time.
Third consider any problems of revenue recognition and unrealized fair value
changes that may or may not be factors in these particular Twitter financial
statements.
"Why This Twitter Earnings Report Matters So Much," by Jon C. Ogg,
24/7 Wall Street, July 28, 2014 ---
Click Here
Twitter, Inc. (NYSE: TWTR) is set to report its
second quarter earnings report after the close of trading on Tuesday. This
will be just the second full quarter earnings report since its late 2013
initial public offering.
24/7 Wall St. has seen that the Thomson Reuters
estimate is for a loss of one-cent per share on revenues of $283 million.
Management had guided in a range of $270 to $180 million. New advertising is
said to be continuing to let the company grow, but we are also looking at
that user growth closely and the internal ad metrics rather than just the
raw revenue number.
We would caution that 2013 revenue was $664.89
million, up almost 110% from the $316.93 million in 2012. Revenue growth is
expected to slow ahead – with 90% growth to $1.27 billion in 2014 and with
revenue growth of another 62% to $2.06 billion in 2015. This is still
massive growth expected, but many
investors
remain mixed to uncertain about Twitter and its
endless growth.
On top of revenue growth, we will again be looking
closely at user growth. This should be up somewhere close to around 6% again
to around 270 million users, although the fair range might be 265 million to
275 million.
The number is too wild to calculate for an
earnings multiple for 2014, but even
after losing half of its post-IPO peak value Twitter still trades above
140-times expected 2015 earnings per share. It is also trading at a multiple
of almost 11-times expected 2015 revenues.
We have long wondered how investors will continue
to treat social media stocks in the years ahead. At some point there will
either be a split where social media takes over or there will be user
fatigue. That verdict remains out.
Twitter shares were above $38 on Monday in
afternoon trading. Its 52-week
trading
range
is $29.51 to $74.73, and the consensus analyst price target is almost
$43.50.
It almost feels like a conundrum for Twitter
investors. The stock has lost half of its peak value, but it likely still
has to post very strong numbers to keep investors happy. Having a
market
cap of $22.25 billion in revenues
comes with high expectations, and disappointing on those expectations could
come with serious consequences.
These were the metrics posted in the first quarter
of 2014, verbatim from Twitter’s release:
Average Monthly Active Users (MAUs)
were 255 million as of March 31, 2014, an increase of 25%
year-over-year.
Mobile MAUs reached
198 million in the first quarter of 2014, an increase of 31%
year-over-year, representing 78% of total MAUs.
Timeline views reached 157 billion for
the first quarter of 2014, an increase of 15% year-over-year.
Advertising revenue per thousand
timeline views reached $1.44 in the first quarter of 2014, an increase
of 96% year-over-year.
What Cuban failed to mention is that net earnings and EBITDA cannot be
defined since the FASB elected to give the balance sheet priority over the
income statement in financial reporting --- "The Asset-Liability Approach: Primacy does not mean Priority,"
by Robert Bloomfield, FASRI Financial Accounting Standards Research
Initiative, October 6, 2009 ---
http://www.fasri.net/index.php/2009/10/the-asset-liability-approach-primacy-does-not-mean-priority/
Abstract:
Since the 1970s, the decision-usefulness has taken center stage and our
attention has been concentrated on valuation of assets and liabilities
instead of income measurement. The concept of income, once considered the
gravitational center of accounting has lost its primacy and become a
byproduct of the balance sheet derived from the measurement of assets and
liabilities.
However, we have not been equipped with robust
conceptual foundation supporting theoretically reasoned accounting
measurement. It is not only theoretically but also practically important to
renew our seemingly waned interest in the concept of income because ongoing
reforms of accounting standards cannot be successfully implemented without a
sound understanding of the concept of income.
Be that as it may, net earnings and EBITDA are all-important because
investors change their portfolios based on net earnings and its derivatives more
than anything in the balance sheet.
"Accounting Alchemy," by Robert E. Verrecchia, Accounting Horizons,
September 2013, pp. 603-618.
Verrecchia alleges that it's not that managers have a functional fixation for
earnings metrics as it is that they believe that other managers and investors
are so fixated with earnings that it because of monumental importance not
because it is inherently a great metric but because they believe deeply that the
market itself makes this index of vital importance.
. . .
In summary, my thesis is that managers project that
others are fixated on earnings—independent of any evidence in support
of, or contrary to, this phenomenon. This leads to managers resisting the
inclusion in earnings items that fail to enhance performance, such as the
amortization of Goodwill, or measures that make future performance more
volatile, such as those based on fair value. In the absence of acknowledging
PEF and attempting to grapple with it, I continue to see confrontations over
accounting regulation along the lines of recent debates about fair value
accounting, in addition to further impediments along the path to greater
transparency in financial statements.
It's a bit like requiring calculus for undergraduate accounting courses.
Calculus probably is not essential in any undergraduate accounting course in the
curriculum, but faculty are fixated that the best accounting majors are the ones
do well in calculus. Similarly, investors change their portfolios based on
earnings, eps, EBITDA, and P/E ratios when in fact those metrics are not defined
and may have a lot of misleading noise and secret manipulation
Be that as it may, net earnings and EBITDA are all-important because
investors change their portfolios based on net earnings and its derivatives more
than anything in the balance sheet.
"Accounting Alchemy," by Robert E. Verrecchia, Accounting Horizons,
September 2013, pp. 603-618.
Verrecchia alleges that it's not that managers have a functional fixation for
earnings metrics as it is that they believe that other managers and investors
are so fixated with earnings that it because of monumental importance not
because it is inherently a great metric but because they believe deeply that the
market itself makes this index of vital importance.
. . .
In summary, my thesis is that managers project that
others are fixated on earnings—independent of any evidence in support
of, or contrary to, this phenomenon. This leads to managers resisting the
inclusion in earnings items that fail to enhance performance, such as the
amortization of Goodwill, or measures that make future performance more
volatile, such as those based on fair value. In the absence of acknowledging
PEF and attempting to grapple with it, I continue to see confrontations over
accounting regulation along the lines of recent debates about fair value
accounting, in addition to further impediments along the path to greater
transparency in financial statements.
It's a bit like requiring calculus for undergraduate accounting courses.
Calculus probably is not essential in any undergraduate accounting course in the
curriculum, but faculty are fixated that the best accounting majors are the ones
do well in calculus. Similarly, investors change their portfolios based on
earnings, eps, EBITDA, and P/E ratios when in fact those metrics are not defined
and may have a lot of misleading noise and secret manipulations.
From the 24/7 Wall Street newsletter on October 28, 2013
Earnings season is in full swing and this coming
week will bring many key earnings reports. This will also be the last week
of major on-calendar earnings for the third quarter, even if important
earnings will still be coming out in the next two weeks or three weeks. 24/7
Wall St. has decided to publish previews for what it feels are the ten most
important earnings reports on the calendar for the week ahead. While these
may be market movers in their own right, they are definitely all sector
movers.
These are the 10 most important earnings in the week ahead.
Accounting theorists who sometimes argue that earnings numbers between firms
or even over time with within a firm are misleading and should not be compared.
Why then do earnings numbers and derivatives like earnings-per-share and P/E
ratios dominate the analyses of both investors and financial analysts?
"Accounting Alchemy," by Robert E. Verrecchia, Accounting Horizons,
September 2013, pp. 603-618.
Verrecchia alleges that it's not that managers have a functional fixation for
earnings metrics as it is that they believe that other managers and investors
are so fixated with earnings that it because of monumental importance not
because it is inherently a great metric but because they believe deeply that the
market itself makes this index of vital importance.
. . .
In summary, my thesis is that managers project that
others are fixated on earnings—independent of any evidence in support
of, or contrary to, this phenomenon. This leads to managers resisting the
inclusion in earnings items that fail to enhance performance, such as the
amortization of Goodwill, or measures that make future performance more
volatile, such as those based on fair value. In the absence of acknowledging
PEF and attempting to grapple with it, I continue to see confrontations over
accounting regulation along the lines of recent debates about fair value
accounting, in addition to further impediments along the path to greater
transparency in financial statements.
Over time, financial statements of public
corporations show more losses, intangibles, and earnings restatements, which
lower their value for predicting corporate bankruptcies.
Corporate bankruptcies, like earthquakes, are rare
events. But when they do occur, says
Maureen
F. McNichols of Stanford's Graduate School of
Business, the results can be financially devastating for investors and other
stakeholders.
An important role of financial statement
information is to permit investors to assess the likely timing and amount of
future cash flows. Recent research by McNichols and coauthors examines the
usefulness of financial statement and market data for investors who want to
ascertain the likelihood of bankruptcy. The results of that research are not
completely reassuring.
The authors — McNichols, Marriner S. Eccles
Professor of Public and Private Management;
William
H. Beaver, Joan E. Horngren Professor of
Accounting, Emeritus, at the Graduate School of Business; and
Maria Correia,
assistant professor of accounting at the London Business School — examined
40 years of financial data garnered from thousands of public corporations.
They analyzed key financial ratios, such as return on assets and leverage,
reported in filings to the
U.S. Securities and Exchange Commission, and market-related data such as
market capitalization and stock returns. Over the period they examined —
1962 to 2002 — the data became significantly less useful in predicting
bankruptcy. "Investors should be concerned and aware of this when they
assess bankruptcy risk," McNichols says.
A professor of accounting, McNichols is quick to add that financial
statement data are still highly relevant. Of the firms she and her
colleagues studied, about 1% fell into bankruptcy, and despite the
deterioration in financial-statement usefulness, financial ratios and market
data are still important tools for predicting insolvency, she says.
Nonetheless, the results are concerning enough that McNichols believes
that regulators and standards setters such as the U.S. Securities and
Exchange Commission and the
Financial Accounting
Standards Board should be aware of this issue.
Three major factors muddy the waters for investors
attempting to predict bankruptcy, the researchers found:
Over the sample period, there is increasing
evidence that management exercises discretion over financial reporting,
and that there have been increasing numbers of restatements because the
financial statements were materially misleading. "Our findings indicate
that the manipulation of reported results gives a misleading impression
of profitability and reduces investors' ability to predict bankruptcy,"
notes Correia. For example, firms recognizing revenue ahead of schedule
or fraudulently may appear profitable. As a result, the bankruptcy
prediction model is much less likely to classify bankrupt firms that
also restated earnings accurately, assigning lower risk due to their
overstated earnings.
Many firms, particularly the technology
companies listed on the
NASDAQ exchange,
are heavy spenders on research and development. R&D in itself is
certainly not a cause for concern, but because this "intangible" is not
recognized on the balance sheet, it makes various financial ratios and
data less useful.
The frequency of firms reporting losses has
increased substantially over the past 40 years. Because predicting
future earnings for firms that suffer losses involves substantially
greater uncertainty than for firms that are profitable, the bankruptcy
prediction model is less likely to accurately classify loss firms that
will go bankrupt.
Consider a firm that suffers a loss. The fact that
it has lost money is obviously not good news, but in and of itself a loss
doesn't mean a company will go bankrupt. Losses complicate the financial
picture, the researchers found, because while firms reporting a loss are
more likely to go bankrupt on average, it is harder to predict which loss
firms will do so relative to firms earning a profit.
Continued in article
Jensen Comment
Until the 1990s net earnings showed a surprising predictive power in empirical
capital market studies. I say "surprising" in the sense that we all knew
historical cost earnings based upon many arbitrary assumptions in accrual
accounting such as depreciation, amortization, and bad debt estimation.
Although net earnings was never defined very well in the old days, the FASB
and IASB pretty well destroyed any remaining definition as fair value
accounting, goodwill impairment, and many other components of earnings took away
any remaining meaning of bottom-line net earnings. The biggest bomb, in my
opinion, was the combining of unrealized fair value changes with realized
revenues on contracts.
Solution 3
Pray hard that the IASB and FASB will one day define "net earnings" in a way
that it will have predictive value. That prayer has about as much hope as
praying for world peace or a balanced Federal Budget in Washington DC.
None of the above approaches necessarily will automatically improve the
predictive value of financial statements. Our hope is that in both solutions
financial analysts will be forced to perform deeper analysis rather than simply
track bottom line net earnings that has little, if any, predictive value after
the FASB and IASB screwed it up.
At the AAA meeting in
DC, I attended a presidential address by Ray Ball and Phil Brown
regarding their seminal research paper (JAR 1968). They described the
motivation for their study as a test of existing scholarly research that
painted a dim picture of reported earnings. The earlier writers noted
that earnings were based on old information (historical cost) or, worse
yet, a mix of old and new information (mixed attributes). The early
articles concluded that earnings could not be informative, and therefore
major changes to accounting practice where necessary to correct the
problem.
Ball and Brown viewed
this literature as providing a testable hypothesis – market participants
should not be able to use earnings in a profitable manner. Stated
another way, knowing the amount of earnings that would be reported at
the end of the year with certainty could not be used to profitably trade
common stocks at the beginning of the year. Evidence to the contrary
would suggest the null that earnings are non-informative does not hold.
While the methods part
of the paper is probably difficult for recent accounting archivalists to
follow, Ball and Brown produce perhaps the single most famous graph in
the accounting literature. It shows stock returns trending up over the
year for companies that ultimately report increases in earnings and
trending down for companies that report decreases in earnings. Thus they
show that accounting numbers can be informative even if the aggregate
number is not computed using a single unified measurement approach
across transactions/events. Subsequent research would show that numbers
from the income statement have predictive ability for future earnings
and cash flows.
As I sat listening to
these two research icons, I could not help but think about some comments
I have heard recently from a few standard setters and practitioners.
Those individuals express contempt for EPS in a mixed attribute world.
They appear to wish they could jump in a time machine and eliminate per
share computations related to income. I readily admit that EPS does not
explain much of the variance in returns over periods of one year or less
( e.g., Lev, JAR 1989). However the link is clearly significant, and
over longer periods, the R2’s are quite high (Easton, Harris, and Ohlson,
JAE 1992). Can the standard setters make incremental improvements to
increase usefulness of EPS? I sure hope so, and maybe the recent paper
posted by Alex Milburn will help. But dismissing a reported number
because it is not derived from a single consistent measurement attribute
– be it fair value or historical cost – seems to revert back to pre-Ball
and Brown views that are rejected by years of research.
Jensen Comment
Given the balance sheet focus of the FASB and the IASB at the expense of the
income statement I don't see how net income or eps could be anything but
misleading to investors and financial analysts. The biggest hit, in my
opinion, is the way the FASB and IASB create earnings volatility not only
unrealized fair value changes but the utter fiction created by posting fair
value changes that will never ever be realized for held-to-maturity
investments and debt. This was not the case at the time of the seminal Ball
and Brown article. Those were olden days before accounting standards
injected huge doses of fair value fiction in eps numbers so beloved by
investors and analysts.
Sydney Finkelstein, the Steven Roth professor of management at the
Tuck School of Business at Dartmouth College, also pointed out that Bank of
America booked a $2.2 billion gain by increasing the value of Merrill
Lynch’s assets it acquired last quarter to prices that were higher than
Merrill kept them. “Although perfectly legal, this move is also perfectly
delusional, because some day soon these assets will be written down to their
fair value, and it won’t be pretty,” he said
"Bank Profits Appear Out of Thin Air ," by Andrew Ross
Sorkin, The New York Times, April 20, 2009 ---
http://www.nytimes.com/2009/04/21/business/21sorkin.html?_r=1&dbk
This is starting to feel
like amateur hour for aspiring magicians.
Another day, another
attempt by a Wall Street bank to pull a bunny out of the hat, showing
off an earnings report that it hopes will elicit oohs and aahs from the
market. Goldman Sachs, JPMorgan Chase, Citigroup and, on Monday, Bank of
America all tried to wow their audiences with what appeared to be —
presto! — better-than-expected numbers.
But in each case,
investors spotted the attempts at sleight of hand, and didn’t buy it for
a second.
With Goldman Sachs, the
disappearing month of December didn’t quite disappear (it changed its
reporting calendar, effectively erasing the impact of a $1.5 billion
loss that month); JPMorgan Chase reported a dazzling profit partly
because the price of its bonds dropped (theoretically, they could retire
them and buy them back at a cheaper price; that’s sort of like saying
you’re richer because the value of your home has dropped); Citigroup
pulled the same trick.
Bank of America sold its
shares in China Construction Bank to book a big one-time profit, but Ken
Lewis heralded the results as “a testament to the value and breadth of
the franchise.”
Sydney
Finkelstein, the Steven Roth professor of management at the Tuck School
of Business at Dartmouth College, also pointed out that Bank of America
booked a $2.2 billion gain by increasing the value of Merrill Lynch’s
assets it acquired last quarter to prices that were higher than Merrill
kept them.
“Although
perfectly legal, this move is also perfectly delusional, because some
day soon these assets will be written down to their fair value, and it
won’t be pretty,” he said.
Investors reacted by
throwing tomatoes. Bank of America’s stock plunged 24 percent, as did
other bank stocks. They’ve had enough.
Why can’t anybody read
the room here? After all the financial wizardry that got the country —
actually, the world — into trouble, why don’t these bankers give their
audience what it seems to crave? Perhaps a bit of simple math that could
fit on the back of an envelope, with no asterisks and no fine print,
might win cheers instead of jeers from the market.
What’s particularly
puzzling is why the banks don’t just try to make some money the
old-fashioned way. After all, earning it, if you could call it that, has
never been easier with a business model sponsored by the federal
government. That’s the one in which Uncle Sam and we taxpayers are
offering the banks dirt-cheap money, which they can turn around and lend
at much higher rates.
“If the federal
government let me borrow money at zero percent interest, and then lend
it out at 4 to 12 percent interest, even I could make a profit,” said
Professor Finkelstein of the Tuck School. “And if a college professor
can make money in banking in 2009, what should we expect from the highly
paid C.E.O.’s that populate corner offices?”
But maybe now the banks
are simply following the lead of Washington, which keeps trotting out
the latest idea for shoring up the financial system.
The latest big idea is
the so-called stress test that is being applied to the banks,
with results expected at the end of this month.
This is playing to a
tough crowd that long ago decided to stop suspending disbelief. If the
stress test is done honestly, it is impossible to believe that some
banks won’t fail. If no bank fails, then what’s the value of the stress
test? To tell us everything is fine, when people know it’s not?
“I can’t think of a
single, positive thing to say about the stress test concept — the
process by which it will be carried out, or outcome it will produce, no
matter what the outcome is,” Thomas K. Brown, an analyst at
Bankstocks.com, wrote. “Nothing good can come of this and, under
certain, non-far-fetched scenarios, it might end up making the banking
system’s problems worse.”
The results of the
stress test could lead to calls for capital for some of the banks. Citi
is mentioned most often as a candidate for more help, but there could be
others.
The expectation, before
Monday at least, was that the government would pump new money into the
banks that needed it most.
But that was before the
government reached into its bag of tricks again. Now Treasury, instead
of putting up new money, is considering swapping its preferred shares in
these banks for common shares.
The benefit to the bank
is that it will have more capital to meet its ratio requirements, and
therefore won’t have to pay a 5 percent dividend to the government. In
the case of Citi, that would save the bank hundreds of millions of
dollars a year.
And — ta da! — it will
miraculously stretch taxpayer dollars without spending a penny more.
Insider Tips by Martha Stewart, Mark Cuban, Tom Selling, and Three Bobs (Vererrecchia,
Jaedicke, and Jensen)
Jensen Comment
I don't think the "The EBITDA Epidemic Takes Its Cue from Standard Setters."
Like Professor Verrecchia currently and my accounting Professor Bob
Jaedicke decades earlier I think the "EBITDA Epidemic" takes its cue from
investors and managers that have a "functional fixation" for earnings, eps,
EBITDA, and P/E ratios --- when in fact those metrics are no longer defined by
the FASB/IASB and may have a lot of misleading noise and secret manipulations.
Jensen Comment
If the FASB cannot define net earnings then it follows from cold logic that they
cannot define measures derived from net earnings like EBITDA.
However, virtually all private sector business firms compute net earnings and
some measures derived from net earnings like eps, EBITDA, and P/E ratios.
It's doubtful whether net earnings for two different companies or even one
company over two time intervals are really comparable.
But all that does not matter when it comes to adjudicating an insider trading
case in court even if the accused may not really be an insider.
I'm reminded of why billionaire Martha Stewart went to prison because she
acted on inside information about a company --- inside information passed on to
her by the CEO of that company. It doesn't matter that the amount of loss saved
by the inside tip involved is insignificant compared to her billion-dollar
portfolio. Evidence in the case made it clear that she did exploit other
investors by acting on the inside tip no matter how insignificant the value of
that tip to her. She was hauled off the clink in handcuffs and was released in
less than five months. But her good name and reputation were tarnished forever
---
http://en.wikipedia.org/wiki/Martha_Stewart
Flamboyant billionaire Mark Cuban is now in trial for very similar reasons,
although the alleged insider tip and the value of the alleged tip is more
obscure than in the Martha Stewart case. Like in the case of Martha Stewart the
loss avoided is pocket change ($750,000) relative to Cuban's billion-dollar
portfolio.
What Cuban failed to mention is that net earnings and EBITDA cannot be
defined since the FASB elected to give the balance sheet priority over the
income statement in financial reporting --- "The Asset-Liability Approach: Primacy does not mean Priority,"
by Robert Bloomfield, FASRI Financial Accounting Standards Research
Initiative, October 6, 2009 ---
http://www.fasri.net/index.php/2009/10/the-asset-liability-approach-primacy-does-not-mean-priority/
Abstract:
Since the 1970s, the decision-usefulness has taken center stage and our
attention has been concentrated on valuation of assets and liabilities
instead of income measurement. The concept of income, once considered the
gravitational center of accounting has lost its primacy and become a
byproduct of the balance sheet derived from the measurement of assets and
liabilities.
However, we have not been equipped with robust
conceptual foundation supporting theoretically reasoned accounting
measurement. It is not only theoretically but also practically important to
renew our seemingly waned interest in the concept of income because ongoing
reforms of accounting standards cannot be successfully implemented without a
sound understanding of the concept of income.
Be that as it may, net earnings and EBITDA are all-important because
investors change their portfolios based on net earnings and its derivatives more
than anything in the balance sheet.
"Accounting Alchemy," by Robert E. Verrecchia, Accounting Horizons,
September 2013, pp. 603-618.
Verrecchia alleges that it's not that managers have a functional fixation for
earnings metrics as it is that they believe that other managers and investors
are so fixated with earnings that it because of monumental importance not
because it is inherently a great metric but because they believe deeply that the
market itself makes this index of vital importance.
. . .
In summary, my thesis is that managers project that
others are fixated on earnings—independent of any evidence in support
of, or contrary to, this phenomenon. This leads to managers resisting the
inclusion in earnings items that fail to enhance performance, such as the
amortization of Goodwill, or measures that make future performance more
volatile, such as those based on fair value. In the absence of acknowledging
PEF and attempting to grapple with it, I continue to see confrontations over
accounting regulation along the lines of recent debates about fair value
accounting, in addition to further impediments along the path to greater
transparency in financial statements.
It's a bit like requiring calculus for undergraduate accounting courses.
Calculus probably is not essential in any undergraduate accounting course in the
curriculum, but faculty are fixated that the best accounting majors are the ones
do well in calculus. Similarly, investors change their portfolios based on
earnings, eps, EBITDA, and P/E ratios when in fact those metrics are not defined
and may have a lot of misleading noise and secret manipulations.
Although I'm inclined to agree
with you about the decline in quality of financial reporting, but
I'm not as inclined to put as much blame on the accounting standards
setters. Perhaps we've just given standard setters an impossible job.
Much of the blame has to be
placed on the clients themselves along with their lawyers and
accountants who created contracts so filled with contingencies and
incomprehensible clauses that it's impossible to account for them, at
least in our overly simplistic double-entry system of accounting.
There were once thousands and
now ten thousands of types of complicated derivatives contracts,
financial structures, and collateralizations. We require accounting
systems to mark contracts to market when markets are thin and unstable
as morning dew on flower petals in a wind.
I think even you would be
overwhelmed if you were appointed to the IASB or IASB. I know that I
would be dumbfounded in less than a week.
As to externalities, I don't
think we will ever be able to measure the costs and benefits because of
the higher order interactions that befuddle even our best scientists. I
sit up here in the mountains and view first-hand what I think is global
warming. But the scientists who measure temperatures around the world
tell us that temperatures are declining rather than rising. There's ever
so much we don't understand in science, macroeconomics (where we are now
facing complexities we've never seen in the history of the world). and
financial risk contracting that the experts who write the contracts do
not understand.
We bookkeepers clomp around in
worlds where angels fear to tread. We can't even explain why financial
statements lost predictive ability since the 1970s.
Jensen Comment
In 1983, nearly four decades ago if you do the math, I wrote my second
monograph published by the AAA Review of Forecasts: Scaling and Analysis of Expert Judgments Regarding
Cross-Impacts of Assumptions of Business Forecasts and Accounting Measures,
(Sarasota, FL: American Accounting Association, 1983).
The AICPA had recently changed auditing rules allowing auditors
to "review" forecasts in the spirit of giving a new line of professional
services to auditing firms. Auditors were not to validate forecast numbers
themselves. The idea, however, was that auditors could review management
forecasts and pass judgment on the "reasonableness" of assumptions underlying
management's forecasts.
I don't think the auditing firms ever made much revenue reviewing
forecasts. Apparently clients did not see a whole lot of value added in when
paying auditing firms for a review of forecasts. One of the huge problems is
that circumstances can impact assumptions so suddenly that forecasts are much
more tenuous. Exhibit A is how Tesla's forecasted revenues and profits keep
changing almost day-to-day. One example of where an auditing firm (Price
Waterhouse) signed off on a "Review of Forecasts" is the 1987 Annual Report of
Days Inn which was then privately owned and contemplating going public. That
1987 annual report is exceptional in other regards, especially the enormous
investment Days Inn made that year to report exit values of 300+ hotels.
Increasingly, forecasts/estimates are subject to enormous and
shifting tides in multinational business and politics. Think of how hard it is
for technology giants like Google and Apple to forecast revenues and profits in
the European Union given the EU's constantly shifting regulations and tax laws.
Think of how difficult it is to forecast revenues during the pending Trump
Administration trade negotiations. Think of how difficult it is to predict the
future of banking under the threat of hostile socialist democrats winning power
of the executive and legislative branches of the Federal government. And of
course there are great unknowns about how technology will impact business firm
future (think AI, robotics, cyber warfare, etc.).
Jensen Comment
It's ironic that the irrelevance of history in our academic disciplines is
transpiring at at time when historical works are increasingly available and
searchable at virtually zero cost. Perhaps one problem is that we're
increasingly discovering how vast the histories of our discipline have
become. Do intermediate accounting instructors even mention the works of
O'Neal, Canning, Paton, and Littleton in this century?
Confucius is described, by Sima Qian and other sources, as having endured
a poverty-stricken and humiliating youth and been forced, upon reaching
manhood, to undertake such petty jobs as accounting and caring for
livestock.
Ages
of American Capitalism ---
https://marginalrevolution.com/marginalrevolution/2021/06/ages-of-american-capitalism.html
Jensen Comment
It would be interesting to have students compare the "ages of American
capitalism" with the increasing complexities of financial contracting and
accounting for those contracts such as the history of insurance contracting,
mezzanine contracts, and the history of derivative financial instruments as
financial risk hedges. The key was the development of markets in those more
complex contracts.
Thank you James Martin for the tremendous MAAW Accounting History
database --- http://maaw.info/
History News Network (not accounting) ---
http://hnn.us/
"The Last Half-Century of the Federal Income Tax, by Lawrence B.
Gibbs, Creighton Law Review, November 29, 2012 ---
http://taxprof.typepad.com/files/gibbs.pdf
Thank you Paul Caron for the heads up.
We commemorate
the 50th anniversary of Ball and Brown [1968] by chronicling its impact on
capital market research in accounting. We trace the evolution of various
research paths that post-Ball and Brown [1968] researchers took as they sought
to build on the foundation laid by Ball and Brown [1968] to create a body of
research on the usefulness, timeliness, and other properties of accounting
numbers. We discuss how those paths often link back to the groundwork laid and
questions originally posed in Ball and Brown [1968].
Keywords: Ball and Brown, earnings, earnings-return relation, earnings
usefulness, earnings timeliness, asymmetric timeliness, conservatism,
association study, event study, information content, value relevance, positive
economics, efficient markets hypothesis, market efficiency, post-announcement
drift
The Year 1552: The First Arithmetic Book
Printed in England
Luca Pacioi ---
https://en.wikipedia.org/wiki/Luca_Pacioli
There are at least two common mistakes with respect to Luca Pacioli (a close
friend of Leonardo da Vinci). One is to assume Pacioli's famous 1494 book is
an accounting book. Pacioli only used bookkeeping as an illustration of
algebraic equations in his famous Summa mathematics book in 1494.
A second mistake is to assume Pacioli invented double-entry bookkeeping. The
origins of double-entry bookkeeping are unknown and this type of bookkeeping
is only illustrated by Pacioli in Summa.
Cuthbert Tunstall died in Lambeth, London, England in 1559. He wrote (in
Latin in 1552) the first arithmetic book printed in England, which he
based on
Pacioli's
Summa de arithmetica.
American Accounting Association 2016 Centennial Video (Short and Sweet)
---
http://commons.aaahq.org/pages/home
This video may only be available to AAA Commons subscribers (free I think)
In a 2008
speech to the Association of American Universities, the former Texas A&M
University president and then-Secretary of Defense Robert M. Gates declared
that "we must again embrace eggheads and ideas." He went on to recall the
role of universities as "vital centers of new research" during the Cold War.
The late Thomas Schelling would have agreed. The Harvard economist and Nobel
laureate once described "a wholly unprecedented ‘demand’ for the results of
theoretical work. … Unlike any other country … the United States had a
government permeable not only by academic ideas but by academic people."
Gates’s
efforts to bridge the gap between Beltway and ivory tower came at a time
when it was growing wider, and indeed, that gap has continued to grow in the
years since. According to a Teaching, Research & International Policy
Project survey,
a regular poll of international-relations scholars, very few believe they
should not contribute to policy making in some way. Yet a majority also
recognize that the state-of-the-art approaches of academic social science
are precisely those approaches that policy makers find least helpful. A
related poll of senior national-security decision-makers confirmed that, for
the most part, academic social science is not giving them what they want.
The problem, in a
nutshell, is that scholars increasingly privilege rigor over relevance. That
has become strikingly apparent in the subfield of international security
(the part of political science that once most successfully balanced those
tensions), and has now fully permeated political science as a whole. This
skewed set of intellectual priorities — and the field’s transition into a
cult of the irrelevant — is the unintended result of disciplinary
professionalization.
The
decreasing relevance of political science flies in the face of a widespread
and longstanding optimism about the compatibility of rigorous social science
and policy relevance that goes back to the Progressive Era and the very dawn
of modern American social science. One of the most important figures in the
early development of political science, the University of Chicago’s Charles
Merriam, epitomized the ambivalence among political scientists as to whether
what they did was "social science as activism or technique," as the
American-studies scholar Mark C. Smith put it. Later, the growing tension
between rigor and relevance would lead to what David M. Ricci termed
the "tragedy of political science": As the discipline sought to become more
scientific, in part to better address society’s ills, it became less
practically relevant.
When
political scientists seek rigor, they increasingly conflate it with the use
of particular methods such as statistics or formal modeling. The sociologist
Leslie A. White captured
that ethos as early as 1943:
We may thus gauge
the ‘scientific-ness’ of a study by observing the extent to which it employs
mathematics — the more mathematics the more scientific the study. Physics is
the most mature of the sciences, and it is also the most mathematical.
Sociology is the least mature of the sciences and uses very little
mathematics. To make sociology scientific, therefore, we should make it
mathematical.
Relevance, in
contrast, is gauged by whether scholarship contributes to the making of
policy decisions.
That increasing
tendency to embrace methods and models for their own sake rather than
because they can help us answer substantively important questions is, I
believe, a misstep for the field. This trend is in part the result of the
otherwise normal and productive workings of science, but it is also
reinforced by less legitimate motives, particularly organizational
self-interest and the particularities of our intellectual culture.
While the
use of statistics and formal models is not by definition irrelevant, their
edging out of qualitative approaches has over time made the discipline less
relevant to policy makers. Many pressing policy questions are not readily
amenable to the preferred methodological tools of political scientists.
Qualitative case studies most often produce the research that policy makers
need, and yet the field is moving away from them.
Continued in article
Jensen Comment
This sounds so, so familiar. The same type of practitioner irrelevancy commenced
in the 1960s when when academic accounting became "accountics science" ---
About the time when The Accounting Review stopped
publishing submissions that did not have equations and practicing accountants
dropped out of the American Accounting Association and stopped subscribing to
academic accounting research journals.
An Analysis of the Contributions of The Accounting
Review Across 80 Years: 1926-2005 --- http://faculty.trinity.edu/rjensen/395wpTAR/Web/TAR395wp.htm
Co-authored with Jean Heck and forthcoming in the December 2007 edition of
the Accounting Historians Journal.
Unlike engineering, academic accounting research is no
longer a focal point of practicing accountants. If we gave a prize for academic
research discovery that changed the lives of the practicing profession who would
practitioners choose to honor for the findings?
This paper analyzes and categorizes
published research papers in three specialist accounting history journals—Accounting
History, The Accounting Historians Journal, and
Accounting History Review.
A key objective is to highlight under-represented areas for future research. We
inductively derive a categorization system, and classify over four hundred
papers from 2006–2015 according to twelve categories. The results show some
rather under-researched areas, namely religion and accounting education. Using
statistical analysis techniques, we note similarities and differences across the
three journals and suggest avenues for future researchers.
CPA Journal
Editors’ Note: Published this past June, Baruch Lev and Fang Gu’s The End
of Accounting and the Path Forward for Investors and Managers (Wiley)
has generated a great deal of controversy within the profession. The CPA
Journal presents two contrasting perspectives on this thought-provoking
book: Arthur J. Radin questions whether the authors are right about the
conclusions they draw from the data, and Thomas I. Selling agrees with some
of their recommendations but disagrees about the linkages to value creation.
Jensen Comment 1
This is my Comment 1 since I want to reflect more on the Radin and Selling
review of the Lev and Gu arguments. Let me say that I really like parts Radin
and Selling review. I've always been disappointed in Baruch Lev's many writings
on intangibles. Lev is great at finding fault but offers nothing (as far as I
can tell it's zero) to find a better way to reliably measure or even disclose
intangibles. Lev writes so much, and for me Lev's attempted positive
contributions are always a huge disappointment.
If Lev's proposals (actually unrealistic dreams) really lowered
cost of capital more firms would be routinely applying Lev's proposals.
Like Ijiri's "Force Accounting" Lev is reaching into the clouds
to touch the angels.
The title "The End of Accounting" seems to be an attempt to
attract attention with an absurd title just like political economist Francis
Fukuyama tried to attract attention with his book "The End of History."
Obviously neither accounting nor history will come to an "end." Accounting will
come to an end when audited financial statements no longer impact portfolio
decisions of investors and employment decisions of business firms such as the
firing of a CEO who fails to meet "earnings" targets. Fukuyama later wrote that
history did not end after all. I wish Lev and Gu would write an article that
admits accounting did not end after all (no thanks to them).
Let me come back to
Comment 2 on these matters once I have more time to think about Comment
2.
Comment 2
Added on December 19, 2017
Comment 2
Accountancy evolved over thousands of years to become what it is rather than
what some academic theorists would like it to be. The best example is the most
popular index used by financial analysts and investors, namely the accounting
net income of a business or some variation thereof such as earnings-per-share (eps)
or other comprehensive income (OCI). Economic theorists would prefer economic
income defined as the amount of discounted net cash flows of a business over all
future time. But neither economists nor accountants have ever been able to
measure economic income reliably because only soothsayers estimate all future
net cash flows, and those soothsayers never agree on the numbers appearing in
their fortune-telling crystal balls.
Traditional for-profit (business) and not-for-profit (e.g., governmental)
accountancy now guided by either national standard setters (e.g., the FASB and
GASB in the USA) or international accounting standard setters (e.g., the
IASB) survived Darwinian-styled evolution over thousands of years because
multiple stakeholders find it to have utility for predicting financial futures
of an organization, stewardship and inputs into macroeconomic analyses. Today
accounting traditions and rules are rooted in the past (e.g. historical cost
book values), present (e.g., market values of derivatives and other marketable
securities), and future (e.g., discounted values of pension obligations).
Baruch Lev's many writings suggest that the biggest controversy in
accountancy is how intangibles are measured and disclosed. See the many books
and papers cited at his home page at
http://www.stern.nyu.edu/faculty/bio/baruch-lev
Baruch writes very well when it comes to emphasizing the importance of
intangibles in predicting a firm's financial future and laying out criticisms of
the present accounting traditions and standards in measuring and otherwise
disclosing such standards. But the world pretty much ignores his soothsayer
suggestions for intangibles measurement and disclosure.
Question:
Where were Enron's intangible assets? In particular, what was
its main intangible asset that has been overlooked in terms of
accounting for intangibles?
Lev's answer essentially was that since he could not find Enron's intangibles
there weren't any intangible assets. My answer is that there were highly
significant intangible assets that could neither be measured in any meaningful
way nor even disclosed without self-incrimination since many of them arose from
illegal bribes and other crimes that gave Enron power around the world and most
importantly inside USA government. Most of Enron's future revenues derived
from the intangible asset of political power. To the extent this intangible
asset arises from shady political activities Enron could not disclose, let alone
measure, the massive value of its political power intangible asset.
Tom Selling leans toward replacement cost valuation of intangible and
tangible assets. I would contend that only soothsayers can measure the
replacement cost of political power.
However, as Radin and Selling suggest not being able to disclose and measure
all important intangibles does not destroy the utility of accountancy or cause
the "end of accountancy" as we know it today. Just because the medical
profession cannot prevent cancer or even save the majority of Stage 4 cancer
patients does not destroy the utility of what the medical profession can do for
such patents. Accountancy is what it is and I do not
think it will "end" because of things it cannot yet do and probably will never
be able to do such as measure and disclose the intangible asset of political
power of a multinational company.
Accounting History Corner
Jensen Comment
Hell Just Got Cold Enough for Academic Accountants to Ice Skate
Two things just happened that I mistakenly thought would never happen in my
lifetime:
The Accounting Review just published
a mainline content paper that has no equations or statistical tables.
The paper referred to above is an
accounting history paper. I don't think TAR has published a history
paper in decades --- since Steve Zeff was TAR's Senior Editor.
Alan Sanster, in my opinion, specialized in
early Italian accounting more than any other academic that I can think of in
the history of accounting.
Special congratulations to Alan for landing this in TAR. And special thanks
to John Harry Evans III who was Senior Editor of TAR when this paper was
accepted.
Bob Jensen
This is the second article published by The Accounting Review
in recent decades that does not contain equations. The other article was also an
accounting history paper by Alan Sangster.
Congratulations Alan --- you've accomplished two miracles!
Alan Sangster (2018) Pacioli's Lens: God, Humanism, Euclid, and the Rhetoric of Double Entry
The Accounting Review: March 2018, Vol. 93, No. 2, pp. 299-314.
https://doi.org/10.2308/accr-51850
This paper investigates why, in 1494, the
Franciscan friar and teacher of mathematics, Luca Pacioli, published an
instructional treatise describing the system of double entry bookkeeping. In
doing so, it also explores the rhetoric and foundations of double entry
through the lens of Pacioli's treatise. Recent findings on Pacioli's life
and works, his writings, and the medieval accounting archives are combined
to identify how he was inspired by his faith and his humanist beliefs to
give all merchants access to the practical mathematics and the bookkeeping
they required. The paper finds that Pacioli's teaching method was inspired
by Euclid, his Franciscan education, and his humanist beliefs, and that
Pacioli reveals a simplicity in then-unrecognized axiomatic foundation
of double entry that has been largely overlooked. The findings represent a
paradigm shift in how we perceive Pacioli, his treatise, and double entry.
The emergence of double entry bookkeeping
marked the shift in bookkeeping from a mechanical task to a skilled craft,
and represented the beginnings of the accounting profession. This study
seeks to identify what caused this significant change in bookkeeping
practice. I do so by adopting a new accounting history perspective to
investigate the circumstances surrounding the emergence of double entry in
early 13th century Italy. Contrary to previous findings, this paper
concludes that the most likely form of enterprise where bookkeeping of this
form emerged is a bank, most likely in Florence. Accountability of the local
bankers in Florence to the Bankers Guild provided a unique external impetus
to generate a new form of bookkeeping. This new bookkeeping format provided
a clear and unambiguous picture of the accounts of all debtors and
creditors, along with the means to check that the entries between them were
complete and accurate.
I. INTRODUCTION
Historians generally accept that the
“Italian method” of double entry bookkeeping, based upon making entries of
equal amounts to the debit and credit of two different accounts, was the
foundation for modern accounting. Although all modern accounting systems
rely upon the principle of duality enshrined in that technique, we do not
understand how this system emerged. This unanswered question is the focus of
this paper: What led to the emergence of double entry bookkeeping?
The importance of this question to
accountants is that the emergence of double entry marked the point at which
accounting evolved from a mechanical task that virtually anyone could
perform to become a skilled craft. It signaled the beginnings of the
accounting profession. By identifying what led to this development, we learn
about our roots and improve our understanding of the importance of our
discipline and of its place in the economic history of the past millennium.
I adopt a “new accounting history”
perspective that reflects the historical context, the local conditions, and
the language and vocabulary in which this particular practice was
articulated (Miller and Napier 1993, 631). I incorporate these factors and
surviving records of the period to understand the reasons behind the change
in bookkeeping practice that gave rise to the emergence of double entry
bookkeeping.
The motivation for this study was the
recent publication of a best-selling book that has popularized the history
of double entry bookkeeping. Its title—Double Entry: How the Merchants of
Venice Shaped the Modern World and How their Invention Could Make or Break
the Planet (Gleeson-White 2011)—tells us that Venetian merchants invented
double entry bookkeeping, but did they?
Various scholars have speculated upon the
origin of double entry bookkeeping, including Rossi (1896), Besta (1909),
Littleton (1927, 1931, 1933), Peragallo (1938), Melis (1950), Zerbi (1952),
de Roover (1971), Lee (1972, 1973a, 1973b, 1977), and Martinelli (1974).
However, with the exception of Rossi and Littleton and, to a lesser extent,
Martinelli, they focus on the presence of an enterprise-wide accounting
system based upon double entry, something that tells us little of the
origins of double entry many years earlier. To identify how, where, why, and
by whom double entry was first developed, the conditions that gave rise to
it are likely to be more fundamental than the circumstances of its first
identifiable enterprise-wide application. Consequently, in looking for the
genesis of double entry bookkeeping, I focus on how and where the concept of
double entry originated, the circumstances that led to its development, and,
particularly, which professional group first developed it.
I follow the approach adopted by Rossi and
Littleton. Littleton also considered what the terminology of double entry
tells us of its origins. However, neither of them specifically sought to
identify the group that developed the method, nor where it first emerged.
This study builds upon and extends their work. We know with certainty that
the technique of double entry emerged in the 13th century in Italy.
Unfortunately, no complete set of documentation from that period has
survived. The earliest confirmed instance of its enterprise-wide application
is from the final year of the 13th century (Lee 1977), while the evidence
indicates that this was many decades after the technique first appeared.1
Previous studies document that double
entry bookkeeping emerged in different places at different times, and that
the form it took varied from place to place. However, these various forms
all share the fundamental characteristic of “dual entries” that serve as the
starting point in the shift to double entry bookkeeping. Dual entries
require that when accounts were being maintained for the parties to and/or
items involved in a transaction, for each entry made in one account, an
equal and opposite “contra entry” must be made in another account. To that
end, I begin this study by seeking instances of items being recorded in a
consistent dual form that could then have developed into a recognizable form
of double entry bookkeeping.
The difference between dual entry and
double entry lies in how the contra entry is recorded. In double entry, each
entry in an account must include the location of the account in which the
contra entry has been made. No such information is provided in dual entry.
Therefore, I include this essential requirement in the definition of double
entry in this study. That is, my approach requires that this additional step
be included in order for bookkeeping entries to qualify as double entry
bookkeeping.
This is an appropriate definition for
double entry for two further reasons. The account books of this period were
solely for debtors and creditors (Goldthwaite 2009) and entries were
sometimes made transferring amounts between two of these accounts, such as
between the accounts of a debtor and a creditor. In such cases, dual entry
occurs by chance because an equal amount is entered on the opposite sides of
two accounts. In contrast, as defined here, the emergence of double entry
stemmed from the belief that each entry should include the location of the
contra entry. This conscious step marked the genesis of double entry
bookkeeping. At this point, bookkeeping moved from being a device used to
maintain a historical record of a transaction to a method that enabled rapid
confirmation that the transaction had been entered accurately in both
accounts. It had become important to ensure that entries were made
correctly. This also marked the point at which bookkeeping shifted from
being a mechanical task to a skilled craft, requiring far more care and
attention, and signaling the beginnings of the accounting profession.
This step was the common starting point
for double entry, the link among all the Italian variants of double entry
bookkeeping that were in use during the 13th to 17th centuries. These
variants included “mingled accounts” (Martinelli 1974) with credits
immediately below the debits, and vice versa; account books with debtor
accounts at the front and creditor accounts at the back; bilateral account
books with the debit and credit entries in each account on opposite-facing
pages; and bilateral account books with the debit and credit entries of each
account in two columns of the same page. All of these formats had their own
variants in word sequence and in the manner in which dates,
cross-references, and amounts were entered. The commonality in the basic
underlying rationale of double entry bookkeeping enabled all these variants
to merge into one unified method many centuries later. Beyond the scope of
this study, the emergence of double entry bookkeeping eventually led to
another phase in the evolution of accounting, which ended with firms
combining the details in their accounts to calculate profits and losses.
This subsequent double entry-based accounting system (Gurskaya, Kuter,
Deliboltoayn, and Zinchenko 2012) combined all accounts, represented
initially in lists of balances and then in income statements and balance
sheets.
Contribution This study contributes to the
debate concerning the conditions that gave rise to modern bookkeeping and
accounting by amending and extending previous theories. I introduce a
context focused in the city of Florence, as opposed to the entire country of
Italy. My approach embraces explanatory conditions that are unique to
Florence and would explain the emergence of double entry there before other
locations. The continuous threat of external scrutiny and penalties for
failure to meet standards present only in Florence were conditions that
demanded an effective response by bankers. Adopting double entry was the
ideal response.
Continued in article
Jensen Comment
Just think about it --- two TAR articles
without equations!
Next thing we know there may be articles
that are not General Linear Model studies using purchased data bases or
hypothetical assumptions for mathematical analysis.
Times may be changing, but I would not
count on it just yet.
The Genesis of Double Entry Bookkeeping.
Alan Sangster, Griffith University, Australia. ABSTRACT. This study
investigates the emergence in Italy early in the ...
Might not be the exact same thing though.
Scott Bonacker CPA –
McCullough and Associates LLC – Springfield, MO
Accounting is perhaps one of the most innovative
professions. Although the CPA is a relatively young designation, the skills
of a CPA are deeply rooted in history.
3000 B.C. to 2500 B.C.
Ancient Sumerians invent the world’s first written
language. Cuneiform eases record-keeping requirements for Sumerian cities
expanding trade. Across the ancient world, rulers tax their people to
finance public works, making records necessary to account for transactions.
1000 B.C.
The commercially oriented Phoenicians invent a
22-character phonetic alphabet, probably for bookkeeping purposes and to
prevent themselves from being cheated by the more advanced Egyptians.
650 B.C.
An Egyptian sarcophagus describes the decedent as,
among other things, a “comptroller of the scribes.” The rise of commerce and
expansion of business activity has expanded the role of the accountant. The
Old Testament may have recorded the first “management consultant” as Jethro
advises Moses on delegating authority. The “Book of Exodus” (38:21) also has
the first auditor with Moses engaging Ithamar to do an audit of the riches
contributed for the building of the Tabernacle to be used in the 40-year
journey.
500 B.C.
Egyptians invent the bead-and-wire abacus.
423 B.C.
Aristophanes refers to the incorrect accounts of
Pericles in his play The Clouds in 423 B.C. Ancient Egyptians and
Babylonians have instituted auditing systems where everything that went into
and came out of storehouses was double-checked. Such “audit reports” were
given orally, thus the later term “auditor,” derived from the Latin audire,
to hear.
200 B.C.
Egyptians inscribe the Rosetta Stone, a key to
their language and civilization, which includes the account of a tax revolt
and the reaction to it by the Egyptian ruler Ptolemy V. Taxation has become
a fuel of Mediterranean civilization, creating the need for scribes to
record payments.
800 A.D.
The term “rationator” (accountant) is used in a
deed.
1086
William the Conqueror promulgates the Doomsday
Book, which contains records of what is due to the king and his lords in
such detail that it defies refutation. William instituted feudalism in
Britain after defeating the English King Harold, and the system required
more record keeping.
1225
The chief magistrate of Milan renders full accounts
of goods carried on ships. Early Italian republics have passed laws
requiring that public scribes keep track of merchandise.
1374
Poet Geoffrey Chaucer works as the comptroller of
customs in the port of London. Chaucer’s Canterbury Tales includes a
bragging merchant and a reeve whom “no auditor could ever win on.” By the
close of the Middle Ages, commerce is so developed that credit transactions
have become widespread, and record keeping (and record keepers) need to be
more exact.
1492
Rodrigo Sanchez becomes the first accountant in the
New World, being engaged by Queen Isabella to keep track of the “riches”
Columbus was expected to encounter.
1494
Italian monk Luca de Pacioli officially introduces
“double entry” bookkeeping in his Summa de Arithmetica, a compendium of
mathematical knowledge. Pacioli bases his work on procedures that have
generally been used in Genoa, Florence, Milan and Venice since about 1350.
Double–entry bookkeeping made it easier for them to detect errors and
provided a fuller picture of business activity—a balance sheet along with an
income statement.
1553
James Peele writes what is probably the first
original English text on bookkeeping.
1581
The Collegio dei Raxonati becomes the world’s first
society of accountants. By 1669, no one will be permitted to practice in
Venice without being a member of the college.
1600
The East India Company is founded. The trading
company introduces invested capital and dividend distributions, creating a
great need for accountability to investors.
1651
Johnannes Dyckman is engaged as bookkeeper for New
Amsterdam under Gov. Peter Stuyvesant. Dyckman will be replaced one year
later because of improperly rendered accounts. The accounting business has
already started to grow in America.
1775 to 1783
The American Revolution indirectly causes growth of
accountancy in Britain as creditors appoint accountants as trustees during
an explosion of bankruptcies. In 1793, more than 20 banking firms in England
and Scotland fail, and accountants step in to settle their affairs.
1789
The U.S. government creates the Treasury
Department, including a comptroller and auditor. Benjamin Franklin urges
businesspeople to have training and facility in “accompts.” Franklin earned
money as a young man keeping books of account, and used those skills later
to create the postal service. Thomas Jefferson’s two bookkeeping texts are
among the first books in the Library of Congress.
1841 to 1850
Expanding railroad empires employ accountants as
auditors independent of management.
1850
There are 264 “accomptants” listed in London’s
directory of professionals. In 1799, there were only 11; in 1840, there were
107.
1854
Scotland formally recognizes the profession under
the designation of “chartered accountants.”
1880
England formally recognizes the chartered
accountant.
1887
The first accounting organization in the United
States is established.
1896
New York state officially recognizes the profession
under the license of certified public accountant.
1897
The New York State Society of Certified Public
Accountants is organized on January 28. Other states rapidly follow. Charles
Waldo Haskins is elected the first president of the NYSSCPA. Haskins already
was the first president of the Board of State Examiners of Public
Accountants in 1896. In 1900, he becomes the first dean of the New York
University School of Commerce, Accounts and Finance.
1895 to 1905
The New York, Ontario and Western Railway Company
becomes the first railroad in the United States to issue audited financial
statements. United States Steel is the first major industrial corporation to
issue an audited report. Equitable Life Assurance Society becomes the first
insurance company to have an independent audit. The floodgates were opened
for certified public accountants. Meanwhile, major universities like the
University of Chicago and Dartmouth establish accounting courses, though
business colleges have been organized to teach bookkeeping and accounting
skills since the mid-19th century.
1913
The enactment of the income tax laws establishes
accountants as the premier profession in this arena. At the same time, CPA
management expertise catapults the profession as top consultants in
boardrooms and on factory floors.
1931
The Ultramares case establishes the principle that
auditors have liability to third parties relying on the auditor’s report.
The American Institute of CPAs eliminates the word “certify” from the report
and replaces it with “examined” to emphasize the report was an opinion, not
a guarantee.
1933
The Academy of Motion Picture Arts and Sciences
chooses Price Waterhouse to oversee the voting for the Oscar awards in 1933,
in response to the widely held belief that the awards were rigged. The
Academy publicizes the engagement to create public confidence in the Oscar.
1938
A firm records fictitious receivables and
nonexistent inventory in warehouses, leading to an auditing standard
requiring the observance of physical inventory and the direct confirmation
of accounts receivable. It also leads to the reporting consistency
requirement and tests of the internal control.
1941
The Securities and Exchange Commission requires the
auditor’s report to state that the examination was made in accordance with
generally accepted accounting standards.
1968
The Continental Vending Case establishes that the
auditor must disclose improper activities of the client or the client’s
officers when such activities are known to the auditor and may reasonably
affect the audited financial statements; and that compliance with GAAP is
not a conclusive defense against criminal liability.
1973
Public awareness of generally accepted accounting
standards leads to the formation of the independent Financial Accounting
Standards Board.
Jensen Comment
Origins of Double Entry Accounting
are Unknown, but the timeline of Mendlowitz leaves out a few items of
interest in the early history.
1300s A.D. crusades opened the
Middle East and Mediterranean trade routes
Venice and Genoa became
venture trading centers for commerce
1296 A.D. Fini Ledgers in
Florence
1340 A.D. City of Massri
Treasurers Accounts are in Double Entry form.
1458 A.D.Benedikt Kotruljevic (Croatian)
(Dubrovnik,1416-L’Aquila,1469) (His Italian name was Benedetto Cotrugli
Raguseo), wrote The Book on the Art of Trading which is now
acknowledged to be the first person to write a book describing
double-entry techniques (although the origins of double
Mendlowitz does list the 1494 book of Pacioli, which was the first
algebra book ever written. It used double entry bookkeeping mainly as an
illustration of algebra
A nice timeline on the
development of U.S. standards and the evolution of thinking about the income
statement versus the balance sheet is provided at:
"The Evolution of U.S. GAAP: The Political Forces Behind Professional
Standards (1930-1973)," by Stephen A. Zeff, CPA Journal, January
2005 ---
http://www.nysscpa.org/cpajournal/2005/105/infocus/p18.htm
Part II covering years 1974-2003 published in February 2005 ---
http://archives.cpajournal.com/
Canadian Printer and Publisher (history of various trades and
industries) ---
http://link.library.utoronto.ca/cpp/
You can search for various industry terms such as accounting, cost,
bookkeeping, etc.
Accounting
History Review was formerly
titled Accounting, Business & Financial History is based out
of Cardiff University. Accounting History is a journal
published by Sage as a journal of the Accounting History Special
Interest Group of the Accounting and Finance Association of
Australia and New Zealand. The Accounting Historians Journal
a publication of the Academy of Accounting Historians is
independently published (and as a result far cheaper in price) than
the other two. The Accounting Historians Journal is much
older than the other two having entered its 39th year of
publication. Older editions of the AHJ are available on JSTOR and
other databases, with older back issues available for free at the
University of Mississippi Libraries website that also maintains the
AICPA libraries. I know editors at all three journals and all are
quite capable and respected individuals. There is a considerable
debate which of the journals are considered better than the other
with arguments made for each of the three.
Jim
McKinney, Ph.D., C.P.A. Accounting
and Information Assurance
Robert H. Smith School of Business
4333G Van Munching Hall
University of Maryland
College Park, MD 20742-1815
http://www.rhsmith.umd.edu
April 7, 2017 message from Barbara Scofield
I met accounting on a vacation visit to Gilcrease Museum in Tulsa, OK, and
I thought I would share this use of ledger books. My photos of the ledgers
are attached.
From
Gilcrease Museum, Tulsa, OK, visited on 8/4/2017
Artistry
of Plains Warriors
For
centuries, Plains Indian men recorded their warfare successes through art,
including rock engravings and drawings and paintings on hides and clothing. This
artistry accompanied by oral recitations of events validated warriors’
heroic deeds and courageous acts in battle performed for the protection of
family and homelands. In the 1860s as warfare with the U.S. military
increased, warriors began to illustrate their battle exploits in ink, pencil
and watercolor, drawings in ledger and sketch books obtained through
traders, military posts, and other government agencies. Through the late
nineteenth century, men continued to recount their past warfare deeds and
new experiences of reservation life through ledger art.
Ledger
Book of Drawings
Cheyenne
and Arapaho artists,
Fort Reno Army Scouts
Oklahoma, 1887
Leather, paper, ink, graphite and colored pencil, watercolor
GM 4526.11
The Indian Scout Unit, Company A, operated at Fort Reno from 185 to
1895. The Indian Scouts were formed primarily to keep peace and prevent
trespassing of cattlemen and others from reservation lands. For Cheyenne
and Arapaho men, scouting during the early reservation years was a viable
and honorable role that allowed them to use their skills as warriors and
skilled horsemen while earning income. Through the 139 drawings in the
book, the Scouts recount warfare with Pawnee, Crow
and Shoshone enemies and depict scenes of domestic life and courtship.
In Washington’s National Gallery of Art
hangs a portrait by Jan Gossaert. Painted around 1530, at the very
moment when the Dutch were becoming the undisputed masters of
European trade, it shows the merchant Jan Snouck Jacobsz at work at
his desk. The painter’s remarkable gift for detail is evident in
Jacobsz’s dignified expression, his fine ermine clothes and
expensive rings. Rendered just as carefully are his quill pen,
account ledger, and receipts.
This is, in short, a portrait of not only
wealth and material success, but of accounting. It might seem
strange that an artist would lavish such care on the nuts and bolts
of something so mundane, like a poet writing couplets about a
corporate expense report. But the Jacobsz portrait is far from
unique: Accounting paintings were a significant genre in Dutch art.
For 200 years, the Dutch not only dominated world trade and
portrayed themselves that way, but in hundreds of paintings, they
also made sure to include the account books.
This was not simply a wealthy nation
crowing about its financial success. The Dutch were the leading
merchants of their time, and they saw good accounting as the key to
both their wealth and the moral health of their society. To the
audience of the time, the paintings carried a clear message:
Mastering finance was an achievement requiring both skill and
humility.
Today when we see accountants in art or
entertainment, they are marginal figures—comically boring
bean-counters or fraudsters cooking the books. Accounting is almost
a synonym for drudgery: from the hapless daydreamer Walter Mitty to
the iconic nerd accountant Rick Moranis plays in “Ghostbusters.”
Accounting is seen as less a moral calling than a fussy brake on the
action.
In the wake of decades of financial
scandal—much of it linked to creative accounting, or to no
accounting all—the Dutch tradition of accounting art suggests it
might be us, not the Dutch, who have misjudged accounting’s
importance in the world. Accounting in the modern sense was still a
new idea in the 1500s, one with a weight that carried beyond the
business world. A proper accounting invoked the idea of debts paid,
the obligation of nightly personal reckonings, and even calling to
account the wealthy and powerful through audits.
It was an idea powerful enough to occupy
the attention of thinkers in religion, art, and philosophy. A look
back at the tradition of accounting in art shows just how much is at
stake in “good accounting,” and how much society can gain from
seeing it, like the Dutch, not just as a tool but as a cultural
principle and a moral position.
***
Scratches on ancient tablets show us that
accounts have been kept for as long as humans have been able to
record them, from ancient Mesopotamians to the Mayans. This kind of
accounting was about measuring stores: Merchants and treasurers
recorded how much grain, bread, gold, or silver they had. Most
ledgers were simple lists of assets or payments.
Accounting in the modern sense started
around 1300 in medieval Italy, when multipartner firms had to
calculate their investments in foreign trade. We don’t know who, if
anyone, can take credit for the invention, but it was around this
time that double-entry bookkeeping emerged in Tuscany. Instead of a
simple list, it consisted of two separate columns, recording income
in one against expenditures in the other. Every transaction of
expenditure could be checked against corresponding income: If one
sold a goat for three florins, one gained three florins and, in the
other column, lost a goat. It was a kind of self-checking mechanism
that also helped calculate profit or loss. In Hogarth’s “Marriage a
la Mode: The Tête a Tête,” the man with the account books walks off
in disgust (left).
HIP/Art Resource, New York
In Hogarth’s “Marriage a la Mode: The Tête
a Tête,” the man with the account books walks off in disgust (left).
It would come to change finance, but was
not an immediate hit. Any system of enforcing fiscal discipline is
an incursion against the absolute control of the account-holder, and
kings and the powerful tended to see themselves above the
merchant-like calculations of bookkeeping. They not only hid their
wealth and debts: They often did not bother to calculate them. In
the end, they saw themselves as only accountable to God; if they
needed more ready cash, they could always lean on their inferiors.
At least in the short run, it was far more comfortable to govern
without the constraints of financial accountability.
But in one place, the idea of financial
accountability did take hold. By the early 1500s, Holland had become
the center of global trade, with Antwerp and later Amsterdam acting
as the most important ports in the world. Ships arrived laden with
spices, exotic fruit, minerals, animals, whale oil, cloths, and
other luxury goods. In 1602, the Dutch government in essence created
modern capitalism by founding both the first publicly traded
company—the Dutch East India Company, or VOC—and the Amsterdam Stock
Exchange.
Accounting was central to managing not only
these companies, but also the Dutch government itself. While not all
tax collectors or company managers kept perfect double-entry books,
it represented an ideal. It was also seen as a necessary skill for
civic participation. Most members of Dutch society were fluent in
accounting, having studied at home or in publicly funded city
accounting schools.
Double-entry accounting made it possible to
calculate profit and capital and for managers, investors, and
authorities to verify books. But at the time, it also had a moral
implication. Keeping one’s books balanced wasn’t simply a matter of
law, but an imitation of God, who kept moral accounts of humanity
and tallied them in the Books of Life and Death. It was a financial
technique whose power lay beyond the accountants, and beyond even
the wealthy people who employed them.
Accounting was closely tied to the notion
of human audits and spiritual reckonings. Dutch artists began to
paint what could be called a warning genre of accounting paintings.
In Jan Provost’s “Death and Merchant,” a businessman sits behind his
sacks of gold doing his books, but he cannot balance them, for there
is a missing entry. He reaches out for payment, not from the man who
owes him the money, but from the grim reaper, death himself, the
only one who can pay the final debts and balance the books. The
message is clear: Humans cannot truly balance their books in the
end, for they are accountable to the final auditor.
This message rubbed off on political and
financial leaders. They were expected to keep good books, and they
could expect to be publicly audited—a notion fiercely resisted in
the great monarchies of the Continent. In the 17th century, another
genre of paintings emerged, showing public administrators holding
their books open for all to see. More than 100 of these paintings
were produced between 1600 and 1800. Transparency became a cultural
ideal worthy of art.
The Dutch also appreciated that ledgers,
bills of exchange, and files, like any tool in human hands, were
liable to misuse in the interest of wealth or pride. Dutch painters
like Marinus van Raemerswaele warned against hubris and greed with
paintings of bookkeepers as twisted, grotesque figures in absurd
hats who would be as likely to commit fraud as to keep good books.
The value the Dutch placed on accounting
made a large impression on the English, who sought to emulate “the
Mighty Dutch” in many ways, including this new business technique.
By the 1700s, they were also the only other nation to paint
accounting pictures. The English celebrated the wealth of their
Industrial Revolution and Empire with portraits of successful
merchants smiling over their books—and, like the Dutch, also used
account books as a way to wag a finger. In one scene from William
Hogarth’s “Marriage à la Mode,” a popular series of paintings from
the 18th century, a noble couple squanders their lives on parties
and gambling. In a final signal of disapproval, almost like a
punctuation mark, their accountant walks away in disgust.
***
By the late 19th century, accounting had
become a profession of its own, rather than fundamentally a shared
practice and value. It receded from the lives of individuals, and
began to take on more the reputation it holds today.
Ross L. Watts Massachusetts Institute of Technology (MIT) - Sloan
School of Management
Luo Zuo Cornell University - Samuel Curtis Johnson Graduate
School of Management
Abstract
This paper
explains how and why Anglo-American accounting and auditing, along
with corporate governance and capital markets, evolved over many
centuries in response to changes in market forces and technology. We
first trace the development of practices that were included in U.S.
corporate governance (including accounting and auditing) before the
1930s. We then describe the nature and effect of the increase in
U.S. regulation from the 1930s and the development of fair value
accounting. Finally, we give an assessment of the current state of
accounting, auditing and corporate governance. Our historical
accounts suggest that the approach to accounting and financial
reporting is more consistent with stewardship (care of net assets)
than an attempt to value the firm, and that conservatism (prudence)
is a critical information control and governance mechanism. We echo
the U.K. Financial Reporting Council’s call on standard setters to
reintroduce an explicit reference to conservatism (prudence) into
the Conceptual Framework for financial reporting.
Accounting History Corner
While accrual historical cost accounting evolved in accounting for ventures and
business firms, exit (liquidation) value accounting remained the tradition in
history clear up to today for personal accounts such as exit value reporting for
estates and trusts. The main reason is the purpose of the accounting.
Fair value reporting of going concerns
would be of greater interest if accountants could figure out how to report
"value in use" to investors apart from "exit value in liquidation." But
accountants have never been able to figure out how to reliably measure "value in
use" that economists in history have preferred but never helped accountants
figure out how to reliably measure in practice. The GAAP for going concerns is
now an amalgamation of accrued historical cost (not really valuation at all)
combined with some exceptions such as lower-of-cost or market for inventories
and exit value reporting of financial instruments and derivative financial
instruments. However, it all becomes exit (liquidation) value reporting when a
firm is deemed to be no longer a going concern.
In personal accounting non-going concerns
are usually the rule rather than the exception. When a person dies his or her
estate if valued on the basis of liquidation value and divided up among the
heirs. When a couple is being divorced the marriage is no longer a going
concern, and the assets and liabilities are accounted for at liquidation value.
It is interesting to look back at the
history of "personal" accounting. As you can see the line between personal and
business is very fuzzy in history.
"PERSONAL ACCOUNTS, ACCOUNT BOOKS AND
THEIR PROBATIVE VALUE: HISTORICAL NOTES, c.1200 TO c.1800," by Basil S.
Yamey, Accounting Historians Journal, Volume 39, Number 2 December 2012
pp. 1-26 ---
http://umiss.lib.olemiss.edu:82/articles/1038708.7435/1.PDF
This paper
discusses a number of topics pertaining to personal accounts in
account books in the period roughly between 1200 and 1800. The main
emphasis is on two topics, namely the use of account books as
evidence in courts of law, and bad and doubtful debts and their
accounting treatment. Examples from various countries and periods
are provided to illustrate the discussion, which is not intended to
be exhaustive.
The majority
of accounts in surviving business account books of the period 1200
to 1800 in Western Europe are personal accounts. They record
dealings of the firm with individuals, one-man businesses,
partnerships, joint stock companies, religious establishments, and
government bodies. In many of the account books there are only
personal accounts, and in some there are mainly personal accounts
together with a sprinkling of non-personal accounts. This paper
considers and illustrates a selection of topics that pertain to
personal accounts in the period covered: personal accounts in single
entry and double entry bookkeeping systems; the use of account books
as evidence in law courts; how a merchant could increase the
probative value of his account books; bad and doubtful debtors and
debts, and the various accounting treatm ents given to them; and
some concluding observations, mainly about ledgers in flames.
Continued in
article
New Accounting History Books Worth Noting
Steve Zeff at Rice University is one of the best-known accounting
historians alive today. He's also the current Book Review Editor of
The Accounting Review. This explains, in part, why the July 2013
listing of book reviews four scholarly reference books on accounting
history. I say reference books, because none of the four history books
is light reading to pass the time on airplanes.
SEBASTIAN BOTZEM, The Politics of Accounting Regulation:
Organizing Transnational Standard Setting in Financial Reporting
(Cheltenham, U.K.: Edward Elgar Publishing, 2012, ISBN
978-1-84980-177-5, pp. x, 223).
Reviewer Scholar: STUART McLEAY
WOLFGANG BURR and ALFRED WAGENHOFER (coordinating editors),
Der Verband der Hoschschullehrer für Betriebswirtschaft:
Geschichte des VHB und Geschichten zum VHB (History of the VHB
and Tales of the VHB) (Wiesbaden, Germany: Gabler Verlag, 2012, ISBN
978-3-8349-2939-6, pp. xxi, 338).
Reviewer Scholar: LISA EVANS
MAHMOUD EZZAMEL, Accounting and Order (New York, NY:
Routledge, 2012, ISBN 978-0-415-48261-5, pp. xx, 482).
Reviewer Scholar: SUDIPTA BASU
GARY PREVITS, PETER WALTON, and PETER WOLNIZER (editors),
A Global History of Accounting, Financial Reporting and Public
Policy: Eurasia, the Middle East and Africa (Bingley, U.K.:
Emerald Group Publishing Limited, 2012, ISBN 978-0-85724-815-2, pp.
xi, 249).
Reviewer Scholar: TIMOTHY S. DOUPNIK
Capsule Commentary on The Future of IFRS (London,
U.K.: Financial Reporting Faculty of the Institute of Chartered
Accountants in England and Wales, 2012, ISBN 978-0-85760-652-5, pp.
25). Downloadable at
www.icaew.com.
Reviewer Commentator: STEPHEN A. ZEFF
One hundred objects from museums across the UK with
resources, information and teaching ideas to inspire your students’ interest
in history.
More about this project
Jensen Comment
As I scanned the above site it dawned on me how we might add historical objects
(or pictures or videos) of those objects into some of our accounting courses,
especially when teaching topics where accounting history is virtually ignored.
For example rather than just define the term "ledger" in bookkeeping the rich
history could be taught with images or even objects of this history such as
papyrus, quill pens, etc.---
http://en.wikipedia.org/wiki/Ledger (note some of the early
history)
Or when teaching modules from "data science" there are various objects that
might be visualized ---
http://en.wikipedia.org/wiki/Data_science
For examples perhaps objects of machine learning, signal processing, etc. could
catch student's attention.
For example, one possible assignment on a give topic might be to ask teams of
students to discover possible objects of historical interest on this topic.
I kick myself for having given or thrown away a succession of six of early
laptop computers that I owned over the years.
Financial Statements Loss of
Quality and Predictive Power
Jensen Comment
I don't think the "The EBITDA Epidemic Takes Its Cue from Standard
Setters." Like Professor Verrecchia currently and my accounting
Professor Bob Jaedicke decades earlier I think the "EBITDA Epidemic"
takes its cue from investors and managers that have a "functional
fixation" for earnings, eps, EBITDA, and P/E ratios --- when in fact
those metrics are no longer defined by the FASB/IASB and may have a lot
of misleading noise and secret manipulations.
Jensen Comment
If the FASB cannot define net earnings then it follows from cold logic
that they cannot define measures derived from net earnings like EBITDA.
However, virtually all private sector business firms compute net
earnings and some measures derived from net earnings like eps, EBITDA,
and P/E ratios.
It's doubtful whether net earnings for two different companies or
even one company over two time intervals are really comparable.
But all that does not matter when it comes to adjudicating an insider
trading case in court even if the accused may not really be an insider.
I'm reminded of why billionaire Martha Stewart went to prison because
she acted on inside information about a company --- inside information
passed on to her by the CEO of that company. It doesn't matter that the
amount of loss saved by the inside tip involved is insignificant
compared to her billion-dollar portfolio. Evidence in the case made it
clear that she did exploit other investors by acting on the inside tip
no matter how insignificant the value of that tip to her. She was hauled
off the clink in handcuffs and was released in less than five months.
But her good name and reputation were tarnished forever ---
http://en.wikipedia.org/wiki/Martha_Stewart
Flamboyant billionaire Mark Cuban went on trial for very similar
reasons (although later acquitted) , although the alleged insider tip and the value of the alleged
tip is more obscure than in the Martha Stewart case. Like in the case of
Martha Stewart the loss avoided is pocket change ($750,000) relative to
Cuban's billion-dollar portfolio.
What Cuban failed to mention to the jury is that net earnings and
EBITDA cannot be defined since the FASB elected to give the balance
sheet priority over the income statement in financial reporting --- "The Asset-Liability Approach: Primacy does not mean
Priority," by Robert Bloomfield, FASRI Financial Accounting
Standards Research Initiative, October 6, 2009 ---
http://www.fasri.net/index.php/2009/10/the-asset-liability-approach-primacy-does-not-mean-priority/
Abstract:
Since the 1970s, the decision-usefulness has taken center stage and
our attention has been concentrated on valuation of assets and
liabilities instead of income measurement. The concept of income,
once considered the gravitational center of accounting has lost its
primacy and become a byproduct of the balance sheet derived from the
measurement of assets and liabilities.
However, we have not been equipped with
robust conceptual foundation supporting theoretically reasoned
accounting measurement. It is not only theoretically but also
practically important to renew our seemingly waned interest in the
concept of income because ongoing reforms of accounting standards
cannot be successfully implemented without a sound understanding of
the concept of income.
Possible Teaching Case
Question
If you presented the following article in class how would you approach the
analysis of this article and/or evaluate student reactions to this article?
Considerations
First consider the fact that neither the FASB nor the IASB has a working
definition of net earnings, and it's quite dangerous to compare earnings numbers
of a company over time.
Second consider the classical debate over whether accrual financial
statements or cash flow financial statements are more important when analyzing
the future of a company --- realizing that both may be important at the same
time.
Third consider any problems of revenue recognition and unrealized fair value
changes that may or may not be factors in these particular Twitter financial
statements.
"Why This Twitter Earnings Report Matters So Much," by Jon C. Ogg,
24/7 Wall Street, July 28, 2014 ---
Click Here
Twitter, Inc. (NYSE: TWTR) is set to report its
second quarter earnings report after the close of trading on Tuesday. This
will be just the second full quarter earnings report since its late 2013
initial public offering.
24/7 Wall St. has seen that the Thomson Reuters
estimate is for a loss of one-cent per share on revenues of $283 million.
Management had guided in a range of $270 to $180 million. New advertising is
said to be continuing to let the company grow, but we are also looking at
that user growth closely and the internal ad metrics rather than just the
raw revenue number.
We would caution that 2013 revenue was $664.89
million, up almost 110% from the $316.93 million in 2012. Revenue growth is
expected to slow ahead – with 90% growth to $1.27 billion in 2014 and with
revenue growth of another 62% to $2.06 billion in 2015. This is still
massive growth expected, but many
investors
remain mixed to uncertain about Twitter and its
endless growth.
On top of revenue growth, we will again be looking
closely at user growth. This should be up somewhere close to around 6% again
to around 270 million users, although the fair range might be 265 million to
275 million.
The number is too wild to calculate for an
earnings multiple for 2014, but even
after losing half of its post-IPO peak value Twitter still trades above
140-times expected 2015 earnings per share. It is also trading at a multiple
of almost 11-times expected 2015 revenues.
We have long wondered how investors will continue
to treat social media stocks in the years ahead. At some point there will
either be a split where social media takes over or there will be user
fatigue. That verdict remains out.
Twitter shares were above $38 on Monday in
afternoon trading. Its 52-week
trading
range
is $29.51 to $74.73, and the consensus analyst price target is almost
$43.50.
It almost feels like a conundrum for Twitter
investors. The stock has lost half of its peak value, but it likely still
has to post very strong numbers to keep investors happy. Having a
market
cap of $22.25 billion in revenues
comes with high expectations, and disappointing on those expectations could
come with serious consequences.
These were the metrics posted in the first quarter
of 2014, verbatim from Twitter’s release:
Average Monthly Active Users (MAUs)
were 255 million as of March 31, 2014, an increase of 25%
year-over-year.
Mobile MAUs reached
198 million in the first quarter of 2014, an increase of 31%
year-over-year, representing 78% of total MAUs.
Timeline views reached 157 billion for
the first quarter of 2014, an increase of 15% year-over-year.
Advertising revenue per thousand
timeline views reached $1.44 in the first quarter of 2014, an increase
of 96% year-over-year.
What Cuban failed to mention is that net earnings and EBITDA cannot be
defined since the FASB elected to give the balance sheet priority over the
income statement in financial reporting --- "The Asset-Liability Approach: Primacy does not mean Priority,"
by Robert Bloomfield, FASRI Financial Accounting Standards Research
Initiative, October 6, 2009 ---
http://www.fasri.net/index.php/2009/10/the-asset-liability-approach-primacy-does-not-mean-priority/
Abstract:
Since the 1970s, the decision-usefulness has taken center stage and
our attention has been concentrated on valuation of assets and
liabilities instead of income measurement. The concept of income,
once considered the gravitational center of accounting has lost its
primacy and become a byproduct of the balance sheet derived from the
measurement of assets and liabilities.
However, we have not been equipped with
robust conceptual foundation supporting theoretically reasoned
accounting measurement. It is not only theoretically but also
practically important to renew our seemingly waned interest in the
concept of income because ongoing reforms of accounting standards
cannot be successfully implemented without a sound understanding of
the concept of income.
"Is Empirical
Management Accounting Research Progressing? Evidence on its Diversity
and Methodological Sophistication Over Three Decades," by Irene
Essert, Maik Lachmann, and Rouven Trapp, SSRN, November 17, 2014 ---
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2526186
Abstract:
This paper assesses three decades of empirical management accounting
research in light of its diversity and methodological
sophistication. In doing so, we first address concerns recently
voiced by distinguished scholars regarding an increasing
homogenization of research approaches that may compromise our
understanding of management accounting practice. Second, we
complement the methodological papers that have prescribed what
researchers should account for to ensure the validity of their
findings by evaluating how four important types of validity –
internal, external, construct and statistical conclusion validity –
are de facto considered. Our study provides initial empirical
evidence on these issues based on a quantitative content analysis of
415 papers published in ten leading accounting journals. We find a
growing narrowness of research content as management control issues
become increasingly prioritized, whereas the range of methods
employed remains broad. Given the corresponding disclosures,
validity improves over time, suggesting that management accounting
research is progressing with respect to its rigor. Based on our
findings, we discuss avenues for further research.
From FAF: USA GAAP Education Helper Site
November 19, 2014 message from Terry Warfield
This week the FAF
launched
a new web page
focused on the benefits of Generally Accepted
Accounting Principles—GAAP—to public companies, private companies,
not-for-profit organizations, and state and local governments in the
U.S. The web page is available at
www.accountingfoundation.org/gaap.
This educational portal
is part of a broader FAF initiative to highlight the benefits of
preparing financial reports according to GAAP.
While many regard GAAP as
the “gold standard” of financial reporting for public companies and
state governments, there are many private companies,
not-for-profits, local governments, and others that may not be
familiar with the benefits of using GAAP.
This initiative explores
those benefits and also seeks to educate and inform all
stakeholders—including preparers, investors, lenders, auditors,
taxpayers, and other users—on how GAAP is essential to the efficient
functioning of our capital markets and the strengthening of our
economy and governments.
Steve Zeff at Rice University is one of the best-known accounting
historians alive today. He's also the current Book Review Editor of
The Accounting Review. This explains, in part, why the July 2013
listing of book reviews four scholarly reference books on accounting
history. I say reference books, because none of the four history books
is light reading to pass the time on airplanes.
SEBASTIAN BOTZEM, The Politics of Accounting Regulation:
Organizing Transnational Standard Setting in Financial Reporting
(Cheltenham, U.K.: Edward Elgar Publishing, 2012, ISBN
978-1-84980-177-5, pp. x, 223).
Reviewer Scholar: STUART McLEAY
WOLFGANG BURR and ALFRED WAGENHOFER (coordinating editors),
Der Verband der Hoschschullehrer für Betriebswirtschaft:
Geschichte des VHB und Geschichten zum VHB (History of the VHB
and Tales of the VHB) (Wiesbaden, Germany: Gabler Verlag, 2012, ISBN
978-3-8349-2939-6, pp. xxi, 338).
Reviewer Scholar: LISA EVANS
MAHMOUD EZZAMEL, Accounting and Order (New York, NY:
Routledge, 2012, ISBN 978-0-415-48261-5, pp. xx, 482).
Reviewer Scholar: SUDIPTA BASU
GARY PREVITS, PETER WALTON, and PETER WOLNIZER (editors),
A Global History of Accounting, Financial Reporting and Public
Policy: Eurasia, the Middle East and Africa (Bingley, U.K.:
Emerald Group Publishing Limited, 2012, ISBN 978-0-85724-815-2, pp.
xi, 249).
Reviewer Scholar: TIMOTHY S. DOUPNIK
Capsule Commentary on The Future of IFRS (London,
U.K.: Financial Reporting Faculty of the Institute of Chartered
Accountants in England and Wales, 2012, ISBN 978-0-85760-652-5, pp.
25). Downloadable at
www.icaew.com.
Reviewer Commentator: STEPHEN A. ZEFF
The accounting history classic in the set is A Global History
of Accounting, Financial Reporting and Public Policyin four
volumes, the fourth volume of which is reviewed in the above listing.
The entire set is devoted to global development of accounting, financial
reporting, and public policy in several key sovereign states. I don't
think any scholarly library on accounting history would be complete
without the entire set, although accounting professors may not invest in
this set unless they are doing research in accounting history. This is
not light reading. The reviewer, Tim Doupnik notes, that is not a book
aimed at teh textbook market. Rather is "intended to be a historical
source book."
The Accounting for Order (in ancient Egypt) book by Mahmoud
Ezzamel provides more than you probably ever wanted to know about
"Egyptian inscriptions to document the role that accounting played in
numerous spheres and theorizing about how accounting helps to create and
sustain order within these spheres." It is a book that should be in
every accounting history library, although professors who buy the book
are probably historians interested in ancient Egypt society, culture,
and economics. Sadipta Basu nearly always does scholarly work, and his
review of this book is well worth the read.
Most of us cannot read the Wolfgang Burr and Alfred Wagenhofer book
since it is written in German. Lisa Evans is obviously a scholar
in accounting as well as the German language and writes the following in
her review:
This book is written in German and, it
seems, for an audience primarily comprising VHB members, or at least
those familiar with the discipline of Betriebswirtschaft (BWL) and
with the organization of German academe. Therefore, an explicit
account of what distinguishes BWL from related disciplines in other
cultures may not have been felt necessary. However, one of the
difficulties in reviewing this book for an English-speaking
readership is the need to translate German concepts for which there
are no English language equivalents. The very terms
Betriebswirtschaft and Betriebswirtschaftslehre (the science of
Betriebswirtschaft) can be translated as, inter alia, business
administration, business management, business economics, or business
studies.
The lack of an equivalent translation is an
indication of the different histories of related disciplines in
different academic and business traditions. The different possible
translations are also a clue to the breadth of the subject matter
and to difficulties in its demarcation from related disciplines
during its history. This relationship with other disciplines is
explored throughout this book.
In essence, the VHB represents interests
considerably wider than accounting and finance, and many of the
famous names (Schmalenbach, Schmidt, Mahlberg, etc.) associated with
the history of BWL were not, or not only, professors of accounting
in a narrow sense. The VHB's membership represents 16 subject areas
or sub-disciplines: banking and finance; business taxation; academic
management; international management; logistics; marketing;
sustainability management; public business administration;
operations research; organization; human resources management;
production management; accounting; technology, innovation and
entrepreneurship; business information systems; and economic science
(VHB website; see also Chapter 1). The subject group for accounting
was formally constituted in 1977 and includes financial reporting,
managerial accounting, controlling, and auditing (VHB website).
Continued in the book review
The author of The Politics of Accounting Regulation: Organizing
Transnational Standard Setting in Financial Reporting, Sebastian
Botzem, is a political scientist who focuses his particular research
skills to the study of the politics of the International Accounting
Standards Board. The reviewer, stuart Mcleay, writes as follows:
. . .
n its attempt to understand the contested
and political nature of accounting standard setting, this
interdisciplinary book focuses on the structures and the procedures
that enable transnational rule-setting. The author starts with an
outline of the social theory that may explain transnational
accounting standardization, noting that the shared beliefs of
professions have long been able to facilitate the social closure
that is important to self-regulation, but that professional bodies
no longer form the main loci of expertise in accounting standard
setting. This is followed by a condensed account of the IASB's
emergence as the pre-eminent international accounting standard
setter. Botzem claims that, in getting to this position, the IASB
has out-competed a number of other endeavors to draw up
international accounting rules. This is a questionable
interpretation, as the two supposed competitors to the IASB (the
European Community and the United Nations) have not been greatly
concerned with financial reporting standards per se, but,
respectively, with the harmonization of company law across the
member states of the European Union and the wider accountability of
multinational companies. Rather than rival initiatives, these are
components of a complex nexus of overlapping demands by social
actors aimed at constraining the behavior of firms.
The book also attempts to set the scene by
drawing links between global capitalism and the content of
international accounting standards, emphasizing the capital-market
orientation embodied in fair value accounting. This too is overly
simplistic, in my view—we do not have to look far for a
counter-example in the potential usefulness of pension accounting of
employee superannuation funds.
The book continues with a reconstruction of
the organizational development of the IASB, arguing that, while the
privately run standard setter has established the necessary
procedures to consult with interested parties, it has done so
without handing over too much influence. In this respect, the author
claims that the IASB has subordinated democratic accountability to
the effectiveness of expertise-based standardization. This is a
well-worn debate among accounting researchers, practitioners, and
standard setters, not only the IASB. It is particularly instructive
that the revised conceptual framework issued jointly by the IASB and
FASB now limits the range of addressees of general purpose financial
reporting to investors, lenders and other creditors, explicitly to
assist them in making decisions about providing resources to the
entity. Needless to say, political scientists should be aware that
various social actors have sought to foist their own public policy
objectives onto the regulation of financial statements, in an
attempt to extend the remit of standard setting beyond that of
financial reporting. Our understanding of the IASB requires in turn
a greater appreciation of international consensus over the public
policy objectives financial statements.
Finally, the book reports on the author's
own empirical research on organizational structures and processes,
by providing an analysis of the dominant individuals and the most
influential organizations within the IASB's wider network.
Throughout the book, the IASB is portrayed
as “a successful, private, transnational, regulatory body,” whose
efforts to be outside of politics are nevertheless fundamentally
political in nature. While the IASB is often referred to as a
“regulator” in this way (both in this book and elsewhere), the
broader perspective is that law-makers, together with the financial
regulators and delegated agencies that produce “soft law,”
contribute jointly to the complex framework of requirements that are
placed on the regulated. At the same time, the multinational
operations of regulated firms readily introduce legal and regulatory
extraterritorialities that muddle institutional boundaries. While
Botzem grapples with some of these complexities, and introduces the
reader to useful universal notions such as “boundary spanning” when
generalizing the diffusion of transnational standards over different
social domains, a fuller understanding of the particularities of the
IASB as a regulatory body requires a more developed appreciation of
the way in which the various institutions of corporate regulation
interact in influencing financial reporting. For instance, not only
is the black letter of corporate law transposed readily from one
jurisdiction to another, so too are the formal and informal rules
and processes of accounting (as they have been since the Middle
Ages). The level of statist interaction, or emulation, was already
high before the advent of the IASB. I suspect that cultural
specificity in accounting is marginal, and that other factors, such
as differences in industrial structure, may explain not only
international accounting practice differentiation (Jaafar and McLeay
2007) but also the within-country alliances that influence statist
regulatory differentiation.
In the latter part of the book, the
analysis of the Board membership is based to a great extent on the
CVs of the individuals involved. In contrast, the analysis of the
other IASB bodies that are investigated (the Standards Advisory
Council, SAC; the International Financial Reporting Interpretations
Committee, IFRIC; and the trustees) depends greatly on the
assumption that each member of these bodies is a “representative” of
their employer. While the modeling is detailed, it builds on shaky
ground in this respect. For example, a small number of universities
are listed as employing organizations (Genoa, Northwestern, São
Paulo, Tama, Unitec NZ, Waseda, and Wellington). It is difficult to
believe that these organizations are “represented” in any way on
IASB committees, and there is no obvious reason to expect that the
individuals involved necessarily act as representatives of the wider
academic community. Likewise, it is not necessarily the case that an
employee of the General Electric Company is a “representative” of
GE, who is just as likely to have been voted in by dint of other
alliances or even on the basis of individual competences. Although
it may be reasonable to infer that an employee of the Korean
Accounting Standards Board is a “representative” of the KASB, or
even of standard setters in general, it is still plausible that
individual factors are as important as institutional representation
in motivating involvement with the IASB, including membership of
other networks. We require a deeper understanding of these
interacting alliances formed by individual members. Moreover, the
analysis would benefit from including the membership of the IASB's
Monitoring Board, which consists of capital market regulators.
Other aspects of the analysis in this book
are similarly underdeveloped. Speaking of one current Board member,
who has worked in India, Europe, and the United States, it is noted
that “[h]e is a member of both the Institute of Chartered
Accountants of India and the American Institute of CPAs and
therefore can be considered to be the ninth ‘Anglo-American'
representative on the Board” (pp. 132–133). It does seem, here, as
though an awkward fact is not allowed to get in the way of a good
story. Unfortunately, the research places too much weight on the
cliché of “Anglo-American domination.” It would be equally valid to
interpret previous employment and early training with large audit
firms as direct experience of international accounting, in
transnational firms that command a global market in accounting and
audit services. For instance, at the time of writing, just one of
these firms has offices in 771 cities across 158 countries, with its
employees distributed throughout Europe (34%), North America (25%),
Asia (21%) and elsewhere (20%)—see PwC's Global Annual Review 2012.
The author stretches the same point in
other ways: “in their daily work the Board members draw on a
foundation of experience rooted in an Anglo-American philosophy
marked by an appreciation for private sector self-regulation and
skepticism toward state intervention” (p. 133). Yet the 18 extracts
from author interviews with IASB members (Tweedie is quoted nine
times and Whittington four times) and others (Cairns is quoted
twice, Mackintosh twice, and Mau once) provide little evidence of
such attitudes, and the hypothesis therefore remains untested.
Indeed, given that one of the main conclusions is that the IASB mode
of expert-based self-regulation is under-representative of the users
of accounting information, one might conclude that this is a very
limited set of interviewees.
Continued in article
Jensen Comment
I might add that accounting history is monumentally neglected in our
North American accountancy doctoral programs and in our academic
accountancy departments and in our top accounting research journals.
Academic researchers prefer to take the easy way out by beating
purchased database pinatas with sticks until findings, mostly
uninteresting findings, fall into research journals that are largely
ignored by the profession and accounting teachers ---
http://www.cs.trinity.edu/~rjensen/temp/AccounticsDamn.htm#Essays
The Sebastian Botzem book should probably be required reading in a
course (probably an economics course) on the history and politics of
regulation. Such a course would not be common in accounting departments.
Great credit should be given to the great success that the IASB has had
to date in bringing over 100 nations into the subset of nations that
require IFRS totally or almost totally as the main set of financial
reporting standards for auditors and investors. Although I'm doubtful
that IFRS should replace current U.S. GAAP in the USA, my hat is off to
the great success of relentless efforts by dedicated global accountants
to succeed in the politics of IFRS. The USA is a special case, and
nobody ever thought it would be easy to bring convergence of USA and
IASB accounting standards.
The USA is a special case because of its long history of raising
business funding from equity markets that are almost non-existent in
most of the 100+ nations who raise a greater share of capital from
central banks and government taxation.
The USA is a special case because of boots-on-the ground wars it has
participated in since World War II. It's not possible to enter into so
many fighting wars without polarizing the rest of the world into nations
that respect the USA's effort to bring world peace versus those that
despise the USA's political alignments and economic dominance,
particularly alignments with Israel that inflame other parts of the
world.
The USA will carry a lot of political baggage to the IASB if the IASB
standards are to be deployed in the USA. Our enemies rise up against us
with both terror and with every political tool at their disposal,
including the politics of the UN that will probably be carried over into
the future politics of the IASB. This of course is Bob Jensen
speaking and not repeating the more optimistic views of Sebastian Botzem.
However, it's probably inevitable that the USA will join the IASB
fold one day down the road.
Steve Zeff in this edition of TAR has a capsule commentary with a
scholarly forecast of The Future of IFRS that is much more
optimistic Capsule Commentary on The Future of IFRS (London, U.K.:
Financial Reporting Faculty of the Institute of Chartered Accountants in
England and Wales, 2012, ISBN 978-0-85760-652-5, pp. 25). Downloadable
at www.icaew.com.
Reviewer Commentator: STEPHEN A. ZEFF
Our open sharing retired accounting professor, Jim Martin, who maintains the
MAAW Website and Blog made the following posting on August 24, 2013 --- http://maaw.blogspot.com/
I have developed an index of accounting
systems for business to make it easier to find information related
to a specific type of business, industry, or activity. I think you
will find it interesting and you might also find it useful in your
work. It is an ongoing project that I will update on a continuous
basis.
Fleck, L.
H. 1926. The incidence of abandonment losses. The Accounting
Review (June): 48-59. (JSTOR
link).
Accounting
Changes (Also see Changes)
Hall, J.
O. and C. R. Aldridge. 2007. Changes in accounting for changes.
Journal of
Accountancy
(February): 45-50.
Schwieger,
B. J. 1977. A summary of accounting for and reporting on
accounting changes. The Accounting Review (October):
946-949. (JSTOR
link).
Accounting
and Business Machines
Gould, S.
W. 1935. The application of tabulating and accounting machines
to real estate and mortgage accounting procedure. N.A.C.A.
Bulletin (November 15): 261-277.
Walker, R.
1947. Synchronized budgeting in the business machine industry.
N.A.C.A. Bulletin (August 1): 1453-1470.
Whisler,
R. F. 1933. Factory payroll budget of the National Cash Register
Company. N.A.C.A. Bulletin (February 1): 853-861.
Woodbridge, J. S. 1959. The inventory concept of accounting as
expressed by electronic data-processing machines and applied to
international air transportation. N.A.A. Bulletin
(October): 5-12. (International airline revenue accounting).
Accounts
Receivable Records
Zeigler,
N. B. 1938. Accounts receivable records and methods. N.A.C.A.
Bulletin (January 15): 581-594.
Before a standard numbering system was
developed, ancient accountants used clay tokens to keep track of
animals and grain.
- The State of New York gave the first CPA
exam in 1896.
- The first African American CPA was John
Wesley Cromwell, Jr., licensed in 1921. John went on to lead a very
successful career after he became the controller of Howard
University in 1930.
- Bubble gum was reportedly invented in
1926 by Walter Diemer, a twenty-three year old accountant for the
Fleer Corporation. The gum was pink because it was the only food
coloring in the factory when the young accountant was experimenting
with the gum recipes in his spare time.
- Al Capone may have been the first
American to make $100 million a year, but the law finally caught up
with him in 1931. Special Agents from the IRS charged him with tax
evasion. Accountants were responsible for ending the crime czar’s
career.
- Oscar winners always remember to thank
their agents, fans, and co-stars, but they should also thank their
CPAs. Accountants have controlled the ballots for the Academy Awards
every year since 1935. A team of nine CPAs spend up to 1,700 hours
prior to Oscar night counting the ballots cast in each category by
hand.
- Arthur Blank, co-founder of the Home
Depot and owner of the Atlanta Falcons, is a CPA.
- Ray Wersching, who was the kicker of the
San Diego and San Francisco 49ers from 1973-1987, was a CPA during
the off-season.
- John Grisham, author of A Time to Kill,
The Firm, and many other popular novels, received his undergraduate
degree in accounting from Mississippi State University in 1981.
- Former Texas Rangers Manager Kevin
Kennedy, a CPA, did his players’ tax returns to make extra money
when he managed in the minor leagues.
- Nearly 1,400 of the FBI’s special agents
are accountants. In fact, the #2 man at the FBI, Thomas Pickard, is
a CPA.
- In 1902, a competent accountant could
expect to earn $2,000 per year.
- Christine Ross, the first woman CPA in
the U.S., received her New York state CPA certificate in 1899.
- The original due date to file individual
tax returns was March 1. It changed to March 15 in 1918, and finally
to April 15 in 1955
Among the AICPA-donated volumes at
Ole Miss are two binders containing photographs of individuals
appearing in the JofA or at accounting conventions from
1887 to 1979. Of the 446 individuals featured, eight are
women—Christine Ross, Ellen Libby Eastman, Miriam Donnelly, Mary E.
Murphy, Helen Lord, Helen H. Fortune, Mary E. Lewis and Beth M.
Thompson. In a time when the profession was the all-but-exclusive
domain of men, they stood out not only because of their gender but
in many cases because of their accomplishments and contributions to
accounting. Consider that in 1933, slightly more than 100 CPA
certificates had been issued to women. By 1946, World War II had
changed traditional notions of gender in the workplace, and female
CPAs had more than tripled to 360—still a small contingent but, as
information gleaned from the AICPA Library indicates, one capable of
exerting a strong and beneficial influence on the profession.
Christine Ross
Born about 1873 in Nova Scotia, Ross took New York by storm in the
late 1890s. New York state enacted licensure legislation in 1896 and
gave its inaugural CPA exam in December 1896. Ross sat for the exam
in June 1898, scoring second or third in her group. Six to 18 months
elapsed while her certificate was delayed by state regents because
of her gender. But she had completed the requirements and became the
first woman CPA in the United States, receiving certificate no. 143
on Dec. 21, 1899.
Ross began practicing accounting
around 1889. For several years, she worked for Manning’s Yacht
Agency in New York. Her clients included women’s organizations,
wealthy women and those in fashion and business.
Helen Lord
Lord received her CPA certificate from New York in 1934 and in 1935
joined the American Society of Certified Public Accountants, which
merged with the American Institute of Accountants (later AICPA) the
following year. In 1937, she was a partner with her father in the
New York firm of Lord & Lord and a member of the AIA. She served in
the late 1940s as business manager of The Woman CPA,
published by the American Woman’s Society of Certified Public
Accountants–American Society of Women Accountants. Lord reported the
journal then had a circulation of more than 2,200.
Helen Hifner Fortune
Fortune, one of the first women CPAs in Kentucky, received
certificate no. 174 in 1935 and was admitted to the AIA the
following year. She became a member of an AIA committee in 1942 and
by 1947 was a partner in the Lexington, Ky., firm of Hifner and
Fortune.
Ellen Libby Eastman
Eastman began her career as a clerk in a Maine lumber company,
eventually becoming chief accountant. She studied for the CPA exam
at night and became the first woman CPA in Maine, receiving
certificate no. 37 dated 1918. She was also the first woman to
establish a public accounting practice in New England. Arriving in
New York in 1920, Eastman focused on tax work and audited the
accounts of the American Women’s Hospital in Greece. In 1925, she
was a member of the ASCPA. In 1940, Eastman began working with the
law firm of Hawkins, Delafield & Longfellow in New York.
She was outspoken and eloquent
regarding a woman’s ability to succeed in accounting. In a 1929
article in The Certified Public Accountant, Eastman
recounted her adventures:
One must be willing and able to
endure long and irregular hours, unusual working arrangements and
difficult travel conditions. I have worked eighteen out of the
twenty-four hours of a day with time for but one meal; I have worked
in the office of a bank president with its mahogany furnishings and
oriental rugs and I have worked in the corner of a grain mill with a
grain bin for a desk and a salt box for a chair; I have been
accorded the courtesy of the private car and chauffeur of my client
and have also walked two miles over the top of a mountain to a
lumber camp inaccessible even with a Ford car. I have ridden from
ten to fifteen miles into the country after leaving the railroad,
the only conveyance being a horse and traverse runners—and this in
the severity of a New England winter. I have done it with a
thermometer registering fourteen degrees below zero and a
twenty-five mile per hour gale blowing. I have chilled my feet and
frozen my nose for the sake of success in a job which I love. I have
been snowbound in railroad stations and have been stranded five
miles from a garage with both rear tires of my car flat. I have
ridden into and out of open culvert ditches with the workmen
shouting warnings to me. And always one must keep the appointment;
“how” is not the client’s concern.
Mary E. Murphy
A long-lived pioneer, Murphy (1905–1985) lectured, researched and
taught in the United States and abroad, retiring in 1973. The Iowa
native earned her bachelor of commerce degree with a major in
accounting from the University of Iowa in 1927, then obtained a
master’s in accountancy in 1928 from Columbia University Business
School. In 1938, she received a doctorate in accountancy—only the
second woman in the United States to do so—from the London School of
Economics.
In 1928, Murphy began working in the New York office of Lybrand,
Ross Bros. & Montgomery. Two years later, she took the CPA exam in
Iowa and received certificate no. 67, to become the first woman CPA
in Iowa. She joined the AIA in 1937.
Following her public accounting
stint, she served for three years as the chair of the Department of
Commerce at St. Mary’s College in Notre Dame, Ind. Murphy also was
an assistant professor of economics at Hunter College of the City
University of New York until 1951. In 1952, she received the first
Fulbright professorship of accounting, with assignments in Australia
and New Zealand. In 1957, she was appointed as the first director of
research of the Institute of Chartered Accountants in Australia.
Murphy retired in 1973 from the accounting faculty at California
State University.
She published or collaborated on
more than 20 books and 100 journal articles and many book reviews
and scholarly papers. From 1946 to 1965 she was the most frequently
published author in The Accounting Review. Murphy
investigated the role of accounting in the economy, made the case
for accounting education improvements and paved the way for other
aspiring women accountants to prosper. More than half her
publications explored international accounting, often advocating
standardization. She also emphasized accounting history and
biographies.
Mary E. Lewis
Lewis received California CPA certificate no. 1404 in 1939. She was
admitted to the AIA that year and by 1947 had her own firm in Los
Angeles.
Beth M. Thompson
Thompson worked as the office manager in the Kentucky Automobile
Agency she and her husband, Charles R. Thompson, owned. After
closing the car business, they moved to Florida, where she worked
for an accounting firm. She passed the CPA exam in 1951 with the
encouragement of her husband and opened her own accounting business
in Miami. In 1955, Thompson was one of only 900 women CPAs and the
only female president of a state association chapter—the Dade County
chapter of the Florida Institute of CPAs.
Miriam Donnelly
From 1949 to 1955, Donnelly was head librarian of the AIA library.
(In 1957, the AIA was renamed the AICPA.) She began her career with
the library as assistant librarian and cataloger in 1927, after
working for two governmental libraries and the New York Public
Library.
Accounting History Libraries at the University of Mississippi (Ole Miss) ---
http://www.olemiss.edu/depts/accountancy/libraries.html There are many items pertaining to accounting women in history, especially
in the Accounting Historians Journal
English Abstract:
The Balanced Scorecard is one of the most well-known concepts in the
field of management accounting
and control. Since its introduction in 1992, the Balanced Scorecard
has been the subject of much attention in academic research and in
practice. The concept has diffused to many countries and regions,
including Norway, where the concept is often referred to as "balansert
målstyring". This article presents a case study of the concept's
evolution pattern in the Norwegian context. The study shows that the
Balanced Scorecard concept was very popular around the turn of the
century, but also that the concept's popularity has not fallen as
much as would be predicted by management fashion theory. Instead,
the data show that the concept has become "good practice" in Norway.
It can therefore be argued that the concept has become
institutionalized, and that it has become an "enduring fashion".
Towards the end of the paper these results are discussed in relation
to extant research on Balanced Scorecard and theories of management
fashions.
My father was a repo man. He did not look
the part, which made him all the more effective. He alternately wore
a long mustache or a shaggy beard and owned bell-bottoms in black,
blue, and cherry red. His imitation-silk shirts were festooned with
city maps, cartoon characters, or sailing ships. Dad sang in the
car, at the top of his lungs, mostly obscure show tunes. His white
Dodge Dart had Mach 1 racing stripes that he had lifted from a
souped-up Ford Mustang. The "deadbeats" saw him coming, that's for
sure, but they did not understand his profession until he walked
into their homes and took away their televisions.
Dad worked for Woolco, a company that lent
appliances on an installment plan. When borrowers failed to pay,
ignored the letters and phone calls, my father would come by. He
often posed as a meter reader or someone with a broken-down car. If
he saw a random object lying abandoned in the yard, he would pick it
up and bring it to the door as if he were returning it. He was warm
and funny, charming, but pushy. He did not carry a gun, but he was
fearless under pressure and impervious to verbal abuse. If the door
opened, he was inside; if he was inside, he shortly had his hands on
the appliance; the rest was bookkeeping.
. . .
In each case, lenders had created complex
financial instruments to protect themselves from defaulters like the
ones I watched from the car. And in each case, the very complexity
of the chain of institutions linking borrowers and lenders made it
impossible for those lenders to distinguish good loans from bad.
In 1837, for example, banks in the north of
England discovered that the unpaid "cotton bills of exchange" in
their vaults made them the indirect owners of slaves in Mississippi.
In 2007, shareholders in DBS, the largest bank in Singapore, found
themselves part owners of homes facing foreclosure in California,
Florida, and Nevada. In both cases, efficient foreclosure proved
impossible.
In those crashes in America's past, perhaps
a repo man in a Dodge Dart with a million gallons of gas could have
visited every debtor, edged his way in, and decided who was good for
it. (My dad did accept cash or money orders for Woolco's goods.) But
big lenders have neither the time nor the capacity to act with the
diligence of a repo man. Instead, such lenders (let's agree to call
them all banks) try to unload debts, hide from their own creditors,
go into bankruptcy, and call on state and federal institutions for
relief. Banks have also routinely overestimated the collateral—the
underlying asset—for the loans they hold. When those debts go unpaid
or appear unpayable, banks quickly withdraw lending; the teller's
window slams shut. A crisis on Wall Street becomes a crisis on Main
Street. Money is tight. Loans are impossible: Crash.
***
Scholarship on these financial downturns
has its own long and checkered past.
From the 1880s to the 1950s, scholars told
the history of the nation's economic downturns as the history of
banks. Such an approach was not entirely wrong, but it tended to
focus on big personalities like J.P. Morgan or New York
institutions; it tended to ignore the farmers, artisans,
slaveholders, and shopkeepers whose borrowing had fed the booms and
busts.
Then, in the 1960s and 1970s, the so-called
new economic historians (or cliometricians) came along with a
different story. Using state and federal data, they tried to build
mathematical models of the nation's financial health. Moving beyond
banks, they emphasized what they termed the "real economy," by which
they meant measurable indices of growth and profit. Taking the
nation's health like a simple temperature reading, they used gross
domestic product, gross income, or collective return on investment.
Of course, none of those figures had been measured directly before
the 1930s, and so the prognoses tended to vary widely.
Such economic models of financial health,
however scientific they looked, tended to be abstract
representations of an economy that was, in fact, more complex and
more interconnected than they pictured. The models, for example,
often assumed that old banks were like modern banks, sharing common
accounting principles, or that because banks first issued credit
cards in the 1960s, they offered no consumer credit before then.
Drilling into historical documents for seemingly relevant numbers,
then plugging those numbers into a model of a world they understood
rather than the economy they sought to describe, the cliometricians
often produced ahistorical work. Hence, one economic historian
assumed that American barrels of flour sent to New Orleans were
consumed in the South, though most were bound for re-export to the
Caribbean. Another calculated that railroads played little role in
America's economic booms by modeling a scenario in which canals
could have (somehow) crossed the arid plains into the Sierra Nevada
mountains.
Bear in mind, that same kind of
intellectual hubris about models of economic behavior had awful
effects in the recent past. Around 2000, Barclays Bank borrowed a
simple diffusion model from physics (called the "Gaussian copula
function") to suggest that foreclosures would have a relatively
small effect on nearby property values. Economists tested it with
two years of foreclosure and price data and agreed. Billions of
investment in real-estate followed, often in indirect markets like
real-estate derivatives and collateralized debt obligations. By 2008
the model proved shockingly inaccurate.
If some historians focused on the
temperature of the "real economy," economists were becoming obsessed
with the money supply as the single factor explaining most American
panics. Again, a certain kind of blindness to the history of debt
and deadbeats ensued. The most important book here was Milton
Friedman and Anna Jacobson Schwartz's seminal A Monetary History of
the United States, 1867-1960 (1963). It urged economists to steer
away from stories of speculation spun out by Keynesians like John
Kenneth Galbraith.
How, according to Friedman and Schwartz,
can we separate speculation and investment? All loans are risky. The
riskier they are, the higher the return. Some investments will fail.
Markets need to clear, and those buyers who come along to sweep up
bargains are not ruthless profiteers but simply maximizers who make
markets work. Thus, the pair steered economists away from problems
of risk and toward the problems of state intervention. They were the
prophets of financial deregulation.
Their story about past financial panics had
the advantage of suggesting simple solutions: Use the Federal
Reserve to inflate or deflate the currency. For them, financial
crises were mostly monetary. Thus, the 1929 downturn started with a
financial shock and then was prolonged by an overly tight monetary
policy. After A Monetary History became gospel, economics textbooks
dropped their numerous chapters on financial panics because the
policy solution became so clear; economists trained after 1965 know
little about financial downturns before the Great Depression.
Yet a tripling of the money supply has
still not fully pulled the United States and the rest of the world
out of our current financial crisis—suggesting that our problems,
and all the previous ones, were not just monetary. My dad would have
pointed out that economists have misunderstood the problem. Crises
are mostly about productive assets—the promises in his trunk.
Social historians (and I count myself among
them) tell a very different story about financial panics, but we
have our own blind spots. Since the late 1960s, we have often
discussed the American economy as if farmers were coherent families
of self-sufficient yeomen surprised by the market economy. That
story of a sudden revolution misses the early and intimate
relationship between Americans and credit. It overlooks how American
stores provided consumer credit to farmers, plantations owners, and
renters who settled the West.
Thus, American social historians have used
the term "market revolution" to describe the period after the 1819
panic. Accordingly market forces rushed in as repo men like my dad
became vanguards of a new capitalist order. The financial jeremiads
of Jacksonian Democrats of the 1820s and 30s against bankers and
paper money became the natural outgrowth of frontier farmers' anger
at a capitalism they had never seen before. But the store system of
Andrew Jackson's day borrowed practices from the colonial store
system that goes back to the 17th century, if not earlier. It was
how the fur-trading and East and West India companies prospered.
John Jacob Astor and Andrew Jackson were cut from the same cloth.
They made their fortunes from their stores, and their store system
made settlement possible.
Part of the reason we overlook the
importance of credit in American history is our continued attachment
to Marx's divide between precapitalist and capitalist forms of
agriculture. That misses the relationship between farming and credit
for most of the people who settled America. The more I study panics,
the more I am persuaded that the pioneer American institution of the
18th and early 19th centuries was not the homestead or the trapper's
shack but the store, an institution that sold foreign goods to
farmers on credit, taking payment in easily movable settler products
like furs, potash, barrel hoops, and butter.
Rather than imagining some golden age of
subsistence, scholars in the Marxist tradition should look more
closely at anticapitalist movements in the wake of panics. I include
here not just the utopian and religious communities like Quakers,
Shakers, and Oneidans but also the early Mormons, the Grangers, and
the Populists. Those people understood what it meant for banks, and
then railroads, to extend credit through stores. Often regarding
capital as a collective inheritance, they built their own
associations to replace such institutions of credit (and the
railroad was an institution of credit) with locally managed
cooperatives that distributed agricultural benefits in a way that
served the broader community. The temple, the elevator, and the
cooperative were attempts to break the chain of debt without
demonizing capital.
From the perspective of business history,
Joseph A. Schumpeter argued that business-cycle downturns came from
periods of "creative destruction" in which new technologies
undermined old ones. Outdated technologies, with millions invested
in them, became instantly obsolete, leading to financial failures
that cascaded to other industries. While Schumpeter, who died in
1950, once persuaded me, I think there is a mechanistic fallacy in
the argument. Railroads, for example, have taken the blame for the
1857, 1873 and 1893 downturns. While there may be something there,
the whole account seems reductive and technologically determinist.
For example, canals, the Bessemer process, fractional distillation
of oil, and washing machines are all revolutionary technologies that
flourished during the American panics, not before them. They did
sweep away older technologies, but rather than causing panics those
technologies benefited by the uncertainty that panic created.
In a very different camp, neo-Marxists like
Giovanni Arrighi and David Harvey betray a similar kind of reductive
history, a latter-day Schumpeterianism. Their work posits a "spatial
fix," a center of capitalism that then organizes and draws tribute
from the rest of the world. For the late Arrighi, it was a kind of
pump that sucked assets from elsewhere as states were forming
throughout the sweep of centuries. For Harvey it is an investment in
a capital city (Amsterdam, London, New York) and a new communication
technology (telegraph, telephone, the Internet) that drew higher
profits from everywhere else. Dutch and British hegemony became
American hegemony after World War II. That suggests that these
scholars have not really considered the tremendous influence of the
U.S. Federal Reserve in reorienting international trade between 1913
and the 1920s. Their story seems more or less political to me:
American empire comes when Americans claim victory in World War II.
The economic material seems to be used in the service of a story
about the rise and decline of empires.
If we follow the money, the American empire
emerged during World War I, when the international flow of debt
changed drastically. For Arrighi and Harvey, the International
Monetary Fund and the World Bank are the pathbreakers of financial
empire. But it is worth remembering that those institutions were
explicitly designed to restrain the dirty tricks of financial
empires of the 1920s and 1930s: No more American banks using gunboat
diplomacy in Peru; no more Germans sending tanks into Poland to
collect unpaid debts.
***
As a historian, I have learned the most
about financial disasters from long-dead historians whose work
blended primary, secondary, and quantitative material. Rosa
Luxemburg, William Graham Sumner, Frank W. Taussig, and Charles
Kindleberger would never have agreed about anything. Luxemburg, a
renegade Marxist who read in five languages, described how the
dangerous mix of a hierarchical production process with the anarchy
of international trade could lead manufacturers to block free trade
and embrace higher prices for their raw materials in the wake of a
panic. Sumner, a laissez-faire Social Darwinist who argued that
income inequality benefited society, carefully explained how drastic
economic changes could follow from tiny changes in international
trade deals. Put in a room together, each would have retreated to a
corner to begin throwing furniture. But they and the others were
storytellers who used a mixture of sources. Telling a story by
looking through the trunk of assets and watching the damage
afterward makes more sense to me than simple models of financial
contagion, money supply, technological watersheds, or global fixes.
My father died before I started writing
about financial panics, but my thoughts have grown out of our
30-year-long argument about financial downturns. Not surprisingly,
he disliked "deadbeats," seeing them as the people whose false
promises weakened our country. He probably had a point, and no doubt
the executives of Woolco would agree. But I find much in them to
admire, for defaulters are often dreamers. Viewing America's
financial panics through the lens of numerous unfulfilled and
forgotten debts that even the oldest banker cannot possibly remember
can afford a perspective my dad would have appreciated: with my view
from the Dodge Dart, the minute he rang the doorbell, when both
debtor and creditor prepared their stories.
Scott Reynolds Nelson is a professor of history at the College
of William and Mary. His book A Nation of Deadbeats: An Uncommon
History of America's Financial Disasters has just been published by
Alfred A. Knopf.
The booked
National Debt in August 2012 went over $16 trillion ---
U.S. National Debt Clock ---
http://www.usdebtclock.org/
Also see
http://www.brillig.com/debt_clock/
The unbooked entitlements have a present value between $80 and $100
trillion. But who's counting?
In 1837, the Massachusetts Board of
Education devoted part of its first annual report to praising a recent
classroom innovation called the blackboard. This “invaluable and
indispensible” innovation...
On March 4, 2013 the Financial Education Daily Linked this Quotation to
the Harvard Gazette, but I could not find the source of the
quote.
On a recent Wednesday morning, 90 high
achievers from around the world prepared to get down to cases.
Their professor buzzed through the
classroom like a worker bee. Armed with large, multicolored pieces
of chalk, he organized his notes, copied pastel-coded facts and
figures on the blackboard, and set up a film screen. Soon his
students would be equally hard at work, but in a strictly cerebral
way.
This day the instructor was inclined to be
kind, giving the young man who would open the class discussion an
early heads-up, allowing some time to prepare. Often in this
setting, classes start with the heart-pounding “cold call,” where a
student is put to the test without warning. The deceptively simple
“start us off” translates into “as quickly and coherently and
convincingly as possible, tell us everything known about this
situation and give us your best insight.”
As well as being busy and congenial, Jan
Rivkin, a professor in the strategy unit at Harvard Business School
(HBS), was clearly engaging, his enthusiasm infectious, his sense of
humor unmistakable.
He started with a brief refresher video,
one he’d secured from a colleague on holiday in the Bahamas. The
class watched their vacationing instructor drop to his knees on the
beach as the tape rolled. With a straight face, he reviewed the
finer points of his recent technology-operations-management
discussion with the class, drawing a series of overlapping diagrams
in the sand. When done, he promptly jumped into the ocean.
The crowd loved it, but it was the last
light moment. For the next hour-and-a-half the class examined
whether the Spanish clothing company Zara should update its
retailers’ IT infrastructure.
During the ensuing discussion and debate,
Jan Rivkin, deftly prodded, questioned, and encouraged his deeply
engaged class.
It was just another day at HBS — and one of
its standard case-classes. The case method is the primary mode of
teaching and learning at the institution, which celebrates its 100th
anniversary this year. In honor of its centennial, the School will
host a series of events on Tuesday (April 8) that will include a
number of panels, a birthday celebration, and a case discussion on
the future of HBS.
While it didn’t begin with the School’s
inception, the revolutionary instructional approach followed shortly
thereafter. But it wasn’t an entirely novel concept. The model was
actually borrowed from the Harvard Law School and Christopher
Columbus Langdell HLS Class of 1853 and dean of the Law School in
1870, who pioneered the technique for the examination of Harvard Law
School cases.
Later, at HBS, it was Dean Wallace P.
Donham, a Law School grad familiar with the technique, who pushed
for the full inclusion of the case method at the Business School,
where it was altered and adapted to a business perspective. Since
1921, it has been a core part of the curriculum.
The method of teaching differs greatly from
the traditional lecture format, in which students take notes as the
professor speaks. Instead, students are engaged in a dynamic
back-and-forth with one another and their professor, discussing a
topic typically pulled from a relevant, real-life business scenario
and featuring a dilemma or challenge. Sometimes, once the class has
examined and discussed the case, the actual CEO or president of the
company in question will appear in person to explain how the
situation ultimately unfolded.
The case topics are wide-ranging and
include everything from the world of finance to semiconductors to
sweeteners to satellite television.
Some cases offer historic reflections,
employing the lessons tragedy imparts. Cases have been written, for
example, about the space shuttle Columbia’s final mission in 2003
and the management decisions made prior to its fatal re-entry into
the Earth’s atmosphere, Abraham Lincoln’s leadership during the
Civil War, and the management of national intelligence prior to the
terrorist attacks of Sept. 11, 2001.
Students are given an overview of the
case’s material to read ahead of time. The packets, roughly 20 to 25
pages long, include a list of facts, an outline of the challenge at
hand, and a history of the company or situation in text, charts, and
graphs, all compiled into a neat brief.
More than 80 percent of HBS classes are
built on the case method. Each week students prepare approximately
14 cases both alone and with the help of study groups. But in the
end they are on their own. In class, it is up to the individual to
articulate his or her argument and persuade others of its merits. A
hefty 50 percent of a student’s grade is determined by class
participation, so taking part in the conversation is crucial.
Students raise their hands energetically, trying to get quality “air
time,” as they call it. Two important unwritten rules, self-enforced
by the students themselves: Never speak unless you have something
valuable to contribute, and keep it brief.
The teaching technique most effectively
prepares the CEOs of tomorrow for what they will inevitably face in
the real world, say the professors who employ it.
“Getting a piece of material, having to
sift through it, figure out what’s important, … come to a point of
view, [then] come to class both prepared to argue that point of view
… [and] prepared to listen and be open to others’ viewpoints — those
are the skills that the business world demands, and via the case
method they get to practice those in the classroom,” said Michael J.
Roberts, senior lecturer of business administration and executive
director of the Arthur Rock Center for Entrepreneurship.
Continued in article
March 4, 2013 reply from Steve Zeff
Bob,
Thanks for this. I presume you save seen my article, "The
Contribution of the Harvard Business School to Management Control,
1908 - 1980," in the special issue 2008 of JMAR. Bob Kaplan invited
me to do the research and write the article for the April 2008
history symposium at HBS, which kicked off its 100th anniversary
celebration. I attach the article.
People can easily list problems they believe are
associated with virtual teams: They haven't met and don't really know other
team members; it is hard to monitor the work of others; and dispersions can
lead to big inefficiencies and degraded performance.
In this HBR webinar, Keith Ferrazzi, a foremost
expert on professional relationship development and author of Never Eat
Alone and Who's Got Your Back?, shares a strategy for managing virtual teams
that can change how your company operates - and how you manage for years to
come.
Continued in article
Jensen Comment
This theory should be tested in a variety of ways with respect to case analysis
by teams. I've always argued that case learning is best in live classrooms, but
I'm beginning to doubt myself on this one. Even Harvard and Darden should
experiment with onsite versus online team assignments. One advantage of online
team assignments is grading if instructors carefully track team member
contributions, possibly by monitoring online performance as silent or active
(avatar) trackers.
I have developed a time-line of accounting
historical dates and events from
1812 to 2012 summarizing materials from various sources. It could be
used as
the basis for a short or a long course on accounting history, or as
a
reference source for accounting events. I suspect most accounting
students
get very little exposure to accounting history. This resource is
offered to
help alleviate that problem.
Thanks for the alert. It is a nice list, but he
puts May's Financial Accounting: A Distillation of Experience in 1953
instead of 1943.
Cheers.
Steve.
Origins of Statistical Sampling in Financial Auditing
January 31, 2013 message from Bob Jensen
A precursor of risk-based auditing was statistical sampling in
auditing.
Is there an earlier reference than the following?
Stringer. K.W.. 1963, "Practical aspects of statistical sampling
in auditing. Proceedings of the Business and Economic Statistics
Section. American Statistical Association. 405-411.
Ken Stringer was a well-known partner in Haskins & Sells in those
days. Was H&S the first auditing firm to innovate widespread
applications of statistical sampling in auditing?
Bob Jensen
February 1, 2013 reply from Steve Zeff
A firm that worked closely with H&S on
statistical sampling in the 1970s and 1980s was Clarkson, Gordon &
Co., the premier public accounting firm in Canada, based in Toronto.
Their partners Rod Anderson and Don Leslie were both significant
figures in this work. Don was very active in the AAA's Auditing
Section. Both are still living but retired. Don's latest address is:
donald.a.leslie@gmail.com He can tell you a lot about academic work
in statistical sampling that was influential in shaping practice.
Steve.
January 31, 2013 reply from Beryl Simonson
I still have “Handbook of Sampling for Auditing and Accounting” by
Herbert Arkin, Professor of Business Statistics, City College of New
York, copyright 1963 in my personal office library published by
McGraw-Hill.
Carman, Lewis A. 1933. The Efficiency of
Tests. The American Accountant, December, 360-66.
"This paper proposes application of a simple probability model for
computing the sampling risk in auditing and is the first publication
of such an attempt in accounting."
I agree that Stringer was the originator of
Probability-Proportional-to-Size Sampling, and some other
innovations. Of course he wasn’t a professor (the subject of our
correspondence this morning). Trueblood also did some statistical
work, including the first book. See the paragraphs below, which are
from a book I am currently working on dealing with the history of
Deloitte.
Dale
Ken Stringer, Robert Trueblood, and Statistical Sampling
During the late 1940s and early 1950s, the use of
statistical sampling began to occur in fields other than
accounting. The technique was used by numerous manufacturers in
their quality testing and inspection procedures, in many instances
dating back to the World War II years. Similarly, the technique was
used in engineering design and military logistics. More broadly,
even the decision to inoculate millions of American children with
the Jonus Salk polio vaccine in 1955 was based upon conclusions
reached in a statistical sampling process. As a result, the
American Institute moved to investigate the application of
statistical sampling in accounting and auditing. The AICPA was
concerned with the perceived need for a more objective approach to
determining sample sizes during audit procedures. Before
statistical sampling, the number of items to be tested was based on
the judgment of the individual auditor on a subjective basis—a
process that would leave the audit firm open to second guessing when
an audit failure occurred. Without statistical principles, any
population sample size was arbitrary. Thus, a non-statistical
sample (typically called a “judgment” sample) might be insufficient,
or excessive; no one could determine which.
Both Touche Ross and H&S were early experimenters with
statistical sampling techniques, as was Price Waterhouse & Company.
According to Oscar Gellein, none of the other Big Eight firms had
any early involvement in the subject. At Touche, it was Robert M.
Trueblood who was the initial pioneer. When the AICPA named its
first Committee on Statistical Sampling in 1956, it was Trueblood
who was selected as the chairman, primarily because Trueblood was
also the principal author on what is likely the first book [Trueblood
and Cyert, 1957] written by an accountant on the use of statistical
sampling in accounting and auditing. One study stated that
Trueblood’s work at what was then Touche, Niven, Bailey & Smart
constituted the earliest experiment with applications of statistical
sampling by any major accounting firm [Tucker and Lordi, 1997, p.
96]. Trueblood pointed out in his book one of the main reasons that
the AICPA was interested in the subject of statistical sampling—the
legal liability issue.
Should auditors’ present methods of
test-checking prove inadequate in a particular case, would it not be
difficult for the profession to justify its failure to use a
technique found to be of such material help in other professional
fields? Is it possible to argue, at the present time, that the
profession has adequately tested the practicability of scientific
sampling and mathematical probability? What would happen if in a
court proceeding involving accountants' liability, a competent
statistician were to demonstrate mathematically that the auditor's
sampling procedures or conclusions were not statistically
justifiable? [Trueblood and Cyert, 1957, p.61].
Thus, the profession needed a statistical sampling plan that would
not only be effective and objective, but would be defensible in a
court of law. The firms of Touche and H&S would come together, via
an AICPA committee, to bring the profession out of the statistical
dark ages. As was pointed out in a study on the subject:
Gellein's memo reveals that large CPA firms
shared information regarding their individual in-house
experimentation with statistical sampling as well as their
progress-to-date. This suggests that a spirit of collegial
cooperation existed among the firms rather than one of
competition-related secrecy [Tucker and Lordi, 1997, p. 110].
The AICPA Committee on Statistical Sampling (CSS) was an
advisor to and reported to the Committee on Auditing Standards.
Trueblood was designated as the chairman because of his recently
authored book. Oscar Gellein of H&S was also a member of the CSS.
Gellein was also serving simultaneously on the New York State
Society of CPAs’ statistical sampling committee which was formed at
about the same time as the AICPA committee. Progress was slow in
coming. Trueblood described the committee’s first two years of
activities in the following words:
Mr. President, members of the Council. The
Committee on Statistical Sampling has held five two-day meetings
since it was first organized in October or November, 1956. It is,
of course, regarded as a satellite committee to the Committee on
Auditing Procedures and our purpose and our function is
investigative and exploratory in a rather new area. For this
reason, during the first year, our meetings were almost totally of a
self-educational nature. They were devoted to exploring the subject
of statistical sampling both from the accountant's point of view and
from the statistician's point of view. They were also devoted to
studying problems involved in the possible or ultimate utilization
of statistical sampling techniques as an auditing tool.
During our second year we have gone into a
slightly more productive type of program. Our production is modest
at best. First, we have developed a glossary of statistical terms
which, in a sense, is a layman's dictionary of such terms and a
bibliography of literature on the general subject of statistical
sampling. This glossary and bibliography is now in the process of
production and will shortly be available to members on request
[Trueblood, 1958; as quoted in Tucker and Lordi, 1997, p. 102].
Much of the early work of the CSS focused on the legal aspects of
statistical sampling. The field of statistical sampling was still
in its infancy and much of theoretical underpinnings had to be
learned by the committee members. In a report to the leadership of
H&S, Oscar Gellein summarized the first year of the CSS as a time of
“attempting to catch up with developments that had taken place in
the application of statistical sampling to accounting. The
Committee perceived its mission to be that of keeping abreast of
developments in the field and keeping the profession informed”
[Tucker and Lordi, 1997, p. 108].
At H&S, Kenneth W. Stringer had long been
dissatisfied with the subjective nature of judgment sampling.
Throughout his career, he had observed that in similar audit
situations, different auditors selected widely different sample
sizes. As a result, he was to develop one of the most frequently
used methods—probability-proportional-to-size (PPS) sampling.
In 1959, he conducted a case study among H&S senior auditors who
were asked to select sample sizes in four different situations. For
example, the auditors were told to select a sample size from a
population of 2,000 accounts receivables when internal control was
considered good. The resulting samples sizes were somewhat evenly
distributed from 50 to 600. When the question was revised to say
that internal control was “bad, but previous audits had not revealed
material errors,” the resulting sampling sizes varied from 100 to
1,400 accounts. Another question asked how many inventory items,
out of a population of 5,000 line items, should be selected for a
test of inventory prices. Responses were fairly evenly distributed
between 25 and 1,250 items. The fourth question dealt with how many
vouchers (out of 1,000) should be examined to provide suitable
evidence of adequate internal control. Nine respondents would have
been satisfied with either 25 or 50 vouchers in the sample, while
ten auditors wanted to examine all 1,000 vouchers [Tucker, 1994, p.
254]. Such randomness of responses created havoc in the audit
budgeting process; if 25 vouchers could be examined in one hour, the
budgeted time would vary from one hour to one week, depending upon
which in-charge auditor was assigned to the engagement. A person
who interviewed Stringer about his case study noted the following
observation.
The results revealed a very wide distribution
of sample sizes selected by these senior auditors in each of the
four cases. When the senior partners of his firm were presented
with the results of his experiment, Stringer stated that they were
“shocked and dismayed at the disparity that the survey showed”
[Tucker and Lordi, 1997, p. 99].
Stringer had been promoting the PPS plan within the firm and his
experiment was apparently sufficient to get the firm to adopt the
PPS statistical sampling plan, although perhaps the firm would have
been willing to accept any movement toward uniformity in selecting
samples sizes.
I can not say that the survey results were the
deciding factor in the firm’s eventual adoption of the Plan, but I
think it is fair to say that the results had a significant influence
on the firm’s views concerning the existing disparity in the extent
of testing and the need to improve the situation. However, there
are two important points I always address in any public discussion
of the survey results. First, given the lack of professional
guidelines in this area, the results were not surprising. Second,
the auditors surveyed were all employed and trained by the same
firm. If the survey had been distributed to a group of auditors who
had been selected randomly from throughout the profession, it is
reasonable to assume that the disparity would have been even greater
[Tucker, 1994, p. 248].
Stringer was not the sole sampling pioneer at H&S; Oscar
Gellein, to whom Stringer reported, was a supporter of both
statistical sampling and Stringer’s ideas. In fact, it was Gellein
who was the second chairman of the AICPA’s Committee on Statistical
Sampling, following Trueblood. Gellein served on the CSS from 1956
through 1961—a total of five years. Stringer then chaired the
committee from 1962 through 1965. Gellein basically allowed
Stringer to spend the majority of his time on statistical sampling,
and saw to it that others in the firm did not bother him. The
latter statement is relevant because there were some in the
accounting profession who were opposed to the use of statistical
sampling. Many argued that statistical sampling, although producing
a better result, was too time consuming to apply in practice and too
complex to teach to staff auditors. Thus, it was not considered by
everyone to be an economically viable method.
Kenneth Stringer and Statistical Sampling
Stringer was born in the small town of Birmingham,
Kentucky (population 300), on February 23, 1918, and graduated from
what is now Western Kentucky University in 1938 (the institution was
known as the Bowling Green College of Commerce during Stringer’s
time there; it later merged with Western Kentucky). He then joined
the accounting staff of the Kentucky Public Service Commission.
When H&S opened an office in Louisville in 1939, Stringer was one of
the first staff members. When World War II started, he resigned
from the firm to spend two years as a civilian employee of the
Ordnance Department accounting staff. He then joined the military
and spent two more years, in uniform, with the Ordnance Department
in Cincinnati. Upon leaving the Army, Stringer worked for six years
for a local firm in Danville, KY. Chafed at the lack of opportunity
to grow professionally in a small firm, Stringer decided to rejoin
H&S in 1952 in the Cincinnati office. He reportedly had to take a
pay cut when he moved from the local firm in Kentucky to the
national firm. He then transferred to the New York Executive Office
in 1957 where he was to work with Weldon Powell, the senior
technical manager in the firm, on special assignments. One such
project was to conduct a review of the firm’s approach to the audit
process. One of his first concerns was the methodology used in
evaluating a client’s system of internal control, while his second
concern was the manner in which items were selected for audit once a
determination had been made of the quality of the internal control
system.
Stringer became a partner in 1959. Eventually, in 1973,
he became partner in charge of Accounting and Auditing Services
[“People…, 1977, p. 32]. Thus, by 1973, it was Stringer’s
responsibility to establish the firm’s position on issues being
considered by the FASB, AICPA committees, and the SEC. He was also
responsible for the firm’s internal policies and procedures and for
resolving questions on accounting applications from practice
offices. In the mid 1970s, Stringer represented the firm on the
AICPA’s Commission on Auditor’s Responsibilities, also known as the
Cohen Commission. He also served five years on the AICPA Committee
on Auditing Procedures.
In the 1950s, Stringer was a member and chairman of the
AICPA’s Statistical Sampling Committee. Shortly after rejoining the
firm in 1952, he found that his interests lay in the practical
application of advanced mathematics to accounting and auditing
techniques. He recognized that statistical sampling—establishing
the reliability of inferences or conclusions from a population by
taking selected samples—was a means of conducting audits more
efficiently. Auditors had been using sampling since World War II,
but these early sampling techniques were based on the subjective
opinion (judgment) of the person selecting the sample. Stringer
began an intensive investigation of statistical sampling in 1958 and
its applicability to accounting and auditing. His first conclusion
was that auditors could not use the statistical sampling methods
that had been used in other fields; a new system of statistical
sampling had to be developed especially for auditing purposes.
Stringer, working with an assistant in the person of Frederick E.
Stephen, a statistics professor at Princeton University, developed
over a period of two years what became known as the “H&S Audit
Sampling Plan,” otherwise known as a probability-proportional-to-size
method. Firm managing partner John Queenan then appointed a special
task force, which included Ralph Johns, Oscar Gellein, and Malcolm
Devore, to study the Plan and conduct field tests. After two years
of study, the task force recommended the adoption of the Plan for
firm-wide use in 1962. Stringer asked future managing partner
Charles Steel and Jim Kusko to assist during the introduction phase
of the Audit Sampling Plan to help local offices implement the
program [“People…, 1977, p. 35]. By 1963, the H&S Audit Sampling
Plan was fully implemented by the firm and was being shared with
accounting students nationwide by speakers from H&S practice
offices.
Stringer returned to the area of statistics in the mid
1960s when he became interested in the possibility of using
regression analysis in audit work. The regression analysis project
eventually led to a product called Statistical Technique for
Analytical Reviews, or STAR. With the assistance of Maurice Newman,
Jim Kirtland, Jim Kusko, and Denny Fox, Stringer developed a
computer program that used regression analysis to improve the audit
selection process. The idea of STAR was that it could be used to
conduct audits of exceptional areas. Stringer explained:
One of the key questions facing any auditor is
determining just what is unusual, which prior to STAR had been done
largely on a subjective basis. What we tried to do was establish an
audit interface for the technique of regression analysis. This lets
us establish various relationships— such as sales of a client versus
expenses, or sales compared with the overall economy—to see if these
relationships appear reasonable. Then the results can be compared
with the client's latest figures, and unusual fluctuations can be
investigated. Extensive use of the STAR program has improved our
review techniques and enables our people to reduce the amount of
detail testing necessary on most audits while maintaining the
desired degree of assurance [“People…, 1977, p. 36].
Stringer was the inaugural recipient in 1981 of the American
Accounting Association Auditing Section’s Distinguished Service in
Auditing Award for his pioneering efforts in auditing research. In
many respects, the existence of a person like Stringer at a firm
indicates the willingness of the firm to improve itself. Unlike
most partners, Stringer was not a revenue center; he was a cost
center. His job was to look at the overall auditing process and
come up with ways to make the audit a better product.
As mentioned previously, Stringer was aided by several
other firm partners, including Maurice E. Newman. Newman became a
partner in Chicago in 1957 and moved to the Executive Office in
1964, which was about the same time that he began working on a Ph.D.
in accounting at New York University. He graduated from NYU in 1972
following the completion of his doctoral dissertation entitled
“Statistical Estimation of Computer-Based Inventories.” Thus, he
was able to combine his love of statistics and his job with a
doctoral degree program.
Besides working with Stringer on the development of statistical
sampling programs for auditing, Newman functioned as a consulting
statistician to several of the firm’s larger clients and also as an
in-house theoretician to staff auditors [“The Graduate,” 1972, p.
27]. Newman was a prolific author over the years, mostly articles
on aspects of management advisory services. His first publication
in the firm’s Selected Papers volumes came in 1956 when he
had an article on the uses of computer-generated reports. The next
year, he had two different articles on “machine accounting.” Newman
retired from H&S in 1977 and joined the faculty of the School of
Accountancy at the University of Alabama in Tuscaloosa.
I am reading an
interesting book titled Life Inc., How Corporatism Conquered the
World, and How We Can Take It Back, by Douglas Ruskhoff (ISBN-13: 978-0812978506). Below
is the URL link to the Amazon.com web page.
Rick Lillie, MAS, Ed.D., CPA
Assistant Professor of Accounting
Coordinator, Master of Science in Accountancy
CSUSB, CBPA, Department of Accounting & Finance
5500 University Parkway, JB-547
San Bernardino, CA. 92407-2397
The years 1770-72 were also infamous for
another reason. The East India Company which had earlier used the grant
given to it by the Mughal emperor Akbar to the city of Calcutta had
established its control over Bengal. Its disastrous tax and other
policies, compounded by drought, led to the death by starvation of 10
million people.
Warren Hastings, who was the Governor General,
was later impeached (for corruption) and later acquitted by the British
Parliament. He was later made a Privy Councillor, a rather strange
honour for one who stood like a Greek hero, counting the British tax
revenues (which multiplied), while 10 million human beings died of
starvation.
Venkat's lament about Alexander Fordyce's
absconding for half a million pounds debt is a petty matter relative to
the death of 10 million people caused by Hastings and his cohorts at the
same British East India Company.
Sen asks a profound rhetorical question why
there have been no famines in India since the British left. Democracy
does not permit it.
Edmund Burke's speech in the British Parliament
in the impeachment proceedings is, in my opinion, one of the finest
pieces of writing in the English language. Here is a snippet:
_________________________________________________
My Lords, the East India Company have not
arbitrary power to give him; the King has no arbitrary power to give
him; your Lordships have not; nor the Commons, nor the whole
Legislature. We have no arbitrary power to give, because arbitrary power
is a thing which neither any man can hold nor any man can give. No man
can lawfully govern himself according to his own will; much less can one
person be governed by the will of another. We are all born in subjection
-- all born equally, high and low, governors and governed, in subjection
to one great, immutable, pre-existent law, prior to all our devices and
prior to all our contrivances, paramount to all our ideas and all our
sensations, antecedent to our very existence, by which we are knit and
connected in the eternal frame of the universe, out of which we cannot
stir.
This great law does not arise from our
conventions or compacts; on the contrary, it gives to our conventions
and compacts all the force and sanction they can have. It does not arise
from our vain institutions. Every good gift is of God; all power is of
God; and He who has given the power, and from Whom alone it originates,
will never suffer the exercise of it to be practised upon any less solid
foundation than the power itself. If, then, all dominion of man over man
is the effect of the Divine disposition, it is bound by the eternal laws
of Him that give it, with which no human authority can dispense neither
he that exercises it, nor even those who are subject to it; and if they
were mad enough to make an express compact that should release their
magistrate from his duty, and should declare their lives, liberties, and
properties dependent upon, not rules and laws, but his mere capricious
will, that covenant would be void. The acceptor of it has not his
authority increased, but he has his crime doubled. Therefore can it be
imagined, if this be true, that He will suffer this great gift of
government, the great, the best, that was ever given by God to mankind,
to be the plaything and the sport of the feeble will of a man, who, by a
blasphemous, absurd, and petulant usurpation, would place his own
feeble, comtemptible, ridiculous will in the place of the Divine wisdom
and justice?
The title of conquest makes no difference at
all. No conquest can give such a right; for conquest, that is force,
cannot convert its own injustice into a just title by which it may rule
others at its pleasure. By conquest, which is a more immediate
designation of the hand of God, the conqueror succeeds to all the
painful duties and subordination to the power of God which belonged to
the sovereign whom he has displaced, just as if he had come in by the
positive law of some descent or some election. To this at least he is
strictly bound: he ought to govern them as he governs his own subjects.
But every wise conqueror has gone much further than he was bound to go.
It has been his ambition and his policy to reconcile the vanquished to
his fortune, to show that they had gained by the change, to convert
their momentary suffering into a long benefit, and to draw from the
humiliation of his enemies an accession to his own glory. This has been
so constant a practice, that it is to repeat the histories of all
politic conquerors in all nations and in all times; and I will not so
much distrust your Lordships' enlightened and discriminating studies and
correct memories as to allude to any one of them. I will only show you
that the Court of Directors, under whom he served, has adopted that idea
that they constantly inculcated it to him, and to all the servants that
they run a parallel between their own and the native government, and,
supposing it to be very evil, did not hold it up as an example to be
followed, but as an abuse to be corrected that they never made it a
question, whether India is to be improved by English law and liberty, or
English law and liberty vitiated by Indian corruption. ... ...
How profound and timely, in the context of all
recent corruption scandals.
Jagdish -- Jagdish S. Gangolly, (j.gangolly@albany.edu)
Vincent O'Leary Professor Emeritus of Informatics, Director, PhD Program
in Information Science, Department of Informatics, College of Computing
& Information 7A Harriman Campus Road, Suite 220 State University of New
York at Albany, Albany, NY 12206. Phone: (518) 956-8251, Fax: (518)
956-8247 URL: http://www.albany.edu/acc/gangolly
Which has many historical documents related to the SEC. The site just
added a 10 year retrospective interview with both Sarbanes and Oxley
conducted last week (under programs). For those interested, we are doing
a presentation on the site at the AAA on Monday at 4:00pm (session 3.05)
Cheers,
Jim McKinney, Ph.D., C.P.A.
Accounting and Information Assurance
Robert H. Smith School of Business
4333G Van Munching Hall
University of Maryland
College Park, MD 20742-1815
http://www.rhsmith.umd.edu
September 29, 2011 message from Barbara
Scofield
One of the 2011
MacArthur Fellows is a historian, one of whose specialties is the
history of accounting:
Barbara W. Scofield,
PhD, CPA
Chair of Graduate Business Studies
Professor of Accounting
The University of Texas of the Permian Basin
4901 E. University Dr.
Odessa, TX 79762
Jacob Soll is a
historian whose meticulously researched studies of early modern Europe
are shedding new light on the origins of the modern state. Drawing on
intellectual, political, cultural, and institutional history, Soll
explores the development of political thought and criticism in relation
to governance from the sixteenth to the eighteenth centuries in Western
Europe. Soll's first book, Publishing "The Prince" (2005),
examines the role of commentaries, editions, and translations of
Machiavelli produced by the previously little-studied figure Amelot de
La Houssaye (1634-1706), who became the most influential writer on
secular politics during the reign of Louis XIV. Grounded in extensive
analysis of archival, manuscript, and early printed sources, Soll shows
how Amelot and his publishers arranged prefaces, columns, and footnotes
in a manner that transformed established works, imbuing books previously
considered as supporting royal power with an alternate, even
revolutionary, political message. In The Information Master
(2009), he investigates the formation of a state-information gathering
and classifying network by Louis XIV's chief minister, Jean-Baptiste
Colbert (1619-1683), revealing that Colbert's passion for information
was both a means of control and a medium for his own political
advancement: his systematic and encyclopedic information collection
served to strengthen and uphold Louis XIV's absolute rule. With these
and other projects in progress — including an intellectual and practical
history of accounting and its role in governance in the modern world and
a study of the composition of library catalogues during the
Enlightenment — Soll is opening up new fields of inquiry and elucidating
how modern governments came into being.
Jacob Soll received a
B.A. (1991) from the University of Iowa, a D.E.A. (1993) from the École
des Hautes Études en Sciences Sociales, and a Ph.D. (1998) from
Magdalene College, Cambridge University. He has been affiliated with
Rutgers University, Camden, since 1999, where he is currently a
professor in the Department of History.
From Encylopedia Britannica ---
http://www.britannica.com/EBchecked/topic/124928/Jean-Baptiste-Colbert
(which in part provides early history of clawback return of gains to
government, something the SEC is avoiding in the early 21st Century fraud
convictions)
Also note the stress on manufacturing regulation and quality controls.
Colbert was born of a merchant family. After
holding various administrative posts, his great opportunity came in
1651, when Cardinal
Mazarin, the dominant political figure in
France, was forced to leave Paris and take refuge in a provincial
city—an episode in the Fronde, a period (1648–53) of struggle between
the crown and the French parlement. Colbert became Mazarin’s
agent in Paris, keeping him abreast of the news and looking after his
personal affairs. When Mazarin returned to power, he made Colbert his
personal assistant and helped him purchase profitable appointments for
both himself and his family. Colbert became wealthy; he also acquired
the barony of Seignelay. On his deathbed, Mazarin recommended him to
Louis XIV, who soon gave Colbert his
confidence. Thenceforth Colbert dedicated his enormous capacity for work
to serving the King both in his private affairs and in the
general administration of the kingdom.
The struggle with Fouquet.
For 25 years Colbert was to be concerned with
the economic reconstruction of France. The first necessity was to bring
order into the chaotic methods of financial administration that were
then under the direction of
Nicolas Fouquet, the immensely powerful
surintendant des finances. Colbert destroyed Fouquet’s reputation
with the King, revealing irregularities in his accounts and denouncing
the financial operations by which Fouquet had enriched himself. The
latter’s fate was sealed when he made the mistake of receiving the King
at his magnificent chateau at Vaux-le-Vicomte; the Lucullan festivities,
displaying how much wealth Fouquet had amassed at the expense of the
state, infuriated Louis. The King subsequently had him arrested. The
criminal proceedings against him lasted three years and excited great
public interest. Colbert, without any rightful standing in the case,
interfered in the trial and made it his personal affair because he
wanted to succeed Fouquet as finance minister. The trial itself was a
parody of justice. Fouquet was sent to prison, where he spent the
remaining 15 years of his life. The surintendance was replaced
by a council of finance, of which Colbert became the dominant member
with the title of intendant until, in 1665, he became controller
general.
Financiers and
tax farmers had made enormous profits from
loansand advances to the state treasury, and Colbert established
tribunals to make them give back (clawbacks)
some of their gains. This was well received
by
public opinion, which held the financiers
responsible for all difficulties; it also lightened the
public debt,
which was further reduced by the repudiation of some
government bonds and the repayment of others
without interest. Private fortunes suffered, but no disturbances ensued,
and the King’s credit was restored.
Financial and economic affairs.
Colbert’s next efforts were directed to
reforming the chaotic system of taxation, a heritage of medieval times.
The King derived the major part of his revenue from a tax called the
taille, levied in some districts on
individuals and in other districts on land and businesses. In some
districts the taille was apportioned and collected by royal officials;
in others it was voted by the representatives of the province. Many
persons, including clergy and nobles, were exempt from it altogether.
Colbert undertook to levy the taille on all who were properly liable for
it and so initiated a review of titles of nobility in order to expose
those who were claimingexemption falsely; he also tried
to make the tax less oppressive by a fairer distribution. He reduced the
total amount of it but insisted on payment in full over a reasonable
period of time. He took care to suppress many abuses of collection
(confiscation of defaulters’ property, seizure of peasants’ livestock or
bedding, imprisonment of collectors who had not been able to produce the
due sums in time). These reforms and the close supervision of the
officials concerned brought large sums into the treasury. Other taxes
were increased, and the tariff system was revised in 1664 as part of a
system of protection. The special dues that existed in the various
provinces could not be swept away, but a measure of uniformity was
obtained in central France.
Colbert devoted endless energy to the
reorganization of industry and commerce. He believed that in order to
increase French power it would be essential to increase France’s share
of
international trade and in particular to
reduce the commercial hegemony of the Dutch. This necessitated not only
the production of high-quality goods that could compete with foreign
products abroad but also the building up of a merchant fleet to carry
them. Colbert encouraged foreign workers to bring their trade skills to
France. He gave privileges to a number of private industries and
foundedstate manufactures. To guarantee the standard of workmanship, he
made regulations for every sort of manufacture and imposed severe
punishments (fines and the pillory) for counterfeiting and shortcomings.
He encouraged the formation of companies to build ships and tried to
obtain monopolies for French commerce abroad through the formation of
trading companies. The French East India and West India companies,
founded in 1664, were followed by others for trade with the eastern
Mediterranean and with northern Europe; but Colbert’s propaganda for
them, though cleverly conducted, failed to attract sufficient capital,
and their existence was precarious. The protection of national industry
demanded tariffs against foreign produce, and other countries replied
with tariffs against French goods. This tariff warfare was one of the
chief causes of the
Dutch War of
1672–78.
Colbert’s system of control was resented by
traders and contractors, who wanted to preserve their freedom of action
and to be responsible to themselves alone. Cautious and thrifty people,
moreover, still preferred the old outlets for
their money (land, annuities,
moneylending) to investing in industry. The period, too, was one of
generally falling prices throughout the world. Colbert’s success,
therefore, fell short of his expectation, but what he did achieve seems
all the greater in view of the obstacles in his way: he raised the
output of manufactures, expanded trade, set up new permanent industries,
and developed communications by road and water across France (Canal
du Midi, 1666–81).
Continued in article
Free Accounting History Book (U.K, Accountants)
Capsule Commentary, by Steve Zeff,
ROBERT H. PARKER, STEPHEN A. ZEFF, and MALCOLM
ANDERSON, Major Contributors to the British Accountancy Profession: A
Biographical Sourcebook (Edinburgh, Scotland, U.K.: The Institute of
Chartered Accountants of Scotland, 2012, ISBN 978-1-904574-85-9, pp.
137).
This is a successor to Robert H. Parker's
compilation of obituaries that was published in 1980 by Arno Press. But
this edition reproduces obituaries, profiles, and interviews with “major
contributors” to the British accounting profession, while the earlier
volume was confined to British accountants. This book reports on 37
important figures who died between 1941 and 2010, and the coverage
includes professional accountants, academics, accountants in industry,
editors of professional and academic journals, librarians, executives in
professional institutes, and public servants.
The authors supply a lengthy introduction in
which they comment on the roles played by the major contributors as well
as on the changing scene in the British accounting profession during the
past three decades. In a supplement, they supply references to other
sources of biographical information about the individuals treated in the
book.
As with other research monographs
published by the Institute of Chartered Accountants of Scotland, this
volume may be downloaded without charge from the Institute's website
(http://icas.org.uk).
Jensen Comment
Various accounting student team projects come to mind using the above
technology. One could be an accounting history project in which students map
important events in early accounting history, some of which are mentioned at
http://faculty.trinity.edu/rjensen/Theory01.htm#AccountingHistory
Abacus Techniques by Totton
Heffelfinger & Gary Flom.
Early History of Mathematics and Calculating in China The best general source for ancient Chinese
mathematics is Joseph Needham's Science and Civilisation in China,
vol. 3. In this volume you will learn, for example, that the Chinese proved
the Pythagorean Theorem at the very latest by the Later Han dynasty (25-221
CE). The proof comes from an ancient text called The Arithmetical Classic of
the Gnomon and the Circular Paths of Heaven. The book has been translated by
Christopher Cullen in his Astronomy and Mathematics in Ancient China: The
Zhou Bi Suan Jing. Needham also discusses the abacus, or suanpan
("calculating plate").
Steve Field, Professor of Chinese, Trinity University, September 24, 2008
Jensen Comment
Later Han Dynasty ---
http://en.wikipedia.org/wiki/Later_Han_Dynasty_(Five_Dynasties)
Pythagorean Theorem Theorem ---
http://en.wikipedia.org/wiki/Pythagorean_Theorem
Pythagorean Theorem (Gougu Theorem in China) History ---
http://en.wikipedia.org/wiki/Pythagorean_Theorem#History
Suanpan ---
http://en.wikipedia.org/wiki/Suanpan
We trace the social positions of the men
and women who found new enterprises from the earliest years of one
industry’s history to a time when the industry was well established.
Sociological theory suggests two opposing hypotheses. First,
pioneering entrepreneurs are socially prominent individuals from
fields adjacent to the new industry and later entrepreneurs are from
an increasingly broad swath of society. Second, the earliest
entrepreneurs come from the social periphery while later
entrepreneurs include more industry insiders and members of the
social elite. To test these hypotheses, we study the magazine
industry in America over the first 120 years of its history, from
1741 to 1860. We find that magazine publishing was originally
restricted to industry insiders, elite professionals, and the highly
educated, but by the time the industry became well established, most
founders came from outside publishing and more were of middling
stature – mostly small-town doctors and clergy without college
degrees. We also find that magazines founded by industry insiders
remained concentrated in the three biggest cities, while magazines
founded by outsiders became geographically dispersed. Finally, we
find that entrepreneurship evolved from the pursuit of a lone
individual to a more organizationally-sponsored activity; this
reflects the modernization of America during this time period. Our
analysis demonstrates the importance of grounding studies of
entrepreneurship in historical context. Our analysis of this “old”
new media industry also offers hints about how the “new” new media
industries are likely to evolve.
Accounting History (across
hundreds of years) A Change Fifty-Years in the Making, by Jennie Mitchell, Project
Accounting WED Interconnect ---
http://accounting.smwc.edu/historyacc.htm
Questions
What was an ancient Greek ploy to combat inflation?
How do you account for interest paid in cabbages during hyperinflation?
"The time has come," the Walrus said,
"To talk of many things:
Of shoes--and ships--and sealing-wax-- Of cabbages--and kings--
And why the sea is boiling hot--
And whether pigs have wings." Lewis Carroll, The
Walrus and the Carpenter ---
http://www.jabberwocky.com/carroll/walrus.html
1300s A.D. crusades opened the
Middle East and Mediterranean trade routes
Venice and Genoa became
venture trading centers for commerce
1296 A.D. Fini Ledgers in
Florence
1340 A.D. City of Massri
Treasurers Accounts are in Double Entry form.
1458 A.D.Benedikt Kotruljevic (Croatian)
(Dubrovnik,1416-L’Aquila,1469) (His Italian name was Benedetto Cotrugli
Raguseo), wrote The Book on the Art of Trading which is now
acknowledged to be the first person to write a book describing
double-entry techniques (although the origins of double entry
bookkeeping in practice are unknown)
1494 Luca Pacioli's Summa
de Arithmetica Geometria Proportionalita (A Review of Arithmetic,
Geometry and Proportions) which is the best known early book on
double entry bookkeeping in algebraic form.
Recall that double entry bookkeeping supposedly
evolved in Italy long before it was put into algebraic form in the book
Summa by
Luca
Pacioli and into an earlier book by Benedikt Kotruljevic.
Jolyon Jenkins investigates how accountants
shaped the modern world. They sit in boardrooms, audit schools, make
government policy and pull the plug on failing companies. And most of us
have our performance measured. The history of accounting and
book-keeping is largely the history of civilisation.
Jolyon asks how this came about and traces the
religious roots of some accounting practices.
Eventually, educators might be able to get copies of these audio files.
October 3, 2009 message from Rick Dull
Benedikt Kotruljevic
(Croatian) (Dubrovnik,1416-L’Aquila,1469) (His Italian name was
Benedetto Cotrugli Raguseo), who in 1458, wrote "The Book on the Art of
Trading" which is now acknowledged to be the first person to write a
book describing double-entry techniques? See the American Mathematical
Society’s web-site:
http://www.ams.org/featurecolumn/archive/book1.html .
Rick Dull
And so on --- I think you get the idea.
One truly valuable research for an accounting history
mapping project is the free Accounting Historians Journal archive (although
not all of the publications are free online but should be free to students
using the hard copy stacks in campus libraries) ---
http://www.olemiss.edu/depts/general_library/dac/files/ahj.html
Even Pacioli was not the first to write about double-entry bookkeeping.
October 3, 2009 message from Rick Dull
Benedikt Kotruljevic
(Croatian) (Dubrovnik,1416-L’Aquila,1469) (His Italian name was
Benedetto Cotrugli Raguseo), who in 1458, wrote "The Book on the Art of
Trading" which is now acknowledged to be the first person to write a
book describing double-entry techniques? See the American Mathematical
Society’s web-site:
http://www.ams.org/featurecolumn/archive/book1.html .
Luca Pacioli did not invent double entry
book-keeping. The rudiments of double entry book-keeping (DEBK) can be found
in Muslim government administration in the 10th Century. (See Book-keeping
and Accounting Systems in a tenth Century Muslim Administrative Office by
Hamid, Craig & Clark in Accounting, Business & Financial History Vol 3 No 5
1995).
As I understand it Pacioli saw the technique being
used by Arab traders and adapted and codified the technique allowing it to
spread to Northern Europe where it became a* key component in Western
economic dominance in the last 500 years.
This is logical if you think about it. DEBK is the
greatest expression of applied algebra – that Arab word betraying the origin
of the particular mathematical technique in which the world’s duality is
reflected.
RW
* but not the key component as Werner Sombart would
have it. But then his reason for wanting that to be was his extreme anti-semitism
… but that is another story.
The one highly negative review has nothing to do with the contents of the
book. The other reviews tend to be more four-star than five-star, but that's not
bad at all until you dig into some of the negatives.
Malcomb Cameron wrote the following (especially note his final paragraph):
Double Entry
How the merchants of Venice shaped the modern world - and how their
invention could make or break the planet
by Jane Gleeson - White
This book is a gem! Dusty old "double entry accounting" is threaded together
with stories of Renaissance Venice, its merchants and scholarly discoveries,
development of capitalism, national GDP, and accounting for environmental
damage.
After a shaky start resurrecting Senator Robert Kennedy, the scene moves on
cue to medieval Pisa, Genoa, Florence and Venice. There the Franciscan monk
Luca Pacioli, mathematician, chess-player, and encylopedist inadvertently
immortalized himself as the "father" of double-entry bookkeeping.
Luca Pacioli made significant mathematical discoveries, taught Leonardo da
Vinci, and in particular wrote a mathematical encyclopedia in 1494
allocating 27 pages to a bookkeeping treatise that bestowed him glory to
this day. This was only a small part of Pacioli's work in "Summa de
Arithmetica, geometria, proportione et proportionalità" or "Everything about
Arithmetic, Geometry, Proportion, and Proportionality" plus other works
including an unpublished treatise on chess which was rediscovered in 2006.
A brilliant intertwined history of merchants and mathematics is presented
from Mesopotamian tablets and ancient Greek mathematics through to the
Hindu-Arabic numerals and the new style bookkeeping. The dark arts of
Egyptian priests and the commercial activities of early merchants triggered
Augustine's warning that "The good Christian should beware of mathematics
... a covenant with the devil to darken the spirit and confine man in the
bonds of Hell". The author successfully combines "the calculations used by
merchants ... and the numbers used by philosophers to express the secret
harmonies of the universe." This is a neat idea particularly for those new
to the history of mathematics or finance.
The focus then turns to bookkeeping, bills of exchange, limited liability,
cost accounting, National Accounts, GDP, etc. Pacioli tells us that "If you
are in business and do not know all about it, your money will go like flies
- That is, you will lose it"; " ... the merchant is like a rooster ... the
most alert and ... keeps his night vigils and never rests". Just like modern
continuous disclosure Pacioli advises "Frequent accounting makes for long
friendship" warning that "if you are not a good bookkeeper ... you will go
on groping like a blind man and meet great losses".
Finally, the author goes `over the top' quoting claims not only that the
concept of capitalism originated with double entry bookkeeping but the
entire modern scientific capitalistic world as well. The book ends by
considering environmental concerns excluded from company accounts longing
for a sort of Accounting of Everything. Accounting can "make or break the
planet ... there may be one last hope for life on earth: accountants". There
are limits, if it is that bad, let us all just "drink and be merry ...".
Malcolm Cameron
13 May 2012
Jensen Comment
Of course Jane Gleeson-White is not the first historian to claim the importance
of doubleentry accounting to capitalism. I've always thought the earlier claims
were "over the top."
"The power of double-entry bookkeeping has been
praised by many notable authors throughout history. In Wilhelm Meister,
Goethe states, "What advantage does he derive from the system of bookkeeping
by double-entry! It is among the finest inventions of the human mind"...
Werner Sombart, a German economic historian, says, "... double-entry
bookkeeping is borne of the same spirit as the system of Galileo and Newton"
and "Capitalism without double-entry bookkeeping is simply inconceivable.
They hold together as form and matter. And one may indeed doubt whether
capitalism has procured in double-entry bookkeeping a tool which activates
its forces, or whether double-entry bookkeeping has first given rise to
capitalism out of its own (rational and systematic) spirit".
If, for a moment, one considers the credibility
crisis of practical accounting, it would be quite impossible to dismiss the
following paradox: the conflict between the enthusiastic praise of the
system's strength on the one hand, and on the other, the many financial
failures in the real world. How can such a powerful system, even when
applied meticulously, still result in disasters? Although it is hardly
necessary to argue more in favour of double-entry book-keeping, I still want
to underline the two qualities of the system which I find are valid
explanations of the system's very important and world-wide role in financial
development for five centuries.
The Logic of Double-Entry Bookkeeping, by Henning
Kirkegaard
Department of Financial & Management Accounting
Copenhagen Business School
Howitzvej 60
Along this same double-entry thread I might mention my mentor at Stanford.
Nobody I know holds the mathematical wonderment of double-entry and historical
cost accounting more in awe than Yuji Ijiri. For example, see Theory of
Accounting Measurement, by Yuji Ijiri (Sarasota: American Accounting
Association Studies in Accounting Research No. 10, 1975).
Dr. Ijirii also extended the concept to triple-entry bookkeeping in
(Sarasota: Triple-Entry Bookkeeping and Income Momentum
American Accounting Association Studies in Accounting Research No. 18, 1982).
http://accounting.rutgers.edu/raw/aaa/market/studar.htm
tm
Brush up your Shakespeare: Medieval manuscripts to hit Internet Stanford University Libraries, the University of
Cambridge and Corpus Christi College, Cambridge, will make hundreds of medieval
manuscripts, dating from the sixth through the 16th centuries, accessible on the
Internet.
"Medieval manuscripts to hit Internet," Stanford Report, July 13, 2005
---
http://news-service.stanford.edu/news/2005/july13/parker-071305.html
A friend of mine, Alan Sangster, who is one of the
top experts in the writings of Pacioli having published numerous articles on
the subject and having done extensive research in Italy, has published an
eleven page review in the August 2012 edition of Accounting History
one of the three top academic English language accounting history journals.
Here are some parts from the beginning and conclusion. In addition, I
understand Accounting Review to be preparing a review of the book as
well.
J Gleeson-White
Double Entry: How the Merchants of Venice Shaped the Modern World and How
their Invention could Make or Break the
Planet, Allen & Unwin: Sydney, 2011, 294 + viii pp.: ISBN: 9781741757552
Reviewed by: Alan Sangster, Griffith University, Australia
DOI: 10.117/1032373212450161
This is a very interesting and easy to read
book from which I gained a great deal of pleasure. The author should be
commended on her courage and her success in absorbing and then retelling
the history of a subject that those more equipped to do so have
generally not done for the simple reason that the sum is greater than
the parts – finding evidence is one thing, putting it all together in a
coherent and internally consistent manner, is another.
The Contents List is a challenging mixture of
accounting history, economic history, and accounting - the art, the
science, and the profession. The opening focus on the inability of
accounting, as we know it, to present in financial statements items
other than those that can be expressed in monetary terms is both
surprising and refreshing. The call made later in the book for a
reinvention or redesign of an accounting which embraces such factors as
the impact upon the environment is well written and argued, and
extremely timely. Professor Rob Gray’s “elephant in the room” (2010,
2013) has rarely had such an outing in public, even if his writings and
those of many others on the subject are strangely absent from this book.
It is a difficult enough task to understand
sufficiently well the treatise on bookkeeping contained in Luca
Pacioli’s Summa Arithmetica of 1494, without attempting to also
understand the activities and processes of accounting in the previous
200 and subsequent 500+ years – a modernised translation of the treatise
was sufficient to warrant a PhD (Cripps, 1995). This is not a minor task
that JaneGleeson-White set herself. In its fullness, it is nothing less
than the work of an entire lifetime, and Jane Gleeson-White did it all
in three years. Could this be possible? Today, with the freedom of the
“library on your desktop” (Sangster, 1995: 3) finally realised,
possibly, but it is still an enormous task requiring the reading of
hundreds of articles, books, and websites. This was a challenge indeed
and Jane Gleeson-White emerges from her travail with honour and
achievement. Yet, speed is not the mother of all invention. Rather, it
is the inevitable creator of shortcuts and assumptions arising from
limited time to follow things through that are destined to leave
questions only partially answered. Nevertheless, in this case, the flaws
are not sufficient to devalue the whole. This is a very well-constructed
book.
Nevertheless, despite its flaws, the book is
the first primer to accounting history and its relevance to the modern
world that I have ever seen. It is suitable for use as a core text for a
one semester or year-long university module/course on accounting
history. I am currently teaching a postgraduate class in accounting
history and would happily use this book as the core student background
reading text on which all the articles I currently use are hung. In this
sense, the flaws in this book are its strengths, offering opportunities
for debate and investigation while maintaining an impressive aura of
certainty for anyone not informed enough to spot the problems. For the
benefit of those interested in identifying the errors and misconceptions
I have found, these are presented in an Appendix to this review, along
with a bibliography of the sources which I have used both here and in
the Appendix.
Double Entry is a book to be savoured, but
handled with care. The messages it contains are clear and unambiguous
and all accountants, practising or not, ought to note the tone of
invocation for change. Jane Gleeson-White is to be congratulated for
presenting us with clarity of appreciation of the issues facing mankind
that accounting could do something about. Whether it has that much to do
with double entry is debatable, but double entry and the mystique
surrounding the technique certainly encourages the silo mentality of
accountants we have witnessed through time, something the author has
identified and rightly criticised. I hope this book makes a difference
and that Jane Gleeson-White may be encouraged to go further in
developing her understanding of accounting and accountants. Voices such
as hers are desperately needed if we are to break the mould and create
accounting that considers the world we live in as much as the enterprise
for which it is being applied. The history of double entry bookkeeping
tells us from where our present-day accounting practices came. Now, it
is time to let the stasis of 700 years of practice evolve into something
truly useful, something suited to the knowledge age in which we now
live.
Jim McKinney, Ph.D., C.P.A.
Accounting and Information Assurance
Robert H. Smith School of Business
4333G Van Munching Hall
University of Maryland
College Park, MD 20742-1815
http://www.rhsmith.umd.edu
Abstract
Within recent years, financial statement users have been accorded great
significance by accounting standard-setters. In the United States, the
conceptual framework maintains that a primary purpose of financial
statements is to provide information useful to investors and creditors in
making their economic decisions. Contemporary accounting textbooks
unproblematically posit this purpose for accounting. Yet, this emphasis is
quite recent and occurred despite limited knowledge about the information
needs and decision processes of actual users of financial statements. This
paper unpacks the taken-for-grantedness of the primacy of financial
statement users in standard-setting and considers their use as a category to
justify and denigrate particular accounting disclosures and practices. It
traces how particular ideas about financial statement users and their
connection to accounting standard setting have been constructed in various
documents and reports including the conceptual framework and accounting
standards. 2006 Elsevier Ltd. All rights reserved.
Joni's paper won the American Accounting Association's Notable Contribution
to the Accounting Literature Award for 2011 ---
http://aaahq.org/awards/awrd3win.htm
Jensen Comment
Accounting standard setters give primacy to providing information to investors
but really don't know a whole lot about how investors and analysts use
information. My long time complaint is that the both the IASB and FASB
Conceptual Frameworks are stronger for balance sheet items vis-a-vis income
statements.
The primary indices that investors and analysts track are earnings and
earnings-based indices such as P/E ratios. And the weakest part of both the IASB
and FASB Conceptual Frameworks is the concept of earnings, including the
inability to distinguish realized/realizable earnings from unrealized earnings
such as the way unrealized changes if fair value of financial instruments
(especially securities ultimately held to maturity) are mixed with earned
profits from sales.
For example, in May 2012 JP Morgan is being lambasted in Congress and the media
for $2-$3 billion so-called "losses" on credit derivatives. And some unrealized
credit derivative losses will be booked and aggregated with realized/earned
income of the bank.
One of the imperfect but often effective way that standard setters learn
about investors, preparers, academics, and auditors is in responses to
exposure drafts. I don't think Joni Young gives enough credit to the
important role feedback on exposure drafts plays in the standard setting
process.
As a rule, standards are not just thrust into the world as surprises
like newborn babies. In the gestation time period, between conception
and birth, a standard is open for debate by virtually all jurisdictions
that will be affected by the proposed new accounting standard. The most
important happenings in this process are the exposure drafts (often a
succession of such drafts) where standard setters invite and publish
serious comments.
And the public's comments often lead to dramatic changes between initial
drafts and final standards, as was definitely the case between ED 162-A
and FAS 133 --- a difference between night and day.
Standard setters are generally disappointed by the quantity and quality
of comments by professors to exposure drafts. Partly as a result of
this, the American Accounting Association annually creates a committee
of leading financial accounting professors to formally respond to
exposure drafts. These responses are generally published in
Accounting Horizons. Such responses can be great for student
learning, and accounting professors are probably remiss in not
assigning these AH articles in their syllabi.
A great example at the moment are the many responses to four differing
exposure drafts of the Joint Committee on a new leasing standard.
Of course the responses to exposure drafts are imperfect ways of
studying the various jurisdictions impacted by accounting standards. It
would be better in many instances to scientifically study these
jurisdictions in the context of the proposed standard. But this is
generally not practical or cost effective. Accountics science has many
imperfections and limitations. For example, studying students as
surrogates for a real-world jurisdiction is not exactly an exciting way
to learn about real-world decision makers.
Capital markets events researchers seldom study standards events before
the standards are implemented. They study the eventual event of a new
standard's implementation, but the event of an exposure draft is much
harder to study since an exposure draft does not usually impact a 10-K
and is often greatly modified before becoming a finalized standard.
Thus I think Joni Young overstates her case about standard setters being
ignorant about investors. She has many good points, but I don't think
members of the IASB and FASB are as ignorant about investors as she
would like us to believe.
Respectfully,
Bob Jensen
Thank you James Martin for the tremendous MAAW Accounting History
database --- http://maaw.info/
This morning on October 18, 2009 I had occasion to search for some Bill
Paton's replacement cost history, so I went to MAAW at
http://maaw.info/ I then entered the word Paton in the Google search box and this led me to
some interesting categories, including the Replacement Cost Accounting
Bibliography --- http://www.maaw.info/ReplacementCostArticles.htm That only yielded two of Paton's articles on replacement cost, but it did
provide a ton of other references including many that cite Bill Paton.
In particular I wandered to a well-known and long forgotten article by
Steve Zeff: "Replacement Cost: Member of the Family, Welcome Guest, or Intruder,"
by Stephen A. Zeff, The Accounting Review, October 1962. Steve was an
Assistant Professor of Accounting at Tulane at the time he wrote this paper.
Replacement Cost: Member of the
Family, Welcome Guest, or Intruder?
Stephen A. Zeff
The Accounting Review,
Vol. 37, No. 4 (Oct., 1962), pp. 611-625 (article consists of 15 pages)
My Emeritus status at Trinity University allows me free access to
Trinity's fabulous subscriptions to electronic library databases, including
Jstor. I next proceeded online to Jstor and found the following articles by
Steve Zeff
I then clicked on Item 8 above and downloaded the Zeff article I was most
interested in at the moment.
I also went back to the Jstor search page and did a search for "William
A. Paton" and got a listing of hits of some of Bill's papers and papers that
cite Bill Paton. One that particularly intrigues me is the following" "Statement by William A. Paton," by William A. Paton,
The Accounting
Review, October 1980, pp. 629-630.
Bill was 91 years old when he wrote the above short piece. What intrigues me
is how he reflects on his famous 1940 monograph written with A.C. Littleton
in 1940 that he claims to have not read once again for 35 years. It's
rumored that he "recanted" his authorship of that most famous monograph, but
that could not be further from the truth. He feels that he and "A.C." "did a
creditable job" and then proceeds to point out where he feels, after 40
years, that this most famous monograph had some flaws.
I will eventually discuss these flaws in another message to the AECM
after I've had time for study on this matter. The purpose of this message is to point out how much fun historical research
can be in what becomes, if you keep going, a process of serendipity that
reveals what a huge amount we think of as current thinking was thought of
decades ago by some very smart writers.
Accounting History Corner
A nice timeline on the development of U.S.
standards and the evolution of thinking about the income statement versus
the balance sheet is provided at:
"The Evolution of U.S. GAAP: The Political Forces Behind Professional
Standards (1930-1973)," by Stephen A. Zeff, CPA Journal, January
2005 ---
http://www.nysscpa.org/cpajournal/2005/105/infocus/p18.htm
Part II covering years 1974-2003 published in February 2005 ---
http://archives.cpajournal.com/
The module for 1940 is as follows:
1940 The American Accounting Association
(AAA) publishes Professors W.A. Paton and A.C. Littleton’s monograph An
Introduction to Corporate Accounting Standards, which is an eloquent
defense of historical cost accounting. The monograph provides a
persuasive rationale for conventional accounting practice, and copies
are widely distributed to all members of the AIA. The Paton and
Littleton monograph, as it came to be known, popularizes the matching
principle, which places primary emphasis on the matching of costs with
revenues, with assets and liabilities dependent upon the outcome of this
matching.
Comment. The Paton
and Littleton monograph reinforced the revenue-and-expense view in the
literature and practice of accounting, by
which one first determines whether a transaction gives rise to a revenue
or an expense. Once this decision is made, the balance sheet is left
with a residue of debit and credit balance accounts, which may or may
not fit the definitions of assets or liabilities.
The monograph also embraced historical cost
accounting, which was taught to thousands of accounting students in
universities, where the monograph was, for more than a generation, used
as one of the standard textbooks in accounting theory courses.
1940s
Throughout the decade, the CAP frequently
allows the use of alternative accounting methods when there is diversity
of accepted practice.
Comment. Most of the matters taken up by the
CAP during the first half of the 1940s dealt with wartime accounting
issues. It had difficulty narrowing the areas of difference in
accounting practice because the major accounting firms represented on
the committee could not agree on proper practice. First, the larger
firms disagreed whether uniformity or diversity of accounting methods
was appropriate. Arthur Andersen & Co. advocated fervently that all
companies should follow the same accounting methods in order to promote
comparability. But such firms as Price, Waterhouse & Co. and Haskins &
Sells asserted that comparability was achieved by allowing companies to
adopt the accounting methods that were most suited to their business
circumstances. Second, the big firms disagreed whether the CAP possessed
the authority to disallow accounting methods that were widely used by
listed companies.
A nice timeline on the development of U.S. standards and the evolution of
thinking about the income statement versus the balance sheet is provided at:
"The Evolution of U.S. GAAP: The Political Forces Behind Professional
Standards (1930-1973)," by Stephen A. Zeff, CPA Journal, January
2005 ---
http://www.nysscpa.org/cpajournal/2005/105/infocus/p18.htm
Part II covering years 1974-2003 published in February 2005 ---
http://archives.cpajournal.com/
The module for 1940 is as follows:
1940 The American Accounting
Association (AAA) publishes Professors W.A. Paton and A.C. Littleton’s
monograph An Introduction to Corporate Accounting Standards, which is an
eloquent defense of historical cost accounting. The monograph provides a
persuasive rationale for conventional accounting practice, and copies
are widely distributed to all members of the AIA. The Paton and
Littleton monograph, as it came to be known, popularizes the matching
principle, which places primary emphasis on the matching of costs with
revenues, with assets and liabilities dependent upon the outcome of this
matching.
Comment.
The Paton and Littleton monograph reinforced the revenue-and-expense
view in the literature and practice of
accounting, by which one first determines whether a transaction gives
rise to a revenue or an expense. Once this decision is made, the balance
sheet is left with a residue of debit and credit balance accounts, which
may or may not fit the definitions of assets or liabilities.
The monograph also embraced historical
cost accounting, which was taught to thousands of accounting students in
universities, where the monograph was, for more than a generation, used
as one of the standard textbooks in accounting theory courses.
1940s
Throughout the decade, the CAP frequently
allows the use of alternative accounting methods when there is diversity
of accepted practice.
Comment. Most of the matters taken up by
the CAP during the first half of the 1940s dealt with wartime accounting
issues. It had difficulty narrowing the areas of difference in
accounting practice because the major accounting firms represented on
the committee could not agree on proper practice. First, the larger
firms disagreed whether uniformity or diversity of accounting methods
was appropriate. Arthur Andersen & Co. advocated fervently that all
companies should follow the same accounting methods in order to promote
comparability. But such firms as Price, Waterhouse & Co. and Haskins &
Sells asserted that comparability was achieved by allowing companies to
adopt the accounting methods that were most suited to their business
circumstances. Second, the big firms disagreed whether the CAP possessed
the authority to disallow accounting methods that were widely used by
listed companies.
Continued in article
"Global Financial Reporting: Implications for U.S.," by
Mary Barth, The Accounting Review, Vol. 83, No. 5, September 2008
On Page 1166 she flatly asserts:
First, there is no “matching principle.”
That is, matching is not an end in itself and matching is not an
acceptable justification for asset or liability recognition or
measurement. The conceptual framework explains that matching involves
the simultaneous or combined recognition of revenues and expenses that
result directly and jointly from the same transactions or other events (FASB
1985, para. 146; IASB 2001, para. 95). Matching will be an outcome of
applying standards if the standards require accounting information that
meets the qualitative characteristics and other criteria in the
conceptual framework. Matched economic positions will naturally result
in matched accounting outcomes. However, the application of a matching
concept in the conceptual framework does not allow the recognition of
items in the statement of financial position that do not meet the
definition of assets or liabilities (IASB 2001, para. 95). Thus, there
would be no justification for deferring expense recognition for an
expenditure that provides no future economic benefit or for deferring
income recognition for a cash inflow that will not result in a future
economic sacrifice.
Jensen Comment
But matching still seems to prevail even though there is no more "matching
principle according to the IASB and the FASB. The answer is that revenue can
be deferred when there will be "future economic sacrifice." Sounds like
matching to me. Neither domestic nor international standards allow early
realization of revenue before it is legally earned. The standards just do
not allow automobile inventories to be written up to expected sales prices
until those sales are finalized. Carrying the inventories at something other
than sales value is part and parcel to the "matching principle" eloquently
laid out years ago by Paton and Littleton. Both international and domestic
standards still require cost amortization, depreciation, and creation of
warranty reserves. These are all rooted in the "matching principle" which
has not yet died when defining assets and liabilities in the conceptual
framework. In most instances the historical cost is still being booked and
spread over the expected life of future economic benefits. Even if a company
adopted a replacement cost (current cost) adjustment of historical cost of a
depreciable asset, those replacement costs still have to be depreciated
since old equipment cannot simply be adjusted upward to new, un-depreciated
replacement cost.
Paton and Littleton never argued that the "matching principle" for
expense deferral applies to assets that have "no future economic benefits."
In that case there would be no benefits against which to match the deferred
expense. Hence there's no deferral in such instances. I do not buy Barth's
contention that there is no longer any "matching principle." If there are
potential future benefits, the matching principle still is king except in
certain instances where assets are carried at exit values such is the case
for precious metals actively traded in commodity markets and financial
assets not classified as "held-to-maturity."
The Matching Principle lives on when there are expected "future economic
sacrifices."
Aleksandra B. Zimmerman, Case Western Reserve University;
Northern Illinois University - Department of Accountancy
Robert Bloom, John Carroll University
Abstract
This paper reassesses the significance of the
concept of matching expenses to revenues as an accounting principle. We
compare and contrast the historical views of authoritative bodies and
the various scholars and practitioners who analyze this subject, drawing
implications for future standard setting. Through this historical
retrospective on matching, which includes a review of more contemporary
research and thought, we find that
matching as an approach to income measurement can be helpful in
forecasting earning power.
Consequently, we conclude that matching should be retained as a
long-standing fundamental accounting principle in standard-setting and
in practice.
Conclusion
Accounting theory professors should not simply declare the matching
principle dead!
Accounting History Corner The Influence of Price Waterhouse & Co. on the CAP, the APB, and in the Early
Years on the FASB
SSRN, March 21, 2016
Author
Stephen
A. Zeff, Rice University
Abstract
Price Waterhouse & Co., for
decades the premier public accounting firm in the United States and which
audits a large number of “blue chip” companies, has, directly and
indirectly, been a large and frequent presence in the U.S. standard-setting
arena. It is the purpose of this paper to document this presence and to
determine whether it had a discernible effect on the outcomes of the
standard setters’ deliberations. The conclusion is that, appearances
notwithstanding, there has been no evidence of a continuing, noticeable
effect.
Jensen Comment When teaching about accounting for liabilities and credit cards, it might be
interesting to introduce students to the history of liabilities --- Buy Now, Pay Later: A History of Personal Credit ---
http://www.library.hbs.edu/hc/credit/
The above site has nothing to do with accounting, but it struck me as an
interesting way to introduce accounting history into most any accounting
course. For assignments (maybe for each class) students could be asked to
verify accounting history myths.
Early accounting was a knotty issue South American Indian culture apparently used layers of knotted strings as a
complicated ledger. Two Harvard University researchers believe they
have uncovered the meaning of a group of Incan khipus, cryptic assemblages
of string and knots that were used by the South American civilization for
record-keeping and perhaps even as a written language. Researchers have long
known that some knot patterns represented a specific number. Archeologist
Gary Urton and mathematician Carrie Brezine report today in the journal
Science that computer analysis of 21 khipus showed how individual strings
were combined into multilayered collections that were used as a kind of
ledger. Thomas H. Maugh, "Researchers Think They've Got the Incas' Numbers,"
Los
Angeles Times, August 12, 2005 ---
http://www.latimes.com/news/science/la-sci-khipu12aug12,1,6589325.story?coll=la-news-science&ctrack=1&cset=true Also note
http://snipurl.com/incaknots [64_233_169_104
Jensen Comment: I'm told that accounting tallies in Africa and other
parts of the world preceded written language. However, tallies alone did
not permit aggregations such as accounting for such things as three goats
plus sixty apples. Modern accounting awaited a combination of the Arabic
numbering (
http://en.wikipedia.org/wiki/Arabic_numbers ) and a common valuation
scheme for valuing heterogeneous items (e.g., gold equivalents or currency
units) such that the values of goats and apples could be aggregated. It is
intriguing that Inca knot patterns were something more than simple tallies
since patterns could depict different numbers and aggregations could
possibly be achieved with "multilayered collections."
Abstract: This essay, following up on the
recent Sy and Tinker [2005] and Tyson and Oldroyd [2007] debate, argues
that accounting history research needs to present critiques of the
present state of accounting’s authoritative concepts and principles,
theory, and present-day practices. It proposes that accounting history
research could benefit by adopting a genealogical, “effective” history
approach. It outlines four fundamental strengths of traditional history
– investigate only the real with facts; the past is a permanent
dimension of the present; history has much to say about the present; and
the past, present, and future constitute a seamless continuum. It
identifies Nietzsche’s major concerns with traditional history,
contrasts it with his genealogical approach, and reviews Foucault’s
[1977] follow up to Nietzsche’s approach. Two examples of genealogical
historiography are presented – Williams’ [1994] exposition of the major
shift in British discourse regarding slavery and Macintosh et al.’s
[2000] genealogy of the accounting sign of income from feudal times to
the present. The paper critiques some of the early Foucauldian-based
accounting research, as well as some more recent studies from this
perspective. It concludes that adopting a genealogical historical
approach would enable accounting history research to become effective
history by presenting critiques of accounting’s present state.
Early History of Mathematics and Calculating in China
The best general source for ancient Chinese
mathematics is Joseph Needham's Science and Civilisation in China,
vol. 3. In this volume you will learn, for example, that the Chinese proved
the Pythagorean Theorem at the very latest by the Later Han dynasty (25-221
CE). The proof comes from an ancient text called The Arithmetical Classic of
the Gnomon and the Circular Paths of Heaven. The book has been translated by
Christopher Cullen in his Astronomy and Mathematics in Ancient China: The
Zhou Bi Suan Jing. Needham also discusses the abacus, or suanpan
("calculating plate"). Steve Field, Professor of Chinese, Trinity University, September 24, 2008 Jensen Comment Later Han Dynasty ---
http://en.wikipedia.org/wiki/Later_Han_Dynasty_(Five_Dynasties) Pythagorean Theorem Theorem ---
http://en.wikipedia.org/wiki/Pythagorean_Theorem Pythagorean Theorem (Gougu Theorem in China) History ---
http://en.wikipedia.org/wiki/Pythagorean_Theorem#History Suanpan --- http://en.wikipedia.org/wiki/Suanpan This makes me respect Wikipedia even more!
In her notes compiled in 1979, Professor Linda
Plunkett of the College of Charleston S.C., calls accounting the "oldest
profession"; in fact, since prehistoric times families had to account for
food and clothing to face the cold seasons. Later, as man began to trade, we
established the concept of value and developed a monetary system. Evidence of
accounting records can be found in the Babylonian Empire (4500 B.C.), in
pharaohs' Egypt and in the Code of Hammurabi (2250 B.C.). Eventually, with the
advent of taxation, record keeping became a necessity for governments to sustain
social orders. James deSantis, A BRIEF HISTORY OF ACCOUNTING: FROM PREHISTORY TO
THE INFORMATION AGE ---http://www.ftlcomm.com/ensign/historyAcc/ResearchPaperFin.htm
Accounting History (across
hundreds of years) A Change Fifty-Years in the Making, by Jennie Mitchell, Project
Accounting WED Interconnect ---
http://accounting.smwc.edu/historyacc.htm
Questions
What was an ancient Greek ploy to combat inflation?
How do you account for interest paid in cabbages during hyperinflation?
"The time has come," the Walrus said,
"To talk of many things:
Of shoes--and ships--and sealing-wax-- Of cabbages--and kings--
And why the sea is boiling hot--
And whether pigs have wings." Lewis Carroll, The Walrus
and the Carpenter ---
http://www.jabberwocky.com/carroll/walrus.html
A University of Cincinnati-based journal devoted to
research on papyri is due out Nov. 1. That research sheds light on an
ancient world with surprisingly modern concerns: including hoped-for medical
cures, religious confusion and the need for financial safeguards.
What's old is new again. That's the lesson that can
be taken from the University of Cincinnati-based journal Bulletin of the
American Society of Papyrologists, due out Nov. 1.
The annually produced journal, edited since 2006 by
Peter van Minnen, UC associate professor of classics, features the most
prestigious global research on papyri, a field of study known as papyrology.
(Papyrology is formally known as the study of texts on papyrus and other
materials, mainly from ancient Egypt and mainly from the period of Greek and
Roman rule.)
It's an area of research that is more difficult
than you might think. That's because it was common among antiquities dealers
of the early 20th century to tear papyri pages apart in order to increase
the number of pieces they could sell.
Below are five topics treated in the upcoming 2010
volume of the Bulletin of the American Society of Papyrologists.
The five issues resonate with our own concerns today.
IOU cabbage
Katherine Blouin from the University of Toronto
publishes on a papyrus text regarding a Greek loan of money with interest in
kind, the interest being paid in cabbages. Such in-kind interest protected
the lender from currency inflation, which was rampant after 275 AD -- and no
doubt also provided a convenient way to get groceries.
Hippo strapped for cash
Cavan Concannon from Harvard University edits a
Greek letter in which a priest of the hippopotamus goddess, Thoeris, asks
for a money transfer he is waiting for. Such money transfers were for large
amounts and required mutual cooperation between two banks in different
places that had sufficient trust between them to accept one another's
"checks."
"American Gladiators" ca. 300 AD
Sofie Remijsen of Leuven University in Belgium
discusses a Greek letter in which the author details his visit to Alexandria
in Egypt, at a time (ca. 300 AD) when the Roman Emperor Diocletian was also
visiting the city -- and demanding entertainment. The letter's author, an
amateur athlete, was selected to entertain the emperor in "pankration"
(Greco-Roman wrestling with very few rules). He did poorly in this event and
so challenged five others to do "pammachon," which literally translates to
"all-out fight," with even fewer rules. The letter's author fought five "pammachon"
rounds, and it appears he won first prize.
Alternative medicine: Don't try this at
home
Magali de Haro Sanchez from Liège University in
Belgium discusses magical texts from Greco-Roman Egypt that use technical
terms for fevers (over 20), wounds, including scorpion bites and epilepsy.
The "prescriptions" (magical spells) were as difficult-to-decipher as any
written in modern medical scrawl. Here is a translation of an amulet against
epilepsy written on gold leaf: "God of Abraham, God of Isaac, God of Jacob,
our God, deliver Aurelia from every evil spirit and from every attack of
epilepsy, I beg you, Lord Iao Sabaoth Eloai, Ouriel, Michael, Raphael,
Gabriel, Sarael, Rasochel, Ablanathanalba, Abrasax, xxxxxx nnnnnn oaa
iiiiiiiiii x ouuuuuuu aoooooooo ono e (cross) e (cross) Sesengenbarpharanges,
protect, Ippho io Erbeth (magical symbols), protect Aurelia from every
attack, from every attack, Iao, Ieou, Ieo, Iammo, Iao, charakoopou,
Sesengenbarpharanges, Iao aeeuuai, Ieou, Iao, Sabaoth, Adonai, Eleleth, Iako."
Spelling counts: Orthodoxy and orthography
in early Christianity
An essay by Walter Shandruk from the University of
Chicago examines the ways in which Christ and Christian are spelled in Greek
papyri. Chrestos, which was pronounced the same way as Christos, was a
common slave name meaning "good" or "useful." Confused by this,
representatives of the Roman government often misspelled Christ's name "Chrestos"
instead of "Christos" meaning "anointed" or "messiah." They also called the
early followers of Christ "Chrestianoi" rather than "Christianoi." The early
Christians themselves went with the Romans here and often spelled their own
name "Chrestianoi," but they stuck to the correct spelling "Christos" for
Christ's name.
APIS is a collections-based repository hosting
information about and images of papyrological materials (e.g. papyri,
ostraca, wood tablets, etc) located in collections around the world. It
contains physical descriptions and bibliographic information about the
papyri and other written materials, as well as digital images and English
translations of many of these texts. When possible, links are also provided
to the original language texts (e.g. through the Duke Data Bank of
Documentary Papyri). The user can move back and forth among text,
translation, bibliography, description, and image. With the
specially-developed APIS Search System many different types of complex
searches can be carried out.
APIS includes both published and unpublished
material. Generally, much more detailed information is available about the
published texts. Unpublished papyri have often not yet been fully
transcribed, and the information available is sometimes very basic. If you
need more information about a papyrus, you should contact the appropriate
person at the owning institution. (See the list of contacts under Rights &
Permissions.)
APIS is still very much a work in progress; current
statistics are shown in the sidebar at right. Other statistics are available
on the statistics page in the project documentation. Curators of collections
interested in becoming part of APIS are invited to communicate with the
project director, Traianos Gagos.
More Than a Numbers Game: A Brief History of Accounting
Author: Thomas A. King
ISBN: 0-470-00873-3
Hardcover 242 pages
September 2006
Inspired by a 1998 speech by former SEC Chairman
Arthur Levitt, this book addresses the why of accounting instead of the how,
providing practitioners and students with a highly readable history of U.S.
corporate accounting. Each chapter explores a controversial accounting topic.
Author Thomas King is treasurer of Progressive Insurance. SmartPros Newsletter, September 25, 2006
Origins of Double Entry Accounting are Unknown
1300s A.D. crusades opened the Middle East and
Mediterranean trade routes
Venice and Genoa became venture trading centers
for commerce
1296 A.D. Fini Ledgers in Florence
1340 A.D. City of Massri Treasurers Accounts are in
Double Entry form.
1458 A.D.Benedikt Kotruljevic (Croatian) (Dubrovnik,1416-L’Aquila,1469)
(His Italian name was Benedetto Cotrugli Raguseo), wrote The Book on the
Art of Trading which is now acknowledged to be the first person to write
a book describing double-entry techniques (although the origins of double
entry bookkeeping in practice are unknown)
1494 Luca Pacioli's Summa de Arithmetica
Geometria Proportionalita (A Review of Arithmetic, Geometry and Proportions) which
is the best known early book on double entry bookkeeping in algebraic form.
Recall that double entry bookkeeping supposedly evolved
in Italy long before it was put into algebraic form in the book Summa by
Luca Pacioli
and into an earlier book by Benedikt Kotruljevic.
Jolyon Jenkins investigates how accountants shaped
the modern world. They sit in boardrooms, audit schools, make government
policy and pull the plug on failing companies. And most of us have our
performance measured. The history of accounting and book-keeping is largely
the history of civilisation.
Jolyon asks how this came about and traces the
religious roots of some accounting practices.
Eventually, educators might be able to get copies of these audio files.
October 3, 2009 message from Rick Dull
Benedikt Kotruljevic
(Croatian) (Dubrovnik,1416-L’Aquila,1469) (His Italian name was
Benedetto Cotrugli Raguseo), who in 1458, wrote "The Book on the Art of
Trading" which is now acknowledged to be the first person to write a
book describing double-entry techniques? See the American Mathematical
Society’s web-site:
http://www.ams.org/featurecolumn/archive/book1.html .
Rick Dull
As a result the of the early Italian use of double
entry bookkeeping, the English term "Debit" really has a Latin origin.
**************
Debit is an accounting and bookkeeping term that comes from the Latin word
debere which means "to owe." The opposite of a debit is a credit. Debit is
abbreviated Dr while credit is abbreviated Cr.
**************
I haven’t seen this little essay on accounting
history [accounting “avoidance”] by Jacob Soll, a Rutgers historian, on AECM
(sorry for redundant post if I missed it):
…Early
pioneers of financial management recognized the inherent anxiety brought
on by keeping account books. In the late Middle Ages and Renaissance,
accountants received training in family firms that required monk-like
self-discipline. In a 1494 treatise, Luca Pacioli of Venice first
explained the basic principle of double-entry bookkeeping: the separate
calculations of the sums of credits and debits had to equal the final
account of capital. Pacioli described how merchants lived with the
constant tension of having to record all the day’s transactions in a
journal, and then rigorously put them into a ledger. Only a trained
mathematician could do this, he warned, for it took mental stamina.
Continued in article
Ed Scribner
New Mexico State
December 4, 2009 reply from Bob Jensen
Hi Ed,
I don’t want to go very far down the path other than to
note that Pacioli was Italian.
Sometimes things just take a little more effort in
Italy.
Recall from WWII that it took 300 Italian marksmen to
put seven bullets into Benito Mussolini.
Jokes about the Italian Army in Ethiopia are classics.
In 1494, quill pens had to be reloaded
for each number and letter if the alphabet. And the ledgers were works of
art as well as records of transactions.
And a “mathematician” in 1494 hardly
took the knowledge that it takes to be a “mathematician” in the 21st
Century. Traces of calculus date back to Egyptian times, but it took
Bonaventura Francesco Cavalieri (1598-1647) to lay the foundations of
infinitesimal calculus.
Abstract:
The precise origin of the accounting records and reports outlined by
Pacioli in 1494 and used in the Italian Republics is presently unknown.
Historical evidence preserved in Turkey and Egypt indicates that
accounting records and reports developed in the early Islamic State were
similar to those used in the Italian Republics as outlined by Pacioli in
1494. Furthermore, some of the records and reports used in different
parts of the Islamic State are comparable to modern-day books and
reports. The religious requirement of Zakat (religious levy) and the
increasing responsibilities of the Islamic State were the force behind
the development of accounting records and reports by Muslims. The
Islamic State was established in 622, and Zakat was imposed on Muslims
in the year 2 Hijri'iah (H) (623). The enactment of Zakat necessitated
the establishment of the Diwan (office where accounts are held) and the
initial development of accounting records and reports. These records
were further developed in Addawlatul Abbasi'iah (Abbaside Caliphate)
between 132-232 H (750-847) whereby seven accounting specializations
were known and practiced. Auditing played a very important role in the
Islamic State and was designated as one of the accounting
specializations. This paper argues that it is most likely that the
commercial links between Muslim traders and their Italian counterparts
influenced the development of accounting books in the Italian Republics.
In the 14th Century, the Phoenicians sent trading
ships to Cathay (China) to trade for silk. Problem was, if a ship sank, the
merchant probably sank (bankrupt) with it. So the merchants pooled their
resources so if a ship sank no one merchant lost everything. Along with
this, an Italian Count named Paole (seriously) set up a system of
recordkeeping to keep track of the ventures. In this system, he created two
registers, a Debit Register (DR), and a Credit Register (CR)
I'll bet 95% of all CPA's don't know that which
makes me .... a trivia freak?
Luca Pacioli did not invent double entry
book-keeping. The rudiments of double entry book-keeping (DEBK) can be found
in Muslim government administration in the 10th Century. (See Book-keeping
and Accounting Systems in a tenth Century Muslim Administrative Office by
Hamid, Craig & Clark in Accounting, Business & Financial History Vol 3 No 5
1995).
As I understand it Pacioli saw the technique being
used by Arab traders and adapted and codified the technique allowing it to
spread to Northern Europe where it became a* key component in Western
economic dominance in the last 500 years.
This is logical if you think about it. DEBK is the
greatest expression of applied algebra – that Arab word betraying the origin
of the particular mathematical technique in which the world’s duality is
reflected.
RW
* but not the key component as Werner Sombart would
have it. But then his reason for wanting that to be was his extreme anti-semitism
… but that is another story.
DR = Debit [Middle English debite, from Latin
dbitum, debt; see debt.]
CR=Credit [French, from Old French, from Old
Italian credito, from Latin crditum, loan, from neuter past participle of
crdere, to entrust; see kerd- in Indo-European roots.]
Who am I to argue with a free dictionary? The
answer is worth what I paid.
Forgotten magic manual contains original da Vinci
code
AFTER lying almost untouched in the vaults of an Italian university for 500
years, a book on the magic arts written by Leonardo da Vinci's best friend
and teacher has been translated into English for the first time.
The world's oldest magic text, De viribus
quantitatis (On the Powers of Numbers), was penned by Luca Pacioli, a
Franciscan monk who shared lodgings with da Vinci.
E. Barry Rice, MBA, CPA
Director, Instructional Services
Emeritus Accounting Professor
Loyola College in Maryland
BRice@Loyola.edu
410-617-2478 www.barryrice.com
"The power of double-entry bookkeeping has been
praised by many notable authors throughout history. In Wilhelm Meister, Goethe
states, "What advantage does he derive from the system of bookkeeping by
double-entry! It is among the finest inventions of the human mind"...
Werner Sombart, a German economic historian, says, "... double-entry
bookkeeping is borne of the same spirit as the system of Galileo and
Newton" and "Capitalism without double-entry bookkeeping is simply
inconceivable. They hold together as form and matter. And one may indeed doubt
whether capitalism has procured in double-entry bookkeeping a tool which
activates its forces, or whether double-entry bookkeeping has first given rise
to capitalism out of its own (rational and systematic) spirit".
If, for a moment, one considers the credibility
crisis of practical accounting, it would be quite impossible to dismiss the
following paradox: the conflict between the enthusiastic praise of the
system's strength on the one hand, and on the other, the many financial
failures in the real world. How can such a powerful system, even when applied
meticulously, still result in disasters? Although it is hardly necessary to
argue more in favour of double-entry book-keeping, I still want to underline
the two qualities of the system which I find are valid explanations of the
system's very important and world-wide role in financial development for five
centuries.
The Logic of Double-Entry Bookkeeping, by Henning
Kirkegaard
Department of Financial & Management Accounting
Copenhagen Business School
Howitzvej 60
Along this same double-entry thread I might mention my mentor at Stanford.
Nobody I know holds the mathematical wonderment of double-entry and historical
cost accounting more in awe than Yuji Ijiri. For example, see Theory of
Accounting Measurement, by Yuji Ijiri (Sarasota: American Accounting
Association Studies in Accounting Research No. 10, 1975).
Dr.
Ijirii also extended the concept to triple-entry bookkeeping in (Sarasota:
Triple-Entry Bookkeeping and Income Momentum
American Accounting Association Studies in Accounting Research No. 18, 1982).
http://accounting.rutgers.edu/raw/aaa/market/studar.htmtm
Brush up your Shakespeare:
Medieval manuscripts to hit Internet Stanford University
Libraries, the University of Cambridge and
Corpus Christi College, Cambridge, will make
hundreds of medieval manuscripts, dating
from the sixth through the 16th centuries,
accessible on the Internet.
"Medieval manuscripts to hit Internet,"
Stanford Report, July 13, 2005 ---
http://news-service.stanford.edu/news/2005/july13/parker-071305.html
Robert Walker in New Zealand
and I have been corresponding about how much of the core of an accounting theory
course should be devoted to the main works of Professor Ijiri, especially his
AAA Monographs ---
http://aaahq.org/market/display.cfm?catID=5
However, given the tradeoffs
of the many topics that are important to accounting theory education, I think I
would devote less time to Yuji’s works than would Robert Walker since I don’t
think Yuji addressed many of our current theoretical problems. Robert Walker
would pretty much begin and end an accounting theory course with the Ijiri
monographs.
Robert Walker is a fine
accounting historian and theorist who asked me to share the following with you.
I admit that my own interest
in theory are probably wider. I’m also inclined with respect to accounting
theory to also focus on issues of operations and implementation. We can always
assume non-existent worlds filled with idealized inhabitants that we program.
Andy way we like But that’s probably theory best left to economists.
From:
Robert Bruce Walker [mailto:walkerrb@actrix.co.nz] Sent: Wednesday, March 31, 2010 9:42 PM To: Jensen, Robert Subject: RE: Accounting Theory Courses
I am not trying to
operationalise ‘triple entry’ bookkeeping. This is ijiri’s ‘bridge too far’
(even a genius, for that is what he is, can be mistaken). Knowing the flaws
of historical cost, he attempted to introduce a third element which
accommodated the future (‘momentum’). In doing so he violated the beauty of
the algebraic formulation that double entry is
I have attempted to
express ‘momentum’ in double entry form – that is, I don’t look to the AAA
study on ‘triple entry bookkeeping’ (which, frankly, is nonsense and an
abject failure) but to the alternative valuation analysis in Theory of
Accounting Measurement. The idea of ‘momentum’ is to try to predict the
future from the past. That is not possible because it pre-supposes that
there is an essential continuity. It cannot take account of what is now
referred to as the ‘black swan’ phenomenon – the wholly unpredictable and
unexpected event. At best the accountant can only lay out the value
propositions that are an attempt to predict the future and adjust them for
discontinuities. The arrival of the black swan is, hopefully, not so
momentous an event as to over-whelm the entity whose accounting is being
carried out. The equity buffer is there for that purpose – to accommodate
the unexpected.
For instance, even in the
example of life insurance where actuarial practice is (a) most precise and
(b) most certain (everybody dies) the actuary cannot take account of events
that have not arisen before. They cannot predict a plague which would
fundamentally alter the stochastic data. All they can do is introduce a
prudential margin (see IAS36.30). Even then it may not be enough and even
then a dangerous thing to do as it under-states equity.
I would go so far as to
say that concepts such as irrationality are not amenable to any real or
sensible mathematical formulation. If it cannot be expressed in that form
it cannot be expressed in accounting notation. It is therefore not the
business of accounting. Perhaps my theory of accounting, if it is a theory
at all, ultimately teaches this – accounting needs to be much more modest in
its ambition. It deals only in money and money’s worth. If it cannot, it
is not practical to express it in money then it shouldn’t be expressed.
Take your concern with
contingent liability (or better provisional liability) it is simply absurd
to predict the outcome of the judicial process when dealing in matters of
tort (as you know these days that is how I make my living and I wouldn’t
even attempt to quantify my future ‘winnings’). A written narrative is all
that you can hope to achieve in such matters. If that understates
liabilities, so be it. As I say that is what equity (ownership interest) is
for.
It might not surprise for
me to claim that my theories are based in Friedrich Nietzsche. Consider
this:
I walk among men as among fragments of the
future; of that future which I scan.
And it is all my
art and aim, to compose into one and bring together that which is fragment, and
riddle and dreadful chance.
For how could I
endure to be a man; if man were not poet and reader of riddles and the redeemer
of chance!
To redeem the
past; to turn every ‘it was’ into ‘I wanted it thus’. That alone would I call
redemption.
Friedrich
Nietzsche Thus Spoke Zarathustra.
You wish to read the
‘fragments of the future’. A Promethean task I think. You cannot ever deal
with ‘dreadful chance’ until it is upon you. Then all you can do is redeem
it. It is foolhardy even an act of hubris to think otherwise. Accounting
can never do what you want it to do. In the end it is about limits, limits
to ambition.
Robert (jensen)
PS I hope your wife is
OK. It is illness, on a human scale, that is ‘dreadful chance’.
PSS Your colleagues might
consider, along with Ijiri, Nietzsche as the foundation to a course of
theory. His book Beyond Good and Evil has a sub-title ‘Towards a Philosophy
of the Future’.
From:
Jensen, Robert [mailto:rjensen@trinity.edu] Sent: Thursday, 1 April 2010 10:26 a.m. To: Robert Bruce Walker Subject: RE: Accounting Theory Courses
Hi Robert (Walker),
I think I understand the
swap, but I cannot connect to Ijiri with this illustration. The revaluations
are given, but they do not relate to force or momentum. That would take a
mathematical model of the future valuations, but this cannot be predicted.
If it could there would be no swap. The party and the counterparty have
different predictions of the future
Bookkeeping in the Ancient Arab Culture and Commerce
Hi Robert,
Thank you very much for this great historical information.
Robert E. (Bob) Jensen Trinity University Accounting Professor (Emeritus) 190
Sunset Hill Road Sugar Hill, NH 03586 Tel. 603-823-8482 www.trinity.edu/rjensen
-----Original Message-----
From: Robert Bruce Walker
[walkerrb@ACTRIX.CO.NZ]
Sent: Thursday, June 10, 2010 5:01 PM
Professor ten Have in his book History of
Accountancy states:
"In this Arabic culture, bookkeeping had already
reached a high level of development. The administration of the customs, some
fragments of which have been preserved, included already a general ledger,
general journal and cash book; the system of monthly and annual closing was
known. In the State budget of 918, which is available, a distinction is made
between current and extraordinary expenditure. In Palermo, Sicily, a well
developed bookkeeping system has been found dating back to 1135; this shows
Arab influence. There is available an Arab manual dealing with the
merchandise trade at the end of the 12th century. This book was printed in
1318.
Accordingly, an assumption is that the Arabs
influenced the development of bookkeeping in Italy has a very strong
foundation; however, it has not been validated to this day" (page 31)
He then cites some European writer (Dr S Elzinga)
writing other than in English which rather cuts off a monolingual persons
such a myself. I have other material, some of which you have sent me, which
suggest that double entry was present in the Nile to the Oxus region for
more than 1000 years. There is a suggestion that it actually comes from
India - this is consistent with the origins of the Arabic numeral (the
positional number system) and of algebra itself, both of which seem to come
from India. The Arabs as the great medieval traders had links to India -
Muhammad himself apparently went there on a trading mission.
The trouble with double entry is that it is always
present as a concept whether the person preparing the record knew it or not.
I think it evolved gradually and imperceptibly. But my contention is that
Arab commerce would not have been possible without it.
The best general description of the foundations of
Islamic culture that I have found is that by Professor Hodgson, previously a
professor of history at Chicago (now long dead), in his 3 volume The Venture
of Islam. The work is absolutely breath taking in its scope but doesn't give
too much about the commercial culture prior to the life of Muhammad.
However, he does describe why Mecca was sited where it was. It did not have
a lot going for it as it did not have much of an oasis. What it did have was
a defensible position and reasonably proximity to a port. For this reason it
became an important trade link between India, SE Asia and China beyond that
and Constantinople and other European destinations. These trade routes were
well established in the 7th century. In short Mecca, whilst it did have a
shrine prior to Islam, was really dependent upon commerce at the time of
Muhammad. The area from the Nile to the Oxus (Professor Hodgon's substitute
for the Middle East) must be seen as the crucible of the mechanics of modern
commerce. It was the cross road between the West and the East.
As may be apparent from what I say I am writing my
version of the history of accounting. I am doing so in accordance with my
version of the Nietzschean genealogical method. Which means of course that I
can write pretty much what I want for Nietzsche says that history is better
understood as myth rather than by the traditional archival methods. So
perhaps I am writing a myth of accounting. At the risk of appearing pompous,
it is as much the philosophy of accounting as anything else. I hope by my
trawl through history and thought to inform the current day problems of
accounting by tracing their genealogy as it were.
I am not writing in sequence. I have started with
the Italians then back to the Arabs which I am working on - and having to
fill large gaps in my knowledge for I too have been educated in an
ethnocentric manner. I am writing the major piece which ends the book - that
is a discussion of solvency. For this I am researching American bankruptcy
law - the National Bankruptcy Act 0f 1898 being the pivot for this
particular piece. What is so peculiar about the US is that the law on
solvency (or otherwise) is entirely a legal pursuit, not informed by
accounting in any way. That is the reason the case law never solves the
problem. There are two strands in the US - one law, one accounting - both
groping their way towards solving the most important accounting issue - that
of solvency determination. Yet neither of them intersects. We in New Zealand
20 years ago discarded our British model for company law and took the
American solvency approach by way of Canada. Whether from some conscious
plan or not solvency determination in NZ was expressly linked to GAAP. Our
law is now filtering into Europe.
As an aside, it is worth noting that national
bankruptcy law in the US is sanctioned by the Constitution itself. The
history of the development of the law through the 19th century is a
fascinating subject unto itself and which has led to the absurdly debtor
friendly Chapter 11. But there is a limit to what I can do.
Robert Bruce Walker
New Zealand
-----Original
Message-----
From: Robert Bruce Walker
[walkerrb@ACTRIX.CO.NZ]
Sent: Friday, June 11, 2010 7:21 AM
Subject: History of Insolvency
Might I then continue by
telling you of the central significance of the National Bankruptcy Act of
1898. As I said it was the culmination of 100 years of law from the time of
the grant of Constitutional authority to Congress to make bankruptcy law.
The law making process would be reactivated each time there was an economic
convulsion. These laws had either sunset clauses or were repealed. Near
the end of the century a St Louis lawyer was commissioned to prepare an Act
that he would have had as debtor friendly. This was not acceptable to
Congress because it preferred rehabilitation to realization. Here lies the
foundation for Chapter 11.
Of more significance to the
accountant is the profound change to the definition of solvency. Hitherto
it had been simply 'to be able to pay debts as they fall due', a rather more
elusive idea than might first appear.
In any event the definition
was changed to one of a comparison between property (assets in accountant's
terms) and liabilities. There was a clause relating to the exclusion of
property fraudulently conveyed, but that is not significant in this
context. This definition has prevailed to this day in the 1978 albeit
modified in a crucial way in that it created an ambiguity tested in the TWA
case in about 1996.
I have summarized the above
from J Adriance Bush in an introduction the Act published in 1899. I got it
from Cornell University's website. Anyway Mr Bush comments that the
radically new solvency test would test the judiciary in years to come. That
has been so. It has culminated somewhat finally in the TWA case. It was
resolved that assets should be at fair value and the liabilities at face
value. This was because one side wanted the market price internalized into
the debt of TWA and another side didn't. And that some might be happy with
that. However, it does beg an important question:
what if there is a liability
but it has no face value? These are Bob's beloved financial instruments.
They can only be recognized by reference to a current interest rate as the
liabilities they absolutely are. If such liabilities are to be so
recognized, why would you apply a different rate to other liabilities? That
would mean more conventional liabilities - being say a bond issued - should
be measured at current rate to be consistent within the balance sheet. It
may sound strange at first, but it is the position adopted by FASB in
concept statement 7. It irritated me to begin with but I have now accepted
it as the right answer.
So we have a clash between
what accounting rules say and what lawyers say.
I think you American
accountants have abandoned the field. If the accountant is not the arbiter
of what is and what is not solvent, then what is he or she?
Brush up your Shakespeare:
Medieval manuscripts to hit Internet Stanford University
Libraries, the University of Cambridge and
Corpus Christi College, Cambridge, will make
hundreds of medieval manuscripts, dating
from the sixth through the 16th centuries,
accessible on the Internet.
"Medieval manuscripts to hit Internet,"
Stanford Report, July 13, 2005 ---
http://news-service.stanford.edu/news/2005/july13/parker-071305.html
Thank you for the notice about the availability of
the medieval manuscripts on the Internet through the project Parker on the
Web at Stanford University. Two manuscripts are currently available, and on
page 11 of the English translation of Matthew Paris's "English History From
1235 to 1273" I have already found references to accounting (see below).
Accountants are still using the principle "under
whatever name it may be called" and entities are still making up new names
for inconvenient economic events in the hopes of avoiding full disclosure.
At this Catholic liberal arts university
Shakespeare is modern, and the medieval world is revered, so I'm interested
in gaining some insight into the medieval worldview.
Barbara W. Scofield, PhD, CPA
Associate Professor of Accounting
University of Dallas
1845 E. Northgate Irving, TX 75062
Braniff 262
scofield@gsm.udallas.edu
...bankers'
checks written in Greek on papyri appeared in ancient Egypt as far
back as 250 B.C. Papyri preserved well in Egypt thanks to its arid
climate, but Goetzmann thinks it's safe to say such checks changed
hands throughout the Mediterranean world . . . So the whole
tradition of bank checks predates the current era and has its roots
at least in Hellenistic Greek times," he says.
From Harvard University: Accounting and Finance History of Lehman
Brothers Deal Books
Lehman Brothers Collection ---
http://www.library.hbs.edu/hc/lehman/
This guide provides information about the resources
available within the Lehman Brothers Collection, including both the deal
book collection and the business records.
Company pages in this guide give a summary of each
deal as well as a company history. Researchers can browse the Lehman
Brothers deal book collection via three access points: the date of the deal,
the company name at the time of the deal, or industry type.
Jensen Comment
For accounting history scholars there are various research opportunities
presented by this open sharing Harvard collection.
Going Concern and Accrual Accounting Evolved in
the 1500s
Venture accounting over the life of a venture with
interim statements evolved in The Netherlands
1673 Code of Commerce in France requires biannual
balance sheet reporting
Charge and Discharge Agency Responsibility and
Stewardship Accounting in English trust accounting
Limited liability Corporations (divorced
professional management from ownership shares)
1555 A.D. Russia Company
1600 A.D. East India Company
1670 A.D. Hudson's Bay Company
England's Joint Stock Companies Act of 1844
required depreciation accounting for railroads, mining, and manufacturing (although the
concept of depreciation dates back to Roman times).
Speculation Fever
Fraud and corruption festered and grew with the trading of joint stock, especially after
1600 A.D. The South Seas Company scandal (reporting stock sales as income and paying
dividends out of capital) led to England's Bubble Act in 1720 A.D. that focused on
misleading accounting practices that helped managers rip off investors, especially by
crediting stock sales to income.
The South Seas Company scandal
(reporting stock sales as income and paying dividends out of capital)
One of the earliest and probably the most famous accounting and
investment scandal was the South Sea Bubble in 1720 From the Harvard University Business School
Sunk in Lucre's Sordid Charms: South Sea Bubble Resources in the Kress
Collection at Baker Library ---
http://www.library.hbs.edu/hc/ssb/
Another
excellent effort – thanks. It did not take me long before I discovered a
gem. This claim is of fundamental importance
The
detachment of reporting from accounting began here it would seem.
There is
just one thing I don’t understand. The text I found by following the link
says the author is a man named Odlyzko. Presumably that was the second
error?
A nice timeline on the development of
U.S. standards and the evolution of thinking about the income statement versus
the balance sheet is provided at:
"The Evolution of U.S. GAAP: The Political Forces Behind Professional
Standards (1930-1973)," by Stephen A. Zeff, CPA Journal, January 2005
---
http://www.nysscpa.org/cpajournal/2005/105/infocus/p18.htm
Part II covering years 1974-2003
published in February 2005 ---
http://archives.cpajournal.com/
Laissez-Faire Accounting survived endless debates
and scandals until the Great Depression in 1933
Much of the debate focused on capital maintenance
(e.g., failure to charge off depreciation and failure to provide for replacement of
operating assets), but governments did not legally impose auditing requirements and
serious GAAP until the U.S. securities laws in the early 1930s. Accountants were
vocal in reform movements, but governments were slow to react with legislation and courts
failed to establish consistent GAAP.
Creation of the SEC in an effort to regain public
trust in financial reporting and equity investing.
Many firms did have independent audits and
conformed to the best GAAP traditions of the day (thereby giving
some evidence that Agency Theory works sometimes.) Agency theory
hypothesizes that it is in the best interest of management to contract for protection of
investors and avoid scandalous asymmetries of information.
After 1933, the AICPA and the SEC seriously
attempted to generate accounting standards, enforce accounting standards, and provide
academic justification for promulgated standards.
ASRs of the SEC
In a 3-2 vote the SEC followed George O. May's
efforts to mandate external audits of securities traded across state lines in the U.S.
1939-1959 A.D.: Accounting standards were
generated by the AICPA's Committee on Accounting Procedure (CAP) that issued Accounting
Research Bulletins (51 ARBs) --- but the tendency was to overlook controversial issues
such as off-balance sheet financing, public disclosure of management forecasts,
price-level accounting, current cost accounting, and exit value accounting.
Controversial items avoided by the CAP included management compensation accounting,
pension accounting, post-employment benefits accounting, and off balance sheet financing
(OBSF). The CAP did very little to restrain diversity of reporting.
1960-1972 A.D.: Accounting standards in the
U.S. were generated by the AICPA's Accounting Principles Board (APB) that had more members
than the CAP and a mandate to attack more controversial reporting issues. The APB
attacked some controversial issues but often failed to resolve their own disputes on such
issues as pooling versus purchase accounting for mergers.
1972-???? A.D. Accounting standards in the
U.S. were, and still are, being generated by the Financial Accounting Standards Board
(FASB) that has seven members, including required members from industry, academe, and
financial analysts in addition to members from public accountancy. FASB members must
divorce themselves from previous income ties and work full time for the FASB. The
formation of the FASB was a desperation move by CPA's to stave off threatened takeover of
accounting standards by the Federal Government (there were the Moss and Metcalf bills to
do just that under pending legislation in the U.S. House and Senate). Unlike the CAP
and APB, the FASB has a full-time research staff and has issued highly controversial
standards forcing firms to abide by pension accounting rules, capitalization of many
leases, and booking of many previous OBSF items (capital leases, pensions, post-employment
benefits, income tax accounting, derivative financial instruments, pooling accounting,
etc.). The road has been long and hard on some other issues where attempts to issue
new standards (e.g., expensing of dry holes in oil and gas accounting and booking of
employee stock options) have been thwarted by highly-publicized political pressuring by
corporations.
I recommend the book “More than a numbers game – a
brief history of accounting”, by Thomas A. King. Mr. King traces the
development of our accounting standards, from the railroad accounting era
through Enron. King describes the major accounting controversies in each
era. The reader gains an understanding of the differing points of view –
academic, management, enforcement, public accountants, internal accountants.
King writes clearly and is a good story teller, so the pace of the book is
fast.
I used the book in a senior level accounting
systems course last semester, covering all 15 chapters in 3 weeks. It would
be possible to go somewhat faster by jettisoning some chapters, without loss
of continuity. I am sure that all my 80 students learned from the book, and
most said they enjoyed learning some of the profession’s history. I liked it
because it allowed me to challenge students to think about what the nature
of our reporting system and of that system’s limitations. In their four
years, our students learn a lot of techniques and rules; the book puts these
into context and I liked the book for that reason, too.
Mr. King began his career in public accounting. He
is now Treasurer of Progressive Insurance.
Joe Brady
Accounting & MIS
Lerner College of Business & Economics
University of Delaware
A
decade ago, the near-simultaneous adoption of IFRS in over one hundred
countries could fairly have been described as a “brave new world” in
financial reporting. Any systems innovation, and especially an innovation of
such importance and magnitude, thrusts those involved (companies, users and
accountants) into the unknown. There was good reason to expect success,
based largely on widespread enthusiasm for international standards and,
behind that, recognition of the strong forces of globalization.
Nevertheless, there were risks involved and there was limited a priori
evidence to guide the decision makers. A decade later, this is still the
case. Globalization remains a potent economic and political force, and
drives the demand for globalization in accounting. Nevertheless, most
political and commercial activity remains local, so adoption of uniform
rules does not by itself lead to uniform reporting behavior around the
world. For many of the claimed benefits of IFRS adoption to be realized,
uniform implementation would have to occur in a wide range of countries,
which seems unlikely and requires more than simply creating regulatory
enforcement mechanisms. Some evidence of actual outcomes from IFRS adoption
has come to light but, as will be argued below, by and large the evidence to
date is not very useful. So IFRS adoption is an innovation of historical
proportions whose worldwide effects remain somewhat uncertain.
Jensen Comment
For earlier history of IFRS see
Stephen A. Zeff (2012) The Evolution of
the IASC into the IASB, and the Challenges it Faces.
The Accounting Review: May 2012, Vol. 87, No. 3,
pp. 807-837.
Editor's note: This
commentary, based on a lecture at the 2011
American Accounting Association Annual
Meeting in Denver, CO, was invited by Senior
Editor John Harry Evans III, consistent with
the AAA Executive Committee's goal to
promote broad dissemination of the AAA
Presidential Scholar Lecture.
I have drafted this
paper based on my Presidential Scholar
address at the American Accounting
Association Annual Meeting on August 10,
2011 in Denver, Colorado. I gratefully
acknowledge the comments on earlier drafts
by Kees Camfferman, Jim Leisenring, Harry
Evans, Paul Pacter, and Kay Stice. I am
solely responsible for what remains.
ABSTRACT:
In
this article, I undertake to review the
major developments and turning-points in
the evolution of the IASC, followed by
the evolution of the IASB. At the
conclusion, I suggest five challenges
facing the IASB.
Jensen Comment
Also See Financial Reporting and Global Capital Markets:
A History of the International Accounting Standards Committee, 1973-2000
by Kees Camfferman and Stephen A. Zeff
ISBN-13: 978-0199296293
ISBN-10: 0199296294
Oxford University Press; First Edition (May 17, 2007)
The 'Australian Accounting Review' has
recently published a special edition that marks the 10th anniversary of the
International Accounting Standards Board (IASB) with research papers
exploring the impact of IFRS on standard setting, financial reporting
practice and accounting education from the perspectives of standard setters,
practitioners and academics. Among the articles are contributions by Warren
McGregor, IASB Board member for ten years, Kevin Stevenson, AASB Chairman,
and Paul Pacter, IASB Board member and former IAS Plus webmaster.
The special edition of the Australian Accounting
Review, a leading practitioner-focused journal, appears in two parts: in the
September and December 2012 issues.
Jensen Comment
At the 2011 AAA Annual Meetings, Steve Zeff made an outstanding historical
presentation entitled"
"The Evolution of the IASC into the IASB, and the Challenges It Faces"
For AAA members with access to the AAA Commons, a video of the entire
presentation is available at
http://commons.aaahq.org/posts/e4ea41e4f4
September 8, 2012 Comment by K. Ramesh
For purpose of full disclosure, Steve is my
colleague! The speech was simply phenomenal. It was much more than a
chronology of easily searchable events, but a thoughtful integration of
various facts and circumstances that resulted in today’s IASB. I am so lucky
to be able to walk a few doors down the hallway to get answers to any
questions that I have on the history of financial reporting regulation.
The non-free FASB comparison study of all standards entitled The IASC-U.S.
Comparison Project: A Report on the Similarities and Differences between IASC
Standards and U.S. GAAP
SECOND EDITION, (October 1999) athttp://stores.yahoo.com/fasbpubs/publications.html
In 1999 the Joint Working Group of the Banking
Associations sharply rebuffed the IAS 39 fair value accounting in two white
papers that can be downloaded from http://www.iasc.org.uk/frame/cen3_112.htm.
Financial Instruments: Issues Relating to Banks
(strongly argues against required fair value adjustments of financial
instruments). The issue date is August 31, 1999.
Trinity University students may view this paper at J:\courses\acct5341\iasc\jwgbaaug.htm.
Others may Go to the IASC download site at http://www.iasc.org.uk/pix/banksjwg.pdf.
Accounting for financial Instruments for Banks (concludes
that a modified form of historical cost is optimal for bank accounting).
The issue date is October 4, 1999
Trinity University students may view this paper at J:\courses\acct5341\iasc\jwgfinal.htm
Others may Go to the IASC download site at
http://www.iasc.org.uk/pix/jwgfinal.pdf.
Also see the Financial Accounting Standards Board (FASB)
and the International Federation of Accountants Committee (IFAC).
I remember a thread or two asking for information
on historical figures or accounting heros or something like that. I couldn't
come up with the right key words to find it by searching the archives
unfortunately.
When I saw this article, I thought this was someone that should be included:
"Mary T. Washington of Chicago stepped bravely beyond race and gender
boundaries in 1943, becoming the first black female certified public
accountant in the United States. Washington, 99 years old when she died in
late July, first opened an accounting practice for African-American clients
in her basement while working on her college degree.
Washington lived and led in a world not yet here, creating what her business
partner later called an "underground railroad" for aspiring black CPAs.
...."
Although there are probably various interesting sites such as those you
mentioned, there are several sites that are of particular interest with
respect to famous accounting practitioners and academics.
The OSU Accounting Hall of Fame
It should be noted that members elected to this Hall of Fame include famous
accountants from around the world ---
http://fisher.osu.edu/acctmis/hall/
U.K. Accounting Hall of Fame
Professors David Otley and Ken Peasnell of the Department of Accounting and
Finance are two of the fourteen founding members of the British Accounting
Association’s Hall of Fame. The ceremony took place at the British
Accounting Association 2004 Annual conference at York in April 2004 ---
http://www.lums.lancs.ac.uk/news/3806/
Michigan State Video Archive
I've not yet seen anything about other accounting Hall of Fame sites.
Michigan State University has a video archive of famous accountants. These
accountants were invited to campus and then taped live. I don't think any of
this footage is available online, but it would be a nice thing to do now
that digitization hardware is so inexpensive. Don Edwards (U. of Georgia)
probably knows more about these videos than anybody else.
Here is a historical figure for consideration.
While not a CPA, Luca Pacioli is considered to be the father of accounting.
Although he did not invent dual-entry accounting, he described the system as
we know it today. I always use this question on my tests.
One of the early contributors to value theory in accounting was Theodore
Limperg from Holland.
The social responsibility of the auditor: A basic theory on the auditor's
function by Theodore Limpberg ((Hard to Find, but no doubt Steve Zeff
has a copy. Steve is an expert on accounting in The Netherlands). A copy no
doubt is also on file at the Accounting History Libraries at the University of
Mississippi (Ole Miss) ---
http://www.olemiss.edu/depts/accountancy/libraries.html
The Business and Economics Library at Columbia
University has digitized 770 historic corporate annual reports from their
very extensive print collection. The reports are from 36 companies, and they
range in dates from the 1850s to the 1960s, and are mainly from
"corporations that operated in and around New York City." Visitors can
search for the reports through an "Alphabetical List" or "Subject List", or
browse by clicking on "View the Full List (XLS)". The "Sample Images" that
are featured in the lower right hand corner of the homepage are from "Edison
Electric Illuminating" and "Hudson & Manhattan Railroad Company". Once
visitors choose an image to view, they will be able to view all of the
years' digitized reports for that corporation, by clicking on the "Table of
Contents" dropdown box. Visitors shouldn't miss the greatly detailed
illustration from 1911 of the "Hudson Terminal Buildings", which is one of
the chosen "Sample Images".
Question
How does accounting for time differ from accounting for money?
Remember those
Taylor
and
Gilbreth time and motion studies in cost accounting.
How has time accounting changed in the workplace (or should change)?
The link below was forwarded by Gregory Morrison at Trinity University
Studies have shown the alarming extent of the
problem: office workers are no longer able to stay focused on one specific task
for more than about three minutes, which means a great loss of productivity. The
misguided notion that time is money actually costs us money.
"Time Out of Mind," by Stefan Klein, The New York Times, March 7,
2008 ---
Click Here
In 1784, Benjamin Franklin composed a satire,
“Essay on Daylight Saving,” proposing a law that would oblige Parisians to
get up an hour earlier in summer. By putting the daylight to better use, he
reasoned, they’d save a good deal of money — 96 million livres tournois —
that might otherwise Go to buying candles. Now this switch to daylight
saving time (which occurs early Sunday in the United States) is an annual
ritual in Western countries.
Even more influential has been something else
Franklin said about time in the same year: time is money. He meant this only
as a gentle reminder not to “sit idle” for half the day. He might be
dismayed if he could see how literally, and self-destructively, we take his
metaphor today. Our society is obsessed as never before with making every
single minute count. People even apply the language of banking: We speak of
“having” and “saving” and “investing” and “wasting” it.
But the quest to spend time the way we do money is
doomed to failure, because the time we experience bears little relation to
time as read on a clock. The brain creates its own time, and it is this
inner time, not clock time, that guides our actions. In the space of an
hour, we can accomplish a great deal — or very little.
Inner time is linked to activity. When we do
nothing, and nothing happens around us, we’re unable to track time. In 1962,
Michel Siffre, a French geologist, confined himself in a dark cave and
discovered that he lost his sense of time. Emerging after what he had
calculated were 45 days, he was startled to find that a full 61 days had
elapsed.
To measure time, the brain uses circuits that are
designed to monitor physical movement. Neuroscientists have observed this
phenomenon using computer-assisted functional magnetic resonance imaging
tomography. When subjects are asked to indicate the time it takes to view a
series of pictures, heightened activity is measured in the centers that
control muscular movement, primarily the cerebellum, the basal ganglia and
the supplementary motor area. That explains why inner time can run faster or
slower depending upon how we move our bodies — as any Tai Chi master knows.
Time seems to expand when our senses are aroused.
Peter Tse, a neuropsychologist at Dartmouth, demonstrated this in an
experiment in which subjects were shown a sequence of flashing dots on a
computer screen. The dots were timed to occur once a second, with five black
dots in a row followed by one moving, colored one. Because the colored dot
appeared so infrequently, it grabbed subjects’ attention and they perceived
it as lasting twice as long as the others did.
Another ingenious bit of research, conducted in
Germany, demonstrated that within a brief time frame the brain can shift
events forward or backward. Subjects were asked to play a video game that
involved steering airplanes, but the joystick was programmed to react only
after a brief delay. After playing a while, the players stopped being aware
of the time lag. But when the scientists eliminated the delay, the subjects
suddenly felt as though they were staring into the future. It was as though
the airplanes were moving on their own before the subjects had directed them
to do so.
The brain’s inclination to distort time is one
reason we so often feel we have too little of it. One in three Americans
feels rushed all the time, according to one survey. Even the cleverest use
of time-management techniques is powerless to augment the sum of minutes in
our life (some 52 million, optimistically assuming a life expectancy of 100
years), so we squeeze as much as we can into each one.
Believing time is money to lose, we perceive our
shortage of time as stressful. Thus, our fight-or-flight instinct is
engaged, and the regions of the brain we use to calmly and sensibly plan our
time get switched off. We become fidgety, erratic and rash.
Tasks take longer. We make mistakes — which take
still more time to iron out. Who among us has not been locked out of an
apartment or lost a wallet when in a great hurry? The perceived lack of time
becomes real: We are not stressed because we have no time, but rather, we
have no time because we are stressed.
Studies have shown the alarming extent of the
problem: office workers are no longer able to stay focused on one specific
task for more than about three minutes, which means a great loss of
productivity. The misguided notion that time is money actually costs us
money.
And it costs us time. People in industrial nations
lose more years from disability and premature death due to stress-related
illnesses like heart disease and depression than from other ailments. In
scrambling to use time to the hilt, we wind up with less of it.
Pondering your question, I keep coming back to a
humorous story I read in Reader's Digest years ago. A person's car breaks
down and a mechanic with a fine reputation is summoned. The mechanic looks
over the engine, pulls out a screwdriver, and in about three seconds
tightens a screw. The mechanic then hands the driver a bill for several
hundred dollars. The driver complains about paying so much for so little of
the mechanic's time. The mechanic replies that the itemization was $0.10
for the act of tightening the screw, and hundreds of dollars for knowing
what to tighten.
At this time I refrain from saying much about the Empire Club and it's
ability to charge thousands of dollars per hour for the time of its models.
I'm wondering if Governor Spitzer maintained personal financials according
to GAAP, would he have reported his time involvement with Empire Club as a
contingent liability.
Bob, you're retired and on pension, I'm still employed and getting paid.
The time you spend surfing, writing and sharing on AECM is unrecompensed,
but mine is not. Yet, you provide much more value to AECM than I.
Arrington, C E and W Schweiker (1992), “The Rhetoric and Rationality of
Accounting Research”, Accounting, Organizations and Society , v 17, pp 511 -
533
Accounting Theory as Rhetoric
Rhetoric is an old discipline dating back to the fourth century BC. Its
contemporary meaning is the art of persuasive communications and eloquence.
Some time ago Arrington and Francis pointed out that:
Every author attempts to persuade (or
perhaps seduce) readers into accepting his or her text as believable.
(1989, p 4) It is important to note here the terms author, persuade and
text.
The author will subjectively select the rhetorical
devices she or he feels will be most useful in persuading others of a
particular position. The word text is widely used and means more than a
written document – it now refers to many other things in which meanings are
being conveyed such as films, speeches, advertisements, instruction manuals,
conversation and, of course, financial reports.
As indicated in Gaffikin (2005a), Mouck (1992)
demonstrated how positive accounting theorists employed several rhetorical
devices to persuade others that positive accounting theory is the only way
to truth. Rhetoric is most commonly encountered in literary studies,
however, in 1980 McCloskey published a paper in the Journal of Economic The
Critique of Accounting Theory, p16 Literature entitled “The Rhetoric of
Economics” which spawned a new movement in economics, consistent with
similar movements in other social sciences, which has seen rhetoric as an
alternative to positivist epistemology ††† . Whereas epistemology is based
on a set of established abstract criteria, rhetoricians hold that truth
emerges from within specific practices of persuasion.
One of McCloskey’s primary aims was to draw the
attention of economists to how they use language and how language shapes
their theories. Similarly, Arrington and Francis seek to show how “the
prescriptions of positive theory function linguistically rather than
foundationally and cannot purge themselves of the rhetorical and ideological
commitments” (1989. p 5). Arrington and Francis move beyond a simplistic
analysis of language and draw on the work of Derrida to make their case.
Derrida’s work is highly complex and extends the discussion of signs and
language to extremes. His concern is with deconstructing the text. That is,
unpacking the text “to reveal, first, how any such central meaning was
constructed, and, second, to show how that meaning cannot be sustained”
(Macintosh, 2002, p 41).
Largely due to its complexity and its controversial
reception by some quarters of the academic community there have been very
few studies in accounting drawing on Derrida’s work. However, his central
message that language cannot be the unambiguous carrier of truth that is
assumed in many methodological positions should never be forgotten or
overlooked. As with other poststructuralists, Derrida saw all knowledge as
textual – comprised of texts. Derrida believed that all western thought is
based on centres. In this sense, a centre was a “belief” from which all
meanings are derived; that which was privileged over other “beliefs”. For
example, most western societies are based (centred) on Christian principles.
Perhaps it could be st ated that accounting is centred on capitalist
ideology. Deconstruction usually involves decentering in order to reveal the
problematic nature of centres. So, it could be argued that many accounting
problems arise from problems with capitalism – it has changed so mu ch over
the years that it is hard to be precise. Another example could be the way so
much accounting thought has been centred on historical cost measurement. In
many di scussions over the years, until recently, it has been “assumed” that
historical cost is the basis for measuring accounting transactions.
Therefore, advocates of alternative measurement bases were viewed as if they
were heretics.
Accounting Theory as Hermeneutics
Hermeneutics is the study of in terpretation and meaning and, as a formal
discipline, was initially used several hundred years ago by biblic al
scholars interpreting biblical texts. In McCloskey later expanded the
argument and published a book by the same name: The Rhetoric of Economics ,
University of Wisconsin Press, 1998. Other economic rhetoricians have
criticized that work as being too conservative and deferential to
neoclassical economics and have greatly extended the arguments of the
rhetoric of economics movement; for example, James Arnt Aune’s Selling the
Free Market: The Rhetoric of Economic Correctness , New York: The Guilford
Press, 2001. Arnt Aune’s argues, like Mouck (1992) that neoclassical have
resorted to various rhetorical devices to sell the idea of the free market
but he goes further by demonstrating that politicians and commentators
(including novelists) have also rhetorically contributed to the selling of
liberalisation, privatisation, globalisation and transnationalisation (ie
the free market and minimum political intervention) economic (and social)
policies.
Last week, while rushing to finish up a review of
Francois Cusset’s French Theory: How Foucault, Derrida, Deleuze, & Co.
Transformed the Intellectual Life of the United States (University of
Minnesota Press), I heard that Stanley Fish had just published a
column about the book for The New York Times.
Of course the only sensible thing to do was to ignore this development
entirely. The last thing you need when coming to the end of a piece of work
is to go off and do some more reading. The inner voice suggesting
that is procrastination disguised as conscientiousness. Better, sometimes,
to trust your own candlepower — however little wax and wick you may have
left.
Once my own cogitations were complete (the piece
will run in the next issue of Bookforum), of course, I took a look at the
Times Web site. By then, Fish’s column had drawn literally hundreds of
comments. This must warm some hearts in Minnesota. Any publicity is good
publicity as long as they spell your name right — so this must count as
great publicity, especially since French Theory itself won’t actually be
available until next month.
But in other ways it is unfortunate. Fish and his
interlocutors reduce Cusset’s rich, subtle, and paradox-minded book (now
arriving in translation) into one more tale of how tenured pseudoradicalism
rose to power in the United States. Of course there is always an audience
for that sort of thing. And it is true that Cusset – who teaches
intellectual history at the Institute d’Etudes Politiques and at Reid
Hall/Columbia University, in Paris – devotes some portions of the book to
explaining American controversies to his French readers. But that is only
one aspect of the story, and by no means the most interesting or rewarding.
When originally published five years ago, the cover
of Cusset’s book bore the slightly strange words French Theory. That the
title of a French book was in English is not so much lost in translation as
short-circuited by it. The bit of Anglicism is very much to the point: this
is a book about the process of cultural transmission, distortion, and
return. The group of thinkers bearing the (American) brand name “French
Theory” would not be recognized at home as engaged in a shared project, or
even forming a cohesive group. Nor were they so central to cultural and
political debate there, at least after the mid-1970s, as they were to become
for academics in the United States. So the very existence of a phenomenon
that could be called “French Theory” has to be explained.
To put it another way: the very category of “French
Theory” itself is socially constructed. Explaining how that construction
came to pass is Cusset’s project. He looks at the process as it unfolded at
various levels of academic culture: via translations and anthologies, in
certain disciplines, with particular sponsors, and so on. Along the way, he
recounts the American debates over postmodernism, poststructuralism, and
whatnot. But those disputes are part of his story, not the point of it.
While offering an outsider’s perspective on our interminable culture wars,
it is more than just a chronicle of them..
Instead, it would be much more fitting to say that
French Theory is an investigation of the workings of what C. Wright Mills
called the “cultural apparatus.” This term, as Mills defined it some 50
years ago, subsumes all the institutions and forms of communication through
which “learning, entertainment, malarky, and information are produced and
distributed ... the medium by which [people] interpret and report what they
see.” The academic world is part of this “apparatus,” but the scope of the
concept is much broader; it also includes the arts and letters, as well as
the media, both mass and niche.
The inspiration for Cusset’s approach comes from
the French sociologist Pierre Bourdieu, rather than Mills, his distant
intellectual cousin from Texas. Even so, the book is in some sense more
Millsian in spirit than the author himself may realize. Bourdieu preferred
to analyze the culture by breaking it up into numerous distinct “fields” –
with each scholarly discipline, art form, etc. constituting a separate
sub-sector, following more or less its own set of rules. By contrast, Cusset,
like Mills, is concerned with how the different parts of American culture
intersect and reinforce one another, even while remaining distinct. (I
didn’t say any of this in my review, alas. Sometimes the best ideas come as
afterthoughts.)
The boilerplate account of how poststructuralism
came to the United States usually begins with visit of Lacan, Derrida, and
company to Johns Hopkins University for a conference in 1966 – then never
really imagines any of their ideas leaving campus. By contrast, French
Theory pays attention to how their work connected up with artists,
musicians, writers, and sundry denizens of various countercultures. Cusset
notes the affinity of “pioneers of the technological revolution” for certain
concepts from the pomo toolkit: “Many among them, whether marginal academics
or self-taught technicians, read Deleuze and Guattari for their logic of
‘flows’ and their expanded definition of ‘machine,’ and they studied Paul
Virilio for his theory of speed and his essays on the self-destruction of
technical society, and they even looked at Baudrillard’s work, in spite of
his legendary technological incompetence.”
And a particularly sharp-eyed chapter titled
“Students and Users” offers an analysis of how adopting a theoretical
affiliation can serve as a phase in the psychodrama of late adolescence (a
phase of life with no clearly marked termination point, now). To become
Deleuzian or Foucauldian, or what have you, is not necessarily a step along
the way to the tenure track. It can also serve as “an alternative to the
conventional world of career-oriented choices and the pursuit of top grades;
it arms the student, affectively and conceptually, against the prospect of
alienation that looms at graduation under the cold and abstract notions of
professional ambition and the job market....This relationship with knowledge
is not unlike Foucault’s definition of curiosity: ‘not the curiosity that
seeks to assimilate what it is proper for one to know, but that which
enables one to get free of oneself’....”
Much of this will be news, not just to Cusset’s
original audience in France, but to readers here as well. There is more to
the book than another account of pseudo-subversive relativism and neocon
hyperventilation. In other words, French Theory is not just another Fish
story. It deserves a hearing — even, and perhaps especially, from people who
have already made up their minds about “deconstructionism,” whatever that
may be.
Jensen Comment
It's pretty difficult to trace these French theories to accounting research and
scholarship, but the leading accounting professor trying to do so is probably my
former doctoral student Ed Arrington who even moved to Europe for a while to
carry on his studies in these theories ---
http://www.uncg.edu/bae/acc/accfacul.htm#arrington
A Google search turns up some of his publications in this area as they relate
to accounting, economics, and business. His publications also branch off into
other areas since Ed has wide ranging interests and is an excellent speaker as
well as a researcher and writer. His thesis was an application of the Analytic
Hierarchy Process in decision modelling, but he's expanded well beyond that
since he got his PhD.
http://en.wikipedia.org/wiki/Analytic_Hierarchy_Process
For years my interests and publications were in AHP, although in latter years I
was mostly critical of Saaty's precious and arbitrary eigenvector mathematical
scaling (but I was not critical of Ed's thesis).
This is also why the financial masters of the
universe tend not to write books. If you have been proved—proved—right, why
bother? If you need to tell it, you can’t truly know it. The story of David
Einhorn and Allied Capital is an example of a moneyman who believed, with
absolute certainty, that he was in the right, who said so, and who then
watched the world fail to react to his irrefutable demonstration of his own
rightness. This drove him so crazy that he did what was, for a hedge-fund
manager, a bizarre thing: he wrote a book about it.
The story began on May 15, 2002, when Einhorn, who
runs a hedge fund called Greenlight Capital, made a speech for a
children’s-cancer charity in Hackensack, New Jersey. The charity holds an
annual fund-raiser at which investment luminaries give advice on specific
shares. Einhorn was one of eleven speakers that day, but his speech had a
twist: he recommended shorting—betting against—a firm called Allied Capital.
Allied is a “business development company,” which invests in companies in
their early stages. Einhorn found things not to like in Allied’s accounting
practices—in particular, its way of assessing the value of its investments.
The mark-to-market accounting
that Einhorn favored is based on the price an asset would fetch if it were
sold today, but many of Allied’s investments were in small startups that
had, in effect, no market to which they could be marked. In Einhorn’s view,
Allied’s way of pricing its holdings amounted to “the
you-have-got-to-be-kidding-me method of accounting.” At the same time,
Allied was issuing new equity,
and, according to Einhorn, the revenue from this could
be used to fund the dividend payments that were keeping Allied’s investors
happy. To Einhorn, this looked like a potential
Ponzi scheme.
The next day, Allied’s stock dipped more than
twenty per cent, and a storm of controversy and counter-accusations began to
rage. “Those engaging in the current misinformation campaign against Allied
Capital are cynically trying to take advantage of the current post-Enron
environment by tarring a great and honest company like Allied Capital with
the broad brush of a Big Lie,” Allied’s C.E.O. said. Einhorn would be the
first to admit that he wanted Allied’s stock to drop, which might make his
motives seem impure to the general reader, but not to him. The function of
hedge funds is, by his account, to expose faulty companies and make money in
the process. Joseph Schumpeter described capitalism as “creative
destruction”: hedge funds are destructive agents, predators targeting the
weak and infirm. As Einhorn might see it, people like him are especially
necessary because so many others have been asleep at the wheel. His book
about his five-year battle with Allied, “Fooling Some of the People All
of the Time” (Wiley; $29.95), depicts analysts, financial journalists,
and the S.E.C. as being culpably complacent. The S.E.C. spent three years
investigating Allied. It found that Allied violated accounting guidelines,
but noted that the company had since made improvements. There were no
penalties. Einhorn calls the S.E.C. judgment “the lightest of taps on the
wrist with the softest of feathers.” He deeply minds this, not least because
the complacency of the watchdogs prevents him from being proved right on a
reasonable schedule: if they had seen things his way, Allied’s stock price
would have promptly collapsed and his short selling would be hugely
profitable. As it was, Greenlight shorted Allied at $26.25, only to spend
the next years watching the stock drift sideways and upward; eventually, in
January of 2007, it hit thirty-three dollars.
All this has a great deal of resonance now,
because, on May 21st of this year, at the same charity event, Einhorn
announced that Greenlight had shorted another stock, on the ground of the
company’s exposure to financial derivatives based on dangerous subprime
loans. The company was Lehman Brothers. There was little delay in Einhorn’s
being proved right about that one: the toppling company shook the entire
financial system. A global cascade of bank
implosions ensued—Wachovia, Washington Mutual, and the Icelandic banking
system being merely some of the highlights to date—and a global bailout of
the entire system had to be put in train. The
short sellers were proved right, and also came to be seen as culprits; so
was mark-to-market accounting, since it caused sudden, cataclysmic drops in
the book value of companies whose holdings had become illiquid. It is
therefore the perfect moment for a short-selling advocate of marking to
market to publish his account. One can only speculate whether Einhorn would
have written his book if he had known what was going to happen next. (One of
the things that have happened is that, on September 30th, Ciena Capital, an
Allied portfolio company to whose fraudulent lending Einhorn dedicates many
pages, went into bankruptcy; this coincided with a collapse in the value of
Allied stock—finally!—to a price of around six dollars a share.) Given the
esteem with which Einhorn’s profession is regarded these days, it’s a little
as if the assassin of Archduke Franz Ferdinand had taken the outbreak of the
First World War as the timely moment to publish a book advocating
bomb-throwing—and the book had turned out to be unexpectedly persuasive.
While leading Price Waterhouse, he called for
regulation of then-Big Eight public accounting firms, stated that auditors
duck responsibility for fraud, and expressed disapproval of the work of the
FASB.
Before reading this you might want to read
the biography of a former Price Waterhouse CEO and United Nations
Under-Secretary-General for Management named Joseph E. Connor ---
http://www.un.org/News/ossg/sg/stories/connor_bio.html
From The Wall Street Journal Accounting
Weekly Review on May 26, 2009
TOPICS: Accounting,
Audit Firms, Auditing, Ethics, Public Accounting, Public Accounting Firms
SUMMARY: This
obituary describes a man who led Price Waterhouse prior to its merger with
Coopers & Lybrand, then went on to lead administration at the U.N.,
significantly improving its operational efficiencies. While leading Price
Waterhouse, he called for regulation of then-Big Eight public accounting
firms, stated that auditors duck responsibility for fraud, and expressed
disapproval of the work of the FASB.
CLASSROOM APPLICATION: The
article can be used to introduce the big public accounting firms, their role
in society and financial markets, and the leadership abilities that the
accounting and auditing professions can develop. The need for accountants'
and auditors' ethical strengths also can be made evident using this piece.
QUESTIONS:
1. (Introductory)
What firm did Mr. Connor, the subject of this obituary, lead? With what
other public accounting firm did Mr. Connor's firm merge?
2. (Introductory)
What are the names of the other large public accounting firms presently
operating in the U.S.?
3. (Advanced)
Consider Mr. Connor's position in 1978 that public accounting was "becoming
a semi-public institution." How are public accounting firms operated? How
are their operations regulated? Consider in particular, the public firms
that audit the companies that are publicly-traded on U.S. exchanges.
4. (Advanced)
Mr. Connor also argued that "auditors duck responsibility for fraud." What
steps must an auditor take when fraud is detected? Have those requirements
changed over time?
5. (Advanced)
When he moved to the U.N., Mr. Connor described the operation as
"precariously balanced" with "no capital and no reserves." What do these
statements mean?
6. (Advanced)
How difficult do you think it was for Mr. Connor to express the opinions he
stated during his career? How have his arguments borne out over time?
Reviewed By: Judy Beckman, University of Rhode Island
Joseph E. Connor, who died May 6 at age 77, was a
reform-minded chairman of Price Waterhouse & Co. who went on to lead a
restructuring at the United Nations as Undersecretary General for
Administration and Management.
At the U.N., where he served from 1994 to 2002, Mr.
Connor oversaw a reduction in staffing in what was generally seen by U.S.
officials as a bloated institution. Relations got so bad that the U.S. for
years underpaid its dues in protest until reforms instituted by Mr. Connor
led the U.S. to pay arrears in 1999. Mr. Connor's was a loud and insistent
voice that Washington pay up.
"His private-sector experience was invaluable,"
said former U.N. secretary general Kofi Annan, who credits Mr. Connor with
introducing modern management practices.
At Price Waterhouse, where Mr. Connor was chairman
for a decade starting in 1978, he became a lightning rod by advocating
increased public oversight of the "Big Eight" accounting firms that
dominated audits of public companies. "We must recognize that we have become
a semi-public institution," he told Fortune in 1978.
He testified on accounting rules before Congress
and was critical of the Financial Accounting Standards Board, a professional
rule-maker. He also urged that accountants should publicly reveal fraud when
they detected it in their clients' books.
"Auditors have been ducking responsibility for
fraud for too long," he told the Independent newspaper in 1988. He added
that when he had said such things publicly in the past, "I had to buy myself
a lot of lunches for some time afterwards."
As a freshly minted Columbia University M.B.A. in
1956, Mr. Connor went to work at Price Waterhouse in New York. He became a
partner in 1967 and was put in charge of the firm's Western U.S. operations
in 1975. There his responsibilities included overseeing the Price Waterhouse
partner who counted the votes for the Academy Awards, though he never knew
the winners in advance himself, family members say. His own practice
included auditing Exxon and the World Bank.
As Price Waterhouse chairman, Mr. Connor reduced
bureaucracy, even while the firm was doubling from 400 to 800 partners. In
1988, he was elected chairman of the Price Waterhouse World Firm, which
coordinates the activities of the company's local partnerships around the
globe.
"Our slogan since we began has been, 'Be strong in
the capital exporting countries,'" he told the Journal of Commerce in 1987,
adding that he was planning to promote business in Germany and Japan.
Experienced as he was with auditing top firms, Mr.
Connor found the U.N. a rude awakening. "I've never seen anything so
precariously balanced at this scale," he told the New York Times in 1995.
"There's no capital and no reserves." He was forced to divert money meant
for peacekeeping to staff salaries, and publicly compared such financial
legerdemain to a Ponzi scheme.
In addition to hectoring American officials into
paying the U.S.'s bills, Mr. Connor also proposed selling bonds based on
U.S. and other nations' U.N. obligations. The idea came to naught as the
U.N. charter doesn't envision dealing with financial markets.
The Bass Business History Collection at the University
of Oklahoma Libraries began in 1955, and since that time the collection has
grown to include books, videos, journals and oral histories. The oral histories
here include
24 interviews with business professors at the University
about everything from the time management studies of Frederick Taylor to the
development of organizational theory. Visitors can browse the alphabetical list
of interviewees on the right-hand side of the page, and they have the option of
listening to the interview or downloading it for later use. Also, visitors can
browse the interviews by key names, words, or subjects. Finally, users can opt
to sign up for updates when new interviews are added to this enticing
collection.
Radical Changes in Financial
Reporting
Yipes! Net earnings and eps will no longer be derived and presented. It's like
getting your kid's report card with summaries of his/her weekly activities and no
final grade
1. Deloitte was started in 1845 as an English firm
(Haskins & Sells was an American firm). Touche Ross too was started as an
English firm (Touche started practice in 1898, but two years later opened
Touche Ross Niven & Smart in the city).
2. Ernst & Ernst was started an an American firm,
but Whinney Murray was an English firm.
3. PW started an an English firm in 1874 (Price by
himself had started practice much earlier in 1849), Lybrand Ross Bros &
Montgomery was an American firm. But Coopers was an English firm established
in 1854.
4. William Barclay Peat & Co, and Marwick Mitchell
& Co both started as English firms and merged in 1911 to form PMM. It merged
with Klynveld Main Goerdeler in 1987; Klynveld was a Dutch firm, Main
Hurdman was American, and Goerdeler was a Canadian firm.
I guess that makes Deloitte the oldest of the Big 4
firms. ICAEW was established only in 1880, 35 years after the beginning of
Deloitte. The Edinburgh society of accountants and the Glasgow Institute of
Accountants and Actuaries both, however, were established in 1854. That is 9
years AFTER opening of Deloitte.
The Joint Stock Companies Act was passed in 1844, 9
years BEFORE Deloitte, but Limited Liability Act (which permitted companies
with limited liability) was passed only in 1855.
But for some reason, PW gained prominence early on
(probably because it was the first large firm to gain a foothold in the US
(in 1890, ten years before Touche Ross did).
Jagdish --
Jagdish Gangolly (gangolly@albany.edu)
Department of Informatics College of Computing &
Information
State University of New York at Albany
7A, Harriman Campus Road, Suite 220 Albany, NY 12206
Phone: (518) 956-8251, Fax: (518) 956-8247
I do have a
PwC Direct password, but I really doubt that the Switzerland link is using a
cookie.
In any case
the home page of PwC does not require any login ---
http://www.pwc.com/
The video is now on this home page.
This takes
me back to the days when Bob Eliott, eventually as President of the AICPA,
was proposing great changes in the profession, including SysTrust, WebTrust,
Eldercare Assurance, etc. For years I used Bob’s AICPA/KPMG videos as
starting points for discussion in my accounting theory course. Bob relied
heavily on the analogy of why the railroads that did not adapt to
innovations in transportation such as Interstate Highways and Jet Airliners
went downhill and not uphill. The railroads simply gave up new opportunities
to startup professions rather than adapt from railroading to transportation.
Bob’s
underlying assumption was that CPA firms could extend assurance services to
non-traditional areas (where they were not experts but could hire new kinds
of experts) by leveraging the public image of accountants as having high
integrity and professional responsibility. That public image was destroyed
by the many auditing scandals, notably Enron and the implosion of Andersen,
that surfaced in the late 1990s and beyond ---
http://faculty.trinity.edu/rjensen/Fraud001.htm
The AICPA
commenced initiatives on such things as Systrust. To my knowledge most of
these initiatives bit the dust, although some CPA firms might be making
money by assuring Eldercare services.
The counter
argument to Bob Elliot’s initiatives is that CPA firms had no comparative
advantages in expertise in their new ventures just as railroads had few
comparative advantages in trucking and airline transportation industries,
although the concept of piggy backing of truck trailers eventually caught
on.
I still have
copies of Bob’s great VCR tapes, but I doubt that these have ever been
digitized. Bob could sell refrigerators to Eskimos.
"A history of U.S. higher education in accounting, Part I: Situating
accounting within the academy," by Glenn Van Wyhe, Issues in Accounting
Education (May 2007): pp. 165–182.
"A History of U.S. Higher Education in Accounting, Part II: Reforming
Accounting within the Academy," by Glenn Van Wyhe, Issues in Accounting
Education (August 2008): pp. 481–501
Question
Why do markets misbehave? How should you measure market risk? And what’s wrong
with academic finance?
These are a few questions that polymath Benoit
Mandelbrot addresses in the fascinating book The Misbehavior of Markets.
Mandelbrot suggests all of these questions can be properly understood by
rejecting the standard assumptions of academic finance and instead using a
“fractal view” of risk and markets.
"The Misbehavior of Markets," Simoleon Sense, April 6, 2009 ---
http://www.simoleonsense.com/
Fractals are at the heart of this book. Fractal
geometry is a form of mathematics developed by Mandelbrot that deals with
rough but highly self-similar structures like trees, coastlines, and
mountains. Fractals have helped explain a wide range of natural phenomena
and revolutionized computer graphics, influencing movies like Star Wars
Episode III. There is room for more applications in this early science, and
fractals may help explain the jagged but predictably irrational patterns in
the stock market, claims Mandelbrot.
In this book, Mandelbrot contends that fractals are
the key to modeling the market. The interesting part is that Mandelbrot does
not merely explain why he’s right but he goes to great length to explain why
others-those using the standard theories of academic finance-are wrong.
Mandelbrot offers interesting history, anecdotes, trivia, and beautiful
illustrations to make his case. The stock market does not act like a random
walk, he says, but rather it’s like the flight of an arrow down an infinite
hallway. It sounds a bit abstract at first, but this is exactly where the
book shines. There are stories and illustrations that make such abstract
concepts easily understandable. I literally felt smarter after reading each
chapter…
Instead of adding more regulating agencies, I think
we should simply make the FBI tougher on crime and the IRS tougher on cheats
Our Main Financial Regulating Agency: The SEC Screw
Everybody Commission
One of the biggest regulation failures in history is the way the SEC failed to
seriously investigate Bernie Madoff's fund even after being warned by Wall
Street experts across six years before Bernie himself disclosed that he was
running a $65 billion Ponzi fund.
CBS Sixty Minutes on June 14, 2009 ran a rerun that is
devastatingly critical of the SEC. If you’ve not seen it, it may still be
available for free (for a short time only) at
http://www.cbsnews.com/video/watch/?id=5088137n&tag=contentMain;cbsCarousel
The title of the video is “The Man Who Would Be King.”
Between 2002 and 2008 Harry Markopolos repeatedly told
(with indisputable proof) the Securities and Exchange Commission that Bernie
Madoff's investment fund was a fraud. Markopolos was ignored and, as a result,
investors lost more and more billions of dollars. Steve Kroft reports.
Markoplos makes the SEC look truly incompetent or
outright conspiratorial in fraud.
I'm really surprised that the SEC survived after Chris
Cox messed it up so many things so badly.
As Far as Regulations Go
An annual report issued by
the Competitive Enterprise Institute (CEI) shows that the U.S. government
imposed $1.17 trillion in new regulatory costs in 2008. That almost equals the
$1.2 trillion generated by individual income taxes, and amounts to $3,849 for
every American citizen. According the 2009 edition of Ten Thousand Commandments:
An Annual Snapshot of the Federal Regulatory State, the government issued 3,830
new rules last year, and The Federal Register, where such rules are listed,
ballooned to a record 79,435 pages. “The costs of federal regulations too often
exceed the benefits, yet these regulations receive little official scrutiny from
Congress,” said CEI Vice President Clyde Wayne Crews, Jr., who wrote the report.
“The U.S. economy lost value in 2008 for the first time since 1990,” Crews said.
“Meanwhile, our federal government imposed a $1.17 trillion ‘hidden tax’ on
Americans beyond the $3 trillion officially budgeted” through the regulations. Adam Brickley,
"Government Implemented Thousands of New Regulations Costing $1.17 Trillion in
2008," CNS News, June 12, 2009 ---
http://www.cnsnews.com/public/content/article.aspx?RsrcID=49487
Jensen Comment
I’m a long-time believer that industries being regulated end up controlling the
regulating agencies. The records of Alan Greenspan (FED) and the SEC from Arthur
Levitt to Chris Cox do absolutely nothing to change my belief ---
http://faculty.trinity.edu/rjensen/FraudRotten.htm
How do industries leverage the regulatory agencies?
The primary control mechanism is to have high paying jobs waiting in industry
for regulators who play ball while they are still employed by the government. It
happens time and time again in the FPC, EPA, FDA, FAA, FTC, SEC, etc. Because so
many people work for the FBI and IRS, it's a little harder for industry to
manage those bureaucrats. Also the FBI and the IRS tend to focus on the worst of
the worst offenders whereas other agencies often deal with top management of the
largest companies in America.
Don't toss hedge accounting just because it's complicated
It’s foolish not to book and maintain derivatives at fair value since in the
1980s and early 1990s derivatives were becoming the primary means of
off-balance-sheet financing with enormous risks unreported financial risks,
especially interest rate swaps and forward contracts and written options.
Purchased options were less of a problem since risk was capped.
Tom’s argument for maintaining derivatives at fair value even if they are hedges
is not a problem if the hedged items are booked and maintained at fair value
such as when a company enters into a forward contracts to hedge its inventories
of precious metals.
But Tom and I part company when the hedged item is not even booked, which is the
case for the majority of hedging contracts. Accounting tradition for the most
part does not hedge forecasted transactions such as plans to purchase a million
gallons of jet fuel in 18 months or plans to sell $10 million notionals in bonds
three months from now. Hedged items cannot be carried on the balance sheet at
fair value if they are not even booked. And there is good reason why we do not
want purchase contracts and forecasted transactions booked. Reason number 1 is
that we do not want to book executory contracts and forecasted transactions that
are easily broken for zero or at most a nominal penalties relative to the
notionals involved. For example, when Dow Jones contracted to buy newsprint
(paper) from St Regis Paper Company for the next 20 years, some trees to be used
for the paper were not yet planted. If Dow Jones should break the contract, the
penalty damages might be less than one percent of the value of a completed
transaction.
Now suppose Southwest Airlines has a forecasted transaction (not even a
contract) to purchase a million gallons of jet fuel in 18 months. Since it has
cash flow risk, it enters into a derivative contract (usually purchased option
in the case of Southwest) to hedge the unknown fuel price of this forecasted
transaction. FAS 133 and IAS 39 require the booking of the derivative as a cash
flow hedge and maintaining it at fair value. The hedged item is not booked.
Hence, the impact on earnings for changes in the value would be asymmetrical
unless the changes in value of the derivative were “deferred” in OCI as
permitted as “hedge accounting” under FAS 133 and IAS 39.
If there were no “hedge accounting,” Southwest Airlines would be greatly
punished for hedging cash flow by having to report possibly huge variations in
earnings at least quarterly when in fact there is no cash flow risk because of
the hedge. Reported interim earnings would be much more stable if Southwest did
not hedge cash flow risk. But not hedging cash flow risk due to financial
reporting penalties is highly problematic. Economic and accounting hit head on
for no good reason, and this collision was avoided by FAS 133 and IAS 39.
Since the majority of hedging transactions are designed to hedge cash flow or
fair value risk, it makes no sense to me to punish companies for hedging and
encouraging them to instead speculate in forecasted transactions and firm
commitments (unbooked purchase contracts at fixed prices).
The FASB originally, when the FAS 133 project was commenced, wanted to book all
derivative contracts and maintain them at fair value with no alternatives for
hedge accounting. FAS 133 would’ve been about 20 pages long and simple to
implement. But companies that hedge voiced huge and very well-reasoned
objections. The forced FAS 133 and its amending standards to be over 2,000 pages
and hellishly complicated.
But this is one instance where hellish complications are essential in my
viewpoint. We should not make the mistake of tossing out hedge accounting
because the standards are complicated. There are some ways to simplify the
standards, but hedge accounting standards cannot be as simple as most other
standards. The reason is that there are thousands of different types of hedging
contracts, and a simple baby formula for nutrition just will not suffice in the
case of all these types of hedging contracts.
Are accounting educators and standard setters commencing to bury their
heads in the sand?
Meanwhile, FASB chairman Robert Herz, also on the
panel, drew a distinction between "avoidable" and "unavoidable" complexity
in financial reporting. Some complexity is a given because "the world of
business and finance is not simple, and not getting any simpler, and you've
got to have reporting that faithfully tries to report that; you can't just
dumb it down."
"Companies Exasperate SEC Accounting Chief: He chides
them for citing accounting standards that "few people understand" in their
financials and for their puzzling apathy on IFRS," CFO.com, July 17, 2009 ---
http://www.cfo.com/archives/directory.cfm/2984368
That is how innovation often proceeds — by learning
from errors and hazards and gradually conquering problems through devices of
increasing complexity and sophistication.
Yale Professor Robert Shiller, "Financial Invention vs. Consumer
Protection," The New York Times, July 18, 2009 ---
http://www.nytimes.com/2009/07/19/business/economy/19view.html?_r=1
JAMES WATT, who invented the first practical steam
engine in 1765, worried that high-pressure steam could lead to major
explosions. So he avoided high pressure and ended up with an inefficient
engine.
It wasn’t until 1799 that Richard Trevithick, who
apprenticed with an associate of Watt, created a high-pressure engine that
opened a new age of steam-powered factories, railways and ships.
That is how innovation often proceeds — by learning
from errors and hazards and gradually conquering problems through devices of
increasing complexity and sophistication.
Our financial system has essentially exploded, with
financial innovations like collateralized debt obligations, credit default
swaps and subprime mortgages giving rise in the past few years to abuses
that culminated in disasters in many sectors of the economy.
We need to invent our way out of these hazards,
and, eventually, we will. That invention will proceed mostly in the private
sector. Yet government must play a role, because civil society demands that
people’s lives and welfare be respected and protected from overzealous
innovators who might disregard public safety and take improper advantage of
nascent technology.
The Obama administration has proposed a number of
new regulations and agencies, notably including a Consumer Financial
Protection Agency, which would be charged with safeguarding consumers
against things like abusive mortgage, auto loan or credit card contracts.
The new agency is to encourage “plain vanilla” products that are simpler and
easier to understand. But representatives of the financial services industry
have criticized the proposal as a threat to innovations that could improve
consumers’ welfare.
As the story of the steam engine shows, innovation
often entails tension between safety and power. We need to foster inventions
that better human welfare while incorporating safety mechanisms that protect
the public. Could the proposed agency accomplish this task?
The subprime mortgage is an example of a recent
invention that offered benefits and risks. These mortgages permitted people
with bad credit histories to buy homes, without relying on guaranties from
government agencies like the Federal Housing Administration. Compared with
conventional mortgages, the subprime variety typically involved higher
interest rates and stiff prepayment penalties.
To many critics, these features were proof of evil
intent among lenders. But the higher rates compensated lenders for higher
default rates. And the prepayment penalties made sure that people whose
credit improved couldn’t just refinance somewhere else at a lower rate, thus
leaving the lenders stuck with the rest, including those whose credit had
worsened.
This made basic sense as financial engineering — an
unsentimental effort to work around risks, selection biases, moral hazards
and human foibles that could lead to disaster.
This might have represented financial progress if
it weren’t for some problems that the designers evidently didn’t anticipate.
As subprime mortgages were introduced, a housing bubble developed. This was
fed in part by demand from new, subprime borrowers who now could enter the
housing market. The bursting of the bubble had results that are now all too
familiar — and taxpayers, among others, are still paying for it all.
Continued in article
Jensen Comment
Accounting theorists and standard setters are constantly being bombarded with
complaints that financial statements and accounting standards are just too
complicated for professional analysts as well as "ordinary" investors. Certainly
there are complexities that can be simplified without great loss in investor
protection. However, some standards become more complex rather than simple
simply because financial innovations become increasingly complex as described
wonderfully in the above article by Professor Shiller.
There's no turning back.
We just cannot replace the fleet of modern aircraft in the U.S. Air Force with
"simple" World War I biplanes. We just cannot replace a 2009 Mercedes and all
its computers with a Model T Ford that my father could tear into pieces, scrape
carbon off the engine head, and put all the pieces together when he was 12 years old in an Iowa
farm barn. My father could've spent the rest of his life just learning how to be
a F-16 or Mercedes mechanic and then, at best, only be an expert on one of many
components on such complex machines.
Similarly, we cannot return to simple accounting standards for complex
derivative financial instruments or complicated financing contracts that defy
simple partitions into debt versus equity. We should keep seeking ways to
simplify as many accounting standards as possible, but in total if we truly want
to protect investors from increasingly complex financial innovations like
Shiller is talking about, we will need increasingly complex accounting standards
to deal with those increasingly complex financial contracts.
What I worry about is that many accounting educators and standards setters
are willing to bury their heads in the sand rather than learn to understand and
track the financial innovations taking place around the world.
Here's one example of a financial innovation.
What is debt? What is equity? What is a Trup?
Banks are going to create huge problems for accountants with newer hybrid
instruments From Jim Mahar's Blog on February 6, 2005 ---
http://financeprofessorblog.blogspot.com/ My guess is that 99.9% of accounting educators have
never studied a Trup!
August 20, 2009 message from Malcolm J. McLelland,
Hi Bob,
I agree: Math is a formal language for a
(semi-)informal world. So it's always possible to find examples where a
mathematical expression doesn't make perfect sense. But, again, when I talk
to AIS programmers they essentially tell me they are programming
mathematical functions. Should we use the same (mathematical) language as
them, or should they use the same (natural) language we use? Programming is
a little outside my area of expertise, but I think they'd have a pretty hard
time programming revenue recognition in non-math programming languages.
Also, we can always allow the parameters to change
over time as well:
(Notice HEP was the only parameter in the function
as previously. Allowing HEP to change over time is essentially allowing
renegotiation of contract price, which happens all the time of course in
long-term contracts; e.g., Halliburton DOD contracts.)
I guess my most basic point to all this is
that--setting aside very clear special cases--there's likely nothing wrong
with the revenue recognition principle, per se, as it stands presently (even
though I've never seen a clear statement of it that didn't lack specificity
from a math/programming perspective). The mathematical statement of the
principle gets us to focus on the three most important things: (1) what the
contract price is, (2) how much of it has been "earned" and what "earned"
means, and (3) how much of it is "realizable" and what "realizable" means.
I have my own definitions of these things that no
one cares about (for good reason). For example, is a "realizable" receivable
the mean, the median, or the mode (present) value of the uncertain, future
payoff? To apply the principle, we kind of need to know these things: We
can't estimate something we're uncertain of unless we're clear on the
estimation objective.
But why is it really so difficult to come to a
consensus on what "earned" and "realizable" mean and then formulate a clear,
concise statement of the principle including a definition of such terms?
Sometimes I think people simply don't want to reach a consensus. It adds
gravitas to our discussions somehow.
Sorry to rant. This is a digression from the
discussion and I apologize.
Best regards,
Malcolm
August 20, 2009 reply from Bob Jensen
Not everything that
can be counted, counts. And not everything that counts can be counted. Albert Einstein
For a long time,
elite accounting researchers could find no “empirical evidence” of
widespread earnings management. All they had to do was look up from the
computers where their heads were buried.
Hi Malcomb,
You're making the fatal assumption that we know the
distribution of outcomes so that we can compute such things as means,
median, modes, quartiles, etc. For a few things we do indeed have actuarial
distributions that might be functional, but in most instances the underlying
probability distributions are unknown and/or unstable. For about two decades
we thought Bayesian subjective probability would solve our accounting
problems, but that turned into a bummer. Who cares about Bayes anymore?
For several decades we thought Box Jenkins time
series would solve our problems such as bad debt estimation. I no longer
read much about Box Jenkins in the accounting world, and I doubt if anybody
at the FASB or IASB gives two hoots about BJ models. BJ models were just too
demanding with unrealistic assumptions.
For a time auditors thought statistical sampling was
going to allow them to estimate financial risk with precision. Statistical
sampling has its place, but it is not the panacea we hoped it would be and
on countless occasions selective sampling has beat statistical sampling
every which way.
Whenever I get news about increased
interest in mathematical models (especially economics and finance)
professors on Wall Street, I think back to "The Trillion Dollar Bet"
in 1993 (Nova
on PBS Video) a bond trader, two Nobel Laureates, and their doctoral
students who very nearly brought down all of Wall Street and the U.S.
banking system in the crash of a hedge fund known as
Long Term Capital Management where the biggest and most prestigious
firms lost an unimaginable amount of money ---
http://en.wikipedia.org/wiki/LTCM
A few weeks ago, TechCrunch published a piece
arguing software is better at investing than 99% of human investment
advisors. That post, titled
Thankfully, Software Is Eating The Personal Investing World,
pointed out the advantages of engineering-driven
software solutions versus emotionally driven human judgment. Perhaps not
surprisingly, some commenters (including some financial advisors) seized the
moment to call into question one of the foundations of software-based
investing, Modern Portfolio Theory.
Given the doubts raised by a small but vocal
chorus, it’s worth spending some time to ask if we need a new investing
paradigm and if so, what it should be. Answering that question helps show
why MPT still is the best investment methodology out there; it enables the
automated, low-cost investment management offered by a new wave of Internet
startups including
Wealthfront
(which I advise),
Personal Capital,
Future Advisor
and SigFig.
The basic questions being raised about MPT run
something like this:
Hasn’t recent experience – i.e., the financial
crisis — shown that diversification doesn’t work?
Shouldn’t we primarily worry about “Black
Swan” events and unforeseen risk?
Don’t these unknown unknowns mean we must
develop a new approach to investing?
Let’s begin by briefly laying out the key insights
of MPT.
MPT is based in part on the assumption that most
investors don’t like risk and need to be compensated for bearing it. That
compensation comes in the form of higher average returns. Historical data
strongly supports this assumption. For example, from 1926 to 2011 the
average (geometric) return on U.S. Treasury Bills was 3.6%. Over the same
period the average return on large company stocks was 9.8%; that on small
company stocks was 11.2% ( See 2012 Ibbotson Stocks, Bonds, Bills and
Inflation (SBBI) Valuation Yearbook, Morningstar, Inc., page 23. ). Stocks,
of course, are much riskier than Treasuries, so we expect them to have
higher average returns — and they do.
One of MPT’s key insights is that while investors
need to be compensated to bear risk, not all risks are rewarded. The market
does not reward risks that can be “diversified away” by holding a bundle of
investments, instead of a single investment. By recognizing that not all
risks are rewarded, MPT helped establish the idea that a diversified
portfolio can help investors earn a higher return for the same amount of
risk.
To understand which risks can be diversified away,
and why, consider Zynga. Zynga hit $14.69 in March and has since dropped to
less than $2 per share. Based on what’s happened over the past few months,
the major risks associated with Zynga’s stock are things such as delays in
new game development, the fickle taste of consumers and changes on Facebook
that affect users’ engagement with Zynga’s games.
For company insiders, who have much of their wealth
tied up in the company, Zynga is clearly a risky investment. Although those
insiders are exposed to huge risks, they aren’t the investors who determine
the “risk premium” for Zynga. (A stock’s risk premium is the extra return
the stock is expected to earn that compensates for the stock’s risk.)
Rather, institutional funds and other large
investors establish the risk premium by deciding what price they’re willing
to pay to hold Zynga in their diversified portfolios. If a Zynga game is
delayed, and Zynga’s stock price drops, that decline has a miniscule effect
on a diversified shareholder’s portfolio returns. Because of this, the
market does not price in that particular risk. Even the overall turbulence
in many Internet stocks won’t be problematic for investors who are well
diversified in their portfolios.
Modern Portfolio Theory focuses on constructing
portfolios that avoid exposing the investor to those kinds of unrewarded
risks. The main lesson is that investors should choose portfolios that lie
on the Efficient Frontier, the mathematically defined curve that describes
the relationship between risk and reward. To be on the frontier, a portfolio
must provide the highest expected return (largest reward) among all
portfolios having the same level of risk. The Internet startups construct
well-diversified portfolios designed to be efficient with the right
combination of risk and return for their clients.
Now let’s ask if anything in the past five years
casts doubt on these basic tenets of Modern Portfolio Theory. The answer is
clearly, “No.” First and foremost, nothing has changed the fact that there
are many unrewarded risks, and that investors should avoid these risks. The
major risks of Zynga stock remain diversifiable risks, and unless you’re
willing to trade illegally on inside information about, say, upcoming
changes to Facebook’s gaming policies, you should avoid holding a
concentrated position in Zynga.
The efficient frontier is still the desirable place
to be, and it makes no sense to follow a policy that puts you in a position
well below that frontier.
Most of the people who say that “diversification
failed” in the financial crisis have in mind not the diversification gains
associated with avoiding concentrated investments in companies like Zynga,
but the diversification gains that come from investing across many different
asset classes, such as domestic stocks, foreign stocks, real estate and
bonds. Those critics aren’t challenging the idea of diversification in
general – probably because such an effort would be nonsensical.
True, diversification across asset classes didn’t
shelter investors from 2008’s turmoil. In that year, the S&P 500 index fell
37%, the MSCI EAFE index (the index of developed markets outside North
America) fell by 43%, the MSCI Emerging Market index fell by 53%, the Dow
Jones Commodities Index fell by 35%, and the Lehman High Yield Bond Index
fell by 26%. The historical record shows that in times of economic distress,
asset class returns tend to move in the same direction and be more highly
correlated. These increased correlations are no doubt due to the increased
importance of macro factors driving corporate cash flows. The increased
correlations limit, but do not eliminate, diversification’s value. It would
be foolish to conclude from this that you should be undiversified. If a seat
belt doesn’t provide perfect protection, it still makes sense to wear one.
Statistics show it’s better to wear a seatbelt than to not wear one.
Similarly, statistics show diversification reduces risk, and that you are
better off diversifying than not.
Timing the market
The obvious question to ask anyone who insists
diversification across asset classes is not effective is: What is the
alternative? Some say “Time the market.” Make sure you hold an asset class
when it is earning good returns, but sell as soon as things are about to go
south. Even better, take short positions when the outlook is negative. With
a trustworthy crystal ball, this is a winning strategy. The potential gains
are huge. If you had perfect foresight and could time the S&P 500
on a daily basis, you could have turned $1,000 on Jan. 1, 2000, into
$120,975,000 on Dec. 31, 2009, just by going in and out of the market. If
you could also short the market when appropriate, the gains would have been
even more spectacular!
Sometimes, it seems someone may have a fairly
reliable crystal ball. Consider John Paulson, who in 2007 and 2008 seemed so
prescient in profiting from the subprime market’s collapse. It appears,
however, that Mr. Paulson’s crystal ball became less reliable after his
stunning success in 2007. His Advantage Plus fund experienced more than a
50% loss in 2011. Separating luck from skill is often difficult.
Some people try to come up with a way to time the
market based on historical data. In fact a large number of strategies will
work well “in the back test.” The question is whether any system is reliable
enough to use for future investing.
There are at least three reasons to be cautious
about substituting a timing system for diversification.
First, a timing system that does not work can
impose significant transaction costs (including avoidable adverse tax
consequences) on the investor for no gain.
Second, an ill-founded timing strategy
generally exposes the investor to risk that is unrewarded. In other
words, it puts the investor below the frontier, which is not a good
place to be.
Third, a timing system’s success may create
the seeds of its own destruction. If too many investors blindly follow
the strategy, prices will be driven to erase any putative gains that
might have been there, turning the strategy into a losing proposition.
Also, a timing strategy designed to “beat the market” must involve
trading into “good” positions and away from “bad” ones. That means there
must be a sucker (or several suckers) available to take on the other
(losing) sides. (No doubt in most cases each party to the trade thinks
the sucker is on the other side.)
Black Swans
What about those Black Swans? Doesn’t MPT ignore
the possibility that we can be surprised by the unexpected? Isn’t it
impossible to measure risk when there are unknown unknowns?
Most people recognize that financial markets are
not like simple games of chance where risk can be quantified precisely. As
we’ve seen (e.g., the “Black Monday” stock market crash of 1987 and the
“flash crash” of 2010), the markets can produce extreme events that hardly
anyone contemplated as a possibility. As opposed to poker, where we always
draw from the same 52-card deck, in financial markets, asset returns are
drawn from changing distributions as the world economy and financial
relationships change.
Some Black Swan events turned out to have limited
effects on investors over the long term. Although the market dropped
precipitously in October 1987, it was close to fully recovered in June 1988.
The flash crash was confined to a single day.
This is not to say that all “surprise” events are transitory. The Great
Depression followed the stock market crash of 1929, and the effects of the
financial crisis in 2007 and 2008 linger on five years later.
The question is, how should we respond to
uncertainties and Black Swans? One sensible way is to be more diligent in
quantifying the risks we can see. For example, since extreme events don’t
happen often, we’re likely to be misled if we base our risk assessment on
what has occurred over short time periods. We shouldn’t conclude that just
because housing prices haven’t gone down over 20 years that a housing
decline is not a meaningful risk. In the case of natural disasters like
earthquakes, tsunamis, asteroid strikes and solar storms, the long run could
be very long indeed. While we can’t capture all risks by looking far back in
time, taking into account long-term data means we’re less likely to be
surprised.
Some people suggest you should respond to the risk
of unknown unknowns by investing very conservatively. This means allocating
most of the portfolio to “safe assets” and significantly reducing exposure
to risky assets, which are likely to be affected by Black Swan surprises.
This response is consistent with MPT. If you worry about Black Swans, you
are, for all intents and purposes, a very risk-averse investor. The MPT
portfolio position for very risk-averse investors is a position on the
efficient frontier that has little risk.
The cost of investing in a low-risk position is a
lower expected return (recall that historically the average return on stocks
was about three times that on U.S. Treasuries), but maybe you think that’s a
price worth paying. Can everyone take extremely conservative positions to
avoid Black Swan risk? This clearly won’t work, because some investors must
hold risky assets. If all investors try to avoid Black Swan events, the
prices of those risky assets will fall to a point where the forecasted
returns become too large to ignore.
Continued in article
Jensen Comment
All quant theories and strategies in finance are based upon some foundational
assumptions that in rare instances turn into the
Achilles'
heel of the entire superstructure. The classic example is the wonderful
theory and arbitrage strategy of Long Term Capital Management (LTCM) formed by
the best quants in finance (two with Nobel Prizes in economics). After
remarkable successes one nickel at a time in a secret global arbitrage strategy
based heavily on the Black-Scholes Model, LTCM placed a trillion dollar bet that
failed dramatically and became the only hedge fund that nearly imploded all of
Wall Street. At a heavy cost, Wall Street investment bankers pooled billions of
dollars to quietly shut down LTCM ---
http://faculty.trinity.edu/rjensen/FraudRotten.htm#LTCM
So what was the Achilles heal of the arbitrage strategy of LTCM? It was an
assumption that a huge portion of the global financial market would not collapse
all at once. Low and behold, the Asian financial markets collapsed all at once
and left LTCM naked and dangling from a speculative cliff.
There is a tremendous (one of the best
videos I've ever seen on the Black-Scholes Model) PBS Nova video called
"Trillion Dollar Bet" explaining why LTCM
collapsed. Go to
http://www.pbs.org/wgbh/nova/stockmarket/
This video is in the media libraries on most college campuses. I highly
recommend showing this video to students. It is extremely well done and
exciting to watch.
The principal
policy issue arising out of the events surrounding the near collapse of LTCM
is how to constrain excessive leverage. By increasing the chance that
problems at one financial institution could be transmitted to other
institutions, excessive leverage can increase the likelihood of a general
breakdown in the functioning of financial markets. This issue is not limited
to hedge funds; other financial institutions are often larger and more
highly leveraged than most hedge funds.
The video and above reports, however, do not delve into the tax shelter
pushed by Myron Scholes and his other LTCM partners. A nice summary of the tax
shelter case with links to other documents can be found at
http://www.cambridgefinance.com/CFP-LTCM.pdf
The above August 27,
2004 ruling by Judge Janet Bond Arterton rounds out the "Trillion Dollar Bet."
The classic and enormous scandal was
Long Term Capital led by Nobel Prize winning Merton and Scholes (actually the
blame is shared with their devoted doctoral students). There is a tremendous
(one of the best videos I've ever seen on the Black-Scholes Model) PBS Nova
video ("Trillion Dollar Bet") explaining why LTC collapsed. Go to
http://www.pbs.org/wgbh/nova/stockmarket/
Another illustration of the Achilles' heel of a popular mathematical theory
and strategy is the 2008 collapse mortgage-backed CDO financial risk bonds based
upon David Li's Gaussian copula function of risk diversification in portfolios.
The Achilles' heel was the assumption that the real estate bubble would not
burst to a point where millions of subprime mortgages would all go into default
at roughly the same time.
"For five years, Li's formula, known as a
Gaussian copula function, looked like an unambiguously positive
breakthrough, a piece of financial technology that allowed hugely
complex risks to be modeled with more ease and accuracy than ever
before. With his brilliant spark of mathematical legerdemain, Li made it
possible for traders to sell vast quantities of new securities,
expanding financial markets to unimaginable levels.
His method was adopted by everybody from bond
investors and Wall Street banks to ratings agencies and regulators. And
it became so deeply entrenched—and was making people so much money—that
warnings about its limitations were largely ignored.
Then the model fell apart." The article goes on to show that correlations
are at the heart of the problem.
"The reason that ratings agencies and investors
felt so safe with the triple-A tranches was that they believed there was
no way hundreds of homeowners would all default on their loans at the
same time. One person might lose his job, another might fall ill. But
those are individual calamities that don't affect the mortgage pool much
as a whole: Everybody else is still making their payments on time.
But not all calamities are individual, and
tranching still hadn't solved all the problems of mortgage-pool risk.
Some things, like falling house prices, affect a large number of people
at once. If home values in your neighborhood decline and you lose some
of your equity, there's a good chance your neighbors will lose theirs as
well. If, as a result, you default on your mortgage, there's a higher
probability they will default, too. That's called correlation—the degree
to which one variable moves in line with another—and measuring it is an
important part of determining how risky mortgage bonds are."
I would highly recommend reading the entire thing that gets much more
involved with the
actual formula etc.
The
“math error” might truly be have been an error or it might have simply been a
gamble with what was perceived as miniscule odds of total market failure.
Something similar happened in the case of the trillion-dollar disastrous 1993
collapse of Long Term Capital Management formed by Nobel Prize winning
economists and their doctoral students who took similar gambles that ignored the
“miniscule odds” of world market collapse -- -
http://faculty.trinity.edu/rjensen/FraudRotten.htm#LTCM
The rhetorical question is whether the failure is ignorance in model building or
risk taking using the model?
ROBERT RUBIN was Bill Clinton’s treasury
secretary. He has worked at the top of Goldman Sachs and Citigroup. But he
made arguably the single most influential decision of his long career in
1983, when as head of risk arbitrage at Goldman he went to the MIT Sloan
School of Management in Cambridge, Massachusetts, to hire an economist
called Fischer Black.
A decade earlier Myron Scholes, Robert
Merton and Black had explained how to use share prices to calculate the
value of derivatives. The Black-Scholes options-pricing model was more than
a piece of geeky mathematics. It was a manifesto, part of a revolution that
put an end to the anti-intellectualism of American finance and transformed
financial markets from bull rings into today’s quantitative powerhouses.
Yet, in a roundabout way, Black’s approach also led to some of the late
boom’s most disastrous lapses.
Derivatives markets are not new, nor are
they an exclusively Western phenomenon. Mr Merton has described how Osaka’s
Dojima rice market offered forward contracts in the 17th century and
organised futures trading by the 18th century. However, the growth of
derivatives in the 36 years since Black’s formula was published has taken
them from the periphery of financial services to the core.
In “The Partnership”, a history of Goldman
Sachs, Charles Ellis records how the derivatives markets took off. The
International Monetary Market opened in 1972; Congress allowed trade in
commodity options in 1976; S&P 500 futures launched in 1982, and options on
those futures a year later. The Chicago Board Options Exchange traded 911
contracts on April 26th 1973, its first day (and only one month before
Black-Scholes appeared in print). In 2007 the CBOE’s volume of contracts
reached almost 1 trillion.
Trading has exploded partly because
derivatives are useful. After America came off the gold standard in 1971,
businesses wanted a way of protecting themselves against the movements in
exchange rates, just as they sought protection against swings in interest
rates after Paul Volcker, Mr Greenspan’s predecessor as chairman of the Fed,
tackled inflation in the 1980s. Equity options enabled investors to lay off
general risk so that they could concentrate on the specific types of
corporate risk they wanted to trade.
The other force behind the explosion in
derivatives trading was the combination of mathematics and computing. Before
Black-Scholes, option prices had been little more than educated guesses. The
new model showed how to work out an option price from the known price-behaviour
of a share and a bond. It is as if you had a formula for working out the
price of a fruit salad from the prices of the apples and oranges that went
into it, explains Emanuel Derman, a physicist who later took Black’s job at
Goldman. Confidence in pricing gave buyers and sellers the courage to pile
into derivatives. The better that real prices correlate with the unknown
option price, the more confidently you can take on any level of risk. “In a
thirsty world filled with hydrogen and oxygen,” Mr Derman has written,
“someone had finally worked out how to synthesise H2O.”
Poetry in Brownian motion Black-Scholes is
just a model, not a complete description of the world. Every model makes
simplifications, but some of the simplifications in Black-Scholes looked as
if they would matter. For instance, the maths it uses to describe how share
prices move comes from the equations in physics that describe the diffusion
of heat. The idea is that share prices follow some gentle random walk away
from an equilibrium, rather like motes of dust jiggling around in Brownian
motion. In fact, share-price movements are more violent than that.
Over the years the “quants” have found
ways to cope with this—better ways to deal with, as it were, quirks in the
prices of fruit and fruit salad. For a start, you can concentrate on the
short-run volatility of prices, which in some ways tends to behave more like
the Brownian motion that Black imagined. The quants can introduce sudden
jumps or tweak their models to match actual share-price movements more
closely. Mr Derman, who is now a professor at New York’s Columbia University
and a partner at Prisma Capital Partners, a fund of hedge funds, did some of
his best-known work modelling what is called the “volatility smile”—an
anomaly in options markets that first appeared after the 1987 stockmarket
crash when investors would pay extra for protection against another imminent
fall in share prices.
The fixes can make models complex and
unwieldy, confusing traders or deterring them from taking up new ideas.
There is a constant danger that behaviour in the market changes, as it did
after the 1987 crash, or that liquidity suddenly dries up, as it has done in
this crisis. But the quants are usually pragmatic enough to cope. They are
not seeking truth or elegance, just a way of capturing the behaviour of a
market and of linking an unobservable or illiquid price to prices in traded
markets. The limit to the quants’ tinkering has been not mathematics but the
speed, power and cost of computers. Nobody has any use for a model which
takes so long to compute that the markets leave it behind.
The idea behind quantitative finance is to
manage risk. You make money by taking known risks and hedging the rest. And
in this crash foreign-exchange, interest-rate and equity derivatives models
have so far behaved roughly as they should.
A muddle of mortgages Yet the idea behind
modelling got garbled when pools of mortgages were bundled up into
collateralised-debt obligations (CDOs). The principle is simple enough.
Imagine a waterfall of mortgage payments: the AAA investors at the top catch
their share, the next in line take their share from what remains, and so on.
At the bottom are the “equity investors” who get nothing if people default
on their mortgage payments and the money runs out.
Despite theory, CDOs were hopeless, at
least with hindsight (doesn’t that phrase come easily?). The cash flowing
from mortgage payments into a single CDO had to filter up through several
layers. Assets were bundled into a pool, securitised, stuffed into a CDO,
bits of that plugged into the next CDO and so on and on. Each source of a
CDO had interminable pages of its own documentation and conditions, and a
typical CDO might receive income from several hundred sources. It was a
lawyer’s paradise.
This baffling complexity could hardly be
more different from an equity or an interest rate. It made CDOs impossible
to model in anything but the most rudimentary way—all the more so because
each one contained a unique combination of underlying assets. Each CDO would
be sold on the basis of its own scenario, using central assumptions about
the future of interest rates and defaults to “demonstrate” the payouts over,
say, the next 30 years. This central scenario would then be “stress-tested”
to show that the CDO was robust—though oddly the tests did not include a 20%
fall in house prices.
This was modelling at its most feeble.
Derivatives model an unknown price from today’s known market prices. By
contrast, modelling from history is dangerous. There was no guarantee that
the future would be like the past, if only because the American housing
market had never before been buoyed up by a frenzy of CDOs. In any case,
there are not enough past housing data to form a rich statistical picture of
the market—especially if you decide not to include the 1930s nationwide fall
in house prices in your sample.
Neither could the models take account of
falling mortgage-underwriting standards. Mr Rajan of the University of
Chicago says academic research suggests mortgage originators, keen to
automate their procedures, stopped giving potential borrowers lengthy
interviews because they could not easily quantify the firmness of someone’s
handshake or the fixity of their gaze. Such things turned out to be better
predictors of default than credit scores or loan-to-value ratios, but the
investors at the end of a long chain of securities could not monitor lending
decisions.
The issuers of CDOs asked rating agencies
to assess their quality. Although the agencies insist that they did a
thorough job, a senior quant at a large bank says that the agencies’ models
were even less sophisticated than the issuers’. For instance, a BBB tranche
in a CDO might pay out in full if the defaults remained below 6%, and not at
all once they went above 6.5%. That is an all-or-nothing sort of return,
quite different from a BBB corporate bond, say. And yet, because both shared
the same BBB rating, they would be modelled in the same way.
Issuers like to have an edge over the
rating agencies. By paying one for rating the CDOs, some may have laid
themselves open to a conflict of interest. With help from companies like
Codefarm, an outfit from Brighton in Britain that knew the agencies’ models
for corporate CDOs, issuers could build securities with any risk profile
they chose, including those made up from lower-quality ingredients that
would nevertheless win AAA ratings. Codefarm has recently applied for
administration.
There is a saying on Wall Street that the
test of a product is whether clients will buy it. Would they have bought
into CDOs had it not been for the dazzling performance of the quants in
foreign-exchange, interest-rate and equity derivatives? There is every sign
that the issuing banks believed their own sales patter. The banks so liked
CDOs that they held on to a lot of their own issues, even when the idea
behind the business had been to sell them on. They also lent buyers much of
the money to bid for CDOs, certain that the securities were a sound
investment. With CDOs in deep trouble, the lenders are now suffering.
Modern finance is supposed to be all about
measuring risks, yet corporate and mortgage-backed CDOs were a leap in the
dark. According to Mr Derman, with Black-Scholes “you know what you are
assuming when you use the model, and you know exactly what has been swept
out of view, and hence you can think clearly about what you may have
overlooked.” By contrast, with CDOs “you don’t quite know what you are
ignoring, so you don’t know how to adjust for its inadequacies.”
Now that the world has moved far beyond
any of the scenarios that the CDO issuers modelled, investors’ quantitative
grasp of the payouts has fizzled into blank uncertainty. That makes it hard
to put any value on them, driving away possible buyers. The trillion-dollar
bet on mortgages has gone disastrously wrong. The hope is that the
trillion-dollar bet on companies does not end up that way too.
Continued in article
Closing Jensen Comment
So is portfolio diversification theory dead? I hardly think so. But if any
lesson is to be learned is that we should question those critical underlying
assumptions in Plato's Cave before worldwide strategies are implemented that
overlook the Achilles' heel of those critical underlying assumptions.
VaR is simply a financial weather forecast. A
high VaR suggests stormy weather and the risk of big losses, while a low
VaR indicates a balmy day and rain, in the form of big losses, is not
likely. But VaR, using its full name, has a misleading description.
‘Value at risk’ sounds like it is communicating the maximum rainfall
rather than just an idea of whether a rainstorm is likely. Indeed, in a
recent speech, the FSA’s Lord Turner implied that even he had been
mislead when he said: “We know that [VaR ..is] praised as a
mathematically precise measure of risk.” But no professional
statistician would describe VaR that way.
Fortunately, my doctoral program experience gave me an extremely thick
skin; many attacks seemed quite personal. That is, criticism of an argument
can be based on its ethos (character of the "arguer"), pathos (emotional
content of the argument), or logos (logic of the argument). I found that
criticism of arguments in accounting research was often directed at ethos
and sometimes at pathos, with surprisingly little effort at examining the
logic of the argument. From my reading of past AECM discussions, I think
people often disregarded what Richard Sansing said largely because "he's
just one of those analytical modeling types"; they don't like the econ
theorist ethos/pathos. So, many people disregard an argument the moment it's
framed in mathematical language. But That Which Does Not Kill Us Makes Us
Stronger ...
So in relation to the original topic, some of the fundamental questions
that remain perennially open, at least in my mind, are:
(1) Is it useful to regard accounting variables, in general, as
random variables?
(2) What are accountants trying to measure when they measure accounting
random variables: mean, median, mode, something else ... ?
(3) Are statistical methods useful in estimating whatever it is
accountant's are trying to estimate, or is "professional judgment"
adequate?
(4) What exactly is "professional judgment" if the estimation objective
for the accounting random variable is not specified, at least in
principle?
I deeply believe many of our discussions in accounting and auditing are
unlikely to be fruitful if we don't carefully answer these questions first.
Cheers,
Malcolm
August 21, 2009 reply from Bob Jensen
Hi Malcomb,
I really like thick skinned activists on the AECM. And I never ignore a
message by Richard Sansing just because he’s an accountics researcher. I
only wish we had more accountics researcher activists on the AECM. I’m
always thankful for Richard.
I don’t think I can answer your specific questions with a broad paint
brush. To consider each question I would first need to have you narrow down
to particular measurements of accounting variables and purposes of the those
measurements.
In terms of fundamental theory of measurement, accounting scholars, many
of whom were outstanding mathematicians and some wannabe mathematicians,
addressed the fundamental problems of measurement in accountancy. One of the
best-known and respected attempts is the “Theory of Accounting Measurement”
by Hall of Fame accounting professor Yuji Ijiri, (Studies in Accounting
Research #10, American Accounting Association, 1975) ---
http://aaahq.org/market/display.cfm?catID=5
Among other things, Yuji developed an axiomatic structure of accounting that
I think was mostly or completely ignored in the development of the FASB and
the IASB Conceptual Frameworks. The point is that the mathematical axiomatic
structures of Ijiri, Mattesich, and others were not deemed to have value
added or sufficient engineering details in the derivation of the official
conceptual frameworks.
By the way, Yuji is, and always was, a staunch supporter of historical
cost accounting because it was the closest measurement system to have
mathematical purety --- See Chapter 6 which also develops his axiom of "fair
value."
Probably the closest thing that Yuji developed of interest to you is his
"multidimensional bookkeeping" extension where he analogizes accounting for
first derivative variations in account balances --- stocks and flows. His
simple illustrations fit nicely into his theory but died an early death due
Go total impracticality and unrealistic assumptions in the real world of
accounting. Still Yuji's work remains a classic in theory to which I think
Paul Williams built an alter in his home.
If you, Malcomb, want to use your mathematical
background to make new contributions to the mathematics of accounting, I
suggest that you build on the above monograph of Professor Ijiri. I'm
certain that Professor Ijiri would be honored. He was a terrific innovator
of ideas in accounting thought but not so much an engineer who designed
bridges that were ever built.
************************
Now let me turn to another grand effort that is elegant but fundamentally
flawed. For this you should turn to Chapter 4 entitled "Decomposition
Analysis of Financial Statement" in Financial Statement Analysis: A
New Approach by Baruch Lev (Prentice-Hall, 197f4). Baruch attempted an
elegant extension of homeostasis relating living organisms to business
organizations. He then attempted to decompose Lockheed's assets and
liabilities for 1969 and 1970 via a decomposition formula using log
functions of ratios. The weighted logarithmic functions of ratios had an
important property of additivity that allowed analysts to disaggregate and
computer weighted averages of decomposition measures. The analysis is
beautiful except that Baruch overlooked the fact that the variables forming
his ratios were not independent but were in fact highly interdependent in
double entry accounting.
Interestingly, I sat beside my Stanford mentor, Yuji Ijiri, at a
University of Chicago conference when Baruch Lev presented his Chapter 4
theory. Yuji downed two aspirins and held his head. He was, however, too
polite to destroy the paper in Chicago style. Unfortunately, Lev's research
went on to become part of his monograph (Chapter 4) that, in my viewpoint,
never should have been included in the monograph. I don't know of any
scholar that ever followed up on the Decomposition Analysis proposed by
Baruch in the early 1970s.
*******************
One point where I think we differ, Malcomb, is the definition of
“unrealized.” I think you were thinking more along the lines of “unrealized
sales revenue” or “unrealized construction revenue for partially completed
contracts.”
I was thinking more along the lines of a fair value interim valuation of
a mortgage payable. If the value of a fixed rate mortgage goes up in one
period (due to a change in interest rates), that change in value is never if
the mortgage is never settled before maturity.
If the mortgage is held to maturity all historic “unrealized fair value
adjustments” over the life of the mortgage will never be realized in the
same sense that unrealized construction revenue will eventually be
collected. My point is that securities designated as held-to-maturity are
almost certain to henceforth and forever more never realized the fair market
value adjustments to carrying values before the mortgage matures.
Bob Jensen
August 22, 2009 reply from Bob Jensen
Hi Again Malcomb,
I knew I should have spent more time before
answering your questions off the top of my head.
My digression into bankruptcy prediction models was
probably more confusing than helpful.
Let's begin with bad debt estimation in large
companies like Sears or JC Penney that have their own charge cards. In most
instances your concern over whether mean, median, or mode is used is
irrelevant because each risk pool assumes a uniform probability distribution
where mean, median, and mode are identical numbers. The typical first step
in bad debt estimation is to partition outstanding accounts into overdue
classes of time. Then these are sub-partitioned as to overdue account
balances. It is possible to further subdivide on the basis of information in
each customer's credit application form (residence location, age, income,
marital status, credit score, etc.) but I don't think this is common across
all companies. A lot of that information is subject to change such as change
in marital status.
Now consider receivables Pool D for accounts
outstanding 31-60 days overdue and balances due between $501-$1000. We
assume that the bad debt probability distribution in Pool D is a uniform
probability distribution. We then look at the recent history of Pool D and
conclude that on average 10% of the total outstanding balance in Pool D is
ultimately written off as bad debt. For next month, September 2009, the
total balance due in Pool D is $64 million. We then estimate that $6.4
million of Pool D accounts will ultimately be declared bad debts.
The only place we used an "average" was to examine
the recent history of Pool D each month for a period of time such as the
last two years. And in doing so we have assumed stationarity. If something
important happened in such as a change in our credit-granting policy or an
economic meltdown where 20% of our steady customers lost their jobs, then we
will most likely resort to a much more qualitative estimation of bad debts.
Back in the 1970s, the large department store chain known as WT Grant got
caught up in a sudden recession where it badly estimated bad debts. Sudden
increases in bad debt risks that were not impounded in past pool estimates
and further granting of credit to overdue customers contributed to the
demise of WT Grant.
I used the following paper year after year in one of
my accounting theory courses:
In 1980 Largay and Stickney (Financial Analysts
Journal) published a great comparison of WT Grant's cash flow statements
versus income statements. I used this study for years in some of my
accounting courses. It's a classic for giving students an appreciation of
cash flow statements! The study is discussed and cited (with exhibits) at
http://www.sap-hefte.de/download/dateien/1239/070_leseprobe.pdf
It also shows the limitations of the current ratio in financial analysis and
the problem of inventory buildup when analyzing the reported bottom line net
income.
Now consider receivables in Pool X for accounts
outstanding 91-120 days with overdue balances between $11 million and $15
million. There are only 12 these huge accounts in Pool X such that the
estimation process illustrated above is nonsense. This is where we might
resort to Altman-like bankruptcy prediction models ---
http://en.wikipedia.org/wiki/Bankruptcy_prediction
Our
Bill Beaver (Stanford) made some contributions to the early efforts to
predict bankruptcy as did an obscure CPA back in 1932 when there were a lot
of failing companies. But Edward Altman is credited with the most widely
used bankruptcy prediction models that have withstood the test of time since
around 1970 in practice.
Of course any multivariate statistical model such as
Altman’s discriminant analysis has its own limiting assumptions. The most
limiting assumption is that of stationarity. If there is a meltdown in the
economy, some of this meltdown might be captured in the input variables to
the model. But with the recent meltdown with its TARP, stimulus payments,
cash-for-clunkers program, etc. bad debt estimation may shift to an entirely
new ball park.
I also digressed into why I think the FASB did not
pay a whole lot of attention to the axiomatic frameworks of
Ijiri and
Mattessich in developing a conceptual framework. I might
elaborate a bit about the FASB’s Conceptual Framework. The initial team
leader, Mike Alexander, was a friend of mine. The FASB did not dip into a
pool of academic scholars for development of the Conceptual Framework. Mike
Alexander was a young and hard-nosed, no-nonsense, partner with Touche Ross
in Montreal. Of course Mike studied the contributions of
Sprouse and
Moonitz to postulates and axioms, but I think Mike wanted to root the
Conceptual Framework more in the practice of accountancy than in its
academic theories.
When you formally study the concepts of accountancy,
Malcomb, you really should focus on the Conceptual Frameworks of the FASB
and IASB. Both standard setting bodies make a concerted effort to root new
standards in those frameworks, although there are research studies that show
where this policy did not always hold for certain standards. Such is life in
the real world of complicated and evolving types of financing and sales
contracts.
Hope this helps.
Robert E. (Bob) Jensen
Trinity University Accounting Professor (Emeritus)
190 Sunset Hill Road
Sugar Hill, NH 03586
Tel. 603-823-8482
www.trinity.edu/rjensen
-----Original Message-----
From: Jensen, Robert
Sent: Friday, August 21, 2009 6:00 PM
To: 'AECM, Accounting Education using Computers and Multimedia'
Subject: RE: Insurers Biggest Writedowns May Be Yet to Come
Hi Malcomb,
I should be smart and think about your questions for
a longer time. But here goes off the top of my head in CAPS below.
Robert E. (Bob) Jensen
Trinity University Accounting Professor (Emeritus)
190 Sunset Hill Road
Sugar Hill, NH 03586
Tel. 603-823-8482
www.trinity.edu/rjensen
-----Original Message-----
From: AECM, Accounting Education using Computers and
Multimedia [mailto:AECM@LISTSERV.LOYOLA.EDU] On Behalf Of Mc Lelland,
Malcolm J
Sent: Friday, August 21, 2009 5:22 PM
To: AECM@LISTSERV.LOYOLA.EDU
Subject: Re: Insurers Biggest Writedowns May Be Yet
to Come
Bob,
I see your point, but mine is much more basic I
think. Let me make my questions concrete in the context of a special case;
i.e., FAS 5 applied to uncollectible receivables:
(1) Is it useful to regard uncollectible receivables
as a random variable?
OF COURSE IT IS COMMON TO TREAT BAD DEBT ESTIMATED
LOSS OF AN AGING POOL OF SIMILAR ACCOUNTS AS A RANDOM VARIABLE. EDWARD
ALTMAN, FOR ONE, DEVELOPED A MULTIVARIATE DISCRIMINANT ANALYSIS SYSTEM FOR
ESTIMATING BAD DEBTS PROVIDED STRINGENT ASSUMPTIONS ARE MET, NOT THE LEAST
OF WHICH IS THE SIZE OF THE POPULATION. OBVIOUSLY IF WE ONLY HAVE 30
ACCOUNTS RECEIVABLE, STATISTICAL ANALYSIS IS NONSENSE. IF WE HAVE 12,000
ACCOUNTS RECEIVABLE, THEN MAYBE ALTMAN OR SOME SIMPLER MODEL CAN BE CALLED
INTO PLAY.
(2) What precisely are accountants trying to measure
when they measure uncollectible receivables: their mean, median, mode, or
something else ... ?
I THINK THEY ARE TRYING TO MEASURE THE DOLLAR AMOUNT
OF EXPECTED LOSS IN A GIVEN POOL OF ACCOUNTS.
(3) Are statistical methods useful in estimating
whatever that thing is, or is "professional judgment" about uncollectible
receivables adequate?
EMPIRICAL STUDIES OF BANKRUPTCY DISCRIMINANT
ANALYSIS ARE VERY GOOD IN CIRCUMSTANCES THAT MEET THE ASSUMPTIONS OF THE
MODEL. BUT ONCE AGAIN SUBJECTIVE JUDGMENT MUST BE USED REGARDING NON-STATIONARITY.
SEE
http://en.wikipedia.org/wiki/Bankruptcy_prediction
IF WE ARE GETTING SIGNALS THAT RISK FACTORS HAVE
CHANGED (SUDDEN ECONOMIC DOWNTURN THAT HITS OUR CUSTOMERS LIKE A HURRICANE)
OR SUDDEN BAD NEWS SIGNALS THAT HIT OUR CUSTOMERS SUCH AS THEIR PRODUCTS
CAUSE CANCER, WE NO LONGER CAN RELY UPON OLD MODELS THAT DO NOT TAKE INTO
ACCOUNT CHANGED CONDITIONS.
STATISTICAL MODELS OF MOST ANY TYPE MUST BE
"TRAINED" UNDER A GIVEN SET OF CONDITIONS ASSUMED TO BE STABLE. JUDGMENT IS
CALLED FOR IN ASSESSING STABILITY VIS-À-VIS UNDERLYING ASSUMPTIONS OF THE
MODEL, INCLUDING VARIABLE INDEPENDENCE, HOMOSCEDASTICITY, RELEVANT RANGE,
ETC.
(4) What exactly is "professional judgment" if no
one has stated the estimation objective for uncollectible receivables?
PROFESSIONAL JUDGMENT IS A DEEP AND ABIDING
KNOWLEDGE OF OUR CUSTOMERS AND THEIR STRENGTHS AND WEAKNESSES AS IT APPLIES
TO CREDIT THAT WE HAVE EXTENDED TO THEM. ONE OF THE HUGE PROBLEMS OF FANNIE
MAE AND FREDDIE MAC COMMENCED WHEN THEY WERE FORCED TO BUY UP MORTGAGES OF
HOME BUYERS WITH ALMOST NO COLLATERAL AND LOW INCOMES AND UNSTEADY WORK. IF
A LOCAL BANK HAD TO CARRY THE MORTGAGE THE BANK WOULD PROBABLY HAVE A FAR
BETTER UNDERSTANDING OF EACH CUSTOMER AND THE LOCAL ECONOMY THAN FANNIE WITH
OVER 100 MILLION CUSTOMERS.
I'm familiar with the provisions of FAS 5: We
recognize uncollectible receivables as expense when it's "probable" they are
impaired at the balance sheet date and the loss can be "reasonably
estimated". Let's say both conditions are met so we can focus on the above
questions, rather than on the standard. Is FAS 5 telling us to recognize
the mean, the median or the mode of the uncollectible accounts? Without
loss of generality, assume the distribution over uncollectibles is both
non-stationary and skewed (and this is a very reasonable assumption). Now
then, if the distribution is skewed as many accounting variable
distributions are, then it makes a difference whether we're supposed to
estimate the mean, the median, or the mode (or something else). So what
precisely is FAS 5 (not) telling us the estimation objective is?
I DON'T THINK OUR TRADITIONAL MODELS DEAL WELL WITH
EXTREME KURTOSIS. IF WE CAN SPECIFY THE APPROPRIATE DISTRIBUTIONS AND THESE
DISTRIBUTIONS ARE STABLE, THEN OUR TECHIES CAN DEVISE MODELS TO ESTIMATE THE
DOLLAR LOSSES OF BAD DEBTS IN A HOMOGENIOUS POOL OF CUSTOMERS. ONCE AGAIN
ISSUES OF STATIONARITY ARE ALWAYS HANGING OVERHEAD LIKE BLACK CLOUDS.
CURRENTLY LARGE AUDITING FIRMS ARE PLEADING
IGNORANCE OF CHANGES IN LOAN LENDING RISKS OF THEIR CUSTOMERS (DELOITTE IS
NOW EMBROILED IN ONE OF THE LARGEST LAWSUITS IN HISTORY OVER ISSUES OF
UNDERESTIMATING LOAN LOSSES IN WASHINGTON MUTUAL BANK. IT SEEMS TO BE POOR
JUDGMENT ON BOTH SIDES OF THE COIN --- EITHER DELOITTE TRULY WAS CAUGHT OFF
GUARD OR DELOITTE DECIDED TO GO ALONG WITH WaMu's HORRIBLY UNDERESTIMATED
LOAN LOSSES THAT EVENTUALLY DESTROYED THE BANK ---
http://faculty.trinity.edu/rjensen/2008Bailout.htm#AuditFirms
European banks and other banks outside the U.S.
will have to record losses on bad loans more quickly and set aside more
reserves for loan losses under an overhaul of finance-accounting rules
that global rule makers made final on Thursday.
Under the new standard, non-U.S. banks will
have to book loan losses based on their expectation that future losses
will occur, beginning in 2018. That is expected to speed up the booking
of losses and require greater loan-loss reserves.
Currently, banks don't record losses until they
have actually happened, but many observers believe that method led banks
to be too slow in taking losses during the financial crisis.
The move by the London-based International
Accounting Standards Board, which has been in the works for years, could
create a conundrum for the banking industry: Because U.S. and global
rule makers haven't been able to agree on the same accounting approach
for writing off bad loans, it could become more difficult to compare
U.S. banks and those outside the U.S.
U.S. and global rule makers have been striving
for years to eliminate differences between their rules in some major
areas of accounting, including loans and other financial instruments,
but the effort has been plagued by problems and delays. The two systems
have gotten more similar in some areas, but on this banking issue, some
analysts say they are growing more different.
The Financial Accounting Standards Board, the
U.S. accounting rule-setter, has proposed U.S. banks switch from the
incurred-loss model that both use now to the expected-loss approach,
too. But the two disagree on just how rapidly banks should book their
loan losses.
The IASB will require non-U.S. banks to
immediately book only those losses based on the probability that a loan
will default in the next 12 months. If the loan's quality gets
significantly worse, other losses would be recorded in the future. The
IASB move will affect all financial assets on non-U.S. companies'
balance sheets, but the treatment of bank loans is particularly
important due to the role that soured loans and credit losses play in
their businesses.
The change "will enhance investor confidence in
banks' balance sheets and the financial system as a whole," said Hans
Hoogervorst, chairman of IASB, which sets accounting rules for most
countries outside the U.S.
The Institute of Chartered Accountants in
England and Wales, a London-based accountants' group, estimated that the
IASB changes will increase banks' loan-loss provisions by about 50% on
average. Iain Coke, head of ICAEW's financial-services faculty, said the
new rule, combined with tougher regulatory-capital requirements, may
force banks to hold more capital for the same risks. "This may make
banks safer but may also make them more costly to run," he said.
The FASB proposal, however, would require all
losses expected over the lifetime of a loan to be booked up front—so if
it is enacted, U.S. banks would record more losses immediately than
banks in other countries, and might have to set aside more reserves,
hurting their current financial results and making them look worse
compared with foreign banks, many banking and accounting observers
believe. The FASB hasn't completed its proposed changes, though it hopes
to do so by year-end.
"It's unfortunate that we do have a different
standard being issued," said Tony Clifford, a partner with Big Four
accounting firm EY.
The IASB said in documents laying out its
proposal Thursday that although it and the FASB had made "every effort"
to agree on the same approach, "ultimately those efforts have been
unsuccessful."
Christine Klimek, a FASB spokeswoman, said the
FASB believes its approach "best serves the interests of investors in
U.S. capital markets because it better reflects the credit risks of
loans on an institution's balance sheet." IASB's approach likely would
lead to lower loan-loss reserves than FASB's at U.S. banks, she said,
"which would have been counterintuitive to the lessons learned during
the recent financial crisis."
In addition, Mr. Clifford said, the new IASB
rule requires banks to use their own judgment to a greater extent than
existing rules when determining their expected losses, and that could
lead to differences between individual banks that could make it harder
for investors to compare them.
Among other provisions of the new rule the IASB
issued Thursday, non-U.S. banks will no longer have to record gains to
net income when their own creditworthiness declines, and losses when
their creditworthiness improves—a counterintuitive practice known in the
U.S. as "debt/debit valuation adjustments," or DVA. Those gains and
losses will be stripped out of the banks' net income and be placed into
"other comprehensive income," a separate measurement that doesn't affect
the main earnings number tracked by most investors. Banks can adopt that
change separately, before the rest of the IASB rule.
The FASB has proposed a similar move for U.S.
banks but has yet to enact it.
Teaching Case on Loan Loss Reserves
From The Wall Street Journal Accounting Weekly Review on July 9, 2010
SUMMARY: The
persistently high U.S. unemployment rate has led to a divergence from
the rate at which credit card receivables are written off by U.S. banks
and other credit card issuers. Those write offs have declined as the
unemployed have simply been washed out of the credit system. Further,
card issuers have reduced available lines of credit as "new rules
limiting fees...and curbs on rate increases...make it less lucrative for
card issuers to lend to the less credit-worthy."
CLASSROOM APPLICATION: The
article may be used in any financial accounting class covering
receivables, bad debts, and write offs.
QUESTIONS:
1. (Introductory)
What is the usual relationship between the level of unemployment and
rates at which credit-card companies write off loan balances? In your
answer, include and define the statistical term "correlation."
2. (Introductory)
Why has the typical relationship between loan write offs and the
unemployment rate diverged as U.S. unemployment has remained high?
3. (Advanced)
Explain the difference between recording bad debt expense and writing
off specific accounts receivable. You may prepare your answer by
including the journal entry format of the accounting for these events.
4. (Advanced)
What does the author mean by the statement that "issuers of plastic also
are seeing a bump in earnings from whittling down their loss
reserves..."? In your answer, propose an alternate term for "loss
reserves."
5. (Advanced)
Describe how information from the financial reporting system for
credit-card issuing corporations provides the data used in the analysis
for this article.
Reviewed By: Judy Beckman, University of Rhode Island
Chronically high unemployment is disrupting
what once used to be easy math: the tight correlation between
joblessness and souring credit-card loans.
For years, the rate at which credit-card
companies write off loan balances has shadowed the unemployment rate. An
out-of-work borrower, of course, tends to fall behind on payments.
But for months now, some U.S. card issuers,
such as American Express Co., Capital One Financial Corp., J.P. Morgan
Chase & Co., Bank of America Corp., Citigroup Inc. and Discover
Financial Services, are reporting improving credit trends despite
stubbornly high unemployment rates. Issuers of plastic are also seeing a
bump in earnings from whittling down their loss reserves, a trend that's
expected to continue this year.
The reason for the divergence is grim: Some
people have been unemployed so long they have simply been washed out of
the credit system and no longer have any effect on the numbers.
"We have never seen the kind of divergence
we've seen this time" between unemployment and credit losses, said David
Nelms, Discover Financial's chief executive, last month in an interview.
"I expect credit will continue to improve. I'm much less optimistic
about the total unemployment rate."
The U.S. economy shed jobs in June for the
first time this year and the unemployment rate remained high at 9.5%,
according to data released Friday. A slight decline in the unemployment
rate, from 9.7%, reflected discouraged workers giving up on searching
for jobs. In a sign of the labor market's continued weakness, 46% of
unemployed Americans were out of work for more than six months in June.
Meanwhile, the quality of credit-card loans has
been broadly improving this year. Discover wrote off an annualized 7.97%
of its card balances in its fiscal second quarter ended May 31, lower
than the 8.51% rate in the first quarter. Write-offs in May similarly
improved for most of its peers, who will report second-quarter results
later this month.
For instance, AmEx's uncollectible U.S. card
balances totaled an annual rate of 6.3% in May, down from 6.7% in April,
and J.P. Morgan Chase wrote off 8.95% of card loans, down from 9.03%,
during the same period. In a sign of things to come, the rate of
borrowers behind on their card payments—a key gauge for future loan
losses—is also falling across the board.
"I think we actually see in this phase of the
cycle a little bit of reduction in the impact on credit metrics of
things like unemployment," said Richard D. Fairbank, Capital One's chief
executive, after the bank reported fourth-quarter results in January.
As Americans stay unemployed for long
stretches, they fall behind on card payments, get written off—and have
no access to new credit. While their continued unemployment keeps the
jobless rate high, they no longer have any influence on the statistics
of delinquencies or write-offs on cards. Meanwhile, card lenders have
tightened standards, and new borrowers are less likely to get into
trouble.
"Over time the weaker cardholders get weeded
out," says Richard X. Bove, an analyst with Rochdale Securities, so "the
quality of your portfolio gets better even as unemployment is high."
Card companies, burned by credit losses and
sweeping credit-card legislation passed last year, have scaled back on
credit lines, becoming more selective on borrowers. New rules limiting
fees, such as those hitting card users exceeding their credit limit or
paying late, and curbs on rate increases, make it less lucrative for
card issuers to lend to the less creditworthy.
This time around, says Scott Hoyt, senior
director of consumer economics at website Moody's Economy.com, the
impact on credit losses "from actions taken by lenders has become
stronger than the unemployment rate."
Sound familiar? The banks are making what they
can based on technical accounting manipulation including playing with
loan loss reserves. There's still a lot of bad debt on their books.
http://www.nytimes.com/2010/07/17/business/17bank.html?_r=1&scp=3&sq=citigroup&st=Search
"Citigroup’s net income declined 37 percent, to
$2.7 billion, and Bank of America’s net income fell 3 percent, to $3.1
billion, from a year earlier. Both banks padded those results with a big
release of funds that had been set aside to cover future loan losses,
with executives citing improvements in the economy."
http://www.businessweek.com/news/2010-07-16/bank-of-america-citigroup-fall-as-loan-books-interest-shrink.html
"
Citigroup also got $599 million of mark-ups on
loans and securities in a “special asset pool” of trading positions left
over from before the credit crisis. Citigroup booked a $447 million gain
from writing down the value of its own debt, under an accounting rule
that allows companies to profit when their creditworthiness declines.
The rules reflect the possibility that a company could buy back its own
liabilities at a discount, which under traditional accounting methods
would result in a profit.
About $1.2 billion of Bank of America’s revenue
came from writing down the value of obligations assumed from its
purchase of Merrill Lynch & Co., according to the bank’s CFO, Charles
Noski."
Francine
Francine
July 19, 2010 reply from Bob Jensen
Hi Francine,
Bank behaviors with auditor blessings are so sad.
Thanks for the tidbit.
Sydney
Finkelstein, the Steven Roth professor of management at the Tuck School
of Business at Dartmouth College, also pointed out that Bank of America
booked a $2.2 billion gain by increasing the value of Merrill Lynch’s
assets it acquired last quarter to prices that were higher than Merrill
kept them. “Although perfectly legal, this move is also perfectly
delusional, because some day soon these assets will be written down to
their fair value, and it won’t be pretty,” he said
"Bank Profits Appear Out of Thin Air ," by Andrew Ross Sorkin,
The New York Times, April 20, 2009 ---
http://www.nytimes.com/2009/04/21/business/21sorkin.html?_r=1&dbk
This is starting to feel like
amateur hour for aspiring magicians.
Another day, another attempt by a
Wall Street bank to pull a bunny out of the hat, showing off an earnings
report that it hopes will elicit oohs and aahs from the market. Goldman
Sachs, JPMorgan Chase, Citigroup and, on Monday, Bank of America all
tried to wow their audiences with what appeared to be — presto! —
better-than-expected numbers.
But in each case, investors
spotted the attempts at sleight of hand, and didn’t buy it for a second.
With Goldman Sachs, the
disappearing month of December didn’t quite disappear (it changed its
reporting calendar, effectively erasing the impact of a $1.5 billion
loss that month); JPMorgan Chase reported a dazzling profit partly
because the price of its bonds dropped (theoretically, they could retire
them and buy them back at a cheaper price; that’s sort of like saying
you’re richer because the value of your home has dropped); Citigroup
pulled the same trick.
Bank of America sold its shares in
China Construction Bank to book a big one-time profit, but Ken Lewis
heralded the results as “a testament to the value and breadth of the
franchise.”
Sydney Finkelstein, the Steven Roth
professor of management at the Tuck School of Business at Dartmouth
College, also pointed out that Bank of America booked a $2.2 billion
gain by increasing the value of Merrill Lynch’s assets it acquired last
quarter to prices that were higher than Merrill kept them.
“Although perfectly legal, this move
is also perfectly delusional, because some day soon these assets will be
written down to their fair value, and it won’t be pretty,” he said.
Investors reacted by throwing
tomatoes. Bank of America’s stock plunged 24 percent, as did other bank
stocks. They’ve had enough.
Why can’t anybody read the room
here? After all the financial wizardry that got the country — actually,
the world — into trouble, why don’t these bankers give their audience
what it seems to crave? Perhaps a bit of simple math that could fit on
the back of an envelope, with no asterisks and no fine print, might win
cheers instead of jeers from the market.
What’s particularly puzzling is
why the banks don’t just try to make some money the old-fashioned way.
After all, earning it, if you could call it that, has never been easier
with a business model sponsored by the federal government. That’s the
one in which Uncle Sam and we taxpayers are offering the banks
dirt-cheap money, which they can turn around and lend at much higher
rates.
“If the federal government let me
borrow money at zero percent interest, and then lend it out at 4 to 12
percent interest, even I could make a profit,” said Professor
Finkelstein of the Tuck School. “And if a college professor can make
money in banking in 2009, what should we expect from the highly paid
C.E.O.’s that populate corner offices?”
But maybe now the banks are simply
following the lead of Washington, which keeps trotting out the latest
idea for shoring up the financial system.
The latest big idea is the
so-called stress test that is being applied to the banks, with results
expected at the end of this month.
This is playing to a tough crowd
that long ago decided to stop suspending disbelief. If the stress test
is done honestly, it is impossible to believe that some banks won’t
fail. If no bank fails, then what’s the value of the stress test? To
tell us everything is fine, when people know it’s not?
“I can’t think of a single,
positive thing to say about the stress test concept — the process by
which it will be carried out, or outcome it will produce, no matter what
the outcome is,” Thomas K. Brown, an analyst at Bankstocks.com, wrote.
“Nothing good can come of this and, under certain, non-far-fetched
scenarios, it might end up making the banking system’s problems worse.”
The results of the stress test
could lead to calls for capital for some of the banks. Citi is mentioned
most often as a candidate for more help, but there could be others.
The expectation, before Monday at
least, was that the government would pump new money into the banks that
needed it most.
But that was before the government
reached into its bag of tricks again. Now Treasury, instead of putting
up new money, is considering swapping its preferred shares in these
banks for common shares.
The benefit to the bank is that it
will have more capital to meet its ratio requirements, and therefore
won’t have to pay a 5 percent dividend to the government. In the case of
Citi, that would save the bank hundreds of millions of dollars a year.
And — ta da! — it will
miraculously stretch taxpayer dollars without spending a penny more.
From: AECM, Accounting Education using Computers and
Multimedia [AECM@LISTSERV.LOYOLA.EDU] On Behalf Of Jensen, Robert [rjensen@TRINITY.EDU]
Sent: Friday, August 21, 2009 4:40 PM
To: AECM@LISTSERV.LOYOLA.EDU
Subject: Re: Insurers Biggest Writedowns May Be Yet
to Com
I tried to point out that Ijiri did take a broad
brush approach in his stocks and flows model for accounting measurement.
I still cannot visualize a broad brush answer to
your questions without at least one illustration or frame of reference for
your line of thinking, which might well entail singling out a particular
type of business transaction to be accounted for using what you envision as
a better approach to setting standards.
Broad accounting concepts and principles are built
upon micro-level thinking about transactions and often upon basic postulates
and axioms (as is the case in science and mathematics). First there were
attempts to generate postulates and axioms without mathematics (Sprouse and
Moonitz in particular) and then mathematics (Ijiri and Mattesich). But I
think the FASB's Conceptual Framework team went back to Square One.
Principles do require formalized concepts even
though the Conceptual Framework was not fully formalized before the FASB
commenced to generate standards.
What we found is that financial engineers devised
increasingly new and complex contracts such as synthetic leasing and
variable interest entities (FAS 141) and interest rate swaps (FAS 133) that
did not fit neatly on top of existing concepts, principles, and standards.
I doubt if
we'll ever resolve issues of debt versus equity or revenue recognition
principles that fit neatly into any set of concepts and principles. Today we
deal with Bill and Hold contracts and embedded derivatives, and tomorrow who
knows what? One thing is certain, U.S. financial engineers are clever at
creating off-balance sheet financing and dispersed financial risks that can
come back an butt bite.
TOPICS: Allowance
For Doubtful Accounts, Bad Debts, Banking, Loan Loss Allowance
SUMMARY: BB&T
Corp. is a Winston-Salem, N.C., bank that has been "...considered among the
best-run regional banks." The bank has "...reported a continued rise in
delinquent loans in states hit by the recession, such as North Carolina,
rather than those known more for being clobbered by the mortgage
meltdown....BB&T Chief Executive Kelly King said during a conference call
with investors that the company added $263 million to its loan-loss reserve,
which he called 'a significant number.' Some investors hoped BB&T would
write off bad loans more decisively than it did and build its loan-loss
reserve more aggressively, analysts said."
CLASSROOM APPLICATION: Questions
relate to loan loss reserve process and understanding the implications of
types of loan losses-those on delinquent loans from states hit hard by
recession, rather than from states with significant real estate value
losses.
QUESTIONS:
1. (Introductory)
Describe the process of creating reserves against losses for loans and
writing off bad loans. Specifically describe when the expense for bad debts
impacts a bank's-or a company's-income calculation.
2. (Introductory)
How do trends in loan write-offs and loan delinquencies inform the process
of creating reserves for loan losses?
3. (Advanced)
What is the significance for future profits of not creating a sufficient
reserve for loan losses?
4. (Advanced)
Analysts following BB&T stated that they wished the bank would write off bad
loans "decisively" and build its loan-loss reserve "aggressively" even as
the bank's chief executive described the balance in the loan-loss reserve as
a "significant number." Why would analysts and investors prefer a "more
aggressive approach." Include in your answer a comment on the notion of
conservatism in accounting.
5. (Advanced)
What is the significance of the source of loans going bad-that is, loans
made in states hit hard by recession versus the real estate market downfall.
In your answer, also comment on commercial versus personal loan categories
as well.
Reviewed By: Judy Beckman, University of Rhode Island
If last week's earnings by three of the largest
U.S. banks gave investors hope that the end of steep losses from soured
loans might be closer, regional bank BB&T Corp. delivered a setback Monday.
The Winston-Salem, N.C., bank, long considered
among the best-run regional banks, reported a continued rise in delinquent
loans in states hit by the recession, such as North Carolina, rather than
those known more for being clobbered by the mortgage meltdown.
"The core BB&T sees more cracks in credit," said
analyst Kevin Fitzsimmons of Sandler O'Neill & Partners LP.
In 4 p.m. New York Stock Exchange composite
trading, BB&T fell $1.22, or 4.3%, to $27.03, with investors also selling
off other regional banks into the rising market Monday. "Regionals simply
don't have any firepower to withstand rapidly eroding commercial assets"
even if losses from consumer loans are stabilizing, analyst Todd Hagerman of
Collins Stewart LLC said.
BB&T Chief Executive Kelly King said during a
conference call with investors that the company added $263 million to its
loan-loss reserve, which he called "a significant number." Some investors
hoped BB&T would write off bad loans more decisively than it did and build
its loan-loss reserve more aggressively, analysts said.
Third-quarter profit fell 58% to $152 million, or
23 cents a share, down from $358 million, or 65 cents a share, a year
earlier.
Credit-loss provisions soared 95% to $709 million
from $364 million a year earlier, while rising from the second quarter's
$701 million. Nonperforming assets, or loans in danger of going bad, rose to
2.5% from 1.2% a year earlier and 2.2% from the previous quarter.
BB&T "has a lot more real-estate exposure than the
money centers, plus it does not have nearly as much capital markets to
offset" such losses than big banks such as Bank of America Corp. and
Citigroup Inc. that reported earnings last week, said Jeff Davis of FTN
Equity Capital Markets Corp.
Losses from bad loans "are going to find the peak
in the next two or three quarters," Mr. King said, adding that
"nonperformance of the industry and for us continue to increase probably at
a declining rate of increase."
BB&T strengthened its capital base in August with a
$963 million offering of common stock after it purchased Colonial Bank, a
unit of Colonial BancGroup Inc., Montgomery, Ala., that was seized by
regulators in August.
In June, BB&T became one of the first U.S. banks to
pay back the capital infusion it got from the Treasury Department's Troubled
Asset Relief Program.
In the latest quarter, average client deposits were
up 20% from a year earlier amid the Colonial takeover, while average loans
and leases held for investment showed a 6% increase.
"An Intuitive Explanation of Bayes': Theorem: Bayes' Theorem
for the curious and bewildered; an excruciatingly gentle introduction," by
Eliezer S., Yudkowsky, August 2009 ---
http://yudkowsky.net/rational/bayes
Your friends and colleagues are talking about
something called "Bayes' Theorem" or "Bayes' Rule", or something called
Bayesian reasoning. They sound really enthusiastic about it, too, so you
google and find a webpage about Bayes' Theorem and...
It's this equation. That's all. Just one equation.
The page you found gives a definition of it, but it doesn't say what it is,
or why it's useful, or why your friends would be interested in it. It looks
like this random statistics thing.
So you came here. Maybe you don't understand what
the equation says. Maybe you understand it in theory, but every time you try
to apply it in practice you get mixed up trying to remember the difference
between p(a|x) and p(x|a), and whether p(a)*p(x|a) belongs in the numerator
or the denominator. Maybe you see theorem, and you understand theorem, and you can use
theorem, but you can't understand why your
friends and/or research colleagues seem to think it's the secret of the
universe. Maybe your friends are all wearing Bayes' Theorem T-shirts, and
you're feeling left out. Maybe you're a girl looking for a boyfriend, but
the boy you're interested in refuses to date anyone who "isn't Bayesian".
What matters is that Bayes is cool, and if you don't know Bayes, you aren't
cool.
Why does a mathematical concept generate this
strange enthusiasm in its students? What is the so-called Bayesian
Revolution now sweeping through the sciences, which claims to subsume even
the experimental method itself as a special case? What is the secret that
the adherents of Bayes know? What is the light that they have seen?
Soon you will know. Soon you will be one of us.
While there are a few existing online explanations
of Bayes' Theorem, my experience with trying to introduce people to Bayesian
reasoning is that the existing online explanations are too abstract.
Bayesian reasoning is very counterintuitive. People do not employ Bayesian
reasoning intuitively, find it very difficult to learn Bayesian reasoning
when tutored, and rapidly forget Bayesian methods once the tutoring is over.
This holds equally true for novice students and highly trained professionals
in a field. Bayesian reasoning is apparently one of those things which, like
quantum mechanics or the Wason Selection Test, is inherently difficult for
humans to grasp with our built-in mental faculties.
Or so they claim. Here you will find an attempt to
offer an intuitive explanation of Bayesian reasoning - an excruciatingly
gentle introduction that invokes all the human ways of grasping numbers,
from natural frequencies to spatial visualization. The intent is to convey,
not abstract rules for manipulating numbers, but what the numbers mean, and
why the rules are what they are (and cannot possibly be anything else). When
you are finished reading this page, you will see Bayesian problems in your
dreams.
Here's a story problem about a situation that
doctors often encounter:
1% of women at age forty who participate in routine
screening have breast cancer. 80% of women with breast cancer will get
positive mammographies. 9.6% of women without breast cancer will also get
positive mammographies. A woman in this age group had a positive mammography
in a routine screening. What is the probability that she actually has breast
cancer?
What do you think the answer is? If you haven't
encountered this kind of problem before, please take a moment to come up
with your own answer before continuing.
Next, suppose I told you that most doctors get the
same wrong answer on this problem - usually, only around 15% of doctors get
it right. ("Really? 15%? Is that a real number, or an urban legend based on
an Internet poll?" It's a real number. See Casscells, Schoenberger, and
Grayboys 1978; Eddy 1982; Gigerenzer and Hoffrage 1995; and many other
studies. It's a surprising result which is easy to replicate, so it's been
extensively replicated.)
Do you want to think about your answer again?
Here's a Javascript calculator if you need one. This calculator has the
usual precedence rules; multiplication before addition and so on. If you're
not sure, I suggest using parentheses.
Continued in article
Question
What are some "aha" moments in the history of accounting that are attributed to
one person's original/seminal idea?
It happened to Archimedes in the bath. To Descartes
it took place in bed while watching flies on his ceiling. And to Newton it
occurred in an orchard, when he saw an apple fall. Each had a moment of
insight. To Archimedes came a way to calculate density and volume; to
Descartes, the idea of coordinate geometry; and to Newton, the law of
universal gravity.
Five light-bulb moments of understanding that
revolutionized science.
In our fables of science and discovery, the crucial
role of insight is a cherished theme. To these epiphanies, we owe the
concept of alternating electrical current, the discovery of penicillin, and
on a less lofty note, the invention of Post-its, ice-cream cones, and
Velcro. The burst of mental clarity can be so powerful that, as legend would
have it, Archimedes jumped out of his tub and ran naked through the streets,
shouting to his startled neighbors: "Eureka! I've got it."
In today's innovation economy, engineers,
economists and policy makers are eager to foster creative thinking among
knowledge workers. Until recently, these sorts of revelations were too
elusive for serious scientific study. Scholars suspect the story of
Archimedes isn't even entirely true. Lately, though, researchers have been
able to document the brain's behavior during Eureka moments by recording
brain-wave patterns and imaging the neural circuits that become active as
volunteers struggle to solve anagrams, riddles and other brain teasers.
Following the brain as it rises to a mental
challenge, scientists are seeking their own insights into these light-bulb
flashes of understanding, but they are as hard to define clinically as they
are to study in a lab.
To be sure, we've all had our "Aha" moments. They
materialize without warning, often through an unconscious shift in mental
perspective that can abruptly alter how we perceive a problem. "An 'aha'
moment is any sudden comprehension that allows you to see something in a
different light," says psychologist John Kounios at Drexel University in
Philadelphia. "It could be the solution to a problem; it could be getting a
joke; or suddenly recognizing a face. It could be realizing that a friend of
yours is not really a friend."
These sudden insights, they found, are the
culmination of an intense and complex series of brain states that require
more neural resources than methodical reasoning. People who solve problems
through insight generate different patterns of brain waves than those who
solve problems analytically. "Your brain is really working quite hard before
this moment of insight," says psychologist Mark Wheeler at the University of
Pittsburgh. "There is a lot going on behind the scenes."
In fact, our brain may be most actively engaged
when our mind is wandering and we've actually lost track of our thoughts, a
new brain-scanning study suggests. "Solving a problem with insight is
fundamentally different from solving a problem analytically," Dr. Kounios
says. "There really are different brain mechanisms involved."
By most measures, we spend about a third of our
time daydreaming, yet our brain is unusually active during these seemingly
idle moments. Left to its own devices, our brain activates several areas
associated with complex problem solving, which researchers had previously
assumed were dormant during daydreams. Moreover, it appears to be the only
time these areas work in unison.
"People assumed that when your mind wandered it was
empty," says cognitive neuroscientist Kalina Christoff at the University of
British Columbia in Vancouver, who reported the findings last month in the
Proceedings of the National Academy of Sciences. As measured by brain
activity, however, "mind wandering is a much more active state than we ever
imagined, much more active than during reasoning with a complex problem."
She suspects that the flypaper of an unfocused mind
may trap new ideas and unexpected associations more effectively than
methodical reasoning. That may create the mental framework for new ideas.
"You can see regions of these networks becoming active just prior to people
arriving at an insight," she says.
In a series of experiments over the past five
years, Dr. Kounios and his collaborator Mark Jung-Beeman at Northwestern
University used brain scanners and EEG sensors to study insights taking form
below the surface of self-awareness. They recorded the neural activity of
volunteers wrestling with word puzzles and scanned their brains as they
sought solutions.
Some volunteers found answers by methodically
working through the possibilities. Some were stumped. For others, even
though the solution seemed to come out of nowhere, they had no doubt it was
correct.
In those cases, the EEG recordings revealed a
distinctive flash of gamma waves emanating from the brain's right
hemisphere, which is involved in handling associations and assembling
elements of a problem. The brain broadcast that signal one-third of a second
before a volunteer experienced their conscious moment of insight -- an
eternity at the speed of thought.
The scientists may have recorded the first
snapshots of a Eureka moment. "It almost certainly reflects the popping into
awareness of a solution," says Dr. Kounios.
In addition, they found that tell-tale burst of
gamma waves was almost always preceded by a change in alpha brain-wave
intensity in the visual cortex, which controls what we see. They took it as
evidence that the brain was dampening the neurons there similar to the way
we consciously close our eyes to concentrate.
"You want to quiet the noise in your head to
solidify that fragile germ of an idea," says Dr. Jung-Beeman at
Northwestern.
At the University of London's Goldsmith College,
psychologist Joydeep Bhattacharya also has been probing for insight moments
by peppering people with verbal puzzles.
Continued in article
Jensen Comment
I'm having a hard time finding a worthy "aha" moment in accountancy. It
certainly would not be Pacioli's double entry contribution since double entry
accounting is thought to have been used for over 1,000 years before Pacioli.
There have been aha moments in the invention of derivative contracts, but none
of them to my knowledge are attributable to accountants. There have been some
seminal accounting ideas such as ABC costing, but I think a team of people at
Deere is credited for ABC Costing.
-----Original
Message-----
From: Dale Flesher University of Mississippi
[mailto:actonya@HOTMAIL.COM]
Sent: Friday, January 25, 2002 1:35 PM
To:
AECM@LISTSERV.LOYOLA.EDU
Subject: Re: The Only Invention of Academic Accountants
Contrary to a
recent statement in this forum, Dollar-Value Lifo (DVL) was not developed by
a professor. The father of DVL was Herbert T. McAnly, who retired in 1964 as
a partner at Ernst & Ernst after 44 years with the firm. Throughout his
career, McAnly was known as "Mr. LIFO."
Although he did not
develop LIFO, which had been around for decades in the form of the
base-stock method, he did develop DVL after the Internal Revenue began
accepting LIFO from all types of companies. The Treasury would probably
never have agreed to allow all companies to use LIFO (in 1939) had they been
able to prognosticate McAnly's idea. He first described the concept in an
address delivered at the Accounting Clinic and the Central States Accounting
Conference in Chicago in May 1941. His concept was finally accepted by the
IRS following the Hutzler Brothers Co. case in 1947 (8 TC 14 (1947)). He
later worked with the Treasury Department trying to get more practical
regulations relating to LIFO.
Dale L. Flesher
Professor of Accountancy University of Mississippi
In recent weeks, editors at a respected
psychology journal have been taking heat from
fellow scientists for deciding to accept a research report that claims to
show the existence of extrasensory perception.
The report, to be published this year in
The Journal of Personality and Social Psychology,
is not likely to change many minds. And the scientific critiques of the
research methods and data analysis of its author, Daryl J. Bem (and the peer
reviewers who urged that his paper be accepted), are not winning over many
hearts.
Yet
the episode has
inflamed one of the longest-running debates in science. For decades, some
statisticians have argued that the standard technique used to analyze data
in much of social science and medicine overstates many study findings —
often by a lot. As a result, these experts say, the literature is littered
with positive findings that do not pan out: “effective” therapies that are
no better than a placebo; slight biases that do not affect behavior;
brain-imaging correlations that are meaningless.
By incorporating statistical techniques that are
now widely used in other sciences —
genetics, economic modeling, even wildlife
monitoring — social scientists can correct for such problems, saving
themselves (and, ahem, science reporters) time, effort and embarrassment.
“I was delighted that this ESP paper was accepted
in a mainstream science journal, because it brought this whole subject up
again,” said James Berger, a statistician at
Duke University. “I was on a mini-crusade about
this 20 years ago and realized that I could devote my entire life to it and
never make a dent in the problem.”
In recent weeks, editors at a respected
psychology journal have been taking heat from
fellow scientists for deciding to accept a research report that claims to
show the existence of extrasensory perception.
The report, to be published this year in
The Journal of Personality and Social Psychology,
is not likely to change many minds. And the scientific critiques of the
research methods and data analysis of its author, Daryl J. Bem (and the peer
reviewers who urged that his paper be accepted), are not winning over many
hearts.
Yet
the episode has inflamed one of the
longest-running debates in science. For decades, some statisticians have
argued that the standard technique used to analyze data in much of social
science and medicine overstates many study findings — often by a lot. As a
result, these experts say, the literature is littered with positive findings
that do not pan out: “effective” therapies that are no better than a
placebo; slight biases that do not affect behavior; brain-imaging
correlations that are meaningless.
By incorporating statistical techniques that are
now widely used in other sciences —
genetics, economic modeling, even wildlife
monitoring — social scientists can correct for such problems, saving
themselves (and, ahem, science reporters) time, effort and embarrassment.
“I was delighted that this ESP paper was accepted
in a mainstream science journal, because it brought this whole subject up
again,” said James Berger, a statistician at
Duke University. “I was on a mini-crusade about
this 20 years ago and realized that I could devote my entire life to it and
never make a dent in the problem.”
The statistical approach that has dominated the
social sciences for almost a century is called significance testing. The
idea is straightforward. A finding from any well-designed study — say, a
correlation between a personality trait and the risk of depression — is
considered “significant” if its probability of occurring by chance is less
than 5 percent.
This arbitrary cutoff makes sense when the effect
being studied is a large one — for example, when measuring the so-called
Stroop effect. This effect predicts that naming the color of a word is
faster and more accurate when the word and color match (“red” in red
letters) than when they do not (“red” in blue letters), and is very strong
in almost everyone.
“But if the true effect of what you are measuring
is small,” said Andrew Gelman, a professor of statistics and political
science at
Columbia University, “then by necessity anything
you discover is going to be an overestimate” of that effect.
Consider the following experiment. Suppose there
was reason to believe that a coin was slightly weighted toward heads. In a
test, the coin comes up heads 527 times out of 1,000.
Is this significant evidence that the coin is
weighted?
Classical analysis says yes. With a fair coin, the
chances of getting 527 or more heads in 1,000 flips is less than 1 in 20, or
5 percent, the conventional cutoff. To put it another way: the experiment
finds evidence of a weighted coin “with 95 percent confidence.”
Yet many statisticians do not buy it. One in 20 is
the probability of getting any number of heads above 526 in 1,000 throws.
That is, it is the sum of the probability of flipping 527, the probability
of flipping 528, 529 and so on.
But the experiment did not find all of the numbers
in that range; it found just one — 527. It is thus more accurate, these
experts say, to calculate the probability of getting that one number — 527 —
if the coin is weighted, and compare it with the probability of getting the
same number if the coin is fair.
Statisticians can show that this ratio cannot be
higher than about 4 to 1, according to Paul Speckman, a statistician, who,
with Jeff Rouder, a psychologist, provided the example. Both are at the
University of Missouri and said that the simple
experiment represented a rough demonstration of how classical analysis
differs from an alternative approach, which emphasizes the importance of
comparing the odds of a study finding to something that is known.
The point here, said Dr. Rouder, is that 4-to-1
odds “just aren’t that convincing; it’s not strong evidence.”
And yet classical significance testing “has been
saying for at least 80 years that this is strong evidence,” Dr. Speckman
said in an e-mail.
The critics have been crying foul for half that
time. In the 1960s, a team of statisticians led by Leonard Savage at the
University of Michigan showed that the classical
approach could overstate the significance of the finding by a factor of 10
or more. By that time, a growing number of statisticians were developing
methods based on the ideas of the
18th-century English mathematician Thomas Bayes.
Bayes devised a way to update the probability for a
hypothesis as new evidence comes in.
So in evaluating the strength of a given finding,
Bayesian (pronounced BAYZ-ee-un) analysis incorporates known probabilities,
if available, from outside the study.
It might be called the “Yeah, right” effect. If a
study finds that kumquats reduce the risk of heart disease by 90 percent,
that a treatment cures alcohol addiction in a week, that sensitive parents
are twice as likely to give birth to a girl as to a boy, the Bayesian
response matches that of the native skeptic: Yeah, right. The study findings
are weighed against what is observable out in the world.
In at least one area of medicine — diagnostic
screening tests — researchers already use known probabilities to evaluate
new findings. For instance, a new lie-detection test may be 90 percent
accurate, correctly flagging 9 out of 10 liars. But if it is given to a
population of 100 people already known to include 10 liars, the test is a
lot less impressive.
It correctly identifies 9 of the 10 liars and
misses one; but it incorrectly identifies 9 of the other 90 as lying.
Dividing the so-called true positives (9) by the total number of people the
test flagged (18) gives an accuracy rate of 50 percent. The “false
positives” and “false negatives” depend on the known rates in the
population.
Today the Securities
and Exchange Commission (SEC) provided many smaller companies with
additional time to comply with the SEC's internal control audit
requirements. Under the final extension, non-accelerated filers (generally
companies with a public float below $75 million) will be required to comply
with the SEC's internal control audit requirements beginning with annual
reports for fiscal years ending on or after June 15, 2010. The additional
extension does not affect companies with fiscal year-ends between June 15
and December 14.
Police raid KPMG, PwC offices regarding failure of Icelandic banks Icelandic
offices of accounting firms KPMG and PricewaterhouseCoopers were raided by
police during an investigation into the failure of Iceland's three biggest
banks. Police seized documents and computer data related to banks Kaupthing,
Glitnir and Landsbanki. Officials are looking into allegations that
accounting and reporting requirements were violated at those banks, the
failure of which drove the country into a financial crisis. Telegraph
(London) (10/1)
Glen L. Gray, PhD, CPA
Accounting & Information Systems, COBAE
California State University, Northridge
18111 Nordhoff ST
Northridge, CA 91330-8372
818.677.3948
818.677.2461 (messages)
http://www.csun.edu/~vcact00f
Recently I visited my
pharmacy to pick up eyedrops for my two golden retrievers. Before he would
give me the prescription, the pharmacist insisted I sign a form on behalf of
Murphy and Millie, representing that they had been apprised of their rights
under the new medical privacy rules. This ludicrous situation is a good
illustration of how complicated life has gotten.
I was still shaking
my head later that same day when I was clicking mindlessly through the 150
or so channels that my local cable TV service makes available to me. I
happened to land on The Andy Griffith Show, and the few minutes I spent with
Andy, Barney, Opie, and Aunt Bea got me thinking about the Good Old Days.
Wouldn’t it be nice, I thought, to go back to the Good Old Days of the
profession in the early 1960s when I graduated from college?
Back then, accounting
was really simple. The Accounting Principles Board hadn’t issued any
standards yet, and FASB didn’t exist. So we didn’t have 880 pages listing
all of the current rules and guidance on derivative financial instruments,
for example. The totality of authoritative GAAP at that time fit in one
softbound booklet about one-third the size of the new derivatives guidance.
In those Good Old
Days, the SEC had been around for quite a while but it rarely got excited
about accounting matters. Neither mandatory quarterly reporting nor
management’s discussion and analysis (MD&A) had yet come into being, for
example. And annual report footnotes could actually be read in an hour or
so.
The country had eight
major accounting firms, and becoming a partner in one was a truly big deal.
Lawsuits against accounting firms were rare, and almost none of them
resulted in substantial damages against the accountants.
In short, accounting
seemed more like a true profession, with good judgment and experience key
requirements for success.
Of course, however
much we might like to return to simpler times, it’s easier said than done.
And most of us would never give up the many benefits of progress, such as
photocopiers, personal computers, e-mail, the Internet, and cellphones. But
I think that accounting rules may have become more complicated than
necessary.
Let me start with a
mea culpa. You may remember the famous line from the comic strip Pogo: “We
have met the enemy, and he is us!” Well, you may be tempted to rephrase that
quote to “We have met the enemy, and he is … Beresford!”
I plead guilty to
having led the development of 40 or so new accounting standards over my time
at FASB. A number of them had pervasive effects on financial statements, and
some have been costly to apply. I always tried to be as practical as
possible, however, although probably few would say that I was 100%
successful in meeting that objective.
In any event,
more-recent accounting standards and proposals seem to be getting
increasingly complicated and harder to apply. Even the best-intentioned
accountants have difficulty keeping up with all of the changes from FASB,
the AICPA, the SEC, the EITF, and the IASB. And some individual standards,
such as those on derivatives and variable-interest entities, are almost
impossible for professionals, let alone laypeople, to decipher.
Furthermore, these
days, companies are subject to what I’ll call quadruple jeopardy. They have
to apply GAAP as best they can, but they are then subject to as many as four
levels of possible second-guessing of their judgments.
First, the external
auditors must weigh in. Second, the SEC will now be reviewing all public
companies’ reports at least once every three years. Third, the PCAOB will be
looking at a sample of accounting firms’ audits, and that could include any
given company’s reports. Finally, the plaintiff’s bar is always looking for
opportunities to challenge accounting judgments and extort settlements.
Broad Principles Versus Detailed Rules
I suspect that all
this second-guessing is what leads many companies and auditors to ask for
more-detailed accounting rules. But we may have reached the point of
diminishing returns. In response to the complexity and sheer volume of many
current standards, some have suggested that accounting standards should be
broad principles rather than detailed rules. FASB and the SEC have expressed
support for the general notion of a principles-based approach to accounting
standards. (It’s kind of like apple pie and motherhood: Who can object to
broad principles?) Of course, implementing such an approach is problematic.
In 2002, FASB issued
a proposal on this matter. And last year the SEC reported to Congress on the
same topic. Specific things that FASB suggested could happen include the
following:
Standards should
always state very clear objectives. Standards should have a clearly defined
scope and there should be few, if any, exceptions (e.g., for certain
industries). Standards should contain fewer alternative accounting
treatments (e.g., unrealized gains and losses on marketable securities could
all be run through income rather than the various approaches used at
present). FASB also said that a principles-based approach probably would
include less in the way of detailed interpretive and implementation
guidance. Thus, companies and auditors would be expected to rely more on
professional judgment in applying the standards.
The SEC prefers to
call this approach “objectives-based” rather than “principles-based.” SEC
Chief Accountant Donald Nicolaisen recently repeated the SEC’s support for
such an approach, agreeing with the notion of clearly identifying and
articulating the objective for each standard. Although he also suggested
that objectives-based standards should avoid bright-line tests such as lease
capitalization rules, he called for “sufficiently detailed” implementation
guidance, including real-world examples.
Although FASB and the
SEC may have reached a meeting of the minds on the overall notion of more
general principles, they may disagree on the key point of how much
implementation guidance to provide. FASB thinks that a principles-based
approach should include less implementation guidance and rely more on
judgment, while the SEC thinks that “sufficiently detailed” guidance is
needed, and I suspect that would make it difficult to significantly reduce
complexity in some cases.
In any event, FASB
recently said that it may take “several years or more” for preparers and
auditors to adjust to a change to less detail. Meantime, little has changed
with respect to individual standards, which if anything are becoming even
harder to understand and apply.
I’ve heard FASB board
members say that FASB Interpretation (FIN) 46, on variable-interest entities
(VIE), is an example of a principles-based standard. I assume they say this
because FIN 46 states an objective of requiring consolidation when control
over a VIE exists. But the definition of a VIE and the rules for determining
when control exists are extremely difficult to understand.
FASB recently
described what it meant by the operationality of an accounting standard. The
first condition was that standards have to be comprehensible to readers with
a reasonable level of knowledge and sophistication. This doesn’t seem to be
the case for FIN 46. Many auditors and financial executives have told me
that only a few individuals in the country truly know how to apply FIN 46.
And those few individuals often disagree among themselves!
Such complications
make it difficult to get decisions on many accounting matters from an audit
engagement team. Decisions on VIEs, derivatives, and securitization
transactions, to name a few, must routinely be cleared by an accounting
firm’s national experts. And with section 404 of the Sarbanes-Oxley Act
(SOA) and new concerns about auditor independence, getting answers is now
even harder. For example, in the past, companies would commonly consult with
their auditors on difficult accounting matters. But now the PCAOB may view
this as a control weakness, under the assumption that the company lacks
adequate internal expertise. And if auditors get too involved in technical
decisions before a complex transaction is completed, the SEC or the PCAOB
might decide that the auditors aren’t independent, because they’re auditing
their own decisions.
When things become
this complicated, I wonder whether it’s time for a new approach. Maybe we do
need to go back to the Good Old Days.
Internal Controls
Today, financial
executives are probably more concerned about internal controls than new
accounting requirements. For the first time, all public companies must
report on the adequacy of their internal controls over financial reporting,
and outside auditors must express their opinion on the company’s controls.
Many people have questioned whether this incredibly expensive activity is
worth the presumed benefit to investors. While one might argue that the
section 404 rules are a regulatory overreaction, shareholders should expect
good internal controls. And audit committees, as shareholders’
representatives, must demand those good controls. So this has been by far
the most time-consuming topic at all audit committee meetings I’ve attended
in the past couple of years.
Companies and
auditors are spending huge sums this year to ensure that transactions are
properly processed and controlled. Yet the most perfect system of internal
controls and the best audit of them might not catch an incorrect
interpretation of GAAP. A good example of this was contained in the PCAOB’s
August 2004 report on its initial reviews of the Big Four’s audit practices.
The report noted that all four firms had missed the fact that some clients
had misapplied EITF Issue 95-22. As the New York Times (August 27, 2004)
noted, “The fact that all of the top firms had been misapplying it raised
issues of just how well they know the sometimes complicated rules.”
Responding to a
different criticism in that same PCAOB report, KPMG noted, “Three
knowledgeable informed bodies—the firm, the PCAOB, and the SEC—had reached
three different conclusions on proper accounting, illustrating the complex
accounting issues registrants, auditors and regulators all face.”
Fair Value Accounting
Even those who are
very confident about their understanding of the current accounting rules
shouldn’t get complacent: Fair value accounting is right around the corner,
making things even harder. In fact, it is already required in several recent
standards.
The Sarbanes-Oxley Act (SOX) mandates management
evaluation and independent audits of internal control effectiveness. The
mandate is costly to firms but may yield benefits through lower information
risk that translates into lower cost of equity. We use unaudited pre–SOX 404
disclosures and SOX 404 audit opinions to assess how changes in internal
control quality affect firm risk and cost of equity. After controlling for
other risk factors, we find that firms with internal control deficiencies
have significantly higher idiosyncratic risk, systematic risk, and cost of
equity. Our change analyses document that auditor-confirmed changes in
internal control effectiveness (including remediation of previously
disclosed internal control deficiencies) are followed by significant changes
in the cost of equity that range from 50 to 150 basis points. Overall, our
cross-sectional and intertemporal change test results are consistent with
internal control reports affecting investors' risk assessments and firms'
cost of equity.
Britain’s big four
auditing firms have been left exposed to a surge in negligence claims after
the Government refused to limit further the damages they could face.
Deloitte, Ernst &
Young, KPMG and PricewaterhouseCoopers (PwC) lobbied hard for a cap on
payouts. Senior figures involved in the discussions said that Lord Mandelson,
the Business Secretary, appeared receptive to their concerns but stopped
short of changing the law.
The decision is a
huge blow to the firms — some face lawsuits relating to Bernard Madoff’s $65
billion fraud — which believe there may not be another chance for a change
in the law for at least two years. They fear that they will be targeted by
investors and liquidators seeking to recover losses from Madoff-style frauds
and big company failures.
At present, auditors
can be held liable for the full amount of losses in the event of a collapse,
even if they are found to be only partly to blame.
In April,
representatives of the companies met Lord Mandelson to plead for new
measures to cap their liability. They warned that British business could be
plunged into chaos if one of them were bankrupted by a blockbuster lawsuit.
However, an official
of the Department for Business, Innovation and Skills said: “The 2006
Companies Act already allows auditor liability limitation where companies
and their auditors want to take this course.”
Under present company
law, directors can agree to restrict their auditors’ liability if
shareholders approve; however, to date, no blue-chip company has done so.
Directors have seen little advantage in limiting their auditors’ liability,
and objections by the US Securities and Exchange Commission (SEC) have also
been a significant obstacle.
The SEC opposes caps
on the ground that their introduction could lead to secret deals whereby
directors agree to restrict liability in return for auditors compromising on
their oversight of a company’s accounts. The SEC could attempt to block caps
put in place by British companies that have operations in the United States.
The big four auditors
had hoped to persuade Lord Mandelson to amend the legislation to address the
SEC’s concerns and to encourage companies to limit their auditors’
liability.
Peter Wyman, a senior
PwC partner, who was involved in the discussions, said that the Government’s
lack of action was disappointing. He said: “The Government, having
legislated to allow proportionate liability for auditors, is apparently
content to have its policy frustrated by a foreign regulator.”
Auditors are often
hit with negligence claims in the aftermath of a company failure because
they are perceived as having deep pockets and remain standing while other
parties may have disappeared or been declared insolvent.
In 2005 Ernst & Young
was sued for £700 million by Equitable Life, its former audit client, after
the insurance company almost collapsed. The claim was dropped but could have
bankrupted the firm’s UK arm if it had succeeded.
This year KPMG was
sued for $1 billion by creditors of New Century, a failed sub-prime lender,
and PwC has faced questions over its audit of Satyam, the Indian outsourcing
company that was hit by a long- running accounting fraud.
Three of the big four
are also facing numerous lawsuits relating to their auditing of the feeder
funds that channelled investors into Madoff’s Ponzi scheme.
Investors and
accounting regulators worry that the big four’s dominance of the audit
market is so great that British business would be thrown into disarray if
one of the four were put out of business by a huge court action. All but two
FTSE 100 companies are audited by the four.
Mr Wyman said: “The
failure of a large audit firm would be very damaging to the capital markets
at a time when they are already fragile.”
Arthur Andersen,
formerly one of the world’s five biggest accounting firms, collapsed in 2002
as a result of its role in the Enron scandal.
Suits you
KPMG
A defendant in a class-action lawsuit in the Southern District of New York
against Tremont, a Bernard Madoff feeder fund
Ernst & Young
Sued by investors in a Luxembourg court with UBS for oversight of a European
Madoff feeder fund
PwC
Included in several lawsuits in Canada claiming damages of up to $2 billion
against Fairfield Sentry, a big Madoff feeder fund
KPMG
Sued in the US for at least $1 billion by creditors of New Century
Financial, a failed sub-prime mortgage lender, which claimed that KPMG’s
auditing was “recklessly and grossly negligent”
Deloitte
Sued by the liquidators of two Bear Stearns-related hedge funds that
collapsed at the start of the credit crunch
Jensen Comment After
the Enron, Worldcom, and other scandals there was serious doubt as to
whether private investors would abandon equity capital markets. SOX was
enacted to save Wall Street. It is doubtful that we, as accountants and
auditors, will ever be able to return to "the good old days."
Abstract:
From its founding in 1934 until the early 1970s, the SEC and especially its
Chief Accountant disapproved of most upward revaluations in property, plant
and equipment as well as depreciation charges based on such revaluations.
This article is a historical study of the evolution of the SEC's policy on
such upward revaluations. It includes episodes when the private-sector body
that established accounting principles sought to gain a degree of acceptance
for them and was usually rebuffed. In the decade of the 1970s, the SEC
altered its policy. Throughout the article, the author endeavors to explain
the factors that influenced the positions taken by the parties.
Abstract:
This paper examines the background and work of the AICPA’s Accounting
Objectives Study Group, chaired by Robert M. Trueblood, which issued its
important report in October 1973. In particular, the research is informed by
interviews with three members of the Study Group and with four of the
principal members of its research staff. Evidence is presented on the
members of the Study Group who supported, or did not support, various
positions in the report, including their apparent reasons, as well on the
influential role of the staff in shaping the report. The conclusion is that
the full-time staff, abetted by the financial analyst member of the Study
Group, played the key role in driving the thrust of the final report, which
recommended that financial statements should provide users with information
about the cash-generating ability of the enterprise, and eventually the cash
flow to the users themselves. This
recommendation resonated with the FASB and with standard setters around the
world.
More Than a Numbers Game: A Brief History of Accounting
Author: Thomas A. King
ISBN: 0-470-00873-3
Hardcover 242 pages
September 2006
Inspired by a 1998 speech by former SEC Chairman
Arthur Levitt, this book addresses the why of accounting instead of the how,
providing practitioners and students with a highly readable history of U.S.
corporate accounting. Each chapter explores a controversial accounting topic.
Author Thomas King is treasurer of Progressive Insurance. SmartPros Newsletter, September 25, 2006
Jensen Comment
The Chief Accountant of the SEC under Arthur Levitt was one of my heroes named
Lynn Turner. Let me close by citing Harry
S. Truman who said, "I never give them hell; I just tell them the truth and they
think its hell!"
Great Speeches About the State of Accountancy
"20th Century Myths," by Lynn Turner when he was still Chief Accountant at the
SEC in 1999 ---
http://www.sec.gov/news/speech/speecharchive/1999/spch323.htm
It is
interesting to listen to people ask for simple, less complex
standards like in "the good old days." But I never hear them ask for
business to be like "the good old days," with smokestacks rather
than high technology, Glass-Steagall rather than Gramm-Leach, and
plain vanilla interest rate deals rather than swaps, collars, and
Tigers!! The bottom line is—things have changed. And so have people.
Today, we have enormous pressure on CEO’s and
CFO’s. It used to be that CEO’s would be in their positions for an
average of more than ten years. Today, the average is 3 to 4 years.
And Financial Executive Institute surveys show that the CEO and CFO
changes are often linked.
In such an environment, we in the auditing
and preparer community have created what I consider to be a
two-headed monster. The first head of this monster is what I call
the "show me" face. First, it is not uncommon to hear one say, "show
me where it says in an accounting book that I can’t do this?" This
approach to financial reporting unfortunately necessitates the level
of detail currently being developed by the Financial Accounting
Standards Board ("FASB"), the Emerging Issues Task Force, and the
AICPA’s Accounting Standards Executive Committee. Maybe this isn’t a
recent phenomenon. In 1961, Leonard Spacek, then managing partner at
Arthur Andersen, explained the motivation for less specificity in
accounting standards when he stated that "most industry
representatives and public accountants want what they call
‘flexibility’ in accounting principles. That term is never clearly
defined; but what is wanted is ‘flexibility’ that permits greater
latitude to both industry and accountants to do as they please." But
Mr. Spacek was not a defender of those who wanted to "do as they
please." He went on to say, "Public accountants are constantly
required to make a choice between obtaining or retaining a client
and standing firm for accounting principles. Where the choice
requires accepting a practice which will produce results that are
erroneous by a relatively material amount, we must decline the
engagement even though there is precedent for the practice desired
by the client."
We create the second head of our monster
when we ask for standards that absolutely do not reflect the
underlying economics of transactions. I offer two prime examples.
Leasing is first. We have accounting literature put out by the FASB
with follow-on interpretative guidance by the accounting
firms—hundreds of pages of lease accounting guidance that, I will be
the first to admit, is complex and difficult to decipher. But it is
due principally to people not being willing to call a horse a horse,
and a lease what it really is—a financing. The second example is
Statement 133 on derivatives. Some people absolutely howl about its
complexity. And yet we know that: (1) people were not complying with
the intent of the simpler Statements 52 and 80, and (2) despite the
fact that we manage risk in business by managing values rather than
notional amounts, people want to account only for notional amounts.
As a result, we ended up with a compromise position in Statement
133. To its credit, Statement 133 does advance the quality of
financial reporting. For that, I commend the FASB. But I believe
that we could have possibly achieved more, in a less complex
fashion, if people would have agreed to a standard that truly
reflects the underlying economics of the transactions in an unbiased
and representationally faithful fashion.
I certainly hope that we can find a way to
do just that with standards we develop in the future, both in the
U.S. and internationally. It will require a change in how we
approach standard setting and in how we apply those standards. It
will require a mantra based on the fact that transparent, high
quality financial reporting is what makes our capital markets the
most efficient, liquid, and deep in the world.
"Living Like It's 1931: Law professor Frank Partnoy questions
whether the regulatory reform bill under debate in Congress will be enough to
move the economy toward prosperity," by Sarah Johnson, CFO.com, June
17, 2010 ---
http://www.cfo.com/article.cfm/14505447/c_14505581?f=home_todayinfinance
The calendar says 2010, but Frank Partnoy believes
that in certain respects, we're living like it's 1931. That was a
transitional year between the 1929 stock market crash and the passing of two
transformative securities laws, in 1933 and 1934, that established a
regulatory body for public companies, mandated widespread financial
reporting, and created antifraud remedies.
Seven decades later, optimists would like to
believe that the regulatory reform bill in Congress will mark the beginning
of better days for the U.S. economy. But Partnoy, a University of San Diego
law and finance professor and longtime follower of regulatory reforms,
thinks 2010 will likewise be considered a transitional time. "We're still in
the middle of the ball game in terms of regulatory response," he told CFO in
a recent interview.
In Partnoy's view, the regulatory response to the
financial crisis thus far has been "muddled." Congress is plodding through
more than 1,500 pages of reforms that will affect various areas of the U.S.
financial system. The reforms include a new government authority to prevent
financial institutions from becoming too big to fail, a consumer protection
agency, regulations for the derivatives market, and even some measures that
could be deemed antiregulation (such as a provision that would exempt the
smallest U.S. publicly traded companies from getting an audit opinion on
their internal controls).
The bill is expected to be finalized at the end of
this month. Around the same time, Partnoy will speak about the new
regulatory reforms and their resemblance to past reforms at the upcoming CFO
Core Concerns Conference, to be held June 27-29 in Baltimore. An edited
version of CFO's recent interview with Partnoy follows.
How can we assess whether the new legislation will
be successful? The only way we'll know is to wait and hope. If we could go
back in time a few years with these proposed rules, would the crisis have
been prevented? The answer is no. Congress is considering more than 1,500
pages of reform, but most of that is not directed at problems that would
have prevented the crisis.
What piece of the legislation do you most hope will
survive the process? The most crucial part is the removal of regulatory
references to credit ratings. I have my fingers crossed that it will pass.
Participants in the financial markets need to stop relying on Moody's and
S&P.
Why isn't a similar proposal by the Securities and
Exchange Commission to end the practice good enough? The SEC doesn't have
the power to change a statute; Congress does. And many of these references
extend beyond the securities area, outside the purview of the SEC. In
addition, it's important for Congress to fire a shot across the bow of all
regulators to let them know that it's not appropriate to rely on ratings.
It's the kind of reform that needs to come from the top, and that means
Congress.
In a joint paper with former SEC chief accountant
Lynn Turner, you called on Congress to "clarify that financial statements
have primacy over footnotes, not the other way around." Why do you think our
financial-reporting system has evolved to become, in your view, not as
transparent as it should be? It's been a slow evolution that has been driven
by lobbying, in particular by major financial institutions. This started in
the 1980s, when accounting standard-setters were trying to figure out
whether swaps should be accounted for on the balance sheet. Once that
argument was lost — once we went down the road of saying that swaps were
different — it was a very slippery slope. There's a focused group of market
participants who benefit from off-balance-sheet treatment but only a few who
represent investor interests. Analysts are in an interesting position
because on the one hand, they would be able to do a better job if they had
more information about exposures and liabilities. But if everything is
off-balance-sheet, they have a comparative advantage in finding out what's
buried on page 246 of Form 10-K.
Do you see any signs that this issue will be
addressed in the legislation? Congress, Wall Street, and large institutional
investors all seem to have united against putting these financial
instruments on the balance sheet. It seems unlikely that there will be any
kind of substantive change.
What's your view on proposed reforms for
derivatives? What I regard as the most important reform has met with mixed
reactions. That would be simply for banks to more accurately report their
exposure to derivatives and give better information about worst-case
scenarios. Those initiatives have taken a back seat to the push for
requiring that derivatives be traded on exchanges, and then for trying to
move derivatives outside of the banking sector. Keep in mind, the
transactions that generated the crisis were not transactions that would ever
find a home on an exchange. They're private, custom-tailored deals that fall
outside of the legislation. Paradoxically, we might end up with a law that
will hurt useful markets in plain-vanilla derivatives, yet will not resolve
problems.
Another one of my heroes is former Coopers partner and SEC Chief Accountant
Lynn Turner. My two heroes, Turner and Partnoy, write about how bank financial
statements should be classified under "Fiction."
From CFO Journal's Morning Ledger on August 9,
2013
Did we waste the recession?
To demonstrate how difficult it is to get a bead on the health of the
financial industry five years after the economic crisis, Adam
Davidson of the New York Times Magazine invited
two finance professors to dig into Citgroup’s most recent SEC report. Within
the “300-page tome,” the experts found three widely varying numbers
representing the bank’s capital-adequacy ratio—a finding similar to a doctor
providing a patient with three temperatures. If finance professors can’t
determine a bank’s health, “how are the rest of us supposed to make any
sense of this?” Davidson talks to banking experts across the political
spectrum who favor strong and simple bank rules that define capital narrowly
and debt broadly. The resulting ratio makes reviewing the soundness of a
bank “as simple as checking the letter grade of a restaurant in New York
City.” Davidson admits that bankers and some economists say simplified rules
would make lending more burdensome. “In finance, though, complexity often
means profit,” he writes. “Simplicity might be good for economics, but it’s
lousy for Wall Street bonuses.”
Frank Partnoy and Lynn Turner contend that bank accounting is an exercise in
writing fiction:
Watch the video! (a bit slow loading)
Lynn Turner is Partnoy's co-author of the white paper "Make Markets Be Markets"
"Bring Transparency to Off-Balance Sheet Accounting," by Frank Partnoy,
Roosevelt Institute, March 2010 --- http://www.rooseveltinstitute.org/policy-and-ideas/ideas-database/bring-transparency-balance-sheet-accounting
Watch the great video!
Pure Munger……must read!!!!!!
This is by Mortimier Adler the author of How to read abook, which as profiled in
Robert Hagstrom’s Investing The Last Liberal Art and Latticework of Mental
Models.
Full Excerpt (Via Mortimier Adler)
The outstanding achievement and
intellectual glory of modern times has been empirical science and the
mathematics that it has put to such good use. The progress is has made in
the last three centuries, together with the technological advances that have
resulted therefrom, are breathtaking.
The equally great achievement and
intellectual glory of Greek antiquity and of the Middle Ages was philosophy.
We have inherited from those epochs a fund of accumulated wisdom. That, too,
is breathtaking, especially when one considers how little philosophical
progress has been made in modern times.
This is not say that no advances in
philosophical thought have occurred in the last three hundred years. They
are mainly in logic, in the philosophy of science, and in political theory,
not in metaphysics, in the philosophy of nature, or in the philosophy of
mind, and least of all in moral philosophy. Nor is it true to say that, in
Greek antiquity and in the later Middle Ages, from the fourteenth century
on, science did not prosper at all. On the contrary, the foundations were
laid in mathematics, in mathematical physics, in biology, and in medicine.
It is in metaphysics, the philosophy of
nature, the philosophy of mind, and moral philosophy that the ancients and
their mediaeval successors did more than lay the foundations for the sound
understanding and the modicum of wisdom we possess. They did not make the
philosophical mistakes that have been the ruination of modern thought. On
the contrary, they had the insights and made the indispensable distinctions
that provide us with the means for correcting these mistakes.
At its best, investigative science gives
us knowledge of reality. As I have argued elsewhere, philosophy is, at the
very least, also knowledge of reality, not mere opinion. Much better than
that, it is knowledge illuminated by understanding. At its best, it
approaches wisdom, both speculative and practical.
Precisely because science is investigative
and philosophy is not, one should not be surprised by the remarkable
progress in science and by the equally remarkable lack of it in philosophy.
Precisely because philosophy is based upon the common experience of mankind
and is a refinement and elaboration of the common-sense knowledge and
understanding that derives from reflection on that common experience,
philosophy came to maturity early and developed beyond that point only
slightly and slowly.
Science knowledge changes, grows,
improves, expands, as a result of refinements in and accretions to the
special experience — the observational data — on which science as an
investigative mode of inquiry must rely. Philosophical knowledge is not
subject to the same conditions of change or growth. Common experience, or
more precisely, the general lineaments or common core of that experience,
which suffices for the philosopher, remains relatively constant over the
ages.
Descartes and Hobbes in the seventeenth
century, Locke, Hume, and Kant in the eighteenth century, and Alfred North
Whitehead and Bertrand Russell in the twentieth century enjoy no greater
advantages in this respect than Plato and Aristotle in antiquity or than
Thomas Aquinas, Duns Scotus, and Roger Bacon in the Middle Ages.
How might modern thinkers have avoided the
philosophical mistakes that have been so disastrous in their consequences?
In earlier works I have suggested the answer. Finding a prior philosopher’s
conclusions untenable, the thing to do is to go back to his starting point
and see if he has made a little error in the beginning.
A striking example of the failure to
follow this rule is to be found in Kant’s response to Hume. Hume’s skeptical
conclusions and his phenomenalism were unacceptable to Kant, even though
they awoke him from his own dogmatic slumbers. But instead of looking for
little errors in the beginning that were made by Hume and then dismissing
them as the cause of Humean conclusions that he found unacceptable, Kant
thought it necessary to construct a vast piece of philosophical machinery
designed to produce conclusions of an opposite tenor.
The intricacy of the apparatus and the
ingenuity of the design cannot help but evoke admiration, even from those
who are suspicious of the sanity of the whole enterprise and who find it
necessary to reject Kant’s conclusions as well as Hume’s. Though they are
opposite in tenor, they do not help us to get at the truth, which can only
be found by correcting Hume’s little errors in the beginning, and the little
errors made by Locke and Descartes before that. To do that one must be in
the possession of insights and distinctions with which these modern thinkers
were unacquainted. Why they were, I will try to explain presently.
What I have just said about Kant in
relation to Hume applies also to the whole tradition of British empirical
philosophy from Hobbes, Locke, and Hume on. All of the philosophical
puzzlements, paradoxes, and pseudo-problems that linguistic and analytical
philosophy and therapeutic positivism in our own century have tried to
eliminate would never have arisen in the first place if the little errors in
the beginning made by Locke and Hume had been explicitly rejected instead of
going unnoticed.
How did those little errors in the
beginning arise in the first place? One answer is that something which
needed to be known or understood had not yet been discovered or learned.
Such mistakes are excusable, however regrettable they may be.
The second answer is that the errors are
made as a result of culpable ignorance — ignorance of an essential point, an
indispensable insight or distinction, that has already been discovered and
expounded.
It is mainly in the second way that modern
philosophers have made their little errors in the beginning. They are ugly
monuments to the failures of education — failures due, on the one hand, to
corruptions in the tradition of learning and, on the other hand, to an
antagonistic attitude toward or even contempt for the past, for the
achievements of those who have come before.
Ten years ago, in 1974-1975, I wrote my
autobiography, and intellectual biography entitled Philosopher at Large. As
I now reread its concluding chapter, I can see the substance of this work
emerging from what I wrote there.
I frankly confessed my commitment to
Aristotle’s philosophical wisdom, both speculative and practical, and to
that of his great disciple Thomas Aquinas. The essential insights and the
indispensable distinctions needed to correct the philosophical mistakes made
in modern times are to be found in their thought.
Some things said in the concluding chapter
of that book bear repetition here in this work. Since I cannot improve upon
what I wrote ten years ago, I shall excerpt and paraphrase what I said then.
In the eyes of my contemporaries the label
“Aristotelian” has dyslogistic connotations. It has had such connotations
since the beginning of modern times. To call a man an Aristotelian carries
with it highly derogatory implications. It suggests that his is a closed
mind, in such slavish subjection to the thought of one philosopher as to be
impervious to the insights or arguments of others.
However, it is certainly possible to be an
Aristotelian — or the devoted disciple of some other philosopher — without
also being a blind and slavish adherent of his views, declaring with
misplaced piety that he is right in everything he says, never in error, or
that he has cornered the market on truth and is in no respect deficient or
defective. Such a declaration would be so preposterous that only a fool
would affirm it. Foolish Aristotelians there must have been among the
decadent scholastics who taught philosophy in the universities of the
sixteenth and seventeenth centuries. They probably account for the vehemence
of the reaction against Aristotle, as well as the flagrant misapprehension
or ignorance of his thought, that is to be found in Thomas Hobbes and
Francis Bacon, in Descartes, Spinoza, and Leibniz.
The folly is not the peculiar affliction
of Aristotelians. Cases of it can certainly be found, in the last century,
among those who gladly called themselves Kantians or Hegelians; and in our
own day, among those who take pride in being disciples of John Dewey or
Ludwig Wittgenstein. But if it is possible to be a follower of one of the
modern thinkers without going to an extreme that is foolish, it is no less
possible to be an Aristotelian who rejects Aristotle’s error and
deficiencies while embracing the truths he is able to teach.
Even granting that it is possible to be an
Aristotelian without being doctrinaire about it, it remains the case that
being an Aristotelian is somehow less respectable in recent centuries and in
our time than being a Kantian or a Hegelian, an existentialist, a
utilitarian, a pragmatist, or some other “ist” or “ian.” I know, for
example, that many of my contemporaries were outraged by my statement that
Aristotle’s Ethics is a unique book in the Western tradition of moral
philosophy, the only ethics that is sound, practical, and undogmatic.
If a similar statement were made by a
disciple of Kant or John Stuart Mill in a book that expounded and defended
the Kantian or utilitarian position in moral philosophy, it would be
received without raised eyebrows or shaking heads. For example, in this
century it has been said again and again, and gone unchallenged, that
Bertrand Russell’s theory of descriptions has been crucially pivotal in the
philosophy of language; but it simply will not do for me to make exactly the
same statement about the Aristotelian and Thomistic theory of signs (adding
that it puts Russell’s theory of descriptions into better perspective than
the current view of it does).
Why is this so? My only answer is that it
must be believed that, because Aristotle and Aquinas did their thinking so
long ago, they cannot reasonable be supposed to have been right in matters
about which those who came later were wrong. Much must have happened in the
realm of philosophical thought during the last three or four hundred years
that requires an open-minded person to abandon their teachings for something
more recent and, therefore, supposedly better.
My response to that view is negative. I
have found faults in the writings of Aristotle and Aquinas, but it has not
been my reading of modern philosophical works that has called my attention
to these faults, nor helped me to correct them. On the contrary, it has been
my understanding of the underlying principles and the formative insights
that govern the thought of Aristotle and Aquinas that has provided the basis
for amending or amplifying their views where they are fallacious or
defective.
I must say one more that in philosophy,
both speculative and practical, few if any advances have been made in modern
times. On the contrary, must has been lost as the result of errors that
might have been avoided if ancient truths had been preserved in the modern
period instead of being ignored.
Modern philosophy, as I see it, got off to
a very bad start — with Hobbes and Locke in England, and with Descartes,
Spinoza, and Leibniz on the Continent. Each of these thinkers acted as if he
had no predecessors worth consulting, as if he were starting with a clean
slate to construct for the first time the whole of philosophical knowledge.
We cannot find in their writings the
slightest evidence of their sharing Aristotle’s insight that no man by
himself is able to attain the truth adequately, although collectively men do
not fail to amass a considerable amount; nor do they ever manifest the
slightest trace of a willingness to call into council the views of their
predecessors in order to profit from whatever is sound in their thought and
to avoid their errors. On the contrary, without anything like a careful,
critical examination of the views of their predecessors, these modern
thinkers issue blanket repudiations of the past as a repository of errors.
The discovery of philosophical truth begins with themselves.
Proceeding, therefore, in ignorance or
misunderstanding of truths that could have been found in the funded
tradition of almost two thousand years of Western though, these modern
philosophers made crucial mistakes in their points of departure and in their
initial postulates. The commission of these errors can be explained in part
by antagonism toward the past, and even contempt for it.
The explanation of the antagonism lies in
the character of the teachers under whom these modern philosophers studied
in their youth. These teachers did not pass on the philosophical tradition
as a living thing by recourse to the writings of the great philosophers of
the past. They did not read and comment on the works of Aristotle, for
example, as the great teachers of the thirteenth century did.
Instead, the decadent scholastics who
occupied teaching posts in the universities of the sixteenth and seventeenth
centuries fossilized the tradition by presenting it in a deadly, dogmatic
fashion, using a jargon that concealed, rather than conveyed, the insights
it contained. Their lectures must have been as wooden and uninspiring as
most textbooks or manuals are; their examinations must have called for a
verbal parroting of the letter of ancient doctrines rather than for an
understanding of their spirit.
It is no wonder that early modern
thinkers, thus mistaught, recoiled. Their repugnance, though certainly
explicable, may not be wholly pardonable, for they could have repaired the
damage by turning to the texts or Aristotle or Aquinas in their mature years
and by reading them perceptively and critically.
That they did not do this can be
ascertained from an examination of their major works and from their
intellectual biographies. When they reject certain points of doctrine
inherited from the past, it is perfectly clear that they do not properly
understand them; in addition, they make mistakes that arise from ignorance
of distinctions and insights highly relevant to problems they attempt to
solve.
With very few exceptions, such
misunderstanding and ignorance of philosophical achievements made prior to
the sixteenth century have been the besetting sin of modern thought. Its
effects are not confined to philosophers of the seventeenth and eighteenth
centuries. They are evident in the work of nineteenth-century philosophers
and in the writings of our day. We can find them, for example, in the works
of Ludwig Wittgenstein, who, for all his native brilliance and philosophical
fervor, stumbles in the dark in dealing with problems on which premodern
predecessors, unknown to him, have thrown great light.
Modern philosophy has never recovered from
its false starts. Like men floundering in quicksand who compound their
difficulties by struggling to extricate themselves, Kant and his successors
have multiplied the difficulties and perplexities of modern philosophy by
the very strenuousness — and even ingenuity — of their efforts to extricate
themselves from the muddle left in their path by Descartes, Locke, and Hume.
To make a fresh start, it is only
necessary to open the great philosophical books of the past (especially
those written by Aristotle and in his tradition) and to read them with the
effort of understanding that they deserve. The recovery of basic truths,
long hidden from view, would eradicate errors that have had such disastrous
consequences in modern times.
It is the mark of an educated mind to be able to
entertain a thought without accepting it.
Aristotle
Standing up for science excites some intellectuals
the way beautiful actresses arouse Warren Beatty, or career liberals boil
the blood of Glenn Beck and Rush Limbaugh. It's visceral. The thinker of
this ilk looks in the mirror and sees Galileo bravely muttering "Eppure si
muove!" ("And yet, it moves!") while Vatican guards drag him away. Sometimes
the hero in the reflection is Voltaire sticking it to the clerics, or Darwin
triumphing against both Church and Church-going wife. A brave champion of
beleaguered science in the modern age of pseudoscience, this Ayn Rand
protagonist sarcastically derides the benighted irrationalists and glows
with a self-anointed superiority. Who wouldn't want to feel that sense of
power and rightness?
You hear the voice regularly—along with far more
sensible stuff—in the latest of a now common genre of science patriotism,
Nonsense on Stilts: How to Tell Science From Bunk (University of Chicago
Press), by Massimo Pigliucci, a philosophy professor at the City University
of New York. Like such not-so-distant books as Idiot America, by Charles P.
Pierce (Doubleday, 2009), The Age of American Unreason, by Susan Jacoby
(Pantheon, 2008), and Denialism, by Michael Specter (Penguin Press, 2009),
it mixes eminent common sense and frequent good reporting with a cocksure
hubris utterly inappropriate to the practice it apotheosizes.
According to Pigliucci, both Freudian
psychoanalysis and Marxist theory of history "are too broad, too flexible
with regard to observations, to actually tell us anything interesting."
(That's right—not one "interesting" thing.) The idea of intelligent design
in biology "has made no progress since its last serious articulation by
natural theologian William Paley in 1802," and the empirical evidence for
evolution is like that for "an open-and-shut murder case."
Pigliucci offers more hero sandwiches spiced with
derision and certainty. Media coverage of science is "characterized by
allegedly serious journalists who behave like comedians." Commenting on the
highly publicized Dover, Pa., court case in which U.S. District Judge John
E. Jones III ruled that intelligent-design theory is not science, Pigliucci
labels the need for that judgment a "bizarre" consequence of the local
school board's "inane" resolution. Noting the complaint of
intelligent-design advocate William Buckingham that an approved science
textbook didn't give creationism a fair shake, Pigliucci writes, "This is
like complaining that a textbook in astronomy is too focused on the
Copernican theory of the structure of the solar system and unfairly neglects
the possibility that the Flying Spaghetti Monster is really pulling each
planet's strings, unseen by the deluded scientists."
Is it really? Or is it possible that the alternate
view unfairly neglected could be more like that of Harvard scientist Owen
Gingerich, who contends in God's Universe (Harvard University Press, 2006)
that it is partly statistical arguments—the extraordinary unlikelihood eons
ago of the physical conditions necessary for self-conscious life—that
support his belief in a universe "congenially designed for the existence of
intelligent, self-reflective life"? Even if we agree that capital "I" and
"D" intelligent-design of the scriptural sort—what Gingerich himself calls
"primitive scriptural literalism"—is not scientifically credible, does that
make Gingerich's assertion, "I believe in intelligent design, lowercase i
and lowercase d," equivalent to Flying-Spaghetti-Monsterism?
Tone matters. And sarcasm is not science.
The problem with polemicists like Pigliucci is that
a chasm has opened up between two groups that might loosely be distinguished
as "philosophers of science" and "science warriors." Philosophers of
science, often operating under the aegis of Thomas Kuhn, recognize that
science is a diverse, social enterprise that has changed over time,
developed different methodologies in different subsciences, and often
advanced by taking putative pseudoscience seriously, as in debunking cold
fusion. The science warriors, by contrast, often write as if our science of
the moment is isomorphic with knowledge of an objective world-in-itself—Kant
be damned!—and any form of inquiry that doesn't fit the writer's criteria of
proper science must be banished as "bunk." Pigliucci, typically, hasn't much
sympathy for radical philosophies of science. He calls the work of Paul
Feyerabend "lunacy," deems Bruno Latour "a fool," and observes that "the
great pronouncements of feminist science have fallen as flat as the
similarly empty utterances of supporters of intelligent design."
It doesn't have to be this way. The noble
enterprise of submitting nonscientific knowledge claims to critical
scrutiny—an activity continuous with both philosophy and science—took off in
an admirable way in the late 20th century when Paul Kurtz, of the University
at Buffalo, established the Committee for the Scientific Investigation of
Claims of the Paranormal (Csicop) in May 1976. Csicop soon after launched
the marvelous journal Skeptical Inquirer, edited for more than 30 years by
Kendrick Frazier.
Although Pigliucci himself publishes in Skeptical
Inquirer, his contributions there exhibit his signature smugness. For an
antidote to Pigliucci's overweening scientism 'tude, it's refreshing to
consult Kurtz's curtain-raising essay, "Science and the Public," in Science
Under Siege (Prometheus Books, 2009, edited by Frazier), which gathers 30
years of the best of Skeptical Inquirer.
Kurtz's commandment might be stated, "Don't mock or
ridicule—investigate and explain." He writes: "We attempted to make it clear
that we were interested in fair and impartial inquiry, that we were not
dogmatic or closed-minded, and that skepticism did not imply a priori
rejection of any reasonable claim. Indeed, I insisted that our skepticism
was not totalistic or nihilistic about paranormal claims."
Kurtz combines the ethos of both critical
investigator and philosopher of science. Describing modern science as a
practice in which "hypotheses and theories are based upon rigorous methods
of empirical investigation, experimental confirmation, and replication," he
notes: "One must be prepared to overthrow an entire theoretical
framework—and this has happened often in the history of science ...
skeptical doubt is an integral part of the method of science, and scientists
should be prepared to question received scientific doctrines and reject them
in the light of new evidence."
Considering the dodgy matters Skeptical Inquirer
specializes in, Kurtz's methodological fairness looks even more impressive.
Here's part of his own wonderful, detailed list: "Psychic claims and
predictions; parapsychology (psi, ESP, clairvoyance, telepathy,
precognition, psychokinesis); UFO visitations and abductions by
extraterrestrials (Roswell, cattle mutilations, crop circles); monsters of
the deep (the Loch Ness monster) and of the forests and mountains
(Sasquatch, or Bigfoot); mysteries of the oceans (the Bermuda Triangle,
Atlantis); cryptozoology (the search for unknown species); ghosts,
apparitions, and haunted houses (the Amityville horror); astrology and
horoscopes (Jeanne Dixon, the "Mars effect," the "Jupiter effect"); spoon
bending (Uri Geller). ... "
Even when investigating miracles, Kurtz explains,
Csicop's intrepid senior researcher Joe Nickell "refuses to declare a priori
that any miracle claim is false." Instead, he conducts "an on-site inquest
into the facts surrounding the case." That is, instead of declaring,
"Nonsense on stilts!" he gets cracking.
Pigliucci, alas, allows his animus against the
nonscientific to pull him away from sensitive distinctions among various
sciences to sloppy arguments one didn't see in such earlier works of science
patriotism as Carl Sagan's The Demon-Haunted World: Science as a Candle in
the Dark (Random House, 1995). Indeed, he probably sets a world record for
misuse of the word "fallacy."
To his credit, Pigliucci at times acknowledges the
nondogmatic spine of science. He concedes that "science is characterized by
a fuzzy borderline with other types of inquiry that may or may not one day
become sciences." Science, he admits, "actually refers to a rather
heterogeneous family of activities, not to a single and universal method."
He rightly warns that some pseudoscience—for example, denial of HIV-AIDS
causation—is dangerous and terrible.
But at other points, Pigliucci ferociously attacks
opponents like the most unreflective science fanatic, as if he belongs to
some Tea Party offshoot of the Royal Society. He dismisses Feyerabend's view
that "science is a religion" as simply "preposterous," even though he
elsewhere admits that "methodological naturalism"—the commitment of all
scientists to reject "supernatural" explanations—is itself not an
empirically verifiable principle or fact, but rather an almost Kantian
precondition of scientific knowledge. An article of faith, some cold-eyed
Feyerabend fans might say.
In an even greater disservice, Pigliucci repeatedly
suggests that intelligent-design thinkers must want "supernatural
explanations reintroduced into science," when that's not logically required.
He writes, "ID is not a scientific theory at all because there is no
empirical observation that can possibly contradict it. Anything we observe
in nature could, in principle, be attributed to an unspecified intelligent
designer who works in mysterious ways." But earlier in the book, he
correctly argues against Karl Popper that susceptibility to falsification
cannot be the sole criterion of science, because science also confirms. It
is, in principle, possible that an empirical observation could confirm
intelligent design—i.e., that magic moment when the ultimate UFO lands with
representatives of the intergalactic society that planted early life here,
and we accept their evidence that they did it. The point is not that this is
remotely likely. It's that the possibility is not irrational, just as
provocative science fiction is not irrational.
Pigliucci similarly derides religious explanations
on logical grounds when he should be content with rejecting such
explanations as unproven. "As long as we do not venture to make hypotheses
about who the designer is and why and how she operates," he writes, "there
are no empirical constraints on the 'theory' at all. Anything goes, and
therefore nothing holds, because a theory that 'explains' everything really
explains nothing."
Here, Pigliucci again mixes up what's likely or
provable with what's logically possible or rational. The creation stories of
traditional religions and scriptures do, in effect, offer hypotheses, or
claims, about who the designer is—e.g., see the Bible. And believers
sometimes put forth the existence of scriptures (think of them as "reports")
and a centuries-long chain of believers in them as a form of empirical
evidence. Far from explaining nothing because it explains everything, such
an explanation explains a lot by explaining everything. It just doesn't
explain it convincingly to a scientist with other evidentiary standards.
A sensible person can side with scientists on
what's true, but not with Pigliucci on what's rational and possible.
Pigliucci occasionally recognizes that. Late in his book, he concedes that
"nonscientific claims may be true and still not qualify as science." But if
that's so, and we care about truth, why exalt science to the degree he does?
If there's really a heaven, and science can't (yet?) detect it, so much the
worse for science.
As an epigram to his chapter titled "From
Superstition to Natural Philosophy," Pigliucci quotes a line from Aristotle:
"It is the mark of an educated mind to be able to entertain a thought
without accepting it." Science warriors such as Pigliucci, or Michael Ruse
in his recent clash with other philosophers in these pages, should reflect
on a related modern sense of "entertain." One does not entertain a guest by
mocking, deriding, and abusing the guest. Similarly, one does not entertain
a thought or approach to knowledge by ridiculing it.
Long live Skeptical Inquirer! But can we deep-six
the egomania and unearned arrogance of the science patriots? As Descartes,
that immortal hero of scientists and skeptics everywhere, pointed out, true
skepticism, like true charity, begins at home.
Carlin Romano, critic at large for The Chronicle Review, teaches
philosophy and media theory at the University of Pennsylvania.
Jensen Comment
One way to distinguish my conceptualization of science from pseudo science is
that science relentlessly seeks to replicate and validate purported discoveries,
especially after the discoveries have been made public in scientific journals
---
http://faculty.trinity.edu/rjensen/TheoryTar.htm
Science encourages conjecture but doggedly seeks truth about that conjecture.
Pseudo science is less concerned about validating purported discoveries than it
is about publishing new conjectures that are largely ignored by other pseudo
scientists.
Peter J. Hammond
Department of Economics, Stanford
University, CA 94305-6072, U.S.A.
e-mail:
hammond@leland.stanford.edu
http://www.warwick.ac.uk/~ecsgaj/ratEcon.pdf
1 Introduction and Outline
Rationality is one of the most
over-used words in economics. Behaviour can be rational, or irrational. So
can decisions, preferences, beliefs, expectations, decision procedures, and
knowledge. There may also be bounded rationality. And recent work in game
theory has considered strategies and beliefs or expectations that are “rationalizable”.
Here I propose to assess how
economists use and mis-use the term “rationality.”
Most of the discussion will concern
the normative approach to decision theory. First, I shall consider single
person decision theory. Then I shall move on to interactive or multi-person
decision theory, customarily called game theory. I shall argue that, in
normative decision theory, rationality has become little more than a
structural consistency criterion. At the least, it needs supplementing with
other criteria that reflect reality. Also, though there is no reason to
reject rationality hypotheses as normative criteria just because people do
not behave rationally, even so rationality as consistency seems so demanding
that it may not be very useful for practicable normative models either.
Towards the end, I shall offer a
possible explanation of how the economics profession has arrived where it
is. In particular, I shall offer some possible reasons why the rationality
hypothesis persists even in economic models which purport to be descriptive.
I shall conclude with tentative suggestions for future research —about where
we might do well to go in future.
2 Decision Theory with Measurable Objectives
In a few cases, a decision-making
agent may seem to have clear and measurable objectives. A football team,
regarded as a single agent, wants to score more goals than the opposition,
to win the most matches in the league, etc. A private corporation seeks to
make profits and so increase the value to its owners. A publicly owned
municipal transport company wants to provide citizens with adequate mobility
at reasonable fares while not requiring too heavy a subsidy out of general
tax revenue. A non-profit organization like a university tends to have more
complex objectives, like educating students, doing good research, etc. These
conflicting aims all have to be met within a limited budget.
Measurable objectives can be measured,
of course. This is not always as easily as keeping score in a football match
or even a tennis, basketball or cricket match. After all, accountants often
earn high incomes, ostensibly by measuring corporate profits and/or
earnings. For a firm whose profits are risky, shareholders with well
diversified portfolios will want that firm to maximize the expectation of
its stock market value. If there is uncertainty about states of the world
with unknown probabilities, each diversified shareholder will want the firm
to maximize subjective expected values, using the shareholder’s subjective
probabilities. Of course, it is then hard to satisfy all shareholders
simultaneously. And, as various recent spectacular bank failures show, it is
much harder to measure the extent to which profits are being made when there
is uncertainly.
In biology, modern evolutionary theory
ascribes objectives to genes —so the biologist Richard Dawkins has written
evocatively of the
Selfish Gene.
The measurable objective of a gene is the extent to which the gene survives
because future organisms inherit it. Thus, gene survival is an objective
that biologists can attempt to measure, even if the genes themselves and the
organisms that carry them remain entirely unaware of why they do what they
do in order to promote gene survival.
Early utility theories up to about the
time of Edgeworth also tried to treat utility as objectively measurable. The
Age of the Enlightenment had suggested worthy goals like “life, liberty, and
the pursuit of happiness,” as mentioned in the constitution of the U.S.A.
Jeremy Bentham wrote of maximizing pleasure minus pain, adding both over all
individuals. In dealing with risk, especially that posed by the St.
Petersburg Paradox, in the early 1700s first Gabriel Cramer (1728) and then
Daniel Bernoulli (1738) suggested maximizing expected utility; most previous
writers had apparently considered only maximizing expected wealth.
3 Ordinal Utility and Revealed Preference
Over time, it became increasingly
clear to economists that any behaviour as interesting and complex as
consumers’ responses to price and wealth changes could not be explained as
the maximization of some objective measure of utility. Instead, it was
postulated that consumers maximize unobservable subjective utility
functions. These utility functions were called “ordinal” because all that
mattered was the ordering between utilities of different consumption
bundles. It would have been mathematically more precise and perhaps less
confusing as well if we had learned to speak of an
ordinal equivalence
class of utility functions.
The idea is to regard two utility functions as equivalent if and only if
they both represent the same
preference ordering
— that is, the same
reflexive, complete, and transitive binary relation. Then, of course, all
that matters is the preference ordering — the choice of utility function
from the ordinal equivalence class that represents the preference ordering
is irrelevant. Indeed, provided that a preference ordering exists, it does
not even matter whether it can be represented by any utility function at
all.
Has the Quality of Accounting Education Declined?
"Has the Quality of Accounting Education Declined? by Paul E.
Madsen, The Accounting Review, Volume 90, Issue 3 (May 2015)---
http://aaajournals.org/doi/full/10.2308/accr-50947
This full article is not open shared.
Abstract
For decades, prominent members of the accounting community have argued that
the quality of accounting education is falling. Support for this claim is
limited because of a scarcity of data characterizing the constructs of
interest. This study is a comparative evaluation of the quality of
accounting education from the 1970s to the 2000s using unique data to
quantify education quality for accounting and many comparison disciplines. I
find that, compared to most other types of college education, accounting
education quality has been steady or increasing over the sample period.
However, relative to other business degree programs, the evidence is mixed.
The quality of students self-selecting non-accounting business degrees has
increased while the quality of accounting students has not. The disparity in
student quality is not reflected in the pay received by accounting
graduates, which has remained stable relative to the pay received by
graduates with other business degrees, although this result is likely
influenced by regulatory changes during the 2000s, including Sarbanes-Oxley
(SOX). Together, the evidence suggests that the quality of accounting
education has not declined rapidly over the last four decades, but in the
competition among business degree programs for high-quality students,
accounting has underperformed.
Conclusions
Since the 1960s, a steady stream of studies and commentaries by accounting
academics and practitioners, as well as reports from professional accounting
organizations, has argued that the quality of accounting education is
declining (AAA 1986; Albrecht and Sack 2000; Baxter 1979; Demski 2007;
Fellingham 2007; Mautz 1965; Sunder 2009, 2010, 2011; Weiser 1966; West
2003; Zeff 1989).
While accounting graduates may have significant shortcomings, it is
difficult to judge from existing evidence whether these shortcomings
represent serious threats to the health of the accounting profession or
whether they represent shortcomings typical of many types of college
education. Existing evidence characterizes accounting students and the
opinions of many members of the accounting community about accounting
education quality with little comparative information from other fields. In
this study, I identify indicators of accounting education quality that are
observable over 40 years of history and for many comparison disciplines, and
test whether accounting education is showing symptoms of declining quality.
I focus specifically on several measures of the quality of students
selecting into accounting degree programs and the relative incomes of young,
college-educated accountants. This approach enables me to quantitatively
characterize the quality of accounting education in the 1970s and 2000s and
estimate how it has changed relative to other disciplines.
I find that accounting degree programs have
attracted students of remarkably consistent quality from the pool of all
college students. These students have had average academic ability but weak
soft skills. Non-accounting business programs have attracted students with
relatively low, but improving, academic ability and relatively strong, and
strengthening, soft skills. I find no evidence of a decline in accounting
education quality when accounting education is compared against a typical
college education. Instead I find that by many measures and especially when
demographic and familial differences are held constant, accounting student
quality and the pay of young accounting graduates have improved relative to
non-business students and workers. However, given improvements in the
quality of non-accounting business students, I find evidence of a decline in
the quality of accounting students when they are compared against
non-accounting business students. Specifically, over 40 years, changes in
the proportion of high-quality students selecting into non-accounting
business programs were more favorable than changes for accounting programs
by between 1.8 percent and 7 percent after controlling for demographic and
familial characteristics. I further find evidence that the pay of young
accountants with bachelor's degrees (but not master's degrees) fell relative
to the pay of workers in non-accounting business occupations holding
bachelor's degrees between 1970 and 2000. However, this decline disappeared
by 2010, possibly because SOX increased the demand for accounting labor
after 2002.
Prior research has documented a number
of deficiencies in accounting education. My comparative evidence enables me
to gauge the magnitude of the threat posed by such deficiencies and suggests
that the threat is real, with accounting programs of the 2000s losing
between 2 and 7 percent of the high-quality students to other business
disciplines that they were able to retain in the 1970s. Declines of this
magnitude, while important, do not likely signal the impending collapse of
the accounting profession, which is, perhaps, surprising given the
seriousness of the deficiencies in accounting education that have been
documented previously. Indeed, my findings suggest that accounting education
has maintained its appeal over the previous four decades relative to the
majority of college majors, likely because all types of college education
are imperfect. The survival of accounting education depends upon how well it
performs relative to the available alternatives. While this study suggests
that accounting has not been an overwhelming winner in the competition among
educational alternatives, it has also not been a loser relative to most of
the alternatives.
Jensen Comment
If this article had been published in the 1990s my first reaction would be a
tendency to agree with the conclusions, especially in terms of the 1990s losses
of accounting major losses in numbers and qualities to the bubble of finance and
technology majors that was happening in the 1990s. However, that bubble burst
badly! I think the numbers and the quality came back into accounting programs in
the 21st Century.
The research in this study assumes a stationarity that I do not think exists
in the data. It is, in my viewpoint, a study that carelessly overlooks the
warnings of Dyckman and Zeff.
Remember, poll aggregators must average several
polls to make a good prediction. Due to sparse state-level polling,
predictions were “stuck” on values from about two weeks prior to the
election, when support for Clinton had been higher. Note that this
sparse polling scenario indicates that polling methods are generally
sound, although more frequent polling of swing states would be helpful.
Continued in article
Jensen Comment This non-stationarity problem is somewhat similar
to the "methodological deficiencies" in accountics research discussed by
Dyckman and Zeff and the "temporal aggregation cointegration" problem
discussed by David Giles.
From Two Former Presidents of the AAA
"Some Methodological Deficiencies in Empirical Research Articles in
Accounting."by Thomas R. Dyckman and Stephen A. Zeff ,
Accounting Horizons: September 2014, Vol. 28, No. 3, pp. 695-712 ---
http://aaajournals.org/doi/full/10.2308/acch-50818 (not free)
This paper uses a sample of the regression and
behavioral papers published in The Accounting Review and the Journal of
Accounting Research from September 2012 through May 2013. We argue first
that the current research results reported in empirical regression
papers fail adequately to justify the time period adopted for the study.
Second, we maintain that the statistical analyses used in these papers
as well as in the behavioral papers have produced flawed results. We
further maintain that their tests of statistical significance are not
appropriate and, more importantly, that these studies do not�and
cannot�properly address the economic significance of the work. In other
words, significance tests are not tests of the economic meaningfulness
of the results. We suggest ways to avoid some but not all of these
problems. We also argue that replication studies, which have been
essentially abandoned by accounting researchers, can contribute to our
search for truth, but few will be forthcoming unless the academic reward
system is modified.
This Dyckman and Zeff paper is indirectly related to the following
technical econometrics research: "The Econometrics of Temporal Aggregation - IV - Cointegration,"
by David Giles, Econometrics Blog, September 13, 2014 ---
http://davegiles.blogspot.com/2014/09/the-econometrics-of-temporal.html
Thoughts on Bill
Paton and Some Other Historical Writers in Accountancy
Accounting history research led me to the following interesting tidbit
about Bill Paton.
Bill was instrumental in founding the American Accounting Association.
He was born in April 1889, so go figure how old he was when the following
book was published.
Professor Paton at one time was perhaps the most influential professor at
the University of Michigan and in all of accounting academe. Rumor has it
that at one time, due to his power of persuasion, a basic accounting course
was in the core requirements at Michigan, although I never confirmed this
rumor. He was notoriously influential in the AAA and notoriously
conservative in his political thinking and speech making. Although his
devotion was to accounting, his pride was his knowledge of economics. He
regined as king and published countless articles when normative methodology
reigned in accounting research. Today he probably could not get one article
accepted in The Accounting Review. He lived and taught us in a bygone
era.
Book Review by Harvey Hendrickson, The Accounting Review, October
1984, pp. 722-723
WILLIAM A. PATON, Words! Combining Fun and
Learning (Ann Arbor: The Graduate School of Business Administration, The
University of Michigan, 1984, pp. vii, 187, $12.00 paper).
This delightful paperback arrived oo late to be
reviewed in the July issue and thus commemorate Mr. Paton's 95th
birthday on July 19. It differs from Mr. Paton's many earlier books in
at least three respects. First, it is not on accounting or related
areas; a careful search indicates that the terms of these areas are
rarely mentioned and when they are it is merely a passing reference.
Second, it is something of a family affair in that the involvement,
including "cooperation and encouragement" (p. iii), of several members
(in addition to William A., Jr. who has been a co-author on many of his
works) is mentioned at numerous points. Third, among potential users, it
should be of interest not only to the accountant but also to
nonaccountant member(s) of the family or household; this has been the
case with this reviewer who has used it on several occasions to
stimulate family conversationsa nd activities. A finding from these
sessions is that our youngest child has encountered exercises similar to
many in the book in the gifted and talented program of our public school
system.
While presenting the lighter side, the a
vocational or anecdotal Paton, this book also provides an insight into
the breadth, versatility, and incisiveness of his thinking, his respect
for and command of the English language, his lifelong commitment to
learning, scholarship, and intellectual development, and his abhorrence
of sloppiness in thinking and any of its other manifestations.
His opening sentence is that "words are man's
greatest tool" (p. 1). He fleshes this out with a brief exploration of
the importance of words in communication and the accumulation,
classification, development, and expansion of knowledge. He continues
with some specifics on reading, writing, speaking, and the misuse of
words, and then proceeds to some 60 word games, puzzles, problems,
challenges, and exercises-which should be enjoyable as well as helpful
in stimulating thinking, increasing the ability to read, speak, and
write. Paton adds that "[he is] convinced that playing word games at
home will offset in some measure the lack of good instruction in many
schools these days" (p. iii). Generously interspersed throughout the
book are other anecdotes, aphorisms, and witticisms that constitute a
part of the Paton lore and will give many chuckles, especially to those
who know, admire, and respect this remarkable person, Outstanding
Accounting Educator, and Book Reviews 723 stimulating thinking,
increasing the ability to read, speak, and write. Paton adds that "[he
is] convinced that playing word games at home will offset in some
measure the lack of good instruction in many schools these days" (p.
iii).
Generously interspersed throughout the
book are other anecdotes, aphorisms, and witticisms that constitute a
part of the Paton lore and will give many chuckles, especially to those
who know, admire, and respect this remarkable person, Outstanding
Accounting Educator, and unforgettable character.
Accounting History Corner The Influence of Price Waterhouse & Co. on the CAP, the APB, and in the Early
Years on the FASB
SSRN, March 21, 2016
Author
Stephen
A. Zeff, Rice University
Abstract
Price Waterhouse & Co., for
decades the premier public accounting firm in the United States and which
audits a large number of “blue chip” companies, has, directly and
indirectly, been a large and frequent presence in the U.S. standard-setting
arena. It is the purpose of this paper to document this presence and to
determine whether it had a discernible effect on the outcomes of the
standard setters’ deliberations. The conclusion is that, appearances
notwithstanding, there has been no evidence of a continuing, noticeable
effect.
A nice timeline on the development of U.S.
standards and the evolution of thinking about the income statement versus
the balance sheet is provided at:
"The Evolution of U.S. GAAP: The Political Forces Behind Professional
Standards (1930-1973)," by Stephen A. Zeff, CPA Journal, January
2005 ---
http://www.nysscpa.org/cpajournal/2005/105/infocus/p18.htm
Part II covering years 1974-2003 published in February 2005 ---
http://archives.cpajournal.com/
The module for 1940 is as follows:
1940 The American Accounting Association
(AAA) publishes Professors W.A. Paton and A.C. Littleton’s monograph An
Introduction to Corporate Accounting Standards, which is an eloquent
defense of historical cost accounting. The monograph provides a
persuasive rationale for conventional accounting practice, and copies
are widely distributed to all members of the AIA. The Paton and
Littleton monograph, as it came to be known, popularizes the matching
principle, which places primary emphasis on the matching of costs with
revenues, with assets and liabilities dependent upon the outcome of this
matching.
Comment. The Paton
and Littleton monograph reinforced the revenue-and-expense view in the
literature and practice of accounting, by
which one first determines whether a transaction gives rise to a revenue
or an expense. Once this decision is made, the balance sheet is left
with a residue of debit and credit balance accounts, which may or may
not fit the definitions of assets or liabilities.
The monograph also embraced historical cost
accounting, which was taught to thousands of accounting students in
universities, where the monograph was, for more than a generation, used
as one of the standard textbooks in accounting theory courses.
1940s
Throughout the decade, the CAP frequently
allows the use of alternative accounting methods when there is diversity
of accepted practice.
Comment. Most of the matters taken up by the
CAP during the first half of the 1940s dealt with wartime accounting
issues. It had difficulty narrowing the areas of difference in
accounting practice because the major accounting firms represented on
the committee could not agree on proper practice. First, the larger
firms disagreed whether uniformity or diversity of accounting methods
was appropriate. Arthur Andersen & Co. advocated fervently that all
companies should follow the same accounting methods in order to promote
comparability. But such firms as Price, Waterhouse & Co. and Haskins &
Sells asserted that comparability was achieved by allowing companies to
adopt the accounting methods that were most suited to their business
circumstances. Second, the big firms disagreed whether the CAP possessed
the authority to disallow accounting methods that were widely used by
listed companies.
Continued in article
"Ideology and reality in accounting: a Marxist history of the US
accounting theory debate from the late 19th century to the FASB’s conceptual
framework," by R.A. Bryer, Warwick Business School --- http://www.st-andrews.ac.uk/business/ecas/7/papers/ECAS-Bryer.pdf
Paton wrote many books and articles on many
issues over his long life, but he rarely changed his mind. One writer
who did effect a temporary change was Littleton, who persuaded him to
give up the idea of ‘value’ in accounting, as it was the self-evident
source of his problems.
A.C. Littleton
Littleton’s main contribution
to the debate was his argument that accounting could achieve its primary
aim of accountability and avoid the Scylla of the LTV and the Charybdis
of economic value, if accounting theorists abandoned the search for a
theory of value, and focused on controlled use-values, but, without one,
he failed to resolve any fundamental questions of practice.
Littleton dismisses any role
for Fisherian economic value in accounting. Failure to sharply
distinguish between economic value and price, he says, "makes for
confusion" (1929, p.148).(
Littleton says this ‘confusion’ existed in 1929 "as it did in the
lifetime of Adam Smith and David Ricardo" (1929, p.148), studiously
ignoring Marx who claimed to have removed precisely these confusions.)
To remove it, Littleton points out
that ‘value’ is subjective and ‘price’ is objective. "Value is a
subjective estimate of an article’s relative importance; price, however,
is a compromise between such subjective estimates and is measured by the
quantity of money for which an article is exchanged…; a value, however,
can exist in one mind alone" (Littleton, 1929, p.149). However, if price
is objective value, this raises the question, an objective value of
what? Littleton goes out of his way to stifle the idea that this value
is a commodity’s labour value, to distance himself from any association
with the LTV. It is, as he said, "easy to see how…some writers feel that
profit represented a certain portion of income created by labor but
retained by enterprisers or the result of a superior bargaining power on
the part of proprietors" (Littleton, 1928, p.281). He naturally
dismissed "the old idea that [value] was stored up labor of the past"
(1929, p.149), "that cost is the basis of value", and Marx’s idea that
capitalists set prices to return them at least the required return on
capital, the idea that price = cost + profit:
"Much of the loose usage of ‘value’ in
accountancy may perhaps be due to the generally held view that value
in business has a cost base, that Price = Cost + Profit. As a matter
of fact: Price – Cost = Profit. …[I]f cost is a proper basis for the
inventory of a stock of unsold goods it must be for other reasons
than that it express the value of the goods. As an expression of the
investment
in goods, cost is quite acceptable, but not as an
expression of their value…[,] a record of
recoverable
outlay, and not a record of values. …What they are
worth
will depend upon future circumstances" (1929, pp.150-152).
Although Littleton was unwavering in defense
of historical cost as the main basis of financial reporting and defended his
"costs attach" theory in the Paton and Littleton (1940) monograph, Bill
Paton later withdrew his strong support of the "costs attach" justification
for historical cost and the importance of matching revenues earned with the
costs attached to the product or service being sold. You can find various
references to this effect in Accounting History Newsletter,
1980-1989 and Accounting History, 1989-1994: A Tribute to Robert William
Gibson, by Garry Carnegie, Peter W. Wolnizer (Editor): (Taylor and
Francis, 1996) ---
Click Here http://snipurl.com/patonrecant [books_google_com]
It should be noted that Bill Paton was in an
advocate of "value accounting" clear back in his 1922 Accounting
Theory, but I take this to be replacement cost rather than exit value
later advocated by MacNeal in 1939 and Chambers and Sterling in the 1960s.
In his famous (prior to the 1940 Paton and Littleton monograph) Accountants Handbook (Ronald Press, 1932, Second Edition, Page 525) it
is stated:
In particular the case of specialized equipment
market value is usually little more than scrap value. That is, a
specialized machine, bolted to the factory floor, has little value apart
from the particular situation, and hence its market value, unless it is
being considered as an element of the market value of the entire
business as a going concern, is limited to net salvage ... buildings and
equipment have a "going concern value"
or "value in use" in excess of
liquidation or market value.
Valuation Premises Fair value
measurements of assets must consider the highest and best use of the asset,
which is determined from the perspective of market participants rather than
the reporting entity’s intended use. Under current U.S. GAAP, the asset’s
highest and best use determines the valuation premise. The valuation premise
determines the nature of the fair value measurement; that is, whether the
fair value of the asset will be measured on a stand-alone basis
("in-exchange") or measured based on an assumption that the asset will be
used in combination with other assets ("in-use"). The proposed ASU would
remove the terms in-use and in-exchange because of constituents’ concerns
that the terminology is confusing and does not reflect the objective of a
fair value measurement. The proposed ASU would also prohibit financial
assets from being measured as part of a group. The FASB decided that the
concept of highest and best use does not apply to financial assets, and
therefore their fair value should be measured on a stand-alone basis.
Entities would still have the ability to measure fair value for a
nonfinancial asset either on a stand-alone basis or as part of a group,
consistent with the nonfinancial asset’s highest and best use.
I've long argued that exit value
non-financial items has the drawback in that the balance sheet is no
different for a bankrupt firm as is the balance sheet of a dynamic going
concern. Who cares about exit values if there is virtually no likelihood of
liquidation of assets used in delivering a product or service?
"Ideology and reality in accounting: a Marxist history of the US
accounting theory debate from the late 19th century to the FASB’s conceptual
framework," by R.A. Bryer, Warwick Business School --- http://www.st-andrews.ac.uk/business/ecas/7/papers/ECAS-Bryer.pdf
On this vital issue, Paton and
Littleton go out of their way to distinguish their notion that ‘costs
attach’ from an anonymous "cost theory of value".32
First, they explain the
function of accounting in monitoring the circuit of capital in a way
that Marx himself could have written:
"When production activity effects a change
in the form of raw materials by the consumption of human labour and
machine-power, accounting keeps step by classifying and summarizing
appropriate portions of materials cost, labor cost, and machine cost
so that together they become product-costs. In other words, it is a
basic concept of accounting that costs can be marshalled into new
groups that possess real significance. It is as if costs had a power
of cohesion when properly brought into contact" (Paton and
Littleton, 1940, p.13).
Rather than say that Paton recanted his
position on historical costs and the "costs attach" theory, it should be
emphasized that Paton was always a "value man" who returned to his roots
after after temporarily being influenced by the "cost man" Ananias
Littleton. Littleton never viewed costs as a measure of value. Instead they
measured sacrifices made at one historical point in time for generating
future revenues. Profits measured the efficiency and effectiveness of
managing purchased for generating those revenues, which is why Littleton
strongly advocated the cost attachment to those resources until they were
used up or otherwise disposed of in operations.
Abe Briloff has died at the age of 96. I will
miss him more than I can say.
Mr. Briloff was an accountant and accounting
professor who cared deeply about, and was outraged by, the games
accountants play. In the 1960s, he wrote an article in The Financial
Analysts Journal detailing how companies could use “pooling of interest
accounting” when they made acquisitions to hide costs and later create
completely fraudulent profits. Few read it, I suspect, but one who did
was Alan Abelson, the editor of Barron’s. He had Abe write an article on
the subject in 1968 for Barron’s.
Over the years he wrote dozens more, and became
by far the most prominent accounting critic. His articles often caused
stock prices to plunge, never to recover.
None of those articles ever had any information
that was not already public. If you believe in the efficient market
hypothesis, Abe should not have existed. But he did. What he did was
tirelessly go through the financial statements and footnotes, and figure
out how accounting rules were being abused.
Why did others not do that? After Abe, more
did. But not enough.
For a few years in the 1980s, I was Abe’s
editor at Barron’s. He became a close friend and inspiration. In recent
years, when my New York Times columns appeared on Fridays, he was almost
always the first caller when a column touched on accounting rules or
audit failures.
At the end of his life, he was working on what
could be done about student loans, which he saw as hobbling a generation
of college graduates. He was an emeritus professor at Baruch College in
New York, a school that gets hard-working students without a lot of
family money.
When a Briloff piece was published in Barron’s,
the immediate reaction from the company criticized was almost always to
angrily protest that their accounting was completely proper and
consistent with generally accepted accounting principles. That response
puzzled me, because the articles seldom alleged otherwise. Instead, they
pointed out how the rules allowed misleading reports, and how the
company in question had produced such.
It was not until 2001 that the Financial
Accounting Standards Board finally killed pooling of interest
accounting, which had enabled many companies, particularly
conglomerates, to report profits that simply did not exist. If the
rule-makers had acted after Abe first pointed out the abuses, a lot of
investor losses would have been avoided.
The companies would also allege darkly that Abe
must have shorted the stock, or at least be in league with the
short-sellers. He was not. Abe was not motivated by a desire to get
rich. He simply believed that accounting should tell, not obscure, the
truth.
In fact, Abe often bought a few shares of
companies he was studying, to make it easier to get shareholder reports
in an age when they were not as readily available as they are now.
All this would be remarkable for any man. But I
have left out one salient point: Abe was legally blind.
He was not completely blind. He could see
enough to walk around, and he could write notes. He would send me
comments on my editing on normal letter-size pieces of paper, with maybe
two or three large-print lines scrawled across most of the page. When we
were working on articles, he would come into Barron’s offices in Lower
Manhattan to discuss them.
He did not read the financial reports he
dissected and then blasted. Instead, he had them read to him, often by
graduate students. I was never present for those sessions, and perhaps
the students resented having to be readers for an old man. But I suspect
at least some of them learned a lot from listening to Abe’s reaction to
what he heard.
I know I did. One of Abe’s articles I edited
for Barron’s was about General Motors. It appeared in 1986. Abe
chronicled how G.M. had gone from being the Tiffany’s of accounting to
using every legal gambit to make its earnings look better. He was
particularly outraged by the way it accounted for some acquisitions. In
his view, the fact that G.M. was doing those things was an indication
that its real business was declining more rapidly than it wanted to
admit.
I don’t remember all the details, but I vividly
recall that there was one assertion he made that I simply could not see
the support for, despite having gone through G.M.’s financial statements
for many hours, both with him and by myself. How, I asked him on the
phone one day as publication neared, could he say that?
He responded immediately. If I looked at one
footnote from G.M.’s most recent annual report — he knew the number;
I’ll say it was footnote 32, but that could be wrong — and compared it
to footnote 30 from two years earlier, I’d understand. And he was right,
even down to the footnote numbers. How, I wondered, could anyone
remember such detail?
Somehow, Abe never seemed to become cynical.
When Enron was collapsing, and I and others were chronicling how it had
abused accounting rules with the evident acquiescence of its auditors at
Arthur Andersen, he sounded simply sad as we discussed the details. He
talked longingly of Leonard Spacek, the man who had made Andersen the
most-respected accounting firm, and wondered what had happened to the
culture.
Continued in article
Jim Martin provides a list of references to some of Abe's academic
publications (excluding his many Barron's article) ---
http://maaw.blogspot.com/2013/12/abraham-j-briloff.html
I might quibble with Jim a bit about Abe being a "philosophy king." I view
Abe as being more of a conscious for the accountancy profession regarding
ethics and professionalism. Abe was not involved in setting the accounting
auditing standards, but he was a tiger when it comes to detecting suspicious
departures from those standards. He's much better known in history than
accountancy scholars who contributed to economic theory psychology/social
theory, and philosophy of accounting. His contributions to the profession
were painful and on target.
"The AICPA's Prosecution
of Dr. Abraham Briloff: Some Observations," by Dwight M. Owsen ---
http://aaahq.org/PublicInterest/docs/newsletters/spring99/item07.htm
I think Briloff was trying to save the profession from what it is now
going through in the wake of the Enron scandal.
In December of 2013 Abe
Briloff passed away. He was one of my all-time heros. It is shameful
that he was not admitted to the Accounting Hall of Fame when he was
still alive.
What was wrong is
the way the large auditing firms reacted with negativism and haughty
arrogance rather than working with Abe to avoid what happened with Andersen
and now the other big firms in the wake of the banking scandals of 2008. A
better way for firms to have reacted to Briloff is to work with him on ways
to improve their audits.
I will not
speculate here as to what I guess (only a guess) is the main reason he’s not
been inducted into the Hall of Fame. In my eyes, he’s one of the most
deserving potential Hall of Famers. But he took the path less traveled among
all Hall of Fame members to date. Abe’s writings are still models to behold
on how to read financial statements with the skepticism of a true
accountant.
Abe’s writings
remain very good source material for students of financial accounting. When
he talked (wrote) the capital markets listened. How many other accounting
professors can say the same? George Foster questioned whether stock prices
reacted more to what Briloff said or to the fact that Briloff said anything
about a corporation’s financial statements.
For example an events study such as the discovery
by George Foster that the publication of a Barrons' paper by Abe Briloff was
highly correlated with a plunge in share prices of McDonalds Corporation
tells us something about an association between Briloff's accounting
publication and capital market events. But correlation is not causation.
Foster's study could not really tell us if the accounting issue (dirty
pooling) or the mere fact that Briloff said something negative about
McDonalds in Barrons actually caused the plunge in share prices.
To find his best
stuff, check to see if your college library has access to the archives of
Barrons where he wrote his infamous columns. You might also check out such
references as his book:
More Debits Than Credits: The Burnt Investor's Guide to Financial Statements
Additional examples have been provided over
the years by Abe. The following is Table 1 from a paper entitled "Briloff
and the Capital Markets" by George Foster, Journal of Accounting Research,
Volume 17, Spring 1979 ---
http://www.jstor.org/view/00218456/di008014/00p0266h/0
As George Foster points out, what makes
Briloff unique in academe are the detailed real-world examples he provides.
Briloff became so important that stock prices reacted instantly to his
publications, particularly those in Barron's. George formally studied
market reactions to Briloff articles.
Companies Professor Briloff criticized for
misleading accounting reports experienced an average drop in share prices of
8%.
TABLE 1 Articles of Briloff Examined
Article
Journal/Publication Date
Companies
Cited That Are Examined in This Note
1.
"Dirty Pooling"
Barron's
(July 15, 1968)
Gulf and Wesern: Ling-Temco-Vought (LTV)
2.
"All a Fandangle?"
Barron's
(December 2, 1968)
Leasco Data Processing: Levin-Townsend
3.
"Much-Abused Goodwill"
Barron's
(April 28, 1969)
Levin-Townsend; National General Corp.
4.
"Out of Focus"
Barron's
(July 28, 1969)
Perfect Film & Chemical Corp.
5.
"Castles of Sand?"
Barron's
(February 2, 1970)
Amrep Corp.; Canaveral International; Deltona Corp.;
General Development Corp.; Great Southwest Corp.; Great Western
United, Major Realty; Penn Central
6.
"Tomorrow's Profits?"
Barron's
(May 11, 1970)
Telex
7.
"Six Flags at Half-Mast?"
Barron's
(January 11, 1971)
Great Southwest Corp.; Penn Central
8.
"Gimme Shelter"
Barron's
(October 25, 1971)
Kaufman & Broad Inc.; U.S. Home Corp.; U.S. Financial
Inc.
9.
"SEC Questions Accounting"
Commercial and Financial Chronicle
(November 2, 1972)
Penn Central
10.
"$200 Million Question"
Barron's
(December 18, 1972)
Leasco Corp.
11.
"Sunrise, Sunset"
Barron's
(May 14, 1973)
Kaufman & Broad
12.
"Kaufman & Broad--More Questions?
Commercial and Financial Chronicle
(July 12, 1973)
Kaufman & Broad
13.
"You Deserve a Break..."
Barron's
(July 8, 1974)
McDonald's
14.
"The Bottom Line: What's Going on at I.T.T."
(Interview with Briloff)
Briloff, A. J. 1958. Price level changes and financial statements: A
critical reappraisal. The Accounting Review (July): 380-388. .
Briloff, A. J. 1961. Price level changes and financial statements at the
threshold of the new frontier. The Accounting Review (October): 603-607.
Briloff, A. J. 1964. Needed: A revolution in the determination and
application of accounting principles. The Accounting Review
(January):12-15.
Briloff, A. J. 1966. Old myths and new realities in accountancy. The
Accounting Review (July): 484-495. (JSTOR link). (Discussion of three
accounting myths related to: 1. The Gap in GAAP, 2. The communication
Gap regarding the auditor's responsibility, and 3. The communication Gap
related to management services and auditor independence).
Briloff, A. J. 1967. Dirty pooling. The Accounting Review (July):
489-496.
Briloff, A. J. 1967. The Effectiveness of Accounting Communication.
Frederick A. Praeger, Inc. Review by T. J. Burns. (JSTOR link).
Briloff, A. J. 1972. Unaccountable Accounting. HarperCollins. Review by
H.E. Milller.
See also Benston, G. J. 1974. Unaccountable accounting. Journal of
Accounting Research (Autumn): 348-354. (JSTOR link).
Briloff, A. J. 1974. Prescription for change. Management Accounting
(July): 63-65, 71.
Briloff, A. J. 1976. More Debits Than Credits: The Burnt Investor's
Guide to Financial Statements. HarperCollins.
Briloff, A. J. 1981. The Truth About Corporate Accounting.
HarperCollins.
Briloff, A. J. 1995. Review of Strengthening the professionalism of the
independent auditor, report to the public oversight board of the SEC
practice section. Accounting Horizons (September): 125-130.
Briloff, A. J. 1996. America Online/ On a roll: A case study in
investigative accounting. Behavioral Research In Accounting (8
Supplement): 1-11.
Briloff, A. J. 2002. Beyond the Brilovian critique: A Brilovian
rejoinder.Accounting and the Public Interest (2): 94-96.
Bob, One of my
heroes, too. His treatment by both the US accounting academy and the
profession is nothing less than sordid. We all know that the powers that
be tried to revoke his certification over a technical error in an
engagement letter with a client of Abe's firm, which consists of one
blind man and his daughter. An issue of Critical Perspectives on
Accounting Vol. 12, No. 2, 2001 is devoted to the Briloff affair. The
affair was a paper Abe wrote (originally titled Garbage In, Garbage Out)
that was critical of the COSO report. It was submitted to Accounting
Horizons and received less that respectful treatment. Subsequent events
proved Abe was right -- Enron and Andersen were not small clients of
small firms. Abe was prescient about what was to befall us two years
after he wrote the paper. The stonewalling on that paper , the refusal
to share data with Abe were not in the best traditons of scholarship.
The Public Interest Section gave Abe our Exemplar Award many years ago.
I agree he should be in the Hall of Fame. I could tell you some stories
about his remarkable generosity, but will just leave it at, "He is a
very generous person!" To paraphrase Pete Axthelm, "There are many men
who are great accountants, but very few accountants who are great men."
Abe is a great man.
Synopsis
"Studies in the Development of Accounting Thought" works to inform
readers of the historical foundations on which the profession is
based, the historical antecedents of today's accounting
institutions, the historical impact of accounting, as well as
exploring the lives and works of pre-eminent individuals in the
profession's history. Recent volumes have addressed: the founders of
accounting in mid-nineteenth century and the origins of the
Institute of Chartered Accountants of Scotland; the life and work of
accountant Stuart Chase (1888-1985), and his concerns about waste,
conservation, social action, justice, ethics and fairness; and the
evolving nature of accounting regulation, looking at the
overwhelming number of systems and checks that practising
accountants face in the wake of modern management fraud. The series
is edited by Gary J. Previts, Past President of the American
Accounting Association and Professor at Weatherhead School of
Management, Case Western Reserve University, and Robert Bricker,
Professor and Ernst & Young Faculty Fellow at Weatherhead, CWRU.
E. RICHARD CRISCIONE
,
Abraham J. (Abe) Briloff: A Biography,
Studies in the Development of Accounting Thought, Volume 11
(Bingley,
U.K.: JAI/Emerald Group, 2009, ISBN: 978-1-84855-588-4, pp. xxi, 258.
Jensen Comment
The shame is that he's not yet been inducted into the Accounting Hall of
Fame. This happens when you create powerful enemies as well as friends in
your professional life.
Question
Remember the days when Professor Abe Briloff was scouring annual reports and
publishing red flags in Barron's about departures from GAAP and GAAS that
sometimes immediately affected stock prices of companies, warnings that
might otherwise have been overlooked by analysts less diligent than
Professor Briloff and his students? ---
http://faculty.trinity.edu/rjensen/Theory01.htm#Briloff
Barron's is still scouring quarterly and annual reports for red flags
without the aid of Professor Briloff who is now over 90 years old and blind.
Abstract
Investors are often concerned that managers might hide negative
information in filings. With advances in textual analysis and widespread
document availability, individuals can now easily search for phrases
that might be red flags indicating questionable behavior. We examine the
impact of 13 suspicious phrases identified by a Barron's article in a
large sample of 10-Ks. There is evidence that phrases like unbilled
receivables signal a firm may subsequently be accused of fraud. At the
10-K filing date, phrases like substantial doubt are linked with
significantly lower filing date excess stock returns, higher volatility,
and greater analyst earnings forecast dispersion.
What actually happened is that Abe’s firm was
auditing a small foundation. As is common in small organizations, they
kept their books on the cash basis. At the end of the year, Abe would
come in and adjust to the accrual basis and make any necessary
adjustments to determine that the annual reports were in conformance
with GAAP. The client in these audits needs to sign a representation
letter stating that the information provided to the auditors is full and
complete…. and that the statements conform to GAAP. Well, Abe knew that
the foundation director would sign it but he also knew that the director
would not have the slightest idea whether or not the statements
conformed to GAAP – so he took that assertion out of the letter. His
ethics infraction was that he was too ethical!
Abe is still at it – sharing his thoughts with
the rest of us. I have attached a recent on-line article he wrote.
He spoke at his annual lecture here a couple of
weeks ago. Although 93 and quite blind, his mind is as clear as ever and
his analysis is spot on. By the way, students can’t wait to hear from
him.
Elliot Kamlet
Briloff Groupie
Binghamton University
Last week, we reported thattwo amendments
relating to the Financial Accounting Standards Board were approved by the
House Financial Services Committee (HFSC) during markup of its systemic risk
bill. The bill, more formally called theFinancial Stability Improvement Act
(FSIA), is part of a broader set of bills being introduced as part offinancial regulatory
reform,
aimed at preventing another credit crisis.
The first of the FASB-related amendments, the Perlmutter/Lucas amendment,
would require the systemic risk council created under the FSIA "to review
and submit comments to the Securities and Exchange Commission and any
standards setting body with respect to an existing or proposed accounting
principle, standard or procedure."
The second accounting-related amendment, the Garrett amendment, would
require the FASB to study the impact of the minimum credit risk retention
rules in the FSIA in combination with the new securitization accounting
rules under FAS 166 and FAS 167 (which eliminate off-balance sheet treatment
previously available under FAS 140 and FIN 46R), and that FASB "make
statutory and regulatory recommendations for eliminating any negative
impacts on the continued viability of the asset-backed securitization
markets and on the availability of credit for new lending," and report the
results within 90 days to the banking regulators and the SEC.
The ultimate fate of the FASB-related amendments approved by the HFSC is not
yet known, since the full House still has to consider the entire financial
regulatory reform package, as does the Senat
(See Sen. Chris Dodd's (D-CT) earlier comments
on the initial version of the Perlmutter/Lucae.s amendment, which would have
transferred oversight of FASB from the SEC to the systemic risk council. The
amendment that eventually passed the HFSC was significantly softened, to
require review and comment of accounting standards, but did not change the
current oversight structure of FASB.) Continued focus on the financial
regulatory reform legislation will take place in December. A Civil War Over Accounting?
The battle over the Perlmutter/Lucas amendment in particular -which, as
approved by the HFSC last week was significantly softened ('watered
down'
per CFO.com's Sarah Johnson;
'gutted'
per the Denver Post's Michael Riley) from its initial version proposed in
March - rose to the level ofCivil War in Corporate
America
(Ryan Grim, Huffington Post).
Some may have wondered how this level of agitation could occur in a
profession that still harbors, in the eyes of some, a
"milquetoast"
image (Michael Riley, Denver Post).
This post attempts to provide some insight into why emotions can run so high
in debates about accounting, by exploring the question of "why accounting
matters." I remind you of the disclaimer which appears on the right side ofthis blog,
which applies to the entire content of the blog, including (but not limited
to) when posts have sections marked off as 'my observations' or 'my two
cents.'
Cent 1 : What Accounting Is Not About: Undue Influence (Undue Pressure)
In aletter
dated Nov. 5, 2009 (during the heat of the debate over the original
Perlmutter/Lucas amendment, which as originally proposed in March, would
have removed the SEC's oversight power over FASB, and transferred that
oversight power to a Federal Accounting Oversight Board consisting of
banking regulators and the SEC), SEC Chairman Mary L. Schapiro told Rep.
Barney Frank (D-MA), chair of the HFSC:
I am deeply concerned about the possible consequences of changing [the
current] system to one that would subject accounting standard setters to the
supervision of entities with other regulatory missions. It is not that those
missions are any less vital to the public interest than the mission
entrusted to the SEC. It is just that they are different -- and I fear the
potential consequences for our capital markets if investors come to believe
that accounting standards serve any purpose other than to report the
unvarnished truth.
[Note: the reference to 'unvarnished truth is discussed separately later in
this post.]
In closing her letter, Schapiro said: "Accounting should be about
accounting, and nothing else." When I first read that closing statement, I
thought it was a very powerful statement, or sound bite, if you will, but
just as sound bites often convey a deeper meaning, I found myself thinking
there are other interpretations about what accounting is about, and what it
is not about.
Given the subject of the letter, I thought to myself, the sentence could be
read to imply, "Accounting should be about accounting, and not about
politics." Or, more precisely, substituting in language from theIASCF Monitoring Board's Sept. 22 statement
on accounting standards and accounting standard-setting (the SEC is a member
of the Monitoring Board), one could end the sentence this way: "Accounting
should be about accounting, and not about undue pressures from political
and corporate interests."
The word "undue" (as in "undue pressures") as used by the Monitoring Board
is very significant: the group did not call for the total exclusion of
dialogue with political and corporate interests; on the contrary, the
Monitoring Board stated: "Interested parties must be afforded the
opportunity to provide input to inform the standard setter’s evaluation of
pertinent issues."
In fact, specific to the topic of fair value accounting (which some view as
the driving force behind the Perlmutter/Lucas amendment) the Monitoring
Board stated:
The IASB and FASB have benefitted from informative input into their
financial instruments and fair value measurement standard setting
initiatives from a broad range of stakeholders. The recommendations of some
constituencies often contradict the strongly held views of others,
reflecting the diversity of uses for and desired outcomes of financial
reporting... robust participation of interested parties is an essential
element of a standard setter’s transparent due process. Equipped with this
input, it is the responsibility of the standard setters to evaluate the
knowledge they have gained against the overarching objectives of financial
reporting and the principles that reinforce those objectives, in a manner
engendering independent decision-making.
Understanding the Role of Neutrality and Due Process
While we're on the subject of soundbites, some journalists over the past six
months have characterized comments made by FASB and IASB board members and
related advisory groups (such as the FASB-IASB Financial Crisis Advisory
Group) as calling for no "meddling" by politicians (see, e.g.Politicians Accused of
Meddling in Bank Rules
(Floyd Norris, NYT, 7.28.09), andEurope Must Stop Its
Meddling, Says FASB Chief
(Mario Christodoulou, Accountancy Age 10.15.09). More recently, I've seen
the word 'tinkering' used by some, in place of where 'meddling' was
previously the term du jour.
Although 'meddling' or 'tinkering' are not defined in FASB's Conceptual
Framework (which serves as the foundation for standard-setting), the term
'neutrality' is the operative term specified inConcepts Statement No. 2;
i.e., the FASB is to exercise 'neutrality' in setting accounting standards.
The IASCF Monitoring Board's Sept. 22 statement repeats the importance of
neutrality.
In understanding the role of 'neutrality' and independence, of particular
note is that it does not require FASB to be walled off from dialogue with
outside parties, just that it act in a neutral fashion. See, e.g.Volcker Heartened by Regulators Reaction to
Crisis Warns Against Isolation (Steven
Burkholder, BNA Daily Report for Executives. Reproduced with permission from
Daily Report for Executives, 208 DER I-4 (Oct. 30, 2009). Copyright 2009 by
The Bureau of National Affairs, Inc. (800-372-1033)
http://www.bna.com/)
The FAF recognizes and is respectful of the need for Congress to maintain
and advance the safety and soundness of this country's financial system...
The FAF does not oppose the recently adopted Perlmutter amendment because it
acknowledges the due process [of accounting standard-setting] which is the
backbone of the FAF mission.
The reference to 'due process' in the FAF spokesman's statement above is
key, as is transparency of that due process, in engendering confidence in
the process. The role of due process was also noted in the IASCF Monitoring
Board's Sept. 22 statement, and in the IASB-FASB Nov. 5 joint statement, as
follows:
IASCF Monitoring Board statement
Sept. 22, 2009: "Visibility into the standard setting process should be
sufficient to enable users to trace the evolution of the standard from
thoughtful consideration of alternatives to final positions".
IASB -FASB Joint statement
Nov. 5, 2009: "We aim to provide a high degree of accountability through
appropriate due process, including wide engagement with
stakeholders, and oversight conducted in the public interest. We are
consulting widely and will continue to draw on expertise from investors,
preparers, auditors, standard-setters, regulators, and others around the
world. ... We will set standards following our robust due process procedures
that provide visibility into the standard-setting process and require
proactive consultation to ensure communication of all points of view and the
expressions of opinion at all stages of the process".
If we all were to agree on what accounting should "not" be about (i.e., that
it should not be about undue influence or undue pressure), then what would
we say accounting "is" about?
We view the primary objective of financial reporting as being to provide
information on an entity’s financial performance in a way that is useful for
decision-making for present and potential investors. To be considered
decision-useful, information provided through the application of the
accounting standards must, at a minimum, be relevant, reliable,
understandable and comparable.
The operative words are that financial reporting information aims at being
decision-useful, by providing information that is relevant,
reliable, understandable and comparable. All of these terms are
longstanding fundamental concepts in FASB's Conceptual Framework
(specifically, in Concepts Statement No. 2). (Note: an amendment to CON 2
was previously proposed and is set to be issued in final form 4Q2009
according toFASB's current technical plan.)
In considering the concepts noted above, people do not always agree on what
'decision-useful' means in particular contexts, and reasonable people may
not always agree on how an accounting standard should be constructed to
produce the most "relevant" and "reliable" information (and how to balance
those two sometimes opposing forces).
For example, some people may say that fair value information is always the
most relevant information ("measurement attribute"), period. Others,
however, may question if fair value information in an illiquid, inactive or
disorderly market, is any more relevant than information measured by some
other means, such as discounted cash flow, or how much emphasis to place on
'market' quotes (e.g. broker quotes) vs. internal cash flow models, in such
a market.
Thus, an 'inconvenient truth' in accounting is that, even if there were
agreement among reasonable people as to which measurement attribute (e.g.
'fair value' vs. 'historic cost') is more relevant, there is not necessarily
going to be universal agreement on which valuation method is most reliable
to arrive at 'fair value' for all financial instruments, or how to balance
relevance and reliability, in producing 'decision useful' information. You
will see such debates if you review the comment letter file on the original
proposal for FAS 157, and on current proposals out for comment by FASB and
the IASB. It is and always has been a natural and healthy debate across all
of standard-setting, as to how to develop standards that result in the most
relevant and reliable information.
Since relevance and reliability, as well as understandability and
comparability lead to decision usefulness, real world investing and
financing decisions take place based on accounting information provided. And
that is "why accounting matters."
Accounting Has Economic Consequences Further on this topic of why accounting matters, Prof. David Albrecht
was the first person to write publicly during the heated debate over the
Perlmutter/Lucas amendment on the issue of why politics has historically had
some role (indirect if not direct) in accounting standard-setting.
Continued in article
Thank you for the heads up Francine!
"Fifteen Risk Factors for Poor Governance A self-diagnostic to identify
risk factors for poor governance and reporting," by Walter Smiechewicz
(who at one time worked for the scandalous Countrywide), Directorship,
September 8, 2009 ---
http://www.directorship.com/fifteen-risk-factors-for-poor-governance/
Some of the best indicators of our overall
physical health come from blood tests. Unfortunately, too often we don’t
begin to watch and manage these numbers until later on in life. Of
course, it’s never too late to improve your diet and exercise, but we’re
always left thinking, “if only I’d paid attention to this earlier.”
With so many recent corporate crises, it is
plain it’s suffice to say that a great many corporate board members and
executives are experiencing similar regret right now. Perhaps this could
have been avoided if they too had practiced routine diagnostic check
ups. Like an individual blood test, board members need to know the risks
their company is facing, and as with any health risk, they also need to
be able to mitigate those exposures.
Sounds great, but the devils in the details,
right? Perhaps not.
As chief consultant for governance and risk at
Audit Integrity, I’ve examined the worst U.S. companies from an
“integrity” standpoint in order to help board members and general
auditors see how their company’s health stacks up. Audit Integrity’s
metrics have shown which companies are 10 times more likely to face SEC
Actions; five times more likely to face class action litigation; and
four times more likely to face bankruptcy.
Using Audit Integrity’s proprietary AGR
(Accounting, Governance, and Risk) score, 196 companies were identified
as laggards or high-risk companies. These companies have been proven to
have higher odds of SEC actions and class action litigation, loss of
shareholder value, and increased odds of material financial restatement
and bankruptcy. All are North American, non-financial, publicly traded
companies with over $2 billion in market capitalization with an
average-to-weak financial condition.
Next, I tested the 119 metrics that Audit
Integrity flags and discovered that 15 of those metrics appeared
consistently as identifiers of problematic companies; the first metric
was prevalent in 65 percent of the 196 high-risk companies and the 11th
evident in 40 percent. The other 8,000 companies tested had low
incidences of these same metrics. A list – dubbed the Risky Business
Catalogue – details the common metrics within high-risk companies. Board
members, the C-suite, and general auditors should note if their company
is a candidate for the RBC. The evidence is not saying that significant
issues are imminent if a company has one of the RBCs, but a combination
of RBC metrics indicate risk factors to the entity’s business model and
strategy.
RBC’s metrics include:
1. The company has entered into a merger within
the last 12 months. While there is certainly nothing wrong with
corporate M&A activity, it’s common for policies to be revised and
system integrations to be rushed. Company directors need to caution
general auditors to be extra vigilant post merger and increase testing
of balance sheet accounts.
2. The CEO and CFO’s compensation is more
highly weighted toward incentive compensation than base compensation.
This situation can cause negative motivations and earnings to be
increased more creatively to ensure a larger portion of executive pay
packages. Close attention should be paid to revenue recognition.
3. The Board Chairman is also the CEO. An
age-old debate, but indispuditedly conflicts of interest invariably
result when a company CEO is also its Chairman. Separate the roles to
improve governance and reduce compromised oversight.Compromised
reliability exists because the very architecture of governance has a
built in conflict when the Chairman is also CEO.
4. The company has undergone a restructuring in
the last 12 months. Restructuring may be completely valid, but also can
be employed to conceal the lack of sustainable earnings growth.
Directors, by role definition, should be intimately involved in
restructuring procedures decisions and promised outcomes.
5. The company has encountered a public
regulatory action in the last 12 months. Many corporate stakeholders
hold true to the statement that where there’s smoke, there’s fire.
Directors should no longer accept “no worries” explanations on
regulatory matters. Compliance tests should be employed routinely and if
regulatory action does occur, management needs to take action.
6. The amount of goodwill carried on the
balance sheet, when compared Go total assets, is high. When intangible
assets such as goodwill grow, boards should ask more probing questions
about how the business model generated these assets and about
concomitant valuation protocols. General Auditors should confirm that
models are comprehensively back tested and impairment procedures are
adhered to assiduously.
7. The ratio of the CEO’s total compensation to
that of the CFO is high. If a CEO is awarded a much larger paycheck than
anyone else (particularly particularally the CFO), it increases
governance risk and leads to a top-directed culture, thus limiting
collaboration. Boards need to be involved in all executive compensation
issues including that which drives pay packages for the CFO, Chief Risk
Officer, as well as internal auditors,. etc.
8. Operating revenue is high when compared to
operating expenses. Riskier companies have revenue recognition in excess
of what is expected based on operating revenues. Directors should fully
understand revenue recognition policies and instruct management to test
them to be sure they are not aggressive.
9. A Divestiture(s) has occurred in the last 12
months. Data shows that riskier companies have more divestures, usually
because it is an opportunity for more aggressive accounting activity.
Board members should inquire as to how this action fits the strategy.
10. Debt to equity ratio is high. When a
business relies too heavily on debt it reveals that markets are not
independently funding the business model or strategy. Boards should know
why the markets are not investing in their entity and therefore why debt
is so heavily relied upon. Board members should also be knowledgeable on
the quality of their equity and not just the amount. Lastly, they should
understand management’s funding overall funding strategy and the
strength of contingent funding plans.
11. A repurchase of company stock has taken
place in the last 12 months. A repurchase of stock is usually presented
to investors as an avenue to increase market demand for the stock,
thereby elevating overall shareholder value. Management must provide
reasoning for why there are no other ways to invest excess funds. Boards
should also request the general auditor to review insider sales during
the period of share repurchase programs.
12. Inventory valuations Go total revenue is
increasing. When inventory increases in relation to revenue it should
raise control questions about inventory valuation. It could indicate
changing consumer preferences, which should spur an analysis of a
corporation’s business model.
13. Accounts receivables to sales is
increasing. This situation can typically be indicative of relaxed credit
standards. Directors should ask whether sales are decreasing due to
market conditions and instruct the general auditor to probe receivables
to determine their viability.
14. Asset turnover has slowed when compared to
industry peers. If assets are increasing and sales are not flowing it
could indicate less productive assets are being brought, or retained, on
the balance sheet. Conversely, if sales are decreasing, executives and
auditors will again want to analyze changing customer preferences.
15. Assets driven by financial models make up a
larger portion of balance sheet. A collection of other accounting
metrics indicates that boards, the C-suite, and general auditors should
pay special attention to the controls, assumptions, and governance
surrounding assets whose valuations are model driven. This is
particularly true if assets that are valued by financial models make up
a larger portion of the entities balance sheet.
To be sure, any one of these in isolation as an
indicator of accounting and governance risk can be debated. Company
divestitures and M&A can be a healthy indicator. But if a corporation
fails more than a few of these metrics, board members need to take
action.
It is easy to dismiss any one of these metrics
when you find it is an issue in your company. Human nature is quick to
retort – maybe for others but not for us. However, like time and tide,
the numbers too, wait for no one. So, if you have any of these AGR
metrics, you need to begin confronting these risk characteristics today
to improve your corporate health and avoid the much more drastic
financial equivalent of cardiovascular surgery tomorrow.
Walter Smiechewicz is chief consultant for governance and risk at
Audit Integrity, a research firm that provides accounting and governance
risk analysis
December 5, 2009 reply from Bob Jensen
Here are some added thoughts:
The risk factors are excerpted from AICPA
Statement on Auditing Standards 82, “Consideration of Fraud in a
Financial Statement Audit” (1997). That statement was issued to provide
guidance to auditors in fulfilling their responsibility “to plan and
perform the audit to obtain reasonable assurance about whether the
financial statements are free of material misstatement, whether caused
by error or fraud.” Although there risk factor cover a broad range of
situations, they are only examples. In the final analysis, audit
committee members should use sound informed judgment when assessing the
significance and relevance of fraud risk factors that may exist.
http://www2.gsu.edu/~wwwseh/Financial Reporting Red Flags.pdf
There may be an update on this material.
What is the world is going to happen to private sector versus public sector
auditing?
The big
difference between private sector auditors versus government auditors is
that we can sue the private sector auditors over and over and over until
they make serious efforts to get it right. Virtually nothing is being done
to make the government’s auditors get it right.
What my inside
contacts in the large firms are telling me is that more than ever efforts
are now being made to make their auditors independent to a point where they
will stand up to their largest and most lucrative clients and demand that
there be better GAAP and GAAS conformance --- Advancing
Quality through Transparency Deloitte LLP Inaugural Report ---
http://www.cs.trinity.edu/~rjensen/temp/DeloitteTransparency Report.pdf
I think the PCAOB
audit reviews have contributed in a small but marked way to improve audits.
But there’s a long way, miles and miles, to go before we sleep ---
http://faculty.trinity.edu/rjensen/fraud001.htm
It’s Market
Versus the Government!
The question is what’s the alternative? Those that want a
Government’s Central Planning Board to allocate resources in the economy
(in place of markets) are aiming the world economy for disaster, confusion,
and disruption. And who keeps the government honest? At the moment the GAO
declares that it’s impossible to audit our largest government agencies like
the Pentagon, the IRS, etc. Government accountability, accounting, and
auditing are in much worse shape than our far less-than-perfect private
sector accountability, accounting, and auditing.
The Sad State of Government Accounting ---
http://faculty.trinity.edu/rjensen/theory01.htm#GovernmentalAccounting
The Sad State of Private Sector Accounting ---
http://faculty.trinity.edu/rjensen/fraud001.htm
No Resource
Allocation System Can Exist Without Accountability, Accounting, and Auditing
Accountability, accounting, and auditing are necessary under any type of
resource stewardship and resource allocation system. At one extreme we have
markets, investors, and creditors who rely upon audits and stewardship
accounting of the private sector market participants. The FASB and the IASB
do indeed, in my viewpoint, focus on the information needs of those
investors and creditors. The auditing firms, however, are faced with what
Tom Selling calls a “broken model” where those being audited choose their
auditors and negotiate the audit fees. This is certainly problematic if not
completely broken.
The Government’s
resource allocation system brought us the Jack Murtha Airport with its full
security system, air controller system, six flights a day to only one
destination, and less than 50 passengers a day. It’s a taxpayer cash flow
black hole.
At the other
extreme we have the government auditors who cannot get any type of handle
on how to audit the enormous agencies to a point with the auditors have just
given up on total system audits. Nobody audits the Pentagon after the GAO
declared it “unauditable.”
http://faculty.trinity.edu/rjensen/theory01.htm#GovernmentalAccounting
The world is not
perfect, and certainly financial and commodities markets were manipulated by
Enron, Lehman, Merrill, etc. Andersen’s audits were among the worst in the
history of the world, and Andersen got its just dessert for not enforcing
quality control of its audits. Government is the land of corrupt resource
allocation that usually leads to even less efficient resource allocations
than the market-based resource allocations.
I think auditing
of banks has been a sham by virtually all the auditing firms, and these
firms will soon pay a heavy price in court for certifying fiction of bank
accounting for the thousands of banks that recently went “bank”rupt. Unless
the large auditing firms overcome their sham audits of banks, they too will
bite the dust.
The question is
whether the professionalism/independence recovery efforts of all the large
auditing firms can save them is still open to question. After all these
years since Andersen imploded, I think the Wall Street bank audits indicate
that the big auditing firms, in Art Wyatt’s wording, “still didn’t get it.”
Art Wyatt was the lead executive research partner for Andersen. After
Andersen imploded, Art observed the lack of professionalism in the surviving
auditing firms and concluded that “They Still Don’t Get It” ---
http://aaahq.org/AM2003/WyattSpeech.pdf
But the real problem in my viewpoint is not the mixing of consulting and
auditing nearly as much as it is the "too big to lose" clients (read that as
auditing firms being unwilling to quit the audit after spending so much time
and money gearing up for the big-client audit).
Can you hear us
now?
The question is whether the auditing firms, in the wake of the banking
collapse and bailout, are more seriously listening and, more importantly,
finally doing the right thing. Investors are amazingly tolerant of the
cycles of scandal and promised reforms in the capital markets. The
Dow remained amazingly high during all the recent Wall Street scandals and
bailouts. And investors and creditors will have their day in court when they
bring the bankers and their auditors to the dock ---
http://faculty.trinity.edu/rjensen/2008Bailout.htm#AuditFirms
But nobody is
bringing the broken government accounting and auditing system to the dock.
You can’t usually sue the government. Many of the recent frauds could’ve
been prevented or mitigated by the SEC, but the SEC is not being held
accountable for its huge failures, especially under an incompetent political
hack named Chris Cox.
Question
What’s the big
difference between Soviet Union Accounting in 1960 and accounting in the
U.K. and the U.S. in 2010?
Answer
In the Soviet Union the public could not haul the sham auditors into court.
Accounting in the Soviet Union really was fiction writing at all levels of
enterprise. In the Soviet Union there could never be a Prem Sikka, an Abe
Briloff, a Frank Partnoy, a Mark Lewis, a Lynn Turner, or a CBS Sixty
Minutes. Why does Prem Sikka now want to destroy our market system and
model us after the Soviet Union? Perhaps I’m being unfair to Prem. He tears
at the foundations of markets without ever suggesting what he thinks should
take their place for an economy’s resource allocation system. Others like
Partnoy, Lewis, and Turner want to “make markets be markets” with better
accountability and auditing” "Make Markets Be Markets"
"Bring Transparency to Off-Balance Sheet Accounting," by Frank Partnoy,
Roosevelt Institute, March 2010 --- http://www.rooseveltinstitute.org/policy-and-ideas/ideas-database/bring-transparency-balance-sheet-accounting
Watch the video!
Why aren’t we
hauling the GAO and the SEC and government watchdogs in general into court
and demanding that they make at least as much effort at reform as the
private sector accountants and auditors?
The big
difference between private sector auditors versus government auditors is
that we can sue the private sector auditors over and over and over until
they make serious efforts to get it right. Virtually nothing is being done
to make the government’s auditors get it right.
http://faculty.trinity.edu/rjensen/fraud001.htm
Summary
Sections of
the Financial Reporting Manual have been updated as of March 31, 2012.
These sections have been marked with the date tag, “Last updated:
3/31/2012,” to identify the changes. Previous updates are marked using
the same convention and represent the last revision to that section. We
include a date tag when the change is significant. Changes that are
administrative in nature (for example, section reference updates or
grammatical improvements) are not marked with a date tag. Below is a
summary of changes included in this update and a brief description of
the change. Clicking the linked section number will direct you to the
location of the change in the document. You may click on the embedded
link in the document to return to this
Section Comment
2045.15
Age of interim financial
statements included in Form 8-K; to conform with sections
2045.13 and 2045.14
9220.8 NOTE Use of pro forma
information in MD&A
12220.1 b Age of financial
statements required in Form 8-K for smaller reporting companies
16210.1 Periods required for financial
statements filed by Canadian issuers on Form 40-F
A Teaching Case on How Regulators Are Targeting Financial Statement
"Window Dressing"
From The Wall Street Accounting Weekly Review on September 24,
2010
SUMMARY: Federal
regulators are poised to propose new disclosure rules targeting "window
dressing...." The SEC "...is expected to issue proposal for public
comment. The action follows a Wall Street Journal investigation...of
financial data fro 18 large banks...[which] showed that, as a group,
they have consistently lowered debt at the end of each of the past six
quarters, reducing it on average by 42% from quarterly peaks."
CLASSROOM APPLICATION: The
article can be used to discuss window dressing beyond the banking
sector, to discuss current reactions to the financial crisis, and to
discuss leverage and debt levels.
QUESTIONS:
1. (Advanced)
Define window dressing, going beyond what is offered in this article. Is
this issue found in other industries beyond banking?
2. (Advanced)
What has been the nature of the window dressing issue in the banking
industry? Include in your answer an explanation of the chart "Masking
Risk" associated with the article.
3. (Introductory)
According to the article, what prompted banks to undertake these window
dressing activities?
4. (Introductory)
How have banks reacted to this WSJ report on window dressing?
5. (Introductory)
What is the SEC proposing to do to improve financial reporting in order
to address this issue?
6. (Advanced)
Do you think the SEC's plan is adequate to address this issue? In your
answer, comment on the nature of items included on the face of the
balance sheet versus those disclosed in the financial statement
footnotes.
7. (Advanced)
Describe a transaction that will help "window dress" financial
statements for quarter end or year end reporting.
Reviewed By: Judy Beckman, University of Rhode Island
Federal regulators are poised to propose new
disclosure rules targeting "window dressing," a practice undertaken by
some large banks to temporarily lower their debt levels before reporting
finances to the public.
The Securities and Exchange Commission is
scheduled to take up the matter at a meeting Friday and is expected to
issue proposals for public comment. The action follows a Wall Street
Journal investigation into the practice, which isn't illegal but masks
banks' true levels of borrowing and risk-taking.
A Journal analysis of financial data from 18
large banks known as primary dealers showed that as a group, they have
consistently lowered debt at the end of each of the past six quarters,
reducing it on average by 42% from quarterly peaks.
The practice suggests the banks are carrying
more risk than is apparent to their investors or customers, who only see
the levels recorded on the companies' quarterly balance sheets.
The SEC focus comes two years after the peak of
the financial panic, which was exacerbated by high levels of borrowing
by the nation's banks.
Since then, heightened scrutiny from regulators
and investors has prompted banks to be more sensitive about showing high
debt levels.
The SEC is expected to propose rules requiring
greater disclosure from banks and other companies about their short-term
borrowings.
The agency's staff has been considering whether
banks should be required to provide more frequent disclosure of their
average borrowings, which would give a better picture of their debt
throughout a quarterly period than do period-end figures.
An SEC spokesman declined to comment.
Short-term borrowing pumps up risk-taking by
banks, allowing them to make bigger trading bets.
Currently, banks are required to disclose their
average borrowings only annually, and nonfinancial companies aren't
required to disclose their average borrowings at all.
Last month, Sen. Robert Menendez, a New Jersey
Democrat, and five other senators urged the agency to require more
disclosure so the public could see if a company tried to dress up its
quarterly borrowings.
"Rather than relying on carefully staged
quarterly and annual snapshots, investors and creditors should have
access to a complete real-life picture of a company's financial
situation," the senators wrote to SEC Chairman Mary Schapiro, citing the
Journal articles, among other things.
Ms. Schapiro, through a spokesman, declined to
comment. Mr. Menendez's office didn't return a call.
Some large banks, including Bank of America
Corp. and Citigroup Inc., frequently have lowered their levels of
repurchase agreements, a key type of short-term borrowing, at the ends
of fiscal quarters, then boosted those "repo" levels again after the
next quarter began.
The banks have said they are doing nothing
wrong, and that the fluctuations in their balance sheets reflect the
needs of their clients and market conditions.
But the practices suggest the banks are more
leveraged and carry more risk during periods when that information isn't
disclosed to the public.
At Friday's meeting, the SEC also will consider
additional guidance for companies about what they should disclose about
borrowing practices in the "Management's Discussion and Analysis"
sections of their securities filings.
In the wake of the financial crisis, the SEC's
staff has been taking a fresh look at companies' disclosures in these
"MD&A" sections about liquidity and capital resources.
In the SEC staff's view, balance-sheet
fluctuations can happen for legitimate reasons, and the important thing
is disclosing them to investors when they are material.
Concern about hidden risk-taking by banks was
heightened after a March report about the collapse of Lehman Brothers
Holdings Inc.
A bankruptcy-court examiner said Lehman had
used a repo-accounting strategy dubbed "Repo 105" to take $50 billion in
assets off its balance sheet and make its finances look healthier than
they were.
The SEC later asked major banks for data about
their repo accounting. SEC Chief Accountant James Kroeker said in May
that the commission's effort hadn't uncovered widespread inappropriate
practices.
Still, both Bank of America and Citigroup found
errors in their repo accounting that amounted to billions of dollars,
though these were relatively small in the context of their giant balance
sheets.
An investigation by the SEC's enforcement
division into Lehman's collapse is zeroing in on this Repo 105
accounting maneuver, according to people familiar with the situation.
In an April congressional hearing, Rep. Gregory
W. Meeks, a New York Democrat, asked Ms. Schapiro about the Journal's
findings regarding banks' end-of-quarter debt reductions.
"It appears investment banks are temporarily
lowering risk when they have to report results, [then] they're
leveraging up with additional risk right after," Mr. Meeks said. "So my
question is: Is that still being tolerated today by regulators,
especially in light of what took place with reference to Lehman?"
Ms. Schapiro said the commission is gathering
detailed information from large banks, "so that we don't just have them
dress up the balance sheet for quarter end and then have dramatic
increases during the course of the quarter."
Jensen Comment
One of my heroes is former Coopers partner and SEC Chief Accountant Lynn
Turner. My two heroes, Turner and Partnoy, write about how bank financial
statements should be classified under "Fiction."
Frank
Partnoy and Lynn Turner contend that bank accounting is an exercise in
writing fiction:
Watch the video! (a bit slow loading)
Lynn Turner is Partnoy's co-author of the white paper "Make Markets Be
Markets"
"Bring Transparency to Off-Balance Sheet Accounting," by Frank Partnoy,
Roosevelt Institute, March 2010 --- http://www.rooseveltinstitute.org/policy-and-ideas/ideas-database/bring-transparency-balance-sheet-accounting
Watch the great video!
Accounting for Derivative Financial Instruments and Hedging Activities
Hi Patricia,
The bottom line is that accounting authors, like intermediate textbook
authors, provide lousy coverage of FAS 133 and IAS 39 because they just do
not understand the 1,000+ types of contracts that are being accounted for in
those standards. Some finance authors understand the contracts but have
never shown an inclination to study the complexities of FAS 133 and IAS 39
(which started out as a virtual clone of FAS 133).
There are some great textbooks on derivatives and hedging written by
finance professors, but those professors never delved into the complexities
of FAS 133 and IAS 39. My favorite book may be out of print at the moment,
but this was a required book in my theory course: Derivatives: An
Introduction by Robert A Strong, Edition 2 (Thomson South-Western, 2005,
ISBN 0-324-27302-9)
Professor Strong's book provides zero about FAS 133 and IAS 39, but my
students were first required to understand the contracts that they later had
to account for in my course. Strong's coverage is concise and relatively
simple.
When first learning about hedging, my Trinity University graduate
students and CPE course participants loved an Excel workbook that I made
them study at
www.cs.trinity.edu/~rjensen/Calgary/CD/Graphing.xls
Note the tabs on the bottom that take you to different spreadsheets.
There are some really superficial books written by accounting professors
who really never understood derivatives and hedging in finance.
Sadly, much of my tutorial material is spread over hundreds of different
links.
However, my dog and pony CD that I used to take on the road such as a
training course that I gave for a commodities trading outfit in Calgary can
be found at
http://www.cs.trinity.edu/~rjensen/Calgary/CD/ T
his was taken off of the CD that I distributed to each participant in each
CPE course, and now I realize that a copyrighted item on the CD should be
removed from the Web.
Note that some of the illustrations and exam answers have changed over
time. For example, the exam material on embedded derivatives is still
relevant under FASB rules whereas the IASB just waved a magic wand and said
that clients no longer have to search for embedded derivatives even though
they're not "clearly and closely related" to the underlyings in their host
contracts. I think this is a cop out by the IASB.
But the core of what I taught about derivatives and hedge accounting in
my accounting theory course can be found in the FAS 133 Excel spreadsheets
listed near the top of the document at
http://www.cs.trinity.edu/~rjensen/
The bottom line is that accounting authors like intermediate textbook
authors provide lousy coverage of FAS 133 and IAS 39 because they just do
not understand the 1,000+ types of contracts that are being accounted for in
those standards. Some finance authors understand the contracts but have
never shown an inclination to delve into the complexities of FAS 133 and IAS
39 (which started out as a virtual clone of FAS 133).
Respectfully,
Bob Jensen
Accounting for the Shadow Economy
Property is much more than a body of norms. It is
also a huge information system that processes raw data until it is
transformed into facts that can be tested for truth, and thereby destroys
the main catalysts of recessions and panics -- ambiguity and opacity.
See below
The Obama administration has finally come
up with a plan to deal with the real cause of the credit crunch: the
infamous "toxic assets" on bank balance sheets that have scared off
investors and borrowers, clogging credit markets around the world. But if
Treasury Secretary Timothy Geithner hopes to prevent a repeat of this global
economic crisis, his rescue plan must recognize that the real problem is not
the bad loans, but the debasement of the paper they are printed on.
Today's global crisis -- a loss on paper
of more than $50 trillion in stocks, real estate, commodities and
operational earnings within 15 months -- cannot be explained only by the
default on a meager 7% of subprime mortgages (worth probably no more than $1
trillion) that triggered it. The real villain is the lack of trust in the
paper on which they -- and all other assets -- are printed. If we don't
restore trust in paper, the next default -- on credit cards or student loans
-- will trigger another collapse in paper and bring the world economy to its
knees.
If you think about it, everything of
value we own travels on property paper.
At the beginning of the decade there was
about $100 trillion worth of property paper representing tangible goods such
as land, buildings, and patents world-wide, and some $170 trillion
representing ownership over such semiliquid assets as mortgages, stocks and
bonds. Since then, however, aggressive financiers have manufactured what the
Bank for International Settlements estimates to be $1 quadrillion worth of
new derivatives (mortgage-backed securities, collateralized debt
obligations, and credit default swaps) that have flooded the market.
These derivatives are the root of the
credit crunch. Why? Unlike all other property paper, derivatives are not
required by law to be recorded, continually tracked and tied to the assets
they represent. Nobody knows precisely how many there are, where they are,
and who is finally accountable for them. Thus, there is widespread fear that
potential borrowers and recipients of capital with too many nonperforming
derivatives will be unable to repay their loans. As trust in property paper
breaks down it sets off a chain reaction, paralyzing credit and investment,
which shrinks transactions and leads to a catastrophic drop in employment
and in the value of everyone's property.
Ever since humans started trading, lending
and investing beyond the confines of the family and the tribe, we have
depended on legally authenticated written statements to get the facts about
things of value. Over the past 200 years, that legal authority has matured
into a global consensus on the procedures, standards and principles required
to document facts in a way that everyone can easily understand and trust.
The result is a formidable property system
with rules and recording mechanisms that fix on paper the facts that allow
us to hold, transfer, transform and use everything we own, from stocks to
screenplays. The only paper representing an asset that is not centrally
recorded, standardized and easily tracked are derivatives.
Property is much more than a body of
norms. It is also a huge information system that processes raw data until it
is transformed into facts that can be tested for truth, and thereby destroys
the main catalysts of recessions and panics -- ambiguity and opacity.
To bring derivatives under the rule of law,
governments should ensure that they conform to six longstanding procedures
that guarantee the value and legitimacy of any kind of paper purporting to
represent an asset:
- All documents and the assets and
transactions they represent or are derived from must be recorded in
publicly accessible registries. It is only by recording and continually
updating such factual knowledge that we can detect the kind of overly
creative financial and contractual instruments that plunged us into this
recession.
- The law has to take into account the
"externalities" or side effects of all financial transactions according
to the legal principle of erga omnes ("toward all"), which was
originally developed to protect third parties from the negative
consequences of secret deals carried out by aristocracies accountable to
no one but themselves.
- Every financial deal must be firmly
tethered to the real performance of the asset from which it originated.
By aligning debts to assets, we can create simple and understandable
benchmarks for quickly detecting whether a financial transaction has
been created to help production or to bet on the performance of distant
"underlying assets."
- Governments should never forget that
production always takes priority over finance. As Adam Smith and Karl
Marx both recognized, finance supports wealth creation, but in itself
creates no value.
- Governments can encourage assets to
be leveraged, transformed, combined, recombined and repackaged into any
number of tranches, provided the process intends to improve the value of
the original asset. This has been the rule for awarding property since
the beginning of time.
- Governments can no longer tolerate
the use of opaque and confusing language in drafting financial
instruments. Clarity and precision are indispensable for the creation of
credit and capital through paper. Western politicians must not forget
what their greatest thinkers have been saying for centuries: All
obligations and commitments that stick are derived from words recorded
on paper with great precision.
Above all, governments should stop
clinging to the hope that the existing market will eventually sort things
out. "Let the market do its work" has come to mean, "let the shadow economy
do its work." But modern markets only work if the paper is reliable.
Continued in article
Question
When is $7 billion not a material bad debt exposure?
Answer
When the "bad debt" is from an "empty creditor"
Now do you understand?
The defining moments of our financial crisis are
now familiar. Last September, Lehman collapsed and AIG was teetering.
Because an AIG collapse was viewed as posing unacceptable systemic risks,
the Federal Reserve provided the company with an emergency $85 billion loan
on Sept. 16.
But a curious incident that fateful day raises
significant public policy issues. Goldman Sachs reported that its exposure
to AIG was "not material." Yet on March 15 of this year, AIG disclosed that
it paid $7 billion of its government loan last fall to satisfy obligations
to Goldman. A "not material" statement and a $7 billion payout appear to be
at odds.
Why didn't Goldman bark that September day? One
explanation is that Goldman was, to use a term that I coined a few years
ago, largely an "empty creditor" of AIG. More generally, the empty-creditor
phenomenon helps explain otherwise-puzzling creditor behavior toward
troubled debtors. Addressing the phenomenon can help us cope with its impact
on individual debtors and the overall financial system.
What is an empty creditor? Consider that debt
ownership conveys a package of economic rights (to receive principal and
interest), contractual control rights (to enforce the terms of the
agreement), and other legal rights (to participate in bankruptcy
proceedings). Traditionally, law and business practice assume these
components are bundled together. Another foundational assumption: Creditors
generally want to keep solvent firms out of bankruptcy and to maximize their
value.
These assumptions can no longer be relied on.
Credit default swaps and other products now permit a creditor to avoid any
actual exposure to financial risk from a shaky debt -- while still
maintaining his formal contractual control rights to enforce the terms of
the debt agreement, and his legal rights under bankruptcy and other laws.
Thus the "empty creditor": someone (or institution)
who may have the contractual control but, by simultaneously holding credit
default swaps, little or no economic exposure if the debt goes bad. Indeed,
if a creditor holds enough credit default swaps, he may simultaneously have
control rights and incentives to cause the debtor firm's value to fall. And
if bankruptcy occurs, the empty creditor may undermine proper
reorganization, especially if his interests (or non-interests) are not fully
disclosed to the bankruptcy court.
Goldman Sachs was apparently an empty creditor of
AIG. On March 20, David Viniar, Goldman's chief financial officer, indicated
that the company had bought credit default swaps from "large financial
institutions" that would pay off if AIG defaulted on its debt. A Bloomberg
News story on that day quotes Mr. Viniar as saying that "[n]et-net I would
think we had a gain over time" with respect to the credit default swap
contracts.
Goldman asserted its contractual rights to require
AIG to provide collateral on transactions between the two, notwithstanding
the impact of such collateral calls on AIG. This behavior was
understandable: Goldman had responsibilities to its own shareholders and, in
Mr. Viniar's words, was "fully protected and didn't have to take a loss."
Nothing in the law prevents any creditor from
decoupling his actual economic exposure from his debt. And I do not suggest
any inappropriate behavior on the part of Goldman or any other party from
such "debt decoupling." But none of the existing regulatory efforts
involving credit derivatives are directed at the empty-creditor issue. Empty
creditors have weaker incentives to cooperate with troubled corporations to
avoid collapse and, if collapse occurs, can cause substantive and disclosure
complexities in bankruptcy.
An initial, incremental, and low-cost step lies in
the area of a real-time informational clearinghouse for credit default swaps
and other over-the-counter (OTC) derivatives transactions and other crucial
derivatives-related information. Creditors are not generally required to
disclose the "emptiness" of their status, or how they achieved it. More
generally, OTC derivatives contracts are individually negotiated and not
required to be disclosed to any regulator, much less to the public
generally. No one regulator, nor the capital markets generally, know on a
real-time basis the entity-specific exposures, the ultimate resting places
of the credit, market, and other risks associated with OTC derivatives.
With such a clearinghouse, the interconnectedness
of market participants' exposures would have been clearer, governmental
decisions about bailing out Lehman and AIG would have been better informed,
and the market's disciplining forces could have played larger roles. Most
important, a clearinghouse could have helped financial institutions to avoid
misunderstanding their own products, and modeling and risk assessment
systems -- misunderstandings that contributed to the global economic crisis.
Henry Hu is a professor at the University of Texas Law School.
Behavioral Economics For Dummies [Paperback]
by Morris Altman (Author)
John Wiley & Sons Canada
2012
From the Back Cover
The guide to understanding why people really make economic and
financial decisions
The field of behavioral economics sheds
light on the many subtle and not-so-subtle factors that contribute
to financial and purchasing choices. This friendly guide explores
how socialand psychological factors, such as instinctual behavior
patterns, social pressure, and mental framing, can dramatically
affect our day-to-day decision making and financial choices. Based
on psychology and sociology and rooted in real-world examples,
Behavioral Economics For Dummies offers the sort of insights
designed to help investors avoid impulsive mistakes, companies
understand the mechanisms behind individual choices, and governments
and nonprofits make public decisions.
Make realistic assumptions for economic analysis —
investigate the assumptions conventional economics makes, and
discover how behavioral economists introduce social,
psychological, and cultural considerations
Explore the relationship between the brain and economics
— understand how human behavior and surroundings affect economic
phenomena
Examine the role of free choice in economic decision
making — review the conditions that are necessary in order
for people to make choices that reflect their true preferences,
given the constraints they face
Get happy — recognize that factors other than wealth
and money are critically important to a person's happiness, as
defined by behavioral economics
Learn to:
Understand how social and psychological factors affect our
economic and financial decisions
Grasp how governments and experts influence our choices
Avoid making impulsive and uninformed decisions
Appreciate why ethics are important to our choices
Open the book and find:
The many subtle factors that contribute to our financial and
purchasing choices
Why people really make financial decisions
Real-world examples of how behavioral economics affects our
lives
What social and psychological factors affect our decision
making
How to use behavioral economics to be happier
Why government policies affect the economy
Helpful consumer tips
Go to Dummies.com for videos, step-by-step examples,
how-to articles, or to shop!
About the Author
Morris Altman, PhD, is a professor of behavioral economics at
Victoria University of Wellington in New Zealand and a professor of
economics at the University of Saskatchewan in Canada. He is on the
board of the Society for the Advancement of Behavioral Economics and
is a former president of that organization. He also edited the
Handbook of Contemporary Behavioral Economics.
I’ve just uploaded the first 8 lectures in my
Behavioral Finance class for 2012. The first few lectures are very
similar to last year’s, but the content changes substantially by about
lecture 5 when I start to focus more on Schumpeter’s approach to
endogenous money ---
http://www.debtdeflation.com/blogs/2012/09/23/behavioral-finance-lectures/
3. “A
Survey of Behavioral Finance” by Nicholas C. Barberis and
Richard H. Thaler (in George Constantinides, Milton Harris, and
Rene Stulz, eds.Handbook of Economics of Finance: Volume 1B,
Financial Markets and Asset Pricing, Elsevier North
Holland, Chapter 18, 1053-1128)
Comment:
Exactly as advertised–what you need to know about behavioral
finance in one place.
4.
“Conditions for Intuitive Expertise: A Failure to Disagree” by
Daniel Kahneman and Gary Klein (American Psychologist,
Vol. 64, No. 6, September 2009, 515-536)
Comment:
We overestimate the abilities of experts. But they do work in
certain settings. This explains when you can trust an expert.
5.
“Hindsight ≠ Foresight: The Effect of Outcome Knowledge on
Judgment Under Uncertainty” by Baruch Fischhoff (Journal of
Experimental Psychology: Human Perception and Performance,
Vol. 1, No. 3, August 1975, 288-299)
Comment:
Hindsight bias and creeping determinism. Big problems.
Feeling is a form of thinking. Both are ways we process
information, but feeling is faster. That’s the crux of Daniel Kahneman’s
mind-clarifying work. It won a psychologist an economics Nobel. And
strange labels helped.
The measurable features of
System 1 and System 2 cut across prior categories. Intuitive
information-processing has typically been considered irrational, but
System 1’s fast thinking is often logical and useful (“intuition
is nothing more and nothing less than recognition”). Conversely,
despite being conscious and deliberate System 2 can produce poor
(sometimes irrational) results.
JUSTIN FOX, The Myth of the Rational Market: A History of Risk,
Reward, and Delusion on Wall Street (New York, NY: HarperCollins
Publishers, 2009/11 (paper), ISBN 978-0-06-059903-4 (paper), pp. xvi,
390).
The Accounting Review, Vol. 88, No. 3, May 2013, pp. 1129-1131
. . .
The ideas of finance academics taking hold on
Wall Street is a remarkable story. Some examples are the acceptance of
portfolio theory, asset pricing models, the rise of the index fund, the
need to systematically collect data to test theories, and the
massive rise of derivative trading due to option pricing models
developed by Black and Scholes, and Merton and Roll. Such success is
also tempered by examples such as the failure of portfolio insurance to
hedge stock market risk and the fallout from Long Term Capital
Management's inability to cover its positions. Jensen's influential work
on theory of the firm is also presented as extending market
discipline to the firm.
Fama and Jensen will feature throughout the
remainder of the book, but the later chapters will focus on the rise of
behavioral finance and insights that challenge the EMH. For example,
Richard Thaler's work on challenging the notion of efficient markets and
rational choice models is followed by Chapter 11, titled “Bob Shiller
Points Out the Most Remarkable Error,” which refers to Shiller's famous
quotation arguing that observing no patterns in stock prices is not the
same as stock prices being right. The response to such challenges is
portrayed as one where the EMH definition shifts due to
counter-arguments being made. In addition, some previous supporters
concede that market anomalies do exist, and this is accompanied by the
rise of work such as Andrei Shleifer's “noise traders” research. There
is now a significant body of literature that highlights that individuals
do not always behave rationally. That does not mean one can exploit this
behavior consistently—particularly if you are a large investor.
Toward the end of the book, Fox crafts a debate
between Fama and Dick Thaler, and Fox makes it clear that the ground has
shifted. However, those who are preaching the demise of the EMH perhaps
do not understand that, while the prices may not always be “right,” the
recommendation to buy an index fund is still good advice, as “markets
are hard to beat” and still harder if you pay someone to manage your
portfolio (p. 306). Furthermore, Markowitz's diversification principle
holds, and “[s]tock prices contain lots of information” (p. 307).
Understanding the powerful forces that make
current prices hard to exploit consistently is one key lesson. On the
other hand, understanding when prices can be manipulated is equally
important. The collapse of financial markets requires us to consider
what went wrong. We should not assume ….
The book encourages the reader to not only
acknowledge the genuine benefits afforded by theoretical advances in
finance, but also to understand the limitations to theory.
Fox is able to provide compelling evidence of
the developments and shortcomings of the past, moralize about the issue,
and conclude that, despite much progress, we have much more to learn.
Is Fox blaming the EMH for the financial
crisis? He gives enough hints for others to draw that conclusion. In
spite of this, this remains a book that provides a balanced discussion.
For example, he acknowledges that stock and bond prices do convey
information, are hard to beat, and that many in Wall Street never
accepted the EMH. He also outlines Shiller's repeated warnings of
irrational exuberance and that by definition the EMH could not predict
such an event (prices are random). Academics have also long acknowledged
that the EMH is a theoretical concept; otherwise, incentives to analyze
information would not exist.
So, while Justin Fox's book is fair, balanced,
insightful, and highlights the need to continue to understand why
markets may or may not be efficient, I found some of the commentary
around the book were more critical of the EMH.1
It is as if the critics believe the proposed
theory was accepted beyond question. Post-earnings drift is shown in
Ball and Brown's 1968 paper. Agency and positive accounting theory
highlight the role of incentives, information processing costs, and
moral hazard. Active investors never believed in the EMH, and lessons
from behavioral finance have been well debated.
So why does the message create such
controversy, and are we doing enough as educators to ensure that the
complexity of the issues is communicated? Part of the problem may be the
need to search for a scapegoat, but are we ensuring that investors fully
understand issues such as the paradox of the market, or why some markets
are efficient and others are not?
Textbooks in accounting and finance tend to
have simplistic discussions of the topic, with the evidence
concentrating on the U.S. stock market. It is relatively easy to
understand the concept but much harder to appreciate the complexity of
the issue. Have we let loose a generation of undergraduates who are
inadequately trained, and who end up either treating the EMH as a piece
of magic or simply rejecting the whole concept without the ability to
explain why?
Consider those who accept market efficiency on
faith. While they may be price-protected in a well-traded market, they
will be more exposed in illiquid markets and out of their depth in a
market where price setters can exist.
Perhaps the more dangerous groups are those who
do not understand why markets can be difficult to beat and are
ill-informed about the evidence and counter-evidence. Fox concludes that
“while mindless conformism was characteristic of financial bubbles and
panics long before there were finance professors, fostering even more of
it has been the gravest sin of modern finance” (p. 328).
I think this book will challenge readers to
better understand how some of the key developments in finance have
evolved—the characters involved, the contradictions that occurred, and
the maturing of thought, so that the difficult issues surrounding
finance can continue to receive the attention that they deserve. Fox
allows the characters to come alive, and he shows their willingness to
be challenged by new ideas and evidence. Finance is not perfect, but Fox
also makes sure that we know of the contribution that finance has made
in better managing and pricing risk.
Reviewer
David Lont
Professor of Accounting
University of Otago
Jensen Question
This seems to beg the question of how accountants can contribute
information to irrational people with an underlying goal of helping
their markets themselves be more rational.
And now, the twist: prospect theory
probably isn't exactly true. Although it holds
up well in experiments where subjects are asked to make hypothetical
choices, it may fare less well in the rare experiments where researchers
can afford to offer subjects choices for real money (this isn't the best
paper out there, but it's one I could find freely available).
Nevertheless, prospect theory seems fundamentally closer to the mark
than simple expected utility theory, and if any model is ever created
that can explain both hypothetical and real choices, I would be very
surprised if at least part of it did not involve something looking a lot
like Kahneman and Tversky's model.
Daniel Kahneman is an Israeli psychologist and
Nobel laureate, notable for his work on the psychology of judgment and
decision-making, behavioral economics and hedonic psychology.With Amos
Tversky and others, Kahneman established a cognitive basis for common human
errors using heuristics and biases , and developed Prospect theory . He was
awarded the 2002 Nobel Memorial Prize in Economics for his work in Prospect
theory. Currently, he is professor emeritus of psychology and public affairs
at Princeton University’s Woodrow Wilson School.
Nobel
Prize-winning psychologist Daniel Kahneman addresses the
Georgetown class of 2009 about the merits of behavioral
economics.
He deconstructs the assumption that people always act
rationally, and explains how to promote rational
decisions in an irrational world.
Topics Covered:
1. The
Economic Definition Of Rationality
2.
Emphasis on Rationality in Modern Economic Theory
3. Examples of Irrational Behavior (watch this part)
4. How
to encourage rational decisions
Speaker Background (Via Fora.Tv)
Daniel
Kahneman - Daniel Kahneman is Eugene Higgins Professor
of Psychology and Professor of Public Affairs Emeritus
at Princeton University. He was educated at The Hebrew
University in Jerusalem and obtained his PhD in
Berkeley. He taught at The Hebrew University, at the
University of British Columbia and at Berkeley, and
joined the Princeton faculty in 1994, retiring in 2007.
He is best known for his contributions, with his late
colleague Amos Tversky, to the psychology of judgment
and decision making, which inspired the development of
behavioral economics in general, and of behavioral
finance in particular. This work earned Kahneman the
Nobel Prize in Economics in 2002 and many other honors
Video 2: Nancy Etcoff is part of a new vanguard of cognitive
researchers asking: What makes us happy? Why do we like beautiful things? And
how on earth did we evolve that way? Simoleon Sense, June 10, 2009
http://www.simoleonsense.com/science-of-happiness/
Behavioral finance has made important contributions
to the field of investing by focusing on the cognitive and emotional aspects
of the investment decision-making process. Although it is tempting to say
that people are the same everywhere, the collective set of common
experiences that people of the same culture share will influence their
cognitive and emotional approach to investing. In this article, the author
discusses the many cultural differences that may influence investor behavior
and how these differences may influence the recommendations of a financial
advisor.
That behavioral finance has revolutionized the
way we think about investments cannot be denied. But its intellectual
appeal may lie in its cross-disciplinary nature, marrying the field of
investments with biology and psychology. This literature review
discusses the relevant research in each component of what is known
collectively as behavioral finance.
This review of behavioral finance
aims to focus on articles with direct relevance to practitioners of
investment management, corporate finance, or personal financial
planning. Given the size of the growing field of behavioral finance, the
review is necessarily selective. As Shefrin (2000, p. 3) points out,
practitioners studying behavioral finance should learn to recognize
their own mistakes and those of others, understand those mistakes, and
take steps to avoid making them. The articles discussed in this review
should allow the practitioner to begin this journey.
Traditional finance uses models in
which the economic agents are assumed to be rational, which means they
are efficient and unbiased processors of relevant information and that
their decisions are consistent with utility maximization. Barberis and
Thaler (2003, p. 1055) note that the benefit of this framework is that
it is “appealingly simple.” They also note that “unfortunately, after
years of effort, it has become clear that basic facts about the
aggregate stock market, the cross-section of average returns, and
individual trading behavior are not easily understood in this
framework.”
Behavioral finance is based on the
alternative notion that investors, or at least a significant minority of
them, are subject to behavioral biases that mean their financial
decisions can be less than fully rational. Evidence of these biases has
typically come from cognitive psychology literature and has then been
applied in a financial context.
Examples of biases include
•
Overconfidence and overoptimism—investors overestimate their ability
and the accuracy of the information they have.
•
Representativeness—investors assess situations based on superficial
characteristics rather than underlying probabilities.
•
Conservatism—forecasters cling to prior beliefs in the face of new
information.
•
Availability bias—investors overstate the probabilities of recently
observed or experienced events because the memory is fresh.
•
Frame
dependence and anchoring—the form of presentation of information can
affect the decision made.
•
Mental
accounting—individuals allocate wealth to separate mental
compartments and ignore fungibility and correlation effects.
•
Regret
aversion—individuals make decisions in a way that allows them to
avoid feeling emotional pain in the event of an adverse outcome.
Behavioral finance also challenges
the use of conventional utility functions based on the idea of risk
aversion.
For example, Kahneman and Tversky
(1979) propose prospect theory as a descriptive theory of decision
making in risky situations. Outcomes are evaluated against a subjective
reference point (e.g., the purchase price of a stock) and investors are
loss averse, exhibiting risk-seeking behavior in the face of losses and
risk-averse behavior in the face of gains.
We are covering the idea of charity or
altruism as rational or irrational. Now
clearly this idea of helping others is irrational is well established in
some circles. To start what is altruism? Let's
ask Google.
Now many economists have argued for years that it
is bad. For instance,
Ayn Rand in her writings and more recently
from the
Ayn Rand Institute.
Last week we ended class talking about
this video where the monkeys shared their
gains and acted in a manner that would be seen as uneconomic (giving
away nuts, caring about "fairness" etc). If you have not seen that
video, I highly recommend it. (oh and
please give me a juicy grape:) ) So
cooperationmay be useful for the species.
Joe and Mary Starbacks "worked" for a short time in the Cuban Coffee
House in Havana. Actually they did not really work very hard and mostly
took long and frequent coffee breaks where they spread a map of America
on a table and dreamed of where they might live the American Dream one
day. They learned from an old National Graphics Magazine that the
Pacific Northwest is a particularly nice place to live.
They soon quit their jobs when they discovered that by pooling their
Cuban Ration Books they could do about as well not working as working.
Then they started a small black market business by pushing a coffee
making cart along busy streets of Havana.
They could only have a small black market business, because anybody
in Cuba is sent to prison for becoming wealthy unless they are members
of the elate in the Cuban Communist Party.
After they prospered in America they agreed completely with the
assessment of Fidel Castro about what's wrong with communism and
socialism:
Fidel Castro told a visiting American
journalist that Cuba's communist economic model doesn't work, a rare
comment on domestic affairs from a man who has conspicuously steered
clear of local issues since stepping down four years ago.
The fact that things are not working
efficiently on this cash-strapped Caribbean island is hardly news.
Fidel's brother Raul, the country's president, has said the same
thing repeatedly. But the blunt assessment by the father of Cuba's
1959 revolution is sure to raise eyebrows.
Jeffrey Goldberg, a national correspondent
for The Atlantic magazine, asked if Cuba's economic system was still
worth exporting to other countries, and Castro replied: "The Cuban
model doesn't even work for us anymore" Goldberg wrote Wednesday in
a post on his Atlantic blog.
He said Castro made the comment casually
over lunch following a long talk about the Middle East, and did not
elaborate. The Cuban government had no immediate comment on
Goldberg's account.
Since stepping down from power in 2006, the
ex-president has focused almost entirely on international affairs
and said very little about Cuba and its politics, perhaps to limit
the perception he is stepping on his brother's toes.
Goldberg, who traveled to Cuba at Castro's
invitation last week to discuss a recent Atlantic article he wrote
about Iran's nuclear program, also reported on Tuesday that Castro
questioned his own actions during the 1962 Cuban Missile Crisis,
including his recommendation to Soviet leaders that they use nuclear
weapons against the United States.
Even after the fall of the Soviet Union,
Cuba has clung to its communist system.
The state controls well over 90 percent of
the economy, paying workers salaries of about $20 a month in return
for free health care and education, and nearly free transportation
and housing. At least a portion of every citizen's food needs are
sold to them through ration books at heavily subsidized prices.
President Raul Castro and others have
instituted a series of limited economic reforms, and have warned
Cubans that they need to start working harder and expecting less
from the government. But the president has also made it clear he has
no desire to depart from Cuba's socialist system or embrace
capitalism.
Fidel Castro stepped down temporarily in
July 2006 due to a serious illness that nearly killed him.
He resigned permanently two years later,
but remains head of the Communist Party. After staying almost
entirely out of the spotlight for four years, he re-emerged in July
and now speaks frequently about international affairs. He has been
warning for weeks of the threat of a nuclear war over Iran.
Castro's interview with Goldberg is the
only one he has given to an American journalist since he left
office.
A Story About Joe and Mary Starbacks in America
After sneaking into Miami, Joe and Mary Starbacks immediately
commenced a long bus trip to Seattle. They only had $2,000 of hard
earned black market profits in their pockets, but in Seattle they
managed to borrow $10,000 from the giant Washington Mutual (WaMu) Bank.
Before it went bankrupt in 2009, WaMu had a reputation of making loans
to almost anybody who came off the streets into a WaMu branch.
Joe and Mary commenced Starbacks Coffee House Number 1 on a busy
downtown Seattle street corner. They worked about 18 hours each day
blending superior coffee, baking great pastries, and keeping their store
and bathrooms spotless. They themselves rarely ever took a break during
any day and put off their dreams of having a family. This was a lot
different than working for a coffee house in Cuba. In Seattle they owned
the store.
After the enormous financial success of their first store, they
opened Starbacks Coffee House Number 2 in Tacoma.
After ten years of booming success they opened Starbacks Coffee House
Number 8,317 in Miami.
Joe and Mary do indeed still live the great American Dream.
How Capitalism, Ambition, and Risk Taking are Fueled by
the Fires of Greed
Now to your question XXXXX:
A serious wealth tax douses the fires of greed,
ambition, risk taking, and capitalism in general,
A serious wealth tax is quite simply a ploy to defeat capitalism and
replace it with egalitarian socialism or Cuban so-called communism
There are of course less-serious taxes on the wealthy such as
enormous property taxes on their mansions and luxury taxes on their
yachts. But I think you had more serious egalitarian wealth taxes in
mind that destroy capitalism, ambition, and risk taking.
Another fall out of serious wealth tax is that the wealthy flee with
their money to places like Switzerland.
Wealthy artists and authors flee to Ireland where they can live
virtually tax free.
Scaling the Heights of Corporate Greed A
Guest Post By Jeremiah H. Chafkin and Andrew W. Lo
In Laurence Gonzales’s riveting book
Deep Survival, he gives a sobering account of four mountain climbers who
successfully scaled the 11,249-foot peak of Mount Hood in Oregon —
considered a “beginner’s” mountain — only to fall disastrously during their
descent.
The climber in the top position — a
veteran of much more challenging climbs — felt that belaying (the laborious
process of anchoring a climber’s rope to the mountainside to arrest a fall)
was an unnecessary precaution in this case, so when he lost his footing and
fell, he yanked his three tethered colleagues, and five climbers below them,
off the side of the snow-covered mountain. Three men died in this
unfortunate incident, and the question posed by Gonzales is what leads some
individuals to such tragic ends, while others faced with the same
circumstances survive?
The answer, which forms the major thesis
of Deep Survival, may also be the ultimate explanation for the
current financial crisis:
The climbers on Mount Hood were set up
for disaster not by their inexperience, but by their experience. It was
the quality of their thinking, the idea that they knew, coupled with
hidden characteristics of the system they had so often used. The system
… was capable of displaying one type of behavior for a long time and
then suddenly changing its behavior completely.
In other words, their mental model of this
beginner’s mountain did not match the reality on that fateful day, resulting
in their tragic accident.
The remarkably consistent performance of
the U.S. residential real-estate market over the decade from 1996 to 2006
may have had the same effect, leading many experienced businessmen to
conclude that such growth was likely to continue indefinitely. And despite
all the protections that were available to these captains of industry —
analytics that showed large potential losses in the event of a downturn in
housing prices, leverage constraints imposed by regulatory capital
requirements, and warning signs from the hedge-fund industry in 2005 and
2006 — they charged ahead anyway, with the single-mindedness of a
well-funded expedition hell-bent on conquering a mountain. Their mental
models apparently did not match reality either.
Much of neoclassical economics is based on
the assumption that individuals act rationally and that markets fully
reflect all available information, i.e., markets are informationally
efficient. So powerful and far-reaching are the implications of this
hypothesis that we sometimes forget it is meant to be an approximation to a
much more complex reality. Recent advances in the cognitive neurosciences
have radically altered our understanding of human decision-making,
underscoring the importance of emotion, “hardwired” responses, and neural
“plasticity” (the adaptability of neural pathways) in producing observed
behavior (see Lo 2004, 2005). These breakthroughs show that decisions are
often the result of several distinct components of the brain — some under
our direct control and others that work behind the scenes and below our
consciousness — that collaborate to yield a course of action best suited to
achieve our immediate goals. On occasion, those immediate goals may conflict
with larger and more important goals, like survival.
One illustration of this mismatch is the
typical response to the following question: what is the primary objective of
any mountain-climbing expedition? If, like most individuals, you answered
“to get to the summit, of course,” you may be suffering from the same mental
blinders as those climbers who fell from Mount Hood. A more risk-aware
response might be: “to get to the summit, and then descend successfully.”
Sometimes, we are so focused on one objective — to the exclusion of all else
— that we neglect the obvious.
Risk-taking in corporate contexts is
surprisingly similar, except that the height of the mountain is measured in
units of earnings-per-share, return-on-equity, and share price. CEO’s are
richly rewarded for the speed of their ascent during times of growing demand
and easy money, but not necessarily for safely navigating the descent to the
bottom of the business and credit cycles. While “greedy” CEO’s are easy
scapegoats, the main object of everyone’s attention — the stock price — is
often driven by shareholders looking for short-term profits, not long-term
capital appreciation. And competition for shareholder dollars is akin to
having many climbers competing to reach the same peak first. In both cases,
the rewards — either bragging rights or bonuses — are proportional to the
difficulty of the climb (barriers to entry) and the speed of the ascent
(growth rate). A well-planned and successful descent is usually not on the
list.
Now it can be argued that descending
safely goes without saying, and most serious climbers are extremely
well-prepared for both legs of their journey. But if it goes without saying,
it sometimes goes without detailed planning, and then without doing,
especially by those lucky climbers who have never experienced any setbacks
or accidents. Similarly, corporate profits are rarely generated without
taking some risks, yet the current culture, compensation structure, and
shareholder and analyst objectives surrounding the modern corporation are
all focused mainly on the race to the summit.
So what is the business equivalent of a
well-crafted plan for descent? One possibility is for a corporation to
appoint a chief risk officer (CRO) who reports directly to the board of
directors and is solely responsible for managing the company’s enterprise
risk exposures, and whose compensation depends not on corporate revenues or
earnings, but on corporate stability. Any proposed material change in a
corporation’s risk profile — as measured by several objective metrics that
are specified in advance by senior management and the board — will require
prior written authorization of the CRO; and the CRO can be terminated if a
corporation’s risk profile deviates from its pre-specified risk mandate, as
determined jointly on an annual basis by senior management and the board.
Such a proposal does invite conflict and
debate among senior management and their directors, but this is precisely
the point. By having open dialogue about the potential risks and rewards of
new initiatives, senior management will have a fighting chance of avoiding
the cognitive traps that can lead to disaster. Imagine if one of the four
ill-fated climbers on Mount Hood had been assigned the role of the
“designated skeptic” in advance, in which capacity he would be expected to
raise every reasonable objection he could think of to a quick descent. We
will never know if this would have been enough to have prevented their fall,
but it would certainly have given them pause, and an opportunity for further
reflection.
Mountains must be scaled, businesses must
be built, and risks imply that occasionally, losses will be severe. But it
would be even more tragic if we compounded our mistakes by failing to learn
from them.
Also see
"Word Power: A New Approach for Content Analysis"
by Narasimhan Jegadeesh (Emory University - Department of Finance) and
Andrew Di Wu (University of Pennsylvania - The Wharton School)
SSRN, April 2011
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1841786
ABSTRACT:
We present a new approach in financial content analysis to determine the
strength of various words in conveying positive or negative tone. We
apply our approach to quantify the tone of 10-K filings and find a
significant relation between document tone and market reaction for both
negative and positive words. Previous research has not been successful
using positive words to quantify tone. We find that our measure of
positive and negative tone is significantly related to filing period
returns after controlling for factors such as earning announcement date
return and accruals, while the earlier approaches in the literature are
not. In addition, we find that the appropriate choice of term weighting
in content analysis at least as important, and perhaps more important,
than a complete and accurate compilation of the word list. We find that
the market underreacts to the tone of 10-K’s, and this underreaction is
corrected over the next two weeks.
The city of Greensboro, N.C., has experimented with
a program designed for teenage mothers. To prevent these teens from having
another child, the city offered each of them $1 a day for every day they
were not pregnant. It turns out that the psychological power of that small
daily payment is huge. A single dollar a day was enough to push the rate of
teen pregnancy down, saving all the incredible costs — human and financial —
that go with teen parenting.
Cass Sunstein, President Obama's pick to head the
Office of Information and Regulatory Affairs, was a vocal supporter of the
program, because it was an economic policy that shaped itself around human
psychology. Sunstein is just one of a number of high-level appointees now
working in the Obama administration who favors this kind of approach.
All are devotees of behavioral economics — a school
of economic thought greatly influenced by psychological research — which
argues that the human animal is hard-wired to make errors when it comes to
decision-making, and therefore people need a little "nudge" to make
decisions that are in their own best interests.
And that is exactly what Obama administration
officials plan to do: By taking account of human psychology, they hope to
save you from yourself.
This is the story of how obscure psychological
research into human decision-making first revolutionized economics and now
appears poised to remake the relationship between the government and its
citizens.
How Behavioral Economics Came To Be
The ideas that underlie the Obama administration's
approach to social policies got their start in 1955 with Daniel Kahneman.
Then a young psychologist in the Israeli army, Kahneman's primary job was to
try to figure out which of his fellow soldiers might make good officers. To
do this, Kahneman ran the men through an unusual exercise: He organized them
into groups of eight, took away all their insignia so know one knew who had
a higher rank, and told them to lift an enormous telephone pole over a
6-foot wall.
Kahneman felt the exercise was incredibly
revealing. "We could see who was a leader, who was taking charge," Kahneman
says. "We could see who was a quitter, who gave up. And we thought that what
we saw before us is how they would behave in combat."
Certain of their wisdom, Kahneman and his fellow
psychologists would make recommendations after the exercise. The chosen men
would Go to officer school, and Kahneman would move on to the next batch of
soldiers. There was only one problem: Kahneman and his colleagues were
terrible at it.
Every month or so, Kahneman would get feedback from
the school about his picks, and "there was absolutely no relationship
between what we saw and what people saw who examined them for six months in
officer training school," he says.
But here's the remarkable thing: Despite the
negative feedback, Kahneman's faith in his own ability was unshaken.
"The next day after getting those statistics, we
put them there in front of the wall, gave them a telephone pole, and we were
just as convinced as ever that we knew what kind of officer they were going
to be."
People Make Irrational Choices
Kahneman was surprised by the pure visceral power
of his own certainty. He eventually coined a phrase for it: "illusion of
validity."
It's a problem that afflicts us all, says Kahneman,
who won the 2002 Nobel Prize in economics for his work on this subject. From
stockbrokers to baseball scouts, people have a huge amount of confidence in
their own judgment, even in the face of evidence that their judgment is
wrong.
But that mistake is just one of many cognitive
errors identified by Kahneman and his frequent collaborator, psychologist
Amos Tversky. For more than a decade, the two worked together cataloging the
ways the human mind systematically misjudges the world around it.
For instance, Kahneman and Tversky identified
"anchoring bias." It turns out that whenever you are exposed to a number,
you are influenced by that number whether you intend to be influenced or
not.
This is why, for example, the minimum payments
suggested on your credit card bill tend to be low. That number frames your
expectation, so you pay less of the bill than you might otherwise, your
interest continues to grow, and your credit card company makes more money
than if you had not had your expectations influenced by the low number.
Through their research, Kahneman and Tversky
identified dozens of these biases and errors in judgment, which together
painted a certain picture of the human animal. Human beings, it turns out,
don't always make good decisions, and frequently the choices they do make
aren't in their best interest.
In the realm of academic psychology, this isn't
much of a revelation — psychologists see people as flawed in all kinds of
ways. So, if the ideas of Kahneman and Tversky had simply stayed in the
realm of academic psychology, there wouldn't be much of a story to tell.
"Feelings, Brain and Prevention of Corruption," Eduardo
Salcedo-Albarán, Isaac De León-Beltrán, and Mauricio Rubio,
International Journal of Psychology Research, Vol. 3, No. 3, 2008, Via
SSRN ---
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1391104
Abstract:
In this paper we propose an answer for the question: why, sometimes,
people don’t perceive corruption as a crime? To answer this question we
use a neurological and a psychological concept. As humans, we experience
our emotions and feelings in first person, but the neuropsychological
mechanism known as “mirror neurons” makes possible to simulate emotions
and feelings of others. It means that our emotions and feelings are
linked with emotions and feelings of others. When mirror areas in the
brain are activated we can understand and simulate in first person the
actions, emotions and feelings of people. Because of these areas, the
observer’s brain acts “as if” it was experiencing the same action or the
same feeling that is perceived. Each organism establishes causal
relations to understand, manipulate and move in the world. Causal
relations can be classified as simple or complex. In a simple causal
relation, cause and effect are close in space and time. When cause and
effect are not close in space and time, the causal relation is complex.
When perceiving or committing homicide, a simple causal relation is
enough for identifying a victim, but when perceiving or committing a
public corruption crime, a complex causal relation must be established
for identifying a victim. When seeing someone committing bribe there is
no an evident victim. If persons can’t identify victims of public
corruption crimes, then they will not generate empathy feelings. When a
victim is not identified and perceived, there is no reason for thinking
that harm is being inflicted and mirror areas in the brain are not
activated.
Accounting for "co-operation and commitment" versus "command and
control?"
Without having read this book (yet) it would seem that it must overstate
the case. Organization behavior and leadership and financial structures do
not change that quickly without a greater shock than the 2009 recession and
efforts made by governments to save the previous structures. However, our
present managerial accounting systems are built upon the foundation of
"command and control," and may take some new foundational building for
whatever is meant by "co-operation and commitment."
As a rule I avoid what I call these Harvard Business School types of
books on leadership (that often preach more than teach based upon
substantive research), but the book below does have a provocative summary.
We are
at the start of a new wave of management. The recent
financial crisis highlighted problems not just in
the economic system, but also in the way that many
companies are governed and managed. Now modern
management has reached its end game and we approach
a new era in leadership. Rather than the certainties
of command and control, this new epoch will be based
on co-operation and commitment. There has been a
strategic revolution - instead of following the
rules, we now have to make them. For some this
represents great risk; for others it is an enormous
opportunity.
The Death of Modern Management is a how-to guide
for surviving and thriving amidst the new
uncertainties of contemporary business.
"...a joyride through new ideas, memorable stories
and superb writing." Philip Kotler
"Jo Owen gives a fascinating insight into how 21st
century management now works. It is helpful to have
someone with his experience, intellect and vision
explain the radical changes in a way that makes
sense and is immediately usable."
Juliet Hope, CEO, Startup
“Jo Owen delivers a robust and wide-ranging assault
on the delusions of management, strategy, finance
and marketing that have created an aura of justified
mistrust around the modern corporation, but does so
with wit, lucidity and lots of enlivening
illustrations. The answers for 21st century business
are helpfully accessible.”
Professor Nigel Nicholson, London Business School,
author of Managing the Human Animal and
Family Wars
"...offers insights that help encourage different
thinking." Director Magazine
In his new book, History of Greed, noted
financial fraud expert David E. Y. Sarna posits that the major scandals
that came to light in 2008, like most of those in the last two hundred
years are just the superficial manifestations of a system that, at its
core, is based on fraud, greed and dishonesty. The root cause of the
markets’ malaise, in one word, is “greed.” In two words, it is “easy
money.” The quest for easy money took many forms, and each greedy person
involved in the financial world found his or her own lucrative niche.
Through anecdotal examples, History of Greed
provides an in-depth, behind-the-scenes look at the world of financial
fraud, large and small. Millions of dollars are made every day (mostly
by promoters and insiders) and lost every day (mostly by innocent but
greedy investors) in the markets for these smaller stocks. The market
for smaller stocks is a giant casino in which the dice are loaded and
the cards are marked. Unlike some of the more exotic greed strategies,
like hard-to-comprehend complex derivatives, this one is easy for
everyone to understand. Sarna looks at smaller cases of fraud and major
financial panics and fruads such as AIG, Goldman Sachs, Enron, and
Twentieth Century Ponzi schemes.
Jensen Comment
A couple of nights ago the controversial liberal commentator Keith Olbermann
(MSNBC) lambasted all critics of President Obama who claim Obama is
anti-business. Olbermann's "proof" is that, under President Obama,
corporations have reported record profits for 2010 ---
http://www.msnbc.msn.com/id/3036677/#40363881
What Keith fails to mention is that those record profits are largely the
result, during present economic recovery, of dubious accounting, deep cost
cutting by plant closings, labor layoffs, outsourcing overseas, and as in
GM's case profits mainly arising from accounting tricks and profitability of
foreign operations such as GM plants in Brazil.
President Obama is being given all sorts of credit for saving the auto
industry without mentioning that the biggest new Chrysler automobile
manufacturing plant will be in Mexico to make Fiats destined for the U.S.
market, and that GM invested over $1 billion of its bailout money to build a
new plant in Brazil.
My main point, however, is that the media commentators like
Keith Olbermann and Rush Limbaugh often make too much of profit reports of
corporations whether the news is good or bad.
One huge problem is double entry bookkeeping that requires offsets to
changes in highly dubious valuations of some things like goodwill, financial
instruments, derivative financial instruments, and intangibles in
ledger accounts. In the opinion of some accounting experts, including me,
GM's financial statements may have been more misleading than helpful to
investors bidding on shares of its highly successful IPO in November 2010.
I'm also dubious of reported "record profits" of the private sector in 2010.
One problem of fair value accounting is the many-to-one mapping of
balance sheet fair value adjustments to a single eps resicual number. As
with nearly all aggregations, many-to-one mapping is a systemic problem that
is too severe (link nutritional ratings of vegetables) ---
http://faculty.trinity.edu/rjensen/FraudConclusion.htm#BadNews
Early extinguishment of debt instruments is often impractical because of
transactions costs of buying back debt plus transactions cost of issuing
replacement debt.
Investors who track earnings/eps often fail to appreciate how the FASB and
the IASB are obsessed with balance sheet reporting accounting
standards that leave earnings statements of dubious value for even
informed investors. Both accounting standard setting bodies have
conceptual framework definitions for assets and liabilities but leave the
concept of earnings somewhere off in the residual either. For example, in
corporate fair market value (mark-to-market) adjustments of assets and
liabilities, the offsetting adjustments to earnings probably include many
adjustments to accrued earnings that will never be realized in cash. For
example, if a company has fixed-rate debt that is marked-to-market, the
unrealized earning adjustments over the years will never be realized if the
company holds that debt to maturity. All those intervening interim earnings
adjustments are certain to sum to zero even though they went up and down in
a misleading way before final maturity of the debt.
I might add that my intention at this point in time is to vote for
President Obama in 2010, and I do not think this President is anti-business.
Because of Obama's ability to silence the overwhelmingly liberal media,
President Obama probably has the best chance among future 2012 rivals for
the Presidency of reducing the trillion+ dollar annual budget deficits.
In fact the November 20, 2010 edition of The Economist magazine
has a front cover picture of President Obama in a lumberjack shirt while
holding a huge budget cutting chain saw. I doubt that any contender to the
Presidency has any chance compared to President Obama of cutting the
trillion-dollar deficits. Liberals can just take on the liberal media in
ways that conservatives would find their budget chain saws pushed back to
their throats. This is not to say that legislators, be they liberal or
conservative, will work with President Obama to cut the deficit. In fact,
the politics of cost cutting probably make it impossible for any chain saw
cuts in the federal budget. States, however, will be forced to cut budgets
because, unlike Ben Bernanke, they can't simply print money without taxation
or borrowing.
LAST week Asia, this week Europe: no wonder
Barack Obama has been to so many foreign summits since his party took a
pounding in the mid-term elections. With the prospect of gridlock at
home, a president naturally turns abroad. Yet Mr Obama badly needs to
show that he can still lead on domestic policy. He should start by
cajoling Congress into an agreement to tackle America’s ominous fiscal
arithmetic.
Conventional wisdom says such an agreement is
impossible: the problem is too big, the politics too difficult. But it
is wrong to suppose that the deficit is unfixable, as two proposals for
fixing it have shown this month (see article). And even the politics may
not be totally intractable.
A trillion-dollar trove
The scale of America’s fiscal problem
depends on how far ahead you look. Today’s deficit, running at 9% of
GDP, is huge. Federal debt held by the public has shot up to 62% of GDP,
the highest it has been in over 50 years. But that is largely thanks to
the economy’s woes. If growth recovers, the hole left by years of serial
tax-cutting and overspending can be plugged: you need to find spending
cuts or tax increases equal only to 2% of GDP to stabilise federal debt
by 2015. But look farther ahead and a much bigger gap appears, as an
ageing population needs ever more pensions and health care. Such
“entitlements” will double the federal debt by 2027; and the number
keeps on rising after then. The figures for state and local debt are
scary too.
The solution should start with an agreement
between Mr Obama and Congress on a target for a manageable level of
publicly held federal debt: say, 60% of GDP by 2020. They should also
agree on the broad balance between lower spending and higher taxes to
achieve this. This newspaper believes that the lion’s share of the
adjustment should come on the spending side. Entitlements are at the
root of the problem and need to be trimmed, and research has shown that
although spending cuts weigh on growth in the short run, they hurt less
than higher taxes. And in the long run later retirement and other
reforms will expand the labour force and thus potential output, whereas
higher taxes dull incentives to work and invest.
Yet even to believers in small government, like
this newspaper, there are good reasons for letting taxes take at least
some of the strain. Politically, this will surely be the price of any
bipartisan agreement. Economically, there is sensible room for manoeuvre
without damaging growth. American taxes are relatively low after the
reductions of recent years. In an ideal world the tax burden would be
gradually shifted from income to consumption (including a carbon tax).
But that is politically hard—and there is a much easier target for
reform.
America’s tax system is riddled with
exemptions, deductions and credits that feed an industry of advisers but
sap economic energy. Simply scrapping these distortions—in other words,
broadening the base of taxation without any new taxes—could bring in
some $1 trillion a year. Even though some of this would have to go in
lowering marginal rates, it is a little like finding money behind the
sofa cushions. The tax system would be simpler, fairer and more
efficient. All this means that America can sensibly aim for a balance
between spending cuts and higher taxes similar to the benchmark set by
Britain’s coalition government. A ratio of 75:25 is about right.
There is legitimate concern that, done hastily,
austerity could derail a weak recovery. But this strengthens the case
for a credible deficit-reduction plan. By reassuring markets that
America will control its debt, the government will have more scope to
boost the economy in the short term if need be—for instance by
temporarily extending the Bush tax cuts.
Mr Obama and the Republicans are brimming with
ideas for freezing discretionary spending, which covers most government
operations from defence to national parks. They have found common cause
in attacking “earmarks”, the pet projects that lawmakers insert into
bills. But discretionary outlays, including defence, are less than 40%
of the total budget. Entitlements, in particular Social Security
(pensions) and Medicare and Medicaid (health care for the elderly and
the poor), represent the bulk of spending and even more of spending
growth.
On pensions, the solution is clear if
unpopular: people will need to work longer. America should index the
retirement age to longevity and make the benefit formula for
upper-income workers less generous. The ceiling on the related payroll
tax should be increased to cover 90% of earnings, from 86% now.
Health-care spending is a much tougher issue,
because it is being fed by both the ageing of the population and rising
per-person demand for services. Richer beneficiaries should pay more of
their share of Medicare, while the generosity of the system should be
kept in check by the independent panel set up under Mr Obama’s health
reform to monitor services and payments. The simplest way for the
federal government to restrain Medicaid would be to end the current
system of matching state spending and replace this with block grants,
which would give the states an incentive to focus on cost-control.
Chainsaw you can believe in
Devising a plan that reduces the deficit, and
eventually the debt, to a manageable size is relatively easy. Getting
politicians to agree to it is a different thing. The bitter divide
between the parties means that politicians pay a high price for
consorting with the enemy. So Democrats cling to entitlements, and
Republicans live in fear of losing their next party nomination to a
tea-party activist if they bend on taxes. Even the president’s own
bipartisan commission can’t agree on what to do.
But true leaders turn the hard into the
possible. Two things should prompt Mr Obama. First, the politics of
fiscal truth may be less awful than he imagines. Ronald Reagan and Bill
Clinton both won second terms after trimming entitlements or raising
taxes. Polls in other countries suggest that nowadays tough love can
sell. Second, in the long term economics will tell: unless it changes
course, America is heading for a bust. If Mr Obama lacks the guts even
to start tackling the problem, then ever more Americans, this paper and
even those foreign summiteers will get ever more frustrated with him.
"By almost any market test, economics is the
premier social science," Stanford University economist Edward Lazear
wrote just over a decade ago. "The field attracts
the most students, enjoys the attention of policy-makers and journalists,
and gains notice, both positive and negative, from other scientists."
Lazear went on to describe how economists, with the
University of Chicago's Gary Becker
leading the way, had been running roughshod over
the other social sciences — using economic tools to study crime, the family,
accounting, corporate management, and countless other not strictly economic
topics. "Economic imperialism" was the name he gave to this phenomenon (and
to his article, which was published in the
February 2000 issue of the Quarterly Journal
of Economics). And in his view it was a benevolent reign. "The power of
economics lies in its rigor," he wrote. "Economics is scientific; it follows
the scientific method of stating a formal refutable theory, testing theory,
and revising theory based on the evidence. Economics succeeds where
other social scientists fail because economists are willing to abstract."
Triumphalism like that calls for a
comeuppance, of course. So, as the nation's (and a lot of the
world's) economists gather this weekend in San Diego for their
annual
hoedown, it's worth asking: Are there any signs
that the imperialist era of economics might finally be coming to an end?
Lazear acknowledged one such indicator in his
article — the invasion of economics by psychological teachings about
cognitive bias. Two years later, in 2002, the co-leader of that invasion,
Princeton psychology professor Daniel Kahneman,
won an economics Nobel (the other co-leader, Amos
Tversky, had died in 1996). But while behavioral economics has since
solidified its status as an important part of the discipline, it hasn't come
close to conquering it. On the really big questions — how to run the
economy, for example — the mainstream view described by Lazear has continued
to dominate. Economists have also continued their imperialist habit of
delving into other fields: 2005's
Freakonomics, co-authored by Becker disciple
Steven Levitt, was a prime example of this — and sold millions of copies. As
for Lazear, he got himself appointed chairman of President George W. Bush's
Council of Economic Advisers in 2006.
And then, well, things didn't go so well. The
financial crisis and subsequent economic downturn — which Lazear
somewhat infamously downplayed while in office —
have put a big dent in the credibility of the macro side of the discipline.
The issue isn't that economists have nothing interesting to say about the
crisis. It's that they have so many different things to say about it. As MIT
financial economist Andrew Lo found after reading 11 accounts of the crisis
by academic economists (along with nine by journalists, plus former Treasury
Secretary Hank Paulson's personal account), there is massive disagreement
not just on why the crisis happened but on what actually happened. "Many of
us like to think of financial economics as a science,"
Lo
wrote, "but complex events like the financial
crisis suggest that this conceit may be more wishful thinking than reality."
Part of the issue is that Lazear's description of
the scientific way in which economics supposedly works (state a theory, test
it, revise) doesn't really apply in the case of a once-in-a-lifetime
financial crisis. I tend to think it doesn't apply for macroeconomics in
general. As economist Paul Samuelson
is said to have said, "We have but one sample of
history." Meaning that you can never get truly scientific answers
out of GDP or unemployment numbers.
That's why Lord Robert Skidelsky
recommended a couple of years ago that while
microeconomists could be allowed to proceed along pretty much the same
statistical and mathematical path they'd been following, graduate education
in macroeconomics needed to be dramatically revamped and supplemented with
instruction in ethics, philosophy, and politics.
I'm not aware of this actually happening in any top
economics PhD program (let me know if I'm wrong), despite the efforts of
George Soros's
Institute for New Economic Thinking and others.
What I've noticed instead, though, is an increasing confidence and boldness
among those who study economic issues through the lens of other academic
disciplines.
A couple of years ago I spent a weekend with a
bunch of business historians and
came away impressed mainly by how embattled most of them felt.
Lately, though, I've found myself talking to and
reading a little of the work of sociologists and political scientists, and
coming away impressed with how adept they are in quantitative methods, how
knowledgeable they are about economics, and how willing they are to
challenge economic orthodoxy. The two main writings I'm thinking about were
unpublished drafts that will be coming out later in HBR and from
the HBR Press, so I don't have links — but I get the sense that there are a
lot of good examples out there, and that after years of looking mainly to
mainstream economics journals I should be broadening my scope. (Two
recommendations I've gotten from Harvard government professor
Dan
Carpenter: Capitalizing
on Crisis: The Political Origins of the Rise of Finance, by
Sociologist Greta Krippner, and The
New Global Rulers: The Privatization of Regulation in the World Economy,
by political scientists Tim Büthe and Walter Mattli.)
Even anthropology, that most downtrodden of the
social sciences, has been encroaching on economists' turf. When a top
executive at the world's largest asset manager (Peter Fisher of BlackRock)
lists
Debt: The First 5,000 Years by anthropologist
(and Occupy Wall Streeter)
David
Graeber as
one of his top reads of 2012, you know something's
going on.
Continued in article
Jensen Comment
Harvard's Justin Fox was an Plenary Speaker at the 2011 American Accounting
Association Annual Meetings.
Those readers who have access to the AAA Commons may view his video at
http://commons.aaahq.org/posts/7bdb75d3d2
Forwarded by Jim Martin
An interesting controversy in economics sounds
familiar.
According to Ronald Coase, it is time to reengage the severely
impoverished
field of economics with the economy. He is a 101 year old Nobel Laureate
in
economics and professor emeritus at the University of Chicago Law
School. He
and Ning Wang of Arizona State University are launching a new journal,
Man and the Economy.
An economist once said that he hated the
physical scientists because they stole all the easy research problems.
In a sense this is so true in one context. The earth does not change its
rotation speed and path just because that speed and path are discovered
by research. But people and social cohorts often change just because
their behaviors are discovered by researcers.
Physical systems like gravity do not change with understanding of their
behavior. Social and economic systems change with discovery. For
example, economic and computer networking systems that work great in
theory and initially become corrupted as smart folks learn how to
exploit the systems.
Hence in social science we must not only discover behavior but discover
behavior that changes because we discover that behavior and discover
behavior that changes because we discover the changes in behavior and so
on and so on.
Except for quantum physics it must be nice to be a physical scientist
doing research on stationary systems. One reason mathematics of the
physical sciences fails us when extended to economics and the social
sciences in general is that these sciences entail nonstationary systems.
Equilibrium conditions are seldom are reached. This, for example, is why
Malthus was correct for an eye blink in astronomical time.
Ronald Coase published his career-making paper,
“The Nature of the Firm,” 75 years ago. He won the Nobel prize for
economics in 1991. In a lecture in 2002, he argued that physics has
moved beyond the assumptions of Isaac Newton, and biology beyond Darwin.
(Not that he knew them.) But economics, he said, had failed to advance
past the efficient-market assumptions of Adam Smith. This year Coase, a
professor emeritus at the University of Chicago Law School, is
attempting to start a new academic journal ambitiously titled Man and
the Economy. The premise: Economics is broken. Coase’s journal is still
just a plan, but his frustration with orthodox economics has energized
his followers.
The financial crisis forced economists to
confront the limitations of their profession. Former Federal Reserve
Chairman Alan Greenspan admitted as much when he told Congress in
October 2008 that markets might not regulate themselves after all. Coase
says the problem runs deeper: Economists study abstractions and numbers,
instead of firms and people. He doesn’t believe this can be fixed by
tweaking models. An entire generation of economists must be encouraged
to think differently.
The idea for the journal stems from his
collaboration with Ning Wang, an assistant professor at the School of
Politics and Global Studies at Arizona State University who grew up in a
rice- and fish-farming village in the Hubei province of China. Coase,
101, began working with Wang in the 1990s at the University of Chicago.
Neither has a degree in economics; the two understood each other. “We’re
not constrained by a mainstream, orthodox view,” says Wang. “A lot of
people would see this as a weakness.” Coase declined to be interviewed.
When Coase and Wang hosted a conference on
China in 2008, they noticed that many Chinese academics had never talked
to either policymakers or entrepreneurs from their own country. They had
learned only what Coase calls “blackboard economics,” sets of theories
and mathematical relationships between bits of data. “I came from
China,” says Wang. “We have a lot of nationals come here; they’re taught
game theory and econometrics. Then they’re going home … without a basic
understanding of how the real world functions.”
In an essay published on Nov. 20 in Harvard
Business Review, Coase argues that in the early 20th century, economists
began to focus on relationships among statistical measures, rather than
problems that firms have with production or people have with decisions.
Economists began writing for each other, instead of for other
disciplines or for the business community. “It is suicidal for the field
to slide into a hard science of choice,” Coase writes in HBR, “ignoring
the influences of society, history, culture, and politics on the working
of the economy.” (By “choice,” he means ever more complex versions of
price and demand curves.) Most economists, he argues, work with measures
like gross domestic product and the unemployment rate that are too
removed from how businesses actually work.
The solution for Coase and Wang is a journal
that presents case studies, historical comparisons, and qualitative
data—not just numbers but ideas, too. In top economics journals, says
Wang, “people think as long as you have a big data set, that’s enough.
You can do all kinds of modeling and regression, and it looks scientific
enough.” Julie Nelson, chairwoman of the economics department at the
University of Massachusetts Boston says economists want the kind of
immutable laws that physicists operate under. But Adam Smith’s 1776 idea
that people are driven by self-interest is not the same as the law of
gravity. “Ask an economist if they’d like to be thought of as a
sociologist,” she says, “and they’ll look at you with terror in their
eyes.”
Christopher Sims, a professor at Princeton
University who won the Nobel prize last year for his work in
macroeconomics, recognizes the problem. “We’re always abstracting and
hoping that the resulting abstractions capture enough of the truth so
that we know what’s going on,” he says. The kind of work that Coase and
Wang are interested in, he says, is “not fashionable now. It’s hard to
make it a science.” Where Coase and Wang see too little demand for new
ideas, Sims sees too little supply. Both he and Nelson, who studies how
economics is taught, describe a process at graduate schools that selects
for economists inclined to focus on abstract modeling.
Some people are impulsive and impatient; they
prefer a dollar or a donut today far more than a dollar or a donut tomorrow,
so much so that they’re willing to give up shocking amounts of dollars and
donuts tomorrow for just one today. This is one reason, some say, that we
see such high interest rates for short-term borrowing, from New York to
Calcutta.
Some people are not only impulsive and impatient,
but inconsistently so. they care a lot about a dollar today versus tomorrow,
but could care less between getting a dollar either 10 or 11 days from now.
Economists call this ‘hyperbolic discounting’.
Both behaviors–impatience and time inconsistency–could be a source of
persistent poverty.
Or not. Abhijit Banerjee
presented
a new paper here yesterday, written with MIT
colleague Sendhil Mullainathan. They look at a number of seemingly unusual
behaviors by the very poor–from exorbitant rates of short-term borrowing to
the low take-up of small, high-return investments. Impatience cannot explain
the patterns, they say. The impatience approach also requires the poor think
differently than the rest of the population.
Another view: we’re all impulsive and impatient in
the same way, but over a narrow range of goods that are quickly and cheaply
satisfied. If you’re poor, these temptations are a big fraction of your
income. If you’re even somewhat wealthy, they are not. Temptations are
declining in income.
The paper runs through half a dozen perplexing
patterns of behavior, and shows that these simple assumptions can explain a
great deal.
This approach has a great deal in common with
hyperbolic discounting, but is empirically distinct (and has very different
policy implications). Parsing out and testing these subtleties strikes me as
one of the most important frontiers in the study of poverty. Declining
temptation, if true, could explain all sorts of odd behaviors. With more
than a few Uganda and Liberia surveys on the horizon, I’m now scheming ways
to test whether it’s true.
It’s a difficult paper, especially for
those uninitiated in micro-economic theory. Even if that sounds like you:
the subtle points are worth the slog.
78% of former NFL players have gone
bankrupt or are under financial
stress because of joblessness or divorce.
Championship Rings in pawn shops, IRS vaults, Ponzi schemer stashes offshore, or
in the clutches of ex-wives
What on earth did athletes learn in college?
Pros seem especially susceptible to Ponzi schemes. Some recent examples ---
Click Here
By the time they have been retired for two
years, 78% of former NFL players have gone
bankrupt
or are under financial stress because of joblessness or divorce.
Within five years of retirement, an estimated
60% of former NBA players are broke.
Numerous retired MLB players have been
similarly ruined.
If that's not bad enough, the
recession
has made things even worse. Too much money in real estate; investments in
Ponzi schemes; and poor financial advising have been exposed with the down
economy.
A sign
of the times? More former stars are
selling their championship rings for money than ever.
"It's amazing that I heard the recession was over,"
says Timothy Robins, owner of
Championshiprings.net,
who buys bling from current and former pros and has
seen a 36% increase in sales during the past year. "I'm getting more calls
from players than ever. They're having a really hard time."
While just about everyone has
lost
money over the past year, athletes
tend to make particularly bad financial decisions, and it's not just
reckless spending.
The Jon Stewart & Jim Cramer battle made numerous
rounds and yet the question still remains- should the financial media be
held accountable for failing to warn citizens of the economic/financial
downturn?
Introduction (Via Fora.TV)
Should financial media be held accountable for
their failure to have warned the public of the current economic downturn?
What steps are being taken to avoid this happening in the future?
A panel of leading financial reporters assess the
global crisis and discuss the ‘perfect storm’ of events that led to it.
Aspiring journalists will hear how to avoid the perils and pitfalls of the
profession, and media observers can decide for themselves if the media is to
blame.
About the Speaker (Via Fora.TV)
Liz Claman - Liz Claman joined FOX Business Network
(FBN) as an anchor in October 2007. Her debut included an exclusive
interview with Berkshire Hathaway CEO and legendary investor Warren Buffett.
Alan Murray - Alan Murray is a Deputy Managing
Editor of The Wall Street Journal and Executive Editor for the Journal
Online. He also has editorial responsibility for Wall Street Journal
television, books, conferences, and the MarketWatch web site. Mr. Murray
spent a decade as the Journal’s Washington bureau chief.
Jeff Bercovici - Jeff Bercovici joined Conde Nast
Portfolio from Radar magazine, where he was part of the relaunch team for
both the online and print editions.
Stocks are still the best investment for the long
run. But maybe not for your long run. Justin Fox, "Are Stocks Still Good for the Long Run?" Time Magazine,
June 15, 2009 ---
http://www.time.com/time/magazine/article/0,9171,1902843-2,00.html
Also see Jim Mahar's June 10, 2009 summary at
http://financeprofessorblog.blogspot.com/
In particular this references a study by Arnott that asserts that over the past
40 years the stock market underperformed the bond market. In my opinion, if you
into bonds for the next 40 years they'd better be inflation-indexed bonds such
as Treasury TIPs.
JUSTIN FOX, The Myth of the Rational Market: A History of Risk,
Reward, and Delusion on Wall Street (New York, NY: HarperCollins
Publishers, 2009/11 (paper), ISBN 978-0-06-059903-4 (paper), pp. xvi, 390).
Reviewed by David Lunt in The Accounting Review, May 2013 ---
http://aaajournals.org/doi/full/10.2308/accr-10330
BOSTON (Reuters) - Security researchers say
they have uncovered a cyber espionage ring focused on stealing corporate
secrets for the purpose of gaming the stock market, in an operation that
has compromised sensitive data about dozens of publicly held companies.
Cybersecurity firm FireEye Inc, which disclosed
the operation on Monday, said that since the middle of last year, the
group has attacked email accounts at more than 100 firms, most of them
pharmaceutical and healthcare companies.
Victims also include firms in other sectors, as
well as corporate advisors including investment bankers, attorneys and
investor relations firms, according to FireEye.
The cybersecurity firm declined to identify the
victims. It said it did not know whether any trades were actually made
based on the stolen data.
Still, FireEye Threat Intelligence Manager Jen
Weedon said the hackers only targeted people with access to highly
insider data that could be used to profit on trades before that data was
made public.
They sought data that included drafts of U.S.
Securities and Exchange Commission filings, documents on merger
activity, discussions of legal cases, board planning documents and
medical research results, she said.
"They are pursuing sensitive information that
would give them privileged insight into stock market dynamics," Weedon
said.
The victims ranged from small to large cap
corporations. Most are in the United States and trade on the New York
Stock Exchange or Nasdaq, she said.
An FBI spokesman declined comment on the group,
which FireEye said it reported to the bureau.
The security firm designated it as FIN4 because
it is number 4 among the large, advanced financially motivated groups
tracked by FireEye.
The hackers don't infect the PCs of their
victims. Instead they steal passwords to email accounts, then use them
to access those accounts via the Internet, according to FireEye.
They expand their networks by posing as users
of compromised accounts, sending phishing emails to associates, Weedon
said.
FireEye has not identified the hackers or
located them because they hide their tracks using Tor, a service for
making the location of Internet users anonymous.
FireEye said it believes they are most likely
based in the United States, or maybe Western Europe, based on the
language they use in their phishing emails, Weedon said.
She said the firm is confident that FIN4 is not
from China, based on the content of their phishing emails and their
other techniques.
Researchers often look to China when assessing
blame for economically motivated cyber espionage. The United States has
accused the Chinese government of encouraging hackers to steal corporate
secrets, allegations that Beijing has denied, causing tension between
the two countries.
Weedon suspects the hackers were trained at
Western investment banks, giving them the know-how to identify their
targets and draft convincing phishing emails.
"They are applying their knowledge of how the
investment banking community works," Weedon said.
Sometimes the Nobel committee seems to make a
partly political statement in choosing winners of the prize in
economics. Not this year. On Monday, the Royal Swedish Academy of
Sciences awarded the 2013 Nobel to three deserving American economists:
Eugene Fama and Lars Peter Hansen at the University of Chicago and
Robert Shiller of Yale University. The prizes were based on the
importance of their work, which "laid the foundation for the current
understanding of asset prices."
Mr. Fama's major contribution, notably with the
1965 paper "Random Walks in Stock Market Prices," has been to show that
stock markets are very efficient. The term "efficient" here does not
mean what it normally means in economics—namely, that benefits minus
costs are maximized. Instead, it means that prices of stocks rapidly
incorporate information that is publicly available.
That happens because markets are so
competitive. Prices now move on earnings news not just within seconds,
but within milliseconds—which is why you're already too late if you
decide to buy Apple AAPL +0.65% stock after hearing about an
unexpectedly high earnings report. There are quicker trigger fingers
acting instantly on new information. But even before supercomputers got
into the game, markets were reacting very efficiently.
One implication of market efficiency is that
trading rules, such as "buy when the price fell yesterday," don't work.
The insight has had big implications for large and small investors:
Don't waste your money on professional financial managers who actively
try to pick individual stocks.
One high-profile beneficiary of Mr. Fama's
insight was John Bogle, who started the Vanguard 500 Index Fund in the
1970s. His idea was to have a fund indexed to the overall market and
save the costs of hiring experts to predict stock prices. He shared Mr.
Fama's skepticism about golden stock-pickers. The result is that over
the past four decades millions of investors who buy index funds from
Vanguard and its competitors have saved hundreds of billions of dollars
by not paying for dubious investment advice.
Mr. Fama, 74, is also skeptical of the word
"bubble," which suggests market inefficiency by letting stock prices
rise higher than justified by market fundamentals. In 2010, he told the
New Yorker magazine: "It's easy to say prices went down, it must have
been a bubble, after the fact. I think most bubbles are twenty-twenty
hindsight. . . . People are always saying that prices are too high. When
they turn out to be right, we anoint them. When they turn out to be
wrong we ignore them."
In the Milton Friedman University of Chicago
tradition, Mr. Fama believes that free markets are better than
government at allocating resources. He strongly opposed the 2008
selective bailout of Wall Street firms, arguing that, without it,
financial markets would have sorted themselves out within "a week or
two."
Robert Shiller's contribution to our
understanding of asset prices has included this insight: that stock
prices fluctuate more than can be explained by fluctuations in
dividends. The 67-year-old Mr. Shiller's finding in the 1980s set off a
revolution in finance. It is now accepted that high prices relative to
earnings signal low subsequent returns and vice-versa. This means, as
George Mason University economist Tyler Cowen has noted, that (contra
Mr. Fama) a very patient investor should be able to beat the market by
betting against short-term market movements. So, for example, if the
price has fallen more than can be explained by relatively steady
dividends, you should buy and hold.
Mr. Shiller's work has been particularly
notable for two reasons: his contribution to the Case-Shiller home price
index, which has been invaluable for those who want good data on home
prices both nationally and regionally; and his proposal that government
pensions and entitlements be "indexed to some indicator of taxpayer
ability to pay, such as GDP." Thus government payments for pensions and
entitlements such as Social Security and Medicare would be tethered to
the relative health of the nation's economy, and the government
wouldn't, as it does now, continue to spend itself ruinously into debt.
Mr. Shiller's young students—given that they're of the generation likely
to be surrendering more and more of their income to the government to
support its payments—should consider building a statue of him.
The third recipient of the Nobel economics
prize, Lars Peter Hansen, 60, earned it for the mathematical techniques
he developed that apply to stock prices and other economic models.
Here's how John H. Cochrane, a University of Chicago colleague of Mr.
Hansen's, put it to me in an interview: "Hansen managed to boil all the
complex statistical techniques used in understanding economic models to
just taking averages. His techniques allowed economists to study the
economy one piece at a time, and to focus on the robust, important
predictions of a model without being distracted by irrelevant
sideshows."
New research by professors at the University of
Bristol suggests that biologists may be avoiding scientific papers that
have extensive mathematical detail,
Times Higher Education reported.
The Bristol researchers studied the number of citations to 600
evolutionary biology papers published in 1998. They found that the most
"maths-heavy" papers were cited by others half as much as other papers.
Each additional math equation appears to reduce the odds of a paper
being cited. Tim Fawcett, a co-author of the paper, told Times Higher
Education, "I think this is potentially something that could be a
problem for all areas of science where there is a tight link between theoretical mathematical models and experiment."
The study, published in the Proceedings of the
National Academy of Sciences USA, suggests that scientists pay less
attention to theories that are dense with mathematical detail.
Researchers in Bristol’s School of Biological
Sciences compared citation data with the number of equations per page in
more than 600 evolutionary biology papers in 1998.
They found that most maths-heavy articles were
referenced 50 per cent less often than those with little or no maths.
Each additional equation per page reduced a paper’s citation success by
28 per cent.
The size of the effect was striking, Tim
Fawcett, research fellow and the paper’s co-author, told Times Higher
Education.
“I think this is potentially something that
could be a problem for all areas of science where there is a tight link
between theoretical mathematical models and experiment,” he said.
The research stemmed from a suspicion that
papers full of equations and technical detail could be putting off
researchers who do not necessarily have much mathematical training, said
Dr Fawcett.
“Even Steven Hawking worried that each equation
he added to A Brief History of Time would reduce sales. So this idea has
been out there for a while, but no one’s really looked at it until we
did this study,” he added.
Andrew Higginson, Dr Fawcett’s co-author and a
research associate in the School of Biological Sciences, said that
scientists need to think more carefully about how they present the
mathematical details of their work.
“The ideal solution is not to hide the maths
away, but to add more explanatory text to take the reader carefully
through the assumptions and implications of theory,” he said.
But the authors say they fear that this
approach will be resisted by some journals that favour concise papers
and where space is in short supply.
An alternative solution is to put much of the
mathematical details in an appendix, which tends to be published online.
“Our analysis seems to show that for equations
put in an appendix there isn’t such an effect,” said Dr Fawcett.
“But there’s a
big risk that in doing that you are potentially hiding the maths away,
so it's important to state clearly the assumptions and implications in
the main text for everyone to see.”
Although the issue is likely to extend beyond
evolutionary biology, it may not be such a problem in other branches of
science where students and researchers tend to be trained in maths to a
greater degree, he added.
Continued in article
Jensen Comment
The causes of this asserted avoidance are no doubt very complicated and vary
in among individual instances. Some biologists might avoid biology quant
papers because they themselves are not sufficiently quant to comprehend the
mathematics. It would seem, however, that even quant biology papers have
some non-mathematics summaries that might be of interest to the non-quant
biologists.
I would be inclined to believer that biologists avoid quant papers for
other reasons, especially some reasons that accounting teachers and
practitioners most often avoid accountics research studies (that are quant
by definition). I think the main reason for this avoidance is that biology
and academic quants typically do their research in
Plato's Cave with "convenient" assumptions that are too removed from
the real and much more complicated world. For example, the real world is
seldom in a state of equilibrium or a "steady state" needed to greatly
simplify the mathematical derivations.
The sad thing in all of this is the vast amount of accountics science
research over the past three decades that relied upon a CAPM Model that worked.
We will probably never learn about how this weakened much of many of the
findings in accountics science capital markets research.
An Older Paper from Nobel Laureate Bill Sharpe (Stanford)
"Today's fad is index funds
that track the Standard and Poor's 500. True, the average soundly
beat most stock funds over the past decade. But is this an eternal
truth or a transitory one?"
"In small stocks, especially, you're probably better off with an
active manager than buying the market."
"The case for passive management rests only on complex and
unrealistic theories of equilibrium in capital markets."
"Any graduate of the ___ Business School should be able to beat an
index fund over the course of a market cycle."
Statements such as these are made
with alarming frequency by investment professionals1.
In some cases, subtle and sophisticated reasoning may be involved. More
often (alas), the conclusions can only be justified by assuming that the
laws of arithmetic have been suspended for the convenience of those who
choose to pursue careers as active managers.
If "active" and "passive"
management styles are defined in sensible ways, it must be the
case that
(1) before costs, the return
on the average actively managed dollar will equal the return on the
average passively managed dollar and
(2) after costs, the return on
the average actively managed dollar will be less than the return on
the average passively managed dollar
These assertions will hold for
any time period. Moreover, they depend only on the laws of
addition, subtraction, multiplication and division. Nothing else is
required.
Of course, certain definitions of
the key terms are necessary. First a market must be selected --
the stocks in the S&P 500, for example, or a set of "small" stocks. Then
each investor who holds securities from the market must be classified as
either active or passive.
A passive investor
always holds every security from the market, with each represented
in the same manner as in the market. Thus if security X represents 3
per cent of the value of the securities in the market, a passive
investor's portfolio will have 3 per cent of its value invested in
X. Equivalently, a passive manager will hold the same percentage of
the total outstanding amount of each security in the market2.
An active investor is
one who is not passive. His or her portfolio will differ from that
of the passive managers at some or all times. Because active
managers usually act on perceptions of mispricing, and because such
misperceptions change relatively frequently, such managers tend to
trade fairly frequently -- hence the term "active."
Over any specified time period,
the market return will be a weighted average of the returns on
the securities within the market, using beginning market values as
weights3.
Each passive manager will obtain precisely the market return, before
costs4.
From this, it follows (as the night from the day) that the return on the
average actively managed dollar must equal the market return.
Why? Because the market return must equal a weighted average of the
returns on the passive and active segments of the market. If the first
two returns are the same, the third must be also.
This proves assertion number 1.
Note that only simple principles of arithmetic were used in the process.
To be sure, we have seriously belabored the obvious, but the ubiquity of
statements such as those quoted earlier suggests that such labor is not
in vain.
To prove assertion number 2, we
need only rely on the fact that the costs of actively managing a given
number of dollars will exceed those of passive management. Active
managers must pay for more research and must pay more for trading.
Security analysis (e.g. the graduates of prestigious business schools)
must eat, and so must brokers, traders, specialists and other
market-makers.
Because active and passive returns
are equal before cost, and because active managers bear greater costs,
it follows that the after-cost return from active management must
be lower than that from passive management.
This proves assertion number 2.
Once again, the proof is embarrassingly simple and uses only the most
rudimentary notions of simple arithmetic.
Enough (lower) mathematics. Let's
turn to the practical issues.
Why do sensible investment
professionals continue to make statements that seemingly fly in the face
of the simple and obvious relations we have described? How can presented
evidence show active managers beating "the market" or "the index" or
"passive managers"? Three reasons stand out5.
First, the passive managers in
question may not be truly passive (i.e., conform to our definition
of the term). Some index fund managers "sample" the market of
choice, rather than hold all the securities in market proportions.
Some may even charge high enough fees to bring their total costs to
equal or exceed those of active managers.
Second, active managers may
not fully represent the "non-passive" component of the market in
question. For example, the set of active managers may exclude some
active holders of securities within the market (e.g., individual
investors). Many empirical analyses consider only "professional" or
"institutional" active managers. It is, of course, possible for the
average professionally or institutionally actively managed dollar to
outperform the average passively managed dollar, after cost. For
this to take place, however, the non-institutional, individual
investors must be foolish enough to pay the added costs of the
institutions' active management via inferior performance. Another
example arises when the active managers hold securities from outside
the market in question. For example, returns on equity mutual funds
with cash holdings are often compared with returns on an all-equity
index or index fund. In such comparisons, the funds are generally
beaten badly by the index in up markets, but sometimes exceed index
performance in down markets. Yet another example arises when the set
of active mangers excludes those who have gone out of business
during the period in question. Because such managers are likely to
have experienced especially poor returns, the resulting
"survivorship bias" will tend to produce results that are better
than those obtained by the average actively managed dollar.
Third, and possibly most
important in practice, the summary statistics for active managers
may not truly represent the performance of the average actively
managed dollar. To compute the latter, each manager's
return should be weighted by the dollars he or she has under
management at the beginning of the period. Some comparisons use a
simple average of the performance of all managers (large and small);
others use the performance of the median active manager. While the
results of this kind of comparison are, in principle, unpredictable,
certain empirical regularities persist. Perhaps most important,
equity fund managers with smaller amounts of money tend to favor
stocks with smaller outstanding values. Thus, de facto, an
equally weighted average of active manager returns has a bias toward
smaller-capitalization stocks vis-a-vis the market as a whole. As a
result, the "average active manager" tends to be beaten badly in
periods when small-capitalization stocks underperform
large-capitalization stocks, but may exceed the market's performance
in periods when small-capitalization stocks do well. In both cases,
of course, the average actively managed dollar will
underperform the market, net of costs.
To repeat: Properly measured, the
average actively managed dollar must underperform the average passively
managed dollar, net of costs. Empirical analyses that appear to refute
this principle are guilty of improper measurement.
Continued in article
Bob Jensen's threads on the efficient capital market or lack thereof
as evidenced by so much research since 1991 ---
http://faculty.trinity.edu/rjensen/Theory01.htm#EMH
Bill shared the Nobel Prize for invention of the CAPM Model which in recent
years has been shown not to work.
"The
CAPM Debate and the Logic and Philosophy of Finance,"
by David Johnstone, Abacus, Volume 49, Issue Supplement S1, pages
1–6, January 2013 ---
http://onlinelibrary.wiley.com/doi/10.1111/j.1467-6281.2012.00378.x/full
Although most Abacus articles not free, this is a free editorial
download.
Finance, and particularly financial decision
making, has much in common with the discipline of statistics and
statistical decision theory. Both fields involve conceptual models and
related methods by which to make numerical assessments that are meant to
assist users to draw inferences about future states and to make choices
between possible actions. In both fields, inferences and decisions are
reached by implementing quantitative methods, and in both fields those
methods require either empirical or subjective inputs (e.g., sample
estimates of relevant input parameters or human estimates of the same
sorts of variables).1
This is not merely saying that finance theory
makes use of statistical theory. That is incidental, as is the fact that
statistics now adopts the language and ideas of finance in some of its
important applications. Rather, the point is that the two disciplines
are fundamentally analogous in their purposes and construction. They
differ markedly, however, in their states of philosophical
introspection, as is natural given that finance arose as a field only in
the 1960s or later, and has therefore had much less time to mature and
look back at itself and its development in a critical philosophical way.
A stark difference between the two fields is
that in statistics there exists a formalized branch of enquiry called
‘the logic, methodology and philosophy of statistical inference and
decision theory’, whereas in finance there is as yet no equivalent
well-defined or orchestrated subfield. The philosophy of statistics is a
highly developed discipline, built upon hundreds of papers and books,
written by statisticians, logicians, philosophers of science and
practitioners in applied fields (e.g., psychology, medicine, economics)
since the early 1900s. All of the great names in statistical theory,
including Karl Pearson, R. A. Fisher, Neyman, Savage, von Neumann and de
Finetti, have contributed philosophically as well as technically to the
field we know as statistics, and indeed virtually all of the empirical
work that is done in finance today is licensed by one or other of these
philosophers. Similarly, very influential modern statistical theorists
such as Lindley, Kadane, Bernardo, Seidenfeld and Berger have
contributed numerous papers and books to the big-picture philosophical
issues in statistics.
By comparison, the philosophy, logic and
methodology of finance are yet to expressly emerge, or to obtain the
overarching respect and influence that such work has in statistics. This
of itself is something for explanation from positivist and sociological
perspectives. In the early years of finance, there was a great deal of
such work published, but in later years the majority of published
research in finance has been predominantly descriptive or empirical
(data driven) rather than conceptual or philosophical. There are some
obvious practical reasons for this, such as for example the modern
availability of excellent unexplored data bases and fast inexpensive
computing. More fundamentally, however, there has been a cultural shift
away from critical philosophical analysis of financial logic and
financial methods within finance.
As one simple example, early generations of
students in finance spent much time trying to understand the NPV versus
IRR debate, and the mathematical explanations of how these techniques
can coincide or clash. Theoretical papers were written on this topic,
not just in finance but also in economics and engineering. By
comparison, current finance students are not asked to think about the
logical foundations of DCF analysis, and are mostly unaware of the
related debate and mathematical enquiry that once took centre stage. The
most that a modern finance student can be expected to know of the issue
is that undergraduate textbooks list some important problems of IRR and
conclude that NPV does not have the same troubles, and that essentially
the case is closed. Generally this superficial appreciation comes from
pre-scripted lecture slides rather than from any individual research or
thought on the issue. Most textbooks give no academic references to the
related historical literature and no inkling of how subtle matters of
interpretation of NPV and IRR can be.
Research students might once have discovered
such issues for themselves, through curiosity and unstructured
background reading, but the modern way of PhD research is much narrower
and usually involves a substantial commitment of time and thought to
learning statistical techniques, and how to implement them using
different software packages, and to cleaning, merging and reconstructing
large data files. There is obviously less time and appetite for
philosophical critique, out of which potential research outcomes are no
doubt less ‘safe’ than those from a well-conceived empirical
investigation.
. . .
The issue nearly 50 years after its invention
is where finance stands on the CAPM. The papers published in this issue
contain the unedited positions on the CAPM of well-known finance
researchers. They are reactions to the main paper of Dempsey, who adopts
a critical and therefore provocative standpoint. Consistent with the
sentiments expressed above, it is my belief that the free and frank
academic discussion provoked by Dempsey's paper is not only essential to
a mature field but is also of great academic and communal enjoyment.
Those who have provided comments on Dempsey's paper did so willingly and
apparently with the thought that it would be worthwhile to put in print
some ideas and opinions that are usually reserved for informal or
unguarded tearoom conversations.
By chance, this issue of Abacus on the status
of the CAPM coincides with the publication of a wonderful book on the
same subject, written by one of the founders of the field. This book by
Haim Levy (2012) titled The Capital Asset Pricing Model in the 21st
Century covers much of the history and debate over the CAPM and its
theoretical, empirical and practical validity. Readers will likely be
interested in how the arguments advanced by Dempsey and others in this
issue of Abacus compare with the position taken by Levy. There is in
fact a great deal of reinforcement between Levy and some of the
commentators. Levy's essential conclusion is that the CAPM stands, in
his words, ‘alive and well’. This is for philosophical reasons,
including particularly that the CAPM is a model of ex ante decision
making and hence does not need to be, and cannot be expected to be,
mirrored neatly by historical data. Levy's faith in the CAPM is also for
practical reasons, particularly for the close approximation with which
it mimics ex ante optimal investment, and the returns thereof, over a
wide class of utility functions.
I conclude this introduction to Dempsey and
others on the topic of the CAPM in the twenty-first century with the
spur that only when we openly discuss what is inadequate or questionable
with our own theories can we lay claim to scientific ‘objectivity’.
Technical or empirical positions adopted routinely, untempered by
philosophical scepticism or appreciation, can prove greatly inadequate,
misleading and ultimately costly to users and to the scientific
reputation of the field, even when used for strictly practical purposes
(such as choosing investments).
Finance as a field embodies more than
sufficient theoretical substance to warrant its own subfield in
philosophy—the logic and philosophy of finance. By nature, philosophical
critique is normative, so any aversion in principle to normative
research needs to be overcome. I began this introduction with the claim
that finance and statistics are like twins. Note, however, that
published research in statistics is predominantly normative (e.g., Bayes
versus non-Bayes, etc.) whereas most finance research is largely
empirical. If we look more closely, however, empirical finance, which is
sometimes championed as ‘positive’ and ‘anti-normative’, is replete with
normative discussion about matters such as how to construct an
experiment or a statistical test, or how to define a key measure such as
the cost of capital. There should therefore be no in-principle
resistance to the reinvigoration of normative or philosophical thought
concerning finance theory proper.
Footnotes
1 For example, applications in finance of portfolio theory and the CAPM
require an ex ante joint probability distribution of the future returns
on all firms in the market. That distribution is usually estimated
empirically but is in principle a subjective probability distribution.
2 ‘There is no inevitable connection between the
validity of the expected utility maxim and the validity of portfolio
analysis based on, say, expected return and variance’ (Markowitz, 1959,
p. 209).
The model assumes that the variance of returns is an adequate
measurement of risk. This would be implied by the assumption that
returns are normally distributed, or indeed are distributed in any
two-parameter way, but for general return distributions other risk
measures (like
coherent risk measures) will reflect the active and potential
shareholders' preferences more adequately. Indeed risk in financial
investments is not variance in itself, rather it is the probability of
losing: it is asymmetric in nature.
Barclays Wealth have published some research on asset allocation
with non-normal returns which shows that investors with very low risk
tolerances should hold more cash than CAPM suggests.[7]
The model assumes that all active and potential shareholders have
access to the same information and agree about the risk and expected
return of all assets (homogeneous expectations assumption).[citation
needed]
The model assumes that the probability beliefs of active and
potential shareholders match the true distribution of returns. A
different possibility is that active and potential shareholders'
expectations are biased, causing market prices to be informationally
inefficient. This possibility is studied in the field of
behavioral finance, which uses psychological assumptions to provide
alternatives to the CAPM such as the overconfidence-based asset pricing
model of Kent Daniel,
David Hirshleifer, and Avanidhar Subrahmanyam (2001).[8]
The model does not appear to adequately explain the variation in
stock returns. Empirical studies show that low beta stocks may offer
higher returns than the model would predict. Some data to this effect
was presented as early as a 1969 conference in
Buffalo, New York in a paper by
Fischer Black,
Michael Jensen, and
Myron Scholes. Either that fact is itself rational (which saves the
efficient-market hypothesis but makes CAPM wrong), or it is
irrational (which saves CAPM, but makes the EMH wrong – indeed, this
possibility makes
volatility arbitrage a strategy for reliably beating the market).[citation
needed]
The model assumes that given a certain expected return, active and
potential shareholders will prefer lower risk (lower variance) to higher
risk and conversely given a certain level of risk will prefer higher
returns to lower ones. It does not allow for active and potential
shareholders who will accept lower returns for higher risk.
Casino gamblers pay to take on more risk, and it is possible that
some stock traders will pay for risk as well.[citation
needed]
The model assumes that there are no taxes or transaction costs,
although this assumption may be relaxed with more complicated versions
of the model.[citation
needed]
The market portfolio consists of all assets in all markets, where
each asset is weighted by its market capitalization. This assumes no
preference between markets and assets for individual active and
potential shareholders, and that active and potential shareholders
choose assets solely as a function of their risk-return profile. It also
assumes that all assets are infinitely divisible as to the amount which
may be held or transacted.[citation
needed]
The market portfolio should in theory include all types of assets
that are held by anyone as an investment (including works of art, real
estate, human capital...) In practice, such a market portfolio is
unobservable and people usually substitute a stock index as a proxy for
the true market portfolio. Unfortunately, it has been shown that this
substitution is not innocuous and can lead to false inferences as to the
validity of the CAPM, and it has been said that due to the
inobservability of the true market portfolio, the CAPM might not be
empirically testable. This was presented in greater depth in a paper by
Richard Roll in 1977, and is generally referred to as
Roll's critique.[9]
The model assumes economic agents optimise over a short-term
horizon, and in fact investors with longer-term outlooks would optimally
choose long-term inflation-linked bonds instead of short-term rates as
this would be more risk-free asset to such an agent.[10][11]
The model assumes just two dates, so that there is no opportunity to
consume and rebalance portfolios repeatedly over time. The basic
insights of the model are extended and generalized in the
intertemporal CAPM (ICAPM) of Robert Merton,
[12]
and the
consumption CAPM (CCAPM) of Douglas Breeden and Mark Rubinstein.[13]
CAPM assumes that all active and potential shareholders will
consider all of their assets and optimize one portfolio. This is in
sharp contradiction with portfolios that are held by individual
shareholders: humans tend to have fragmented portfolios or, rather,
multiple portfolios: for each goal one portfolio — see
behavioral portfolio theory[14]
and
Maslowian Portfolio Theory.[15]
Empirical tests show market anomalies like the size and value effect
that cannot be explained by the CAPM.[16]
For details see the
Fama–French three-factor model.[17]
Alternative to CAPM: Dual-Beta
Dual-beta model differentiates
downside beta from
upside beta. The difference between CAPM and dual-beta model is that the
CAPM assumes that upside and downside betas are the same while the dual-beta
model does not. Since this assumption is rarely accurate, the dual-beta
model is considered to provide better information for investors.[2]
Jensen Comment
My own threads on how the CAPM has been misleading for much of accountics
research are at
http://faculty.trinity.edu/rjensen/theory01.htm#AccentuateTheObvious
Be patient, this document is very slow to load at the second stage (#AccentTheObvious)due
to the immense size of the document.
You have to scroll down quite a ways for the CAPM tidbits.
Two tidbits of particular interest are as follows:
For example, in the figures below I’ve plotted
the Fama-French 25 (portfolios ranked on size and book-to-market)
against beta.
In the first figure, I plot the average excess
return to the FF 25 against the average excess return one would expect,
given beta.
If you’d like to see how I calculated the
charts above, please reference the excel file
here.
Given such a poor track record, is
anyone still using the CAPM?
Lot’s of people, apparently…
Welch (2008) finds that ~75% of professors
recommend the use of the model when estimating the cost of capital, and
Graham and Harvey (2001) find that ~74% of
CFOs use the CAPM in their work.
A few quotes from Graham and Harvey 2001 sum up
common sentiment regarding the CAPM:
“While the CAPM is popular, we show later
that it is not clear that the model is applied properly in practice.
Of course, even if it is applied properly, it is not clear that the
CAPM is a very good model [see Fama and French (1992)].
“…practitioners might not apply the CAPM or
NPV rule correctly. It is also interesting that CFOs pay very little
attentionto risk factors based on momentum and
book-to-market-value.”
Of course, there are lots of arguments to
consider before throwing out the CAPM. Here are a few:
Everyone learns about it and knows how to
use it (although, Graham and Harvey suggest that many practitioners
don’t even apply the CAPM theory correctly)
Data is easy to obtain on betas.
Roll’s critique–maybe the CAPM isn’t a
junk theory, rather, the empirical tests showing the CAPM doesn’t
work are bogus.
Regardless, being that this blog is dedicated
to empirical data and evidence, and not about ‘mentally masturbating
about theoretical finance models,’ we’ll operate under the assumption
that the CAPM is dead until new data comes available.
The Fama French Alternative?
Given the CAPM doesn’t work that well in
practice, perhaps we should look into the Fama French model (which isn’t
perfect or cutting edge, but a solid workhorse nonetheless). And while
the FF model inputs are highly controversial, one thing is clear: the FF
3-factor model does a great job explaining the variability of returns.
For example, according to
Fama French 1993, the 3-factor model explains
over 90% of the variability in returns, whereas the CAPM can only
explain ~70%!
The 3-factor model is great, but how the
heck does one estimate the FF factors?
Dartmouth Professor Ken French comes in for the
rescue!
Abstract:
We
investigate the relation between various alternative risk measures and
future daily returns using a sample of firms over the 1988-2009 time
period. Previous research indicates that returns are not normally
distributed and that investors seem to care more about downside risk
than total risk. Motivated by these findings and the lack of research on
upside risk, we model the relation between future returns and risk
measures and investigate the following questions: Are investors
compensated for total risk? Is the compensation for downside risk
different than the compensation for upside risk? and which measure of
risk (i.e., upside, downside, or total) is most important to investors?
We find that, although investors seem to be compensated for total risk,
measures of downside risk, such as the lower partial moment, better
explain future returns. Further, when downside and upside risk are
modeled simultaneously, investors seem to care only about downside risk.
Our findings are robust to the addition of control variables, including
prior returns, size, book-to-market ratio of equity (B/M), and leverage.
We also find evidence of short-run mean reversals in daily returns. Our
findings are important because we document a positive risk-return
relationship, using both total and downside risk measures; however, we
find that investors are concerned more with downside risk than total
risk.
An alternative to CAPM theory is Arbitrage Pricing Theory. My long
critique of APT was rejected by the Journal of Finance. The Editor
said if he did not understand it nobody else would probably understand it.
In retrospect is should have been rejected because it was poorly written ---
http://faculty.trinity.edu/rjensen/default4.htm#BigOnes
The sad thing in all of this is the vast amount of accountics science
research over the past three decades that relied upon a CAPM Model that
worked. We will probably never learn about how this weakened much of many of
the findings in accountics science capital markets research.
Jensen Comment
The same applies to not over-relying on historical data in valuation. My
favorite case study that I used for this in teaching is the following:
Questrom vs. Federated Department
Stores, Inc.: A Question of Equity Value," by University of Alabama faculty
members by Gary Taylor, William Sampson, and Benton Gup, May 2001
edition of Issues in Accounting Education ---
http://faculty.trinity.edu/rjensen/roi.htm
Jensen Comment
I want to especially thank
David Stout, Editor of the May 2001
edition of Issues in Accounting Education. There has been
something special in all the editions edited by David, but the May
edition is very special to me. All the articles in that edition are
helpful, but I want to call attention to three articles that I will use
intently in my graduate Accounting Theory course.
"Questrom vs. Federated
Department Stores, Inc.: A Question of Equity Value," by University
of Alabama faculty members Gary Taylor, William Sampson, and
Benton Gup, pp. 223-256.
This is perhaps the best short case that I've ever read. It will
undoubtedly help my students better understand weighted average cost
of capital, free cash flow valuation, and the residual income
model. The three student handouts are outstanding. Bravo to
Taylor, Sampson, and Gup.
"Using the Residual-Income
Stock Price Valuation Model to Teach and Learn Ratio Analysis," by
Robert Halsey, pp. 257-276.
What a follow-up case to the Questrom case mentioned above! I have
long used the Dupont Formula in courses and nearly always use the
excellent paper entitled "Disaggregating the ROE:
A New Approach," by T.I. Selling and C.P.
Stickney,Accounting Horizons, December 1990,
pp. 9-17. Halsey's paper guides students through the swamp of stock
price valuation using the residual income model (which by the way is
one of the few academic accounting models that has had a major
impact on accounting practice, especially consulting practice in
equity valuation by CPA firms).
"Developing Risk Skills:
An Investigation of Business Risks and Controls at Prudential
Insurance Company of America," by Paul Walker, Bill Shenkir, and
Stephen Hunn, pp. 291
I will use this case to vividly illustrate the "tone-at-the-top"
importance of business ethics and risk analysis. This is case is
easy to read and highly informative.
Does low inflation justify higher valuation
multiples? There are many valuation models for stocks. They mostly don’t
work very well, or at least not consistently well. Over the years, I’ve
come to conclude that valuation, like beauty, is in the eye of the
beholder.
For many investors, stocks look increasingly
attractive the lower that inflation and interest rates go. However, when
they go too low, that suggests that the economy is weak, which wouldn’t
be good for profits. Widespread deflation would almost certainly be bad
for profits. It would also pose a risk to corporations with lots of
debt, even if they could refinance it at lower interest rates. Let’s
review some of the current valuation metrics, which we monitor in our Stock
Market Valuation Metrics & Models:
(1) Reversion to the mean. On Tuesday,
the forward P/E of the S&P 500 was 16.1. That’s above its historical
average of 13.7 since 1978.
(2) Rule of 20. One rule of thumb is that the forward P/E of
the S&P 500 should be close to 20 minus the y/y CPI inflation rate. On
this basis, the rule’s P/E was 18.3 during October.
(3) Misery Index. There has been an inverse relationship
between the S&P 500’s forward P/E and the Misery Index, which is just
the sum of the inflation rate and the unemployment rate. The index fell
to 7.4% during October. That’s the lowest reading since April 2008, and
arguably justifies the market’s current lofty multiple.
(4) Market-cap ratios. The ratio of the S&P 500 market cap to
revenues rose to 1.7 during Q3, the highest since Q1-2002. That’s
identical to the reading for the ratio of the market cap of all US
equities to nominal GDP.
Today's Morning Briefing: Inflating
Inflation. (1) Dudley expects Fed to hit inflation target next
year. (2) It all depends on resource utilization. (3) What if
demand-side models are flawed? (4) Supply-side models explain
persistence of deflationary pressures. (5) Inflationary expectations
falling in TIPS market. (6) Bond market has gone global. (7) Valuation
and beauty contests. (8) Rule of 20 says stocks still cheap. (9) Other
valuation models find no bargains. (10) Cheaper stocks abroad, but for
lots of good reasons. (11) US economy humming along. (More
for subscribers.)
Jensen Comment
The Accountics Science stock valuation models we teach our students are
almost worthless because they only deal with the accounting data that is
booked into the ledgers. Often the most important data affecting values are
not booked into ledgers such as value of a firm's human resources and R&D
and intangibles that we don't know how to measure.
For example, accountics scientists love to teach
weighted average cost of capital, free
cash flow valuation, and the residual income valuation. These can be highly
misleading as illustrated in the following terrific real-world case:
"Questrom vs. Federated
Department Stores, Inc.: A Question of Equity Value," by University of
Alabama faculty members Gary Taylor, William Sampson, and Benton Gup,
pp. 223-256.
This is perhaps the best short case that I've ever read. It will
undoubtedly help my students better understand weighted average cost of
capital, free cash flow valuation, and the residual income model. The
three student handouts are outstanding. Bravo to Taylor, Sampson, and
Gup.
Jensen Comment
Problems of appraisal professionalism include the following:
Assets and liabilities are
so specialized in terms of valuation estimation. Appraisals of debentures is
quite unlike appraisals of commodities. Appraisals of options is quite
unlike appraisals of interest rate swaps. Appraisals of housing development
real estate is quite unlike appraisals cattle or even land having oil and
mineral reserves.
There is notorious
subjectivity in most appraisal tasks, especially subjectivity built upon
widely varying assumptions.
Assets and liabilities are
often very unique even within a given classification. For example, the
estimating value of development property ofExit 132 of an interstate highway
may be totally unlike estimating the value of development property off Exits
131 .133, and 167. Estimation of a McDonald's debenture may be quite unlike
estimating an Intel debenture.
The appraisal professions
vary widely as to fraud history and barriers to entry (e.g., certification
examinations), experience requirements, and notorious histories of fraud.
For example, most real estate bubbles and recoveries bring out the worst in
terms of real estate appraisals of loan values of homes and businesses. The
bottom line is that the appraisal professions are not as respected as the
professions of accounting, law, and medicine. Yeah even law!
The same appraisal firm
gave me widely varying estimates of my home based upon the purpose of the
appraisal. The appraisal when I wanted to take out a mortgage was much
higher than the subsequent appraisal when I wanted to lower my property
taxes. The appraisal firm aimed to please me. Go figure!
Abstract:
Auditors frequently rely on valuation specialists in audits of fair values
to help them improve audit quality in this challenging area. However,
auditing standards provide inadequate guidance in this setting, and problems
related to specialists’ involvement suggest specialists do not always
improve audit quality. This study examines how auditors use valuation
specialists in auditing fair values and how specialists’ involvement affects
audit quality. I interviewed 28 audit partners and managers with extensive
experience using valuation specialists and analyzed the interviews from the
perspective of Giddens’ (1990, 1991) theory of trust in expert systems. I
find that while valuation specialists perform many of the most difficult and
important elements of auditing fair values, auditors retain the final
responsibility for making overall conclusions about fair values. This
situation causes tension for auditors who bear responsibility for the final
conclusions about fair values, yet who must rely on the expertise of
valuation specialists to make their final judgments. Consistent with this
tension, auditors tend to make specialists’ work conform to the audit team’s
prevailing view. This puts audit quality at risk. Additional threats to
audit quality arise from the division of labor between auditors and
valuation specialists because auditors, though ultimately responsible for
audit judgments, must rely on work done by valuation specialists that they
cannot understand or review in the depth that they review other audit work
papers. This study informs future research addressing problems related to
auditors’ use of valuation specialists, an area in which problems have
already been identified by the PCAOB and prior research.
Jensen Comment 1
One of the problems is that some types of valuation may rely upon the same
defective databases no matter whether they are used by employees of audit firms
or outsourced valuation specialists hired by audit firms.Exhibit A is that
virtually all valuation experts of interest rate swaps and forward contracts
using the LIBOR underlying were relying upon LIBOR yeild curves in the Bloomberg
or Reuters database terminals that were using LIBOR rates manipulated
fraudulently by the large banks like Barclays ---
http://en.wikipedia.org/wiki/Libor
On 28 February 2012, it was revealed that the U.S.
Department of Justice was conducting a criminal investigation into Libor
abuse.[49] Among the abuses being investigated were the possibility that
traders were in direct communication with bankers before the rates were set,
thus allowing them an advantage in predicting that day's fixing. Libor
underpins approximately $350 trillion in derivatives. One trader's messages
indicated that for each basis point (0.01%) that Libor was moved, those
involved could net "about a couple of million dollars".[50]
On 27 June 2012, Barclays Bank was fined $200m by
the Commodity Futures Trading Commission,[7] $160m by the United States
Department of Justice[8] and £59.5m by the Financial Services Authority[9]
for attempted manipulation of the Libor and Euribor rates.[51] The United
States Department of Justice and Barclays officially agreed that "the
manipulation of the submissions affected the fixed rates on some
occasions".[52][53] On 2 July 2012, Marcus Agius, chairman of Barclays,
resigned from the position following the interest rate rigging scandal.[54]
Bob Diamond, the chief executive officer of Barclays, resigned on 3 July
2012. Marcus Agius will fill his post until a replacement is found.[55][56]
Jerry del Missier, Chief Operating Officer of Barclays, also resigned, as a
casualty of the scandal. Del Missier subsequently admitted that he had
instructed his subordinates to submit falsified LIBORs to the British
Bankers Association.[57]
By 4 July 2012 the breadth of the scandal was
evident and became the topic of analysis on news and financial programs that
attempted to explain the importance of the scandal.[58] On 6 July, it was
announced that the U.K. Serious Fraud Office had also opened a criminal
investigation into the attempted manipulation of interest rates.[59]
On 4 October 2012, Republican U.S. Senators Chuck
Grassley and Mark Kirk announced that they were investigating Treasury
Secretary Tim Geithner for complicity with the rate manipulation scandal.
They accused Geithner of knowledge of the rate-fixing, and inaction which
contributed to litigation that "threatens to clog our courts with
multi-billion dollar class action lawsuits" alleging that the manipulated
rates harmed state, municipal and local governments. The senators said that
an American-based interest rate index is a better alternative which they
would take steps towards creating.[60] Aftermath
Early estimates are that the rate manipulation
scandal cost U.S. states, counties, and local governments at least $6
billion in fraudulent interest payments, above $4 billion that state and
local governments have already had to spend to unwind their positions
exposed to rate manipulation.[61] An increasingly smaller set of banks are
participating in setting the LIBOR, calling into question its future as a
benchmark standard, but without any viable alternative to replace
Jensen Comment 2
FAS 133 and IAS 39 ushered in national and international requirements to book
derivative contracts at fair values and adjust those values to "market" at least
every 90 days. However, those "markets" are replete with market manipulation
scandals that corrupt the databases used by valuation experts---
http://faculty.trinity.edu/rjensen/FraudRotten.htm#DerivativesFrauds
JUSTIN FOX, The Myth of the Rational Market: A History of Risk,
Reward, and Delusion on Wall Street (New York, NY: HarperCollins
Publishers, 2009/11 (paper), ISBN 978-0-06-059903-4 (paper), pp. xvi,
390).
The Accounting Review, Vol. 88, No. 3, May 2013, pp. 1129-1131
. . .
The ideas of finance academics taking hold on
Wall Street is a remarkable story. Some examples are the acceptance of
portfolio theory, asset pricing models, the rise of the index fund, the
need to systematically collect data to test theories, and the
massive rise of derivative trading due to option pricing models
developed by Black and Scholes, and Merton and Roll. Such success is
also tempered by examples such as the failure of portfolio insurance to
hedge stock market risk and the fallout from Long Term Capital
Management's inability to cover its positions. Jensen's influential work
on theory of the firm is also presented as extending market
discipline to the firm.
Fama and Jensen will feature throughout the
remainder of the book, but the later chapters will focus on the rise of
behavioral finance and insights that challenge the EMH. For example,
Richard Thaler's work on challenging the notion of efficient markets and
rational choice models is followed by Chapter 11, titled “Bob Shiller
Points Out the Most Remarkable Error,” which refers to Shiller's famous
quotation arguing that observing no patterns in stock prices is not the
same as stock prices being right. The response to such challenges is
portrayed as one where the EMH definition shifts due to
counter-arguments being made. In addition, some previous supporters
concede that market anomalies do exist, and this is accompanied by the
rise of work such as Andrei Shleifer's “noise traders” research. There
is now a significant body of literature that highlights that individuals
do not always behave rationally. That does not mean one can exploit this
behavior consistently—particularly if you are a large investor.
Toward the end of the book, Fox crafts a debate
between Fama and Dick Thaler, and Fox makes it clear that the ground has
shifted. However, those who are preaching the demise of the EMH perhaps
do not understand that, while the prices may not always be “right,” the
recommendation to buy an index fund is still good advice, as “markets
are hard to beat” and still harder if you pay someone to manage your
portfolio (p. 306). Furthermore, Markowitz's diversification principle
holds, and “[s]tock prices contain lots of information” (p. 307).
Understanding the powerful forces that make
current prices hard to exploit consistently is one key lesson. On the
other hand, understanding when prices can be manipulated is equally
important. The collapse of financial markets requires us to consider
what went wrong. We should not assume ….
The book encourages the reader to not only
acknowledge the genuine benefits afforded by theoretical advances in
finance, but also to understand the limitations to theory.
Fox is able to provide compelling evidence of
the developments and shortcomings of the past, moralize about the issue,
and conclude that, despite much progress, we have much more to learn.
Is Fox blaming the EMH for the financial
crisis? He gives enough hints for others to draw that conclusion. In
spite of this, this remains a book that provides a balanced discussion.
For example, he acknowledges that stock and bond prices do convey
information, are hard to beat, and that many in Wall Street never
accepted the EMH. He also outlines Shiller's repeated warnings of
irrational exuberance and that by definition the EMH could not predict
such an event (prices are random). Academics have also long acknowledged
that the EMH is a theoretical concept; otherwise, incentives to analyze
information would not exist.
So, while Justin Fox's book is fair, balanced,
insightful, and highlights the need to continue to understand why
markets may or may not be efficient, I found some of the commentary
around the book were more critical of the EMH.1
It is as if the critics believe the proposed
theory was accepted beyond question. Post-earnings drift is shown in
Ball and Brown's 1968 paper. Agency and positive accounting theory
highlight the role of incentives, information processing costs, and
moral hazard. Active investors never believed in the EMH, and lessons
from behavioral finance have been well debated.
So why does the message create such
controversy, and are we doing enough as educators to ensure that the
complexity of the issues is communicated? Part of the problem may be the
need to search for a scapegoat, but are we ensuring that investors fully
understand issues such as the paradox of the market, or why some markets
are efficient and others are not?
Textbooks in accounting and finance tend to
have simplistic discussions of the topic, with the evidence
concentrating on the U.S. stock market. It is relatively easy to
understand the concept but much harder to appreciate the complexity of
the issue. Have we let loose a generation of undergraduates who are
inadequately trained, and who end up either treating the EMH as a piece
of magic or simply rejecting the whole concept without the ability to
explain why?
Consider those who accept market efficiency on
faith. While they may be price-protected in a well-traded market, they
will be more exposed in illiquid markets and out of their depth in a
market where price setters can exist.
Perhaps the more dangerous groups are those who
do not understand why markets can be difficult to beat and are
ill-informed about the evidence and counter-evidence. Fox concludes that
“while mindless conformism was characteristic of financial bubbles and
panics long before there were finance professors, fostering even more of
it has been the gravest sin of modern finance” (p. 328).
I think this book will challenge readers to
better understand how some of the key developments in finance have
evolved—the characters involved, the contradictions that occurred, and
the maturing of thought, so that the difficult issues surrounding
finance can continue to receive the attention that they deserve. Fox
allows the characters to come alive, and he shows their willingness to
be challenged by new ideas and evidence. Finance is not perfect, but Fox
also makes sure that we know of the contribution that finance has made
in better managing and pricing risk.
Reviewer
David Lont
Professor of Accounting
University of Otago
Jensen Comment
One of the more distressing parts of this interview is the discussion of the
holy grail of accountics research --- the CAPM that accountics scientists
continue to plug into their models without challenge.
Stocks are still the best investment for the
long run. But maybe not for your long run. Justin Fox, "Are Stocks Still Good for the Long Run?" Time
Magazine, June 15, 2009 ---
http://www.time.com/time/magazine/article/0,9171,1902843-2,00.html
Also see Jim Mahar's June 10, 2009 summary at
http://financeprofessorblog.blogspot.com/
In particular this references a study by Arnott that asserts that over the
past 40 years the stock market underperformed the bond market. In my
opinion, if you into bonds for the next 40 years they'd better be
inflation-indexed bonds such as Treasury TIPs.
For much of the last 25 years, most of the
investment management world has promoted the idea that individual
investors can't beat the market. To beat the market, stock pickers of
course have to discover mispricings in stocks, but the Nobel-acclaimed
Efficient Market Hypothesis (EMH) claims that
the market is a ruthless mechanism acting instantly to arbitrage away
any such opportunities, claiming that the current price of a stock is
always the most accurate estimate of its value (known as
"informational efficiency"). If this is true, what hope can there be for
motivated stock pickers, no matter how much they sweat and toil, vs.
low-cost index funds that simply mechanically track the market? As it
turns out, there's plenty!
The (absurd) rise of the Efficient
Market Hypothesis
First proposed in University of Chicago
professor Eugene Fama’s 1970 paper
Efficient Capital Markets: A Review of Theory and Empirical Work,
EMH has evolved into a concept that a stock price
reflects all available information in the market, making it impossible
to have an edge. There are no undervalued stocks, it is argued, because
there are smart security analysts who utilize all available information
to ensure unfailingly appropriate prices. Investors who seem to beat the
market year after year are just lucky.
However, despite still being widely taught in
business schools, it is increasingly clear that the efficient market
hypothesis is "one of the most remarkable errors in the history of
economic thought" (Shiller). As Warren Buffett famously quipped, "I'd be
a bum on the street with a tin cup if the market was always efficient."
Similarly, ex-Fidelity fund manager and
investment legend
Peter Lynch said in a 1995 interview with
Fortune magazine: “Efficient markets? That’s a bunch of junk, crazy
stuff.”
So what's so bogus about EMH?
Firstly, EMH is based on a set of absurd
assumptions about the behaviour of market participants that goes
something like this:
Investors can trade stocks freely in any
size, with no transaction costs;
Everyone has access to the same
information;
Investors always behave rationally;
All investors share the same goals and the
same understanding of intrinsic value.
All of these assumptions are clearly
nonsensical the more you think about them but, in particular, studies in
behavioural finance initiated by Kahneman, Tversky and Thaler has shown
that the premise of shared investor rationality is a seriously flawed
and misleading one.
Secondly, EMH makes predictions that do not
accord with the reality. Both the Tech Bubble and the Credit
Bubble/Crunch show that that the market is subject to fads, whims and
periods of irrational exuberance (and despair) which can not be
explained away as rational. Furthermore, contrary to the predictions of
EMH, there have been plenty of individuals who have managed to
outperform the market consistently over the decades.
Bob, et al,
I never cease to marvel at the powers of rationalization defenders of
sacred institutions can muster. The above characterization of EMH was
certainly not the version pedaled by its accounting disciples (notably
Bill Beaver) back in the late 60s and early 70s. An accounting research
industry was created based on a version of EMH that was decidedly more
certain that securities were "properly priced." [Why else do studies to
debunk the Briloff effect?].
Given the interpretation offered above,
"Information Content Studies" make no sense. The whole idea of this
methodology was that accounting data that correlated with prices implied
market participants found it useful for setting prices based on publicly
available data, which implied such prices were the ones that would exist
in an idealized world of perfectly informed investors. Thus, this data
met the test of being information and was to be preferred to other
"non-information" to which the market did not react.
But now we are told that this latest version of
EMH does not justify such sanguinity because "...the prices in the
market are mostly wrong...", thus prices are not an indicator of the
value of data, i.e., just because there is a price effect we still don't
know if that data is truly "information." Think of the millions and
millions of taxpayer dollars that have been wasted over the last forty
years subsidizing people to search for something that is indeterminate
given the methodology they are employing.
And for this the AAA awarded Seminal
Contributions. Jim Boatsman had an ingenious little paper in Abacus eons
ago titled, "Why Are There Tigers and Things," that cast serious doubts
on the whole enterprise of "testing" market efficiency. It addressed the
issue Carl Devine harped on about needing an independent definition of
"information." And this is related to the logical slight of hand EMH
required of surmising there is a way to know what the "true" price is
since we glibly talk about over and under and mis-priced securities.
But there is no way to know this, since
security prices are CREATED by the institution of the securities market.
There does not exist a natural process against which market performance
can be compared. "Market value," which is what a price is, is a value
established by the market. The market is all there is. To paraphrase
NC's current governor's favorite expression, "The price is what it is."
It isn't over or under or mis or proper or
anything else, other than what a particular institution created by us at
one moment in time determines it is. If we lived in a society in which
mob rule settled issues of justice, it would make little sense to argue
that someone the mob hung was "not guilty." Of course he was guilty,
because the mob hung him!!
In the great book Dear Mr. Buffett, Janet Tavakoli shows how
Warren Buffet learned value (fundamentals) investing while taking Benjamin
Graham's value investing course while earning a masters degree in economics
from Columbia University. Buffet also worked for Professor Graham.
The following book supposedly takes the Graham approach to a new level
(although I've not yet read the book). Certainly the book will be
controversial among the efficient markets proponents like Professors Fama
and French.
Given that its the Berkshire annual meeting
this weekend, now is as good a time to roll out these quotes from Warren
himself:
“To invest successfully, you need not
understand beta, efficient markets, modern portfolio theory, option
pricing or emerging markets. You may, in fact, be better off knowing
nothing of these. That, of course, is not the prevailing view at most
business schools, whose finance curriculum tends to be dominated by such
subjects. In our view, though, investment students need only two
well-taught courses
-How to Value a Business, and How to Think About Market Prices.”
Source: Chairman’s Letter, 1996
“The best thing that happens to us is when a
great company gets into temporary trouble…We want to buy them when
they’re on the operating table.”
Source: Businessweek, 1999
“None of this means, however, that a business
or stock is an intelligent purchase simply because it is unpopular; a
contrarian approach is just as foolish as a follow-the-crowd strategy.
What’s required is thinking rather than polling. Unfortunately, Bertrand
Russell’s observation about life in general applies with unusual force
in the financial world: “Most men would rather die than think. Many do.”
Source: Chairman’s Letter, 1990
“Over the long term, the stock market news will
be good. In the 20th century, the United States endured two world wars
and other traumatic and expensive military conflicts; the Depression; a
dozen or so recessions and financial panics; oil shocks; a flu epidemic;
and the resignation of a disgraced president. Yet the Dow rose from 66
to 11,497.”
Source: The New York Times, October 16, 2008
“The line separating investment and
speculation, which is never bright and clear, becomes blurred still
further when most market participants have recently enjoyed triumphs.
Nothing sedates rationality like large doses of effortless money. After
a heady experience of that kind, normally sensible people drift into
behavior akin to that of Cinderella at the ball. They know that
overstaying the festivities ¾ that is, continuing to speculate in
companies that have gigantic valuations relative to the cash they are
likely to generate in the future ¾ will eventually bring on pumpkins and
mice. But they nevertheless hate to miss a single minute of what is one
helluva party. Therefore, the giddy participants all plan to leave just
seconds before midnight. There’s a problem, though: They are dancing in
a room in which the clocks have no hands.”
Source: Letter to shareholders, 2000
“You don’t need to be a rocket scientist.
Investing is not a game where the guy with the 160 IQ beats the guy with
130 IQ.”
Source: Warren Buffet Speaks, via msnbc.msn
Fundamentals Approach to Valuing a Business
In the great book Dear Mr. Buffett, Janet Tavakoli shows how
Warren Buffet learned value (fundamentals) investing while taking Benjamin
Graham's value investing course while earning a masters degree in economics
from Columbia University. Buffet also worked for Professor Graham.
The following book supposedly takes the Graham approach to a new level
(although I've not yet read the book). Certainly the book will be
controversial among the efficient markets proponents like Professors Fama
and French.
Purportedly a Great, Great Book on Value Investing From Simoleon Sense, November 16, 2009 ---
http://www.simoleonsense.com/
OMG Did I Die & Go to heaven?
Just Read, Applied Value Investing, My Favorite Book of the Past
5 Years!!
Listen To This Interview!
I have a confession, I might have read the best
value investing book published in the past 5 years!
The book is called
Applied Value Investing By Joseph Calandro Jr.
In the book Mr. Calandro applies the tenets of value investing via
(real) case studies. Buffett, was once asked how he would teach a class
on security analysis, he replied, “case studies”. Unlike other books
which are theoretical this book provides you with the actual steps for
valuing businesses.
Without a doubt, this book ranks amongst the
best value investing books (with SA, Margin of Safety, Buffett’s letters
to corporate America, and Greenwald’s book) & you dont have to take my
word for it. Seth Klarman, Mario Gabelli and many top investors have
given the book a plug!
Purportedly a Great, Great Book on Value Investing From Simoleon Sense, November 16, 2009 ---
http://www.simoleonsense.com/
OMG Did I Die & Go to heaven?
Just Read, Applied Value Investing, My Favorite Book of the Past
5 Years!!
Listen To This Interview!
I have a confession, I might have read the best
value investing book published in the past 5 years!
The book is called
Applied Value Investing By Joseph Calandro Jr.
In the book Mr. Calandro applies the tenets of value investing via
(real) case studies. Buffett, was once asked how he would teach a class
on security analysis, he replied, “case studies”. Unlike other books
which are theoretical this book provides you with the actual steps for
valuing businesses.
Without a doubt, this book ranks amongst the
best value investing books (with SA, Margin of Safety, Buffett’s letters
to corporate America, and Greenwald’s book) & you dont have to take my
word for it. Seth Klarman, Mario Gabelli and many top investors have
given the book a plug!
Leading Accountics researchers like Bill Beaver and Steve Penman have a
hard time owning up to CAPM's discovered limitations that trace back to
their own research built on CAPM. Steve Penman owns up to this somewhat in
his own latest book Accounting for Value that seems to run
counter to his earlier book Financial Statement Analysis and Security
Valuation.
Bill Beaver's review of Accounting for Value makes an
interesting proposition:
Since Accounting for Value admits to limitations of CAPM and lack of
capital market efficiency it should be of interest to investors, security
analysts, and practicing accountants consulting on valuation. However,
Penman's Accounting for Value is not of much interest to accounting
professors and students who, at least according to Bill, should continue to
dance in the fantasyland of assumed efficient markets and relevance of CAPM
in accountics research.
Accounting for Value
by Stephan Penman
(New York, NY: Columbia Business School Publishing, 2011, ISBN
978-0-231-15118-4, pp. xviii, 244).
Reviewed by William H. Beaver
The Accounting Review, March 2012, pp. 706-709
http://aaajournals.org/doi/full/10.2308/accr-10208
Jensen Note: Since TAR book reviews are free to the public, I quoted Bill's
entire review
When I was asked by Steve Zeff to review
Accounting for Value, my initial reaction was that I was not sure I
was the appropriate reviewer, given my priors on market efficiency.
As I shall discuss below, a central premise of the book is that there
are substantial inefficiencies in the pricing of common stock securities
with respect to published financial statement information. At one point,
the book suggests that most, if not all, of the motivation for reading
the book disappears if one believes that markets are efficient with
respect to financial statement information (page 3). I disagree with
this statement and found the book to be of value even if one assumes
market efficiency is a reasonable approximation of the behavior of
security prices.
It is unclear who is the intended
audience—academic or nonacademic. This is an important issue, because it
determines the basis against which the book should be judged. For an
academic audience, the book would be good as a supplemental text for an
investments or financial statement analysis course. However, for
an academic audience, it is not a replacement for his previous,
impressive text, Financial Statement Analysis and Security
Valuation (2009). The earlier text goes into much more detail, both in
terms of how to proceed and what the evidence or research basis is for
the security valuation proposed. The previous book is excellent as the
prime source for a course, and the current effort is not a substitute
for the earlier text.
However, as clearly stated, the primary
audience is not academic and is certainly not the passive investor. The
book was written for investors, and for those to whom they trust their
savings (page 1). Moreover, as stated on pages 3–4, the intended
audience is the investor who is skeptical of the efficient market, who
is one of Graham's “defensive investors,” who thinks they can beat the
market, and who perceives they can gain by trading at “irrational”
prices.1 For this reason, the book can be compared with the plethora of
“how to beat the market” books that fill the “Investments” section of
most popular bookstores. By this standard, Accounting for Value is well
above the competition. It is much more conceptually based and includes
references to the research that underlies the basic philosophy. By this
standard, the book is a clear winner.
Another standard is to judge the effort, not by
the average quality of the competition, but by one of the best, Benjamin
Graham's The Intelligent Investor (1949). This, indeed, is a high
standard. The Intelligent Investor is the text I was assigned in my
first investments course. My son is currently in an M.B.A. program,
taking an investments course, so for his birthday I gave him a copy of
Graham's book. However, markets and our knowledge of how markets work
have changed enormously since Graham's book was written.
The comparison with The Intelligent Investor is
natural in part because the text itself explicitly invites such
comparisons with the many references to Graham and by suggesting that it
follows the heritage of Graham's book. It also invites comparisons
because, like Graham's book, it is essentially about investing based on
fundamentals and tackles the subject at a conceptual level with simple
examples, without getting bogged down in extreme details of a “how to”
book. I conclude that Accounting for Value measures up very well against
this high standard and is one of the best efforts written on fundamental
investing that incorporates what we have learned in the intervening
years since the first publication of The Intelligent Investor in 1949. I
have reached this conclusion for several reasons.
One of the major points eloquently made is that
modern finance theory (e.g., CAPM and option pricing models) consists of
models of the relationship among endogenous variables (prices or
returns). These models derive certain relative relationships among
securities traded in a market that must be preserved in order to avoid
arbitrage opportunities. However, as the text points out, these models
are devoid of what exogenous informational variables (i.e.,
fundamentals) cause the model parameters to be what they are. For
example, in the context of the CAPM, beta is a driving force that
produces differential expected returns among securities. However, the
CAPM is silent on what fundamental variables would cause one company's
beta to be different from another's. One of major themes developed in
the text is that accounting data can be viewed as a primary set of
variables through which one can gain an understanding of the underlying
fundamentals of the value of a firm and its securities.2 This is
extremely important to understand, regardless of one's priors about
market efficiency. A central issue is the identification of
informational variables that aid in our understanding of security prices
and returns. As accounting scholars, we have an interest in the “macro”
(or equilibrium) role of accounting data beyond or independent of the
“micro” role of determining whether it is helpful to an individual in
identifying “mispriced” securities.
Another major contribution is the development
of a valuation model of fundamentals through the lens of accounting data
based on accrual accounting. In doing so, the text makes another
important point—namely the role of accrual accounting in bringing the
future forward into the present (e.g., revenue recognition).3 In other
words, accrual accounting contains implicit (or explicit) predictions of
the future. It is argued that, since the future is difficult to predict,
accrual accounting permits the investor to make judgments over a shorter
time horizon and to base those judgments on “what we know.” The text
develops the position that, in general, forecasts and hence valuation
analysis based on accrual accounting numbers will be “better” than cash
flow-based valuations. It is important to understand that the predictive
role is a basic feature of accrual accounting, even if one disagrees
about how well accrual accounting performs that role. Penman believes it
performs that function very well and dominates explicit future cash flow
prediction, based on the intuitive assumption that the investor does not
have to forecast accrual accounting numbers as far into the future as
would be required by cash flow forecasting. The implicit assumption is
that the prediction embedded in accrual numbers is at least as good, if
not better, than attempts to forecast future cash flows explicitly.
A third major point is that book-value-only or
earnings-only models are inherently underspecified and fundamentally
incomplete, except in special cases. Instead, a more complete valuation
approach contains both a book value and a (residual) earnings term. A
point effectively made is that measurement of one term can be
compensated for by the inclusion of the other variable by virtue of the
over-time compensating mechanism of accrual accounting.
A major implication of the model is the myopic
nature of two of the most popular methods for selecting securities:
market-to-book ratios and price-to-earnings ratios. Stocks may appear to
be over- or underpriced when partitioning on only one these two
variables. Using a double partitioning can help alleviate this myopia.
The book is positioned almost exclusively from
the perspective of the purchaser of securities. For example, one of the
ten principles of fundamental analysis (page 6) is “Beware of paying too
much for growth.” Presumably, a fundamental investor of an existing
portfolio is a potential seller as well as a buyer. As a potential
seller, the investor has an analogous interest in selling overpriced
securities, but this is not the perspective explicitly taken. In spite
of the apparent asymmetry of perspective, the concepts of the valuation
model would appear to have important implications for the evaluation of
existing securities held.
In the basic valuation model, value is equal to
current book value, residual earnings for the next two years, and a
terminal value term based on the present value of residual earnings
stream beyond two years.4 The model bears some resemblance to the
modeling of Feltham and Ohlson (1995) but adds context of its own. A
central feature of the approach is to understand what you know and
separate it from speculation.5 In this context, book value is “what you
know,” and everything else involves some degree of speculation. The
degree of speculation increases as the time horizon increases (e.g.,
long-term growth estimates).
A key feature is that it is residual earnings
growth, not simply earnings growth, that is the driver in valuation.
Price-earnings-only models are incomplete because of a failure to make
this distinction. The nature of the long-term residual earnings growth
is highly speculative, which leads to one of the investment
principles—beware of paying too much for growth. The text provides some
benchmarks in terms of the empirical behavior of long-term residual
growth rates and reasons why abnormal earnings might be expected to
decay rapidly. A higher expected residual growth is also likely to be
associated with higher risk and hence a higher discount rate. All of
these factors mitigate against long-term growth playing a large role in
the fundamental value (i.e., do not pay too much for growth). A similar
point is made with respect to the effect of leverage upon growth rates
(Chapter 4).
A remarkable feature of the book is how far it
is able to develop its basic perspective without specifying the nature
of the accounting system upon which it is anchoring valuation other than
to say that it is based on accrual accounting. Chapter 5 begins to
address the nature of the accrual accounting system. A central point is
that accounting treatments that lower current book value (e.g.,
write-offs and the expensing of intangible assets) will increase future
residual earnings (Accounting Principle 4). In particular, conservative
accounting with investment growth induces growth in residual income
(Accounting Principle 5). However, conservatism does not increase value.
Hence, valuations that focus only on earnings to the exclusion of book
value can lead to erroneous valuation conclusions. An investor must
consider both (Valuation Principle 6).
Chapter 6 addresses the estimation of the
discount rate. A central theme is how little we know about estimating
the discount rate (cost of capital), and we can provide, at best, very
imprecise estimates. The proposed solution is to “reverse engineer” the
discount rate implied by the current market price and ask yourself if
you consider this to be a rate of return at which you are willing to
invest, which is viewed as a personal attribute. Several examples and
sensitivity analyses are provided.
Chapter 7 synthesizes points made in earlier
chapters about how the investor can gain insights into distinguishing
growth that does not add to value from growth that does, through a joint
analysis of market-to-book and price-to-earnings partitions. The joint
analysis is clever and is likely to be informative to an investor
familiar with these popular partitioning variables, but is perhaps not
yet ready to use the explicit accounting-based valuation models
recommended.
Chapter 8 addresses the attributes of fair
value and historical cost accounting and is the chapter that is the most
surprising. The chapter is essentially an attack on fair value
accounting. Up until this point, the text has been free of policy
recommendations. The strength lies in taking the accounting rules as you
find them, which is a very practical suggestion and has great potential
readership appeal. The flexibility of the framework to accommodate a
variety of accounting systems is one of its strengths. As a result, the
conceptual framework is relatively simple. It does not attempt to
tediously examine accounting standards in detail, nor does it attempt to
adjust accounting earnings or assets to conform to a concept of “better”
earnings or assets, in contrast to other valuation approaches. I found
the one-sided treatment of fair value accounting to be disruptive of the
overall theme of taking accounting rules as you find them.
The text provides an important caveat. The
framework is a starting point rather than the final answer. A number of
issues are not explicitly addressed. It can also be important to
understand the specific effects of complex accounting standards on the
numbers they produce. Further, there is ample evidence that the market
does price disclosures supplemental to the accounting numbers.
Discretionary use of accounting numbers also can raise a number of
important issues.
In sum, the text provides an excellent
framework for investors to think about the role that accounting numbers
can play in valuation. In doing so, it provides a number of important
insights that make it worthwhile for a wide readership, including those
who may have stronger priors in favor of market efficiency.
This time last week, I, like nine out of
every 10 investors, believed
AOL (AOL)
was a dead-end investment. How could it not be? This is no longer a
56k, dial-up world, when those ubiquitous AOL
disks inundated mailboxes. AOL botched the chance to morph into a
broadband player with its
spectacularly bad marriage to
Time Warner (TWX).
AOL is behind on social media, and is struggling
to compete for ad dollars with
Google (GOOG)
and Facebook. Its sales declined in each quarter last year.
How many chances does a legacy company get?
(Remember
this reinvention?)
Then, on April 9, as if out of nowhere,
Microsoft (MSFT)dropped
in to buy $1 billion of AOL’s patents, sending
the latter’s shares up 43 percent in a single day. In the two years
leading up to the deal, the stock was down 37 percent.
How could a supposedly omniscient market get
this story so wrong? One explanation was offered by MDB, an intellectual
property-focused investment bank. MDB says the AOL patents had more
relevance to Microsoft and that company was uniquely well-studied on
them, especially in light of AOL’s ancient acquisition of Netscape, that
Microsoft nemesis in the age of Windows 95. MDB
found that Microsoft cited AOL patents as
related intellectual property 1,331 times in its own patent filings, vs.
AOL citing its own patents 1,267 times.
Even so, it’s surprising that this play
remained largely the province of tech-geek attorneys. After all, about
15 Wall Street analysts cover AOL—nine of them rating it either a hold
or sell. Hedge funds and bloggers are constantly on it. The Microsoft
deal shot AOL shares up two and a half times where they traded in
August, when the company owned the same patents.
I was similarly puzzled last summer when Google
paid big (63 percent-premium-to-close big) for
remnants of Motorola—placing major emphasis on the legacy tech company’s
patents. Motorola
Mobility (MMI)
shares popped 57 percent in a matter of hours. I
also scratched my head in September 2010, when
Hewlett-Packard (HPQ)emerged
victorious from a bidding war for a tiny data
storage company called 3Par—by paying $33 a share for a stock that
traded below $10 just three weeks earlier. How did everyone completely
whiff on 3Par’s desirability and valuation?
These disconnects have me thinking back to the
words of my friend, Justin Fox of the Harvard Business Review Group,
whose book
The Myth of the Rational Market
excoriated the idea that “the decisions of millions of investors, all
digging for information and striving for an edge, inevitably add up to
rational, perfect markets.”
Fair Value Accounting for Financial Instruments:
Does It Improve the Association between Bank Leverage and Credit Risk?
I preface this tidbit that I've been pretty negative (especially to Tom
Selling's posts in The Accounting Onion Blog) of fair value
accounting when unrealized fair values are comingled with legally recognized
revenues. This balance sheet priority over the income statement has pretty
much destroyed FASB and IASB ability to even define net income.
I support fair value reporting under a multi-column reporting format
where legally recognized revenues are segregated from unrealized fair value
changes in the derivation of net earnings. Hence I am not really critical of
fair value accounting if dual earnings measures are provided in the process.
On the AECM Tom Selling and Patricia Walters (and I suspect many others)
cling to a preference even when unrealized fair value changes are comingled
with legally recognized revenues in the calculations of net earning and its
derivatives like eps and P/E ratios in single-column reporting.
In the interest of academic integrity, however, I respect these opinions
of my AECM friends and am willing to point out empirical evidence that
support their positions and the positions of the IASB and FASB regarding
fair value accounting for financial instruments.
One such important piece of empirical evidence is provided in the
following citation:
Title: "Fair Value Accounting for Financial Instruments: Does It
Improve the Association between Bank Leverage and Credit Risk?"
Authors: Elizabeth Blankespoor, Thomas J. Linsmeier, Kathy R. Petroni
and Catherine Shakespeare
Source: The Accounting Review, July 2013, pp. 1143-1178
http://aaajournals.org/doi/full/10.2308/accr-50419
Abstract
Many have argued that financial statements created under an accounting
model that measures financial instruments at fair value would not fairly
represent a bank's business model. In this study we examine whether
financial statements using fair values for financial instruments better
describe banks' credit risk than less fair-value-based financial
statements. Specifically, we assess the extent to which various leverage
ratios, which are calculated using financial instruments measured along
a fair value continuum, are associated with various measures of credit
risk. Our leverage ratios include financial instruments measured at (1)
fair value; (2) U.S. GAAP mixed-attribute values; and (3) Tier 1
regulatory capital values. The credit risk measures we consider are bond
yield spreads and future bank failure. We find that leverage measured
using the fair values of financial instruments explains significantly
more variation in bond yield spreads and bank failure than the other
less fair-value-based leverage ratios in both univariate and
multivariate analyses. We also find that the fair value of loans and
deposits appear to be the primary sources of incremental explanatory
power.
Jensen Caution
As is common in nearly all accountics science studies the analysis is
limited to only association and not causation which, in this particular
paper, is dutifully pointed out by these veteran accoutics scientists.
The authors also dutifully point out arguments for and against fair value
accounting in credit risk analysis
Several parties currently support fair value
accounting. In a 2008 joint letter to the Securities and Exchange
Commission, the Chartered Financial Analyst Institute Centre for
Financial Market Integrity (CFA Institute), the Center for Audit
Quality, the Consumer Federation of America, and the Council of
Institutional Investors support fair value accounting because they
believe it provides more accurate, timely, and comparable information to
investors than amounts that would be reported under other alternative
accounting approaches (CFA 2008a). In a survey of CFA Institute members
worldwide more than 75 percent of the 2,006 respondents indicate that
they believe that fair value requirements improve transparency and
contribute to investor understanding of financial institutions' risk and
that full fair value accounting for financial instruments will improve
market integrity (CFA 2008b). Presumably if fair values better describe
bank risk, then fair value accounting may mitigate rather than
exacerbate financial crises (Financial Crisis Advisory Group 2009; Bleck
and Liu 2007). In a Financial Times editorial, Lloyd Blankfein, chairman
and chief executive officer of Goldman Sachs, argues that “an
institution's assets must be valued at fair market value—the price at
which buyers and sellers transact—not at the (frequently irrelevant)
historic value” (Blankfein 2009).
There are five basic arguments against fair
value accounting as discussed in more detail in ABA (2006, 2009). First,
fair value accounting for assets that are instruments held for
collection does not faithfully represent a bank's financial condition.
As discussed above, changes in fair value of these instruments may be
transitory. Consistent with this view, Sheila Bair, then chairman of the
Federal Deposit Insurance Corporation, has argued that there is no
relevance in using fair value accounting for loans that are held to
maturity (N'Diaye 2009).
Second, fair value accounting for liabilities
that are instruments held for payment is not appropriate for two
reasons. First, there are few opportunities for firms to settle
liabilities before maturity at other than the principal amount. Debt
markets are frequently very illiquid and contractual restrictions often
preclude the transfer of financial liabilities. These limited
opportunities to transfer liabilities before payment suggest that fair
values of financial liabilities are less relevant for decision making
than fair values of financial assets because the fair values of
liabilities are less likely to be realized.6 Second, many argue that it
is counterintuitive that under fair value accounting for fixed-rate
debt, an increase in credit risk results in a write-down of the value of
the debt and an associated gain in net income.7
The third argument against fair value is that
the financing of a bank's operations links loans issued with the
deposits received and, therefore, in order to best capture the economics
of the banking model, loans and deposits need to be similarly measured.
From this perspective, because it is difficult to estimate the fair
values of deposits, especially non-term deposits, both loans and
deposits should be recognized at amortized cost. The difference between
fair values and historical cost of non-term deposits, such as demand and
savings deposits that bear low rates of interest, arises because a
significant proportion of these funds can be expected to remain on
deposit for long periods of time, allowing the bank to invest the
deposits in higher yielding and longer duration loans. As shown by
Flannery and James (1984), because these non-term deposits are fairly
insensitive to interest rate changes, they serve as a type of hedge
against the effect that changes in interest rates have on loans.
Specifically, if interest rates rise, then the fair value of fixed-rate
loans held by the bank will fall, but this loss will be offset by a rise
in the fair value of the deposits associated with the increasing
benefits of low- or no-cost financing in an increasing interest rate
environment. If the stable source of funding provided by depositors is
not recognized while the fair value of loans is recognized, then the
bank will appear more volatile than it truly is.8
The fourth opposing argument is that when fair
values must be estimated, the valuation process can be significantly
complex and the resulting numbers sufficiently unreliable to cause the
benefits not to outweigh the costs. The fifth argument is that because
fair value accounting contributes to the procyclicality of the financial
system, it is one of the root causes of the recent financial crisis,
creating significant harm to the economy.
Our examination of the ability of fair values
versus more historical-cost-based measures (GAAP and Tier 1 capital) to
reflect a bank's credit risk directly addresses the first three opposing
arguments. Our paper, however, does not contribute to understanding the
costs, complexity, and reliability of fair value accounting or whether
fair values contribute to procyclicality. We believe procyclicality is
an interesting issue and acknowledge that the role of fair values in the
recent financial crisis is still not fully understood.
And the authors dutifully conclude the following on the last page of the
article:
The results of our study should not be used in
isolation to suggest that all financial instruments should be recognized
and measured at fair value. Our study only speaks to the ability of fair
values to reflect credit risks of banks. There are other costs and
benefits associated with a movement to fair values that we do not
consider. Most notably, our study does not address the potential
implications that fair value accounting has on procyclicality or
contracting. In addition, we do not demonstrate that decision makers are
using the fair values to determine credit risk; rather, we only
demonstrate that fair values are most highly associated with the credit
risk determinations. Last, it is worthwhile to note that we measure fair
values based on the fair values currently being recognized or disclosed
by banks. The FASB and the IASB have recently issued standards that
define fair values more precisely (see footnote 5 for details) and, to
the extent that this new definition affects the ultimate fair values
recognized or disclosed under future expected revisions to the
classification and measurement guidance for financial instruments, our
results may not generalize.
Added Jensen Comment
This paper does not provide any information on how the IASB is currently
butting heads with the EU Parliament (at the behest of the powerful EU
banking lobby) regarding different stances on fair value accounting by EU
banks.
Control Fraud --- "cases where the officers who control what look like
legitimate entities use them as “weapons” to commit crimes. Each time, Alan
Greenspan, former chairman of the Federal Reserve, played a catastrophic role.
First, his policies created the fraud-friendly (criminogenic) environment that
produces epidemics of control fraud, then he failed to identify those epidemics
and incipient crises, and finally, he failed to counter them."
At the heart of Greenspan’s failure lies an
ethical void in the brand of economics that has dominated American
universities and policy circles for the last several decades, a brand
known as “free market fundamentalism” or the “neoclassical school.” (I
call it “theoclassical economics” for its quasi-religious belief
system.) Mainstream economists who follow this school assert a deeply
flawed and controversial concept known as the “efficient market
hypothesis,” which holds that financial markets magically regulate
themselves (they automatically “self-correct”) and are thus immune to
fraud. When an economist starts believing in that kind of fallacy, he is
bound to become blind to reality. Let’s take a look at what blinded
Greenspan:
Greenspan knew that markets were
“efficient” because the efficient market hypothesis is the
foundational pillar underlying modern finance theory.
Markets can’t be efficient if there is
control fraud, so there must not be any.
Wait, there are control frauds!
Tens of thousands of them.
Then control fraud must not really be
harmful, or markets would not be efficient.
Control fraud, therefore, must not be
immoral. As crime boss Emilio Barzini put it in The Godfather,
“It’s just business.”
As delusional and immoral as this “logic” chain
is, many elite economists believe it. This warped perspective has
spawned policies so perverse that they turn the world of finance into
the optimal environment for criminals. The upshot is that most of our
elite financial leaders and professionals have thrown integrity out the
window, and we end up with recurrent, intensifying financial crises,
de factoimmunity for our most elite criminals, and the rise of
crony capitalism. Let’s do a little time travel to see exactly how this
plays out.
. . .
How to create a regulatory black hole
Alan Greenspan was Ayn Rand’s protégé, but he
moved radically to the wacky side of Rand on the issue of financial
fraud. And that, friends, is pretty wacky. Greenspan pushed the idea
that preventing fraud was not a legitimate basis for regulation, and
said so in a
famous encounter [3] with Commodities Futures
Trading Commission (CFTC) Chair Brooksley Born. “I don’t think there is
any need for a law against fraud,” Born recalls Greenspan telling her.
Greenspan actually believed the market would sort itself out if any
fraud occurred. Born knew she had a powerful foe on any regulation.
She was right. Greenspan, with the rabid
support of the Rubin wing of the Clinton administration, along with
Republican Chairman of the Senate Banking Committee Phil Gramm, crushed
Born’s effort to regulate credit default swaps (CDS). The plutocrats and
their political allies deliberately created what’s known as a regulatory
black hole – a place where elite criminals could commit their crimes
under the cover of perpetual night.
Greenspan chose another Fed economist, Patrick
Parkinson, to testify on behalf of the bill to create the regulatory
black hole for these dangerous financial instruments. Parkinson offered
the old line that efficient markets easily excluded fraud — otherwise,
they wouldn’t be efficient markets! (Parkinson would later tell the
Financial Crisis Inquiry Commission in 2011 that the “whole concept” of
a related financial instrument known as an “ABS CDO” had been an
“abomination”). Greenspan’s successor richly rewarded Parkinson for
being stunningly wrong in his belief: Ben Bernanke appointed Parkinson —
who had no experience as a supervisor or examiner — as the Fed’s head of
supervision.
Lynn Turner, former chief accountant of the
SEC, told me of Greenspan’s infamous question to his group of senior
officials who met at the Fed in late 1998 or early 1999 (roughly the
same time as Greenspan’s conversation with Born): “Why does it matter if
the banks are allowed to fudge their numbers a little bit?” What’s wrong
with a “little bit” of fraud?
Conservatives often support the “broken
windows” theory of criminal activity, which asserts that you stop
serious blue-collar crime by cracking down on minor offenses. Yet
mysteriously, they never apply the concept to white-collar financial
crimes by elites. The little-bit-of fraud-is-ok concept got made into
law in the Commodities Futures Modernization Act of 2000, which created
the regulatory black hole for credit default swaps. That black hole was
compounded by the Commodity Futures Trading Commission under the
leadership of Wendy Gramm, spouse of Senator Phil Gramm.
Enron’s fraudulent leaders were delighted to
exploit that black hole, because they were engaged in a massive control
fraud. They appointed Wendy Gramm to their board of directors and
proceeded to use derivatives to manipulate prices and aid their cartel
in driving electricity prices far higher on the Pacific Coast. In a
bizarre irony, the massive increase in prices led to the defeat of
California Governor Gray Davis (the leading opponent of the cartel) and
his replacement by Governor Schwarzenegger – a man who was part of the
group that met secretly with Enron’s leadership to try to defeat Davis’s
efforts to get the federal regulators to kill the cartel.
How damaging was Greenspan’s dogmatic and
delusional defense of elite financial frauds in the case of Enron? If
you look closely, you can see that Enron brought together all the
critical elements of a financial crisis: big-time accounting control
fraud, derivatives, cartels, and the use of off-balance sheet scams to
inflate income and hide real losses and leverage. On top of all that,
many of the world’s largest banks aided Enron and its extremely creative
CFO Andrew Fastow to create frauds. The Fed could have responded by
adopting and enforcing mandates to end the criminal practices that were
driving the epidemic, but it didn’t. Instead, Greenspan and other Fed
economists championed Enron’s leadership and cited the company as proof
that regulation was unnecessary to prevent control fraud. They were so
extreme that they attacked their own senior supervisors for daring to
criticize the banks’ role in aiding and abetting Enron’s activities.
Later, when risky derivatives activities and
control frauds at large financial institutions were pushing us toward
the catastrophic crash of 2007-2008, the Fed took no meaningful action
based on the lessons learned from Enron. Greenspan and the senior
leadership of the Fed had learned absolutely nothing, which shows how
disabling economic dogma is to regulators – making them worse than
simply useless. They become harmful, again attacking their supervisors
for criticizing the banks’ fraudulent “liar’s” loans. When Bernanke
placed Patrick Parkinson (an economist blind to fraud by elite banksters)
in a supervisory role at the Fed, he sealed the fate of millions of
Americans whose financial well-being would be sucked right into that
regulatory black hole – and removed the ability of the accursed
supervisors to criticize the largest banks.
How to protect predatory lenders
Finally, we come to the mortgage meltdown of
2008, when the entire housing industry went into freefall. Central to
this crisis is the story of the liar’s loan — mortgage-industry slang
for a mortgage that a lender gives without checking tax returns,
employment history, or anything else that might reliably indicate that
the borrower can make the payments.
The Fed, and only the Fed, had authority under
the Home Ownership and Equity Protection Act (HOEPA) to ban liar’s loans
by all lenders. At a series of hearings mandated by Congress, dozens of
witnesses representing home mortgage borrowers and state and local
criminal investigators urged the Fed to do this. The testimony included
a study that found a 90 percent incidence of fraud in liar’s loans.
What did Greenspan and Bernanke do? Exactly
nothing. They consistently refused to act.
Greenspan went so far as to refuse pleas to
send Fed examiners into bank holding company affiliates to find the
facts and collect data on liar’s loans. Simultaneously, the Fed’s
economists dismissed the warnings from progressives about fraudulent
liar’s loans as “merely anecdotal.” In 2005, the desperate Fed
regulators, blocked by Greenspan from sending in the examiners to get
data from the banks, resorted to simply sending a letter to the largest
banks requesting information. The Fed supervisor who received the banks’
response to that letter termed the data “very alarming.”
If you suspect that the banks would typically
respond to such requests by understating their problem assets
significantly, then you have the right instincts to be a financial
regulator.
. . .
We did not have to suffer this crisis.
Economists who were not blinded by neoclassical theory, like George
Akerlof (who won the Nobel Prize in 2001) and Christina Romer (adviser
to President Obama from 2008-2010), had warned their colleagues about
accounting control fraud and liar’s loans, as did criminologists and
regulators like me. But Greenspan (and Timothy Geithner) refused to see
the obvious truth.
Alan Greenspan had no excuse for assuming fraud
out of existence, and his exceptionally immoral position on fraud and
regulation proved catastrophic to America and much of the world. We
cannot afford the price, measured in many trillions of dollars, over 10
million jobs, and endless suffering, of unethical economists.
Question for Fama and French ---
http://www.dimensional.com/famafrench/2009/03/qa-confidence-in-the-bell-curve.html#more
It would be very enlightening if you would comment on the Nassim Nicholas Taleb
("The Black Swan") attack on the use of Gaussian (normal bell curve) mathematics
as the foundation of finance. As you may know, Taleb is a fan of Mandelbrot,
whose mathematics account for fat tails. He argues that the bell curve doesn't
reflect reality. He is also quite critical of academics who teach modern
portfolio theory because it is based on the assumption that returns are normally
distributed. Doesn't all this imply that academics should start doing
reality-based research?
Answer from Gene Fama (Chicago)
EFF: Half of my 1964 Ph.D. thesis is tests of market efficiency, and the
other half is a detailed examination of the distribution of stock returns.
Mandelbrot is right. The distribution is fat-tailed relative to the normal
distribution. In other words, extreme returns occur much more often than
would be expected if returns were normal.
There was lots of interest in this issue for about
ten years. Then academics lost interest. The reason is that most of what we
do in terms of portfolio theory and models of risk and expected return works
for Mandelbrot's stable distribution class, as well as for the normal
distribution (which is in fact a member of the stable class). For passive
investors, none of this matters, beyond being aware that outlier returns are
more common than would be expected if return distributions were normal.
For other applications, however, the difference can
be critical. Risk management by financial institutions is a good example.
For example, portfolio insurance, which was the rage in the early 1980s,
bombed in the crash of October 1987, because this was an event that was
inconceivable in their normality based return model. The normality
assumption is also likely to be a serious problem in various kinds of
derivatives, where lots of the price is due to the probability of extreme
events. For example, news story accounts suggest that AIG blew up because
its risk model for credit default swaps did not properly account for outlier
events.
Answer from Kenneth French (Dartmouth)
KRF: I agree with Gene, but want to make another point that he is
appropriately reluctant to make. Taleb is generally correct about the
importance of outliers, but he gets carried away in his criticism of
academic research. There are lots of academics who are well aware of this
issue and consider it seriously when doing empirical research. Those of us
who used Gene's textbook in our first finance course have been concerned
with this fat-tail problem our whole careers. Most of the empirical studies
in finance use simple and robust techniques that do not make precise
distributional assumptions, and Gene can take much of the credit for this as
well, whether through his feedback in seminars, suggestions on written work,
comments in referee reports, or the advice he has given his many Ph.D.
students over the years.
The possibility of extreme outcomes is certainly
important for things like risk management, option pricing, and many
complicated "arbitrage" strategies. Investors should also recognize the
potential effect of outliers when assessing the distribution of future
returns on their portfolios. None of this implies, however, that the
existence of outliers undermines modern portfolio theory or asset pricing
theory. And the central implications of modern portfolio theory and asset
pricing—the benefits of diversification and the trade-off between risk and
return—remain valid under any reasonable distribution of returns.
"How Dragon Kings Could Trump Black Swans Power laws have a hidden
structure that reveals why extreme events are more common than we'd thought,"
MIT's Technology Review, August 4, 2009 ---
http://www.technologyreview.com/blog/arxiv/
Sornette gives as an example the distribution of
city sizes in France which follows a classic power law, meaning that there
are many small cities and only a few large ones. On a log-log scale, this
distribution gives a straight line. Except for Paris, which is an outlier,
many times larger than it ought to be if it were to follow the power law.
Paris is an outlier because it has been hugely
influential in the history of France and so has benefited from various
positive feedback mechanisms that have ensured its outsize growth.
Apparently London occupies a similarly outlying position in the distribution
of cities in the UK.
Sornette goes on to identify a number of data sets
showing power laws with outliers that he says are the result of positive
feedback mechanisms that make them much larger than their peers. He calls
these events dragon kings. What's interesting about them is that they are
entirely unaccounted for by a current understanding of power laws, from
which Nassim Nicholas Taleb built the idea of black swans.
The special characteristic of dragon kings is that
a positive feedback mechanism creates faster-than-exponential growth making
them larger than expected.
So what to make of this? Sornette makes one
interesting observation. The seemingly ubiquitous existence of these dragon
kings in all kinds of data sets means that extreme events are significantly
more likely than power laws alone suggest.
That's important. If you've ever wondered why we've
experienced not just a single 100-year financial crises in the last couple
of decades but two or three, here's your answer. It also implies that you'll
experience a few more before your time is up.
But Sornette goes further. He argues that dragon
kings may have properties that make them not only identifiable in real time
but also predictable. He puts it like this: "These processes provide clues
that allow us to diagnose the maturation of a system towards a crisis."
That's much more speculative. It's one thing to
identify the feedback mechanisms that cause faster-than-exponential growth
(and it's not clear that Sornette can do even this) but quite another to
spot the event that trigger a crash.
Sornette looks to be onto something interesting
with his notion of dragon kings: outliers that exist beyond the usual realm
of power laws. That could be a hugely infuential. But his contention that
these outliers are in some way more easily predictable than other events
smacks more of wishful thinking than good science.
For example, in the figures below I’ve plotted
the Fama-French 25 (portfolios ranked on size and book-to-market)
against beta.
In the first figure, I plot the average excess
return to the FF 25 against the average excess return one would expect,
given beta.
If you’d like to see how I calculated the
charts above, please reference the excel file
here.
Given such a poor track record, is
anyone still using the CAPM?
Lot’s of people, apparently…
Welch (2008) finds that ~75% of professors
recommend the use of the model when estimating the cost of capital, and
Graham and Harvey (2001) find that ~74% of
CFOs use the CAPM in their work.
A few quotes from Graham and Harvey 2001 sum up
common sentiment regarding the CAPM:
“While the CAPM is popular, we show later
that it is not clear that the model is applied properly in practice.
Of course, even if it is applied properly, it is not clear that the
CAPM is a very good model [see Fama and French (1992)].
“…practitioners might not apply the CAPM or
NPV rule correctly. It is also interesting that CFOs pay very little
attentionto risk factors based on momentum and
book-to-market-value.”
Of course, there are lots of arguments to
consider before throwing out the CAPM. Here are a few:
Everyone learns about it and knows how to
use it (although, Graham and Harvey suggest that many practitioners
don’t even apply the CAPM theory correctly)
Data is easy to obtain on betas.
Roll’s critique–maybe the CAPM isn’t a
junk theory, rather, the empirical tests showing the CAPM doesn’t
work are bogus.
Regardless, being that this blog is dedicated
to empirical data and evidence, and not about ‘mentally masturbating
about theoretical finance models,’ we’ll operate under the assumption
that the CAPM is dead until new data comes available.
The Fama French Alternative?
Given the CAPM doesn’t work that well in
practice, perhaps we should look into the Fama French model (which isn’t
perfect or cutting edge, but a solid workhorse nonetheless). And while
the FF model inputs are highly controversial, one thing is clear: the FF
3-factor model does a great job explaining the variability of returns.
For example, according to
Fama French 1993, the 3-factor model explains
over 90% of the variability in returns, whereas the CAPM can only
explain ~70%!
The 3-factor model is great, but how the
heck does one estimate the FF factors?
Dartmouth Professor Ken French comes in for the
rescue!
Bob, It is astonishing that we are still having
this debate. What always goes unremarked in these debates is the
underlying political motivation for the development of EMH. It is not a
coincidence that devotees of a free market ideology were the inventors
of both EMH (randomness connotes irrationality so let's make randomness
rational) and principal-agent theory (Berle and Means raised the
prospect of managerial power, so let's construct a fable that concludes
that concentrated economic power is still efficient). The mathematician
David Orrell, in his book The Future of Everything, uses EMH as an
example of misguided belief in modeling/prediction. As he notes: "In its
insistence on rationality, the EMH is therefore a strange inversion of
reality. Its primary aim, it appears, is not to predict the future, but
to make it look like we all know what we're doing. This is dangerous for
two reasons (p. 264)." The first reason Orrell cites is the one familiar
from the work of Taleb, much discussed on this network. Less discussed,
but perhaps more important is the second: "
The second danger comes from the insidious idea
that "the market is always right," that it is some kind of
hyper-rational being that can outwit any speculator or government
regulator. This view of the economy, enshrined in EMH, turns the market
into a deity who is watched over, granted legitimacy, and explained to
the rest of us by the economic priesthood (ibid)." This priesthood
includes most of accounting scholarship (the "rigorous research"
(accountics) crowd) at least in the U.S. This theology has had
disastrous consequences -- Alan Greenspan, a true believer, expressed
some remorse over how wrong he was about the god he worshipped. Markets,
particularly financial ones, left to their own devices, do not
self-regulate, are not omnicient, and should never be left without
public control (Adam Smith was quite adamant about this particularly
with respect to "projectors" (18th jargon for "speculators"). The lack
of innovation in accounting scholarship that AAA president Greg Waymire
has made his presidential theme (Seeds of Innovation) is largely
attributable to the EMH dogma that has held the AMerican academy in its
thrall for over 40 years. Dogmas don't innovate; indeed innovation is
characterized by the destruction of dogmas. "Ah, but faith tis pleasant
'til tis past; the trouble is, twill not last."
For much of the last 25 years, most of the
investment management world has promoted the idea that individual
investors can't beat the market. To beat the market, stock pickers of
course have to discover mispricings in stocks, but the Nobel-acclaimed
Efficient Market Hypothesis (EMH) claims that
the market is a ruthless mechanism acting instantly to arbitrage away
any such opportunities, claiming that the current price of a stock is
always the most accurate estimate of its value (known as
"informational efficiency"). If this is true, what hope can there be for
motivated stock pickers, no matter how much they sweat and toil, vs.
low-cost index funds that simply mechanically track the market? As it
turns out, there's plenty!
The (absurd) rise of the Efficient
Market Hypothesis
First proposed in University of Chicago
professor Eugene Fama’s 1970 paper
Efficient Capital Markets: A Review of Theory and Empirical Work,
EMH has evolved into a concept that a stock price
reflects all available information in the market, making it impossible
to have an edge. There are no undervalued stocks, it is argued, because
there are smart security analysts who utilize all available information
to ensure unfailingly appropriate prices. Investors who seem to beat the
market year after year are just lucky.
However, despite still being widely taught in
business schools, it is increasingly clear that the efficient market
hypothesis is "one of the most remarkable errors in the history of
economic thought" (Shiller). As Warren Buffett famously quipped, "I'd be
a bum on the street with a tin cup if the market was always efficient."
Similarly, ex-Fidelity fund manager and
investment legend
Peter Lynch said in a 1995 interview with
Fortune magazine: “Efficient markets? That’s a bunch of junk, crazy
stuff.”
So what's so bogus about EMH?
Firstly, EMH is based on a set of absurd
assumptions about the behaviour of market participants that goes
something like this:
Investors can trade stocks freely in any
size, with no transaction costs;
Everyone has access to the same
information;
Investors always behave rationally;
All investors share the same goals and the
same understanding of intrinsic value.
All of these assumptions are clearly
nonsensical the more you think about them but, in particular, studies in
behavioural finance initiated by Kahneman, Tversky and Thaler has shown
that the premise of shared investor rationality is a seriously flawed
and misleading one.
Secondly, EMH makes predictions that do not
accord with the reality. Both the Tech Bubble and the Credit
Bubble/Crunch show that that the market is subject to fads, whims and
periods of irrational exuberance (and despair) which can not be
explained away as rational. Furthermore, contrary to the predictions of
EMH, there have been plenty of individuals who have managed to
outperform the market consistently over the decades.
Question for Fama and French ---
http://www.dimensional.com/famafrench/2009/03/qa-confidence-in-the-bell-curve.html#more
It would be very enlightening if you would comment on the Nassim Nicholas Taleb
("The Black Swan") attack on the use of Gaussian (normal bell curve) mathematics
as the foundation of finance. As you may know, Taleb is a fan of Mandelbrot,
whose mathematics account for fat tails. He argues that the bell curve doesn't
reflect reality. He is also quite critical of academics who teach modern
portfolio theory because it is based on the assumption that returns are normally
distributed. Doesn't all this imply that academics should start doing
reality-based research?
Answer from Gene Fama (Chicago)
EFF: Half of my 1964 Ph.D. thesis is tests of market efficiency, and the
other half is a detailed examination of the distribution of stock returns.
Mandelbrot is right. The distribution is fat-tailed relative to the normal
distribution. In other words, extreme returns occur much more often than
would be expected if returns were normal.
There was lots of interest in this issue for about
ten years. Then academics lost interest. The reason is that most of what we
do in terms of portfolio theory and models of risk and expected return works
for Mandelbrot's stable distribution class, as well as for the normal
distribution (which is in fact a member of the stable class). For passive
investors, none of this matters, beyond being aware that outlier returns are
more common than would be expected if return distributions were normal.
For other applications, however, the difference can
be critical. Risk management by financial institutions is a good example.
For example, portfolio insurance, which was the rage in the early 1980s,
bombed in the crash of October 1987, because this was an event that was
inconceivable in their normality based return model. The normality
assumption is also likely to be a serious problem in various kinds of
derivatives, where lots of the price is due to the probability of extreme
events. For example, news story accounts suggest that AIG blew up because
its risk model for credit default swaps did not properly account for outlier
events.
Answer from Kenneth French (Dartmouth)
KRF: I agree with Gene, but want to make another point that he is
appropriately reluctant to make. Taleb is generally correct about the
importance of outliers, but he gets carried away in his criticism of
academic research. There are lots of academics who are well aware of this
issue and consider it seriously when doing empirical research. Those of us
who used Gene's textbook in our first finance course have been concerned
with this fat-tail problem our whole careers. Most of the empirical studies
in finance use simple and robust techniques that do not make precise
distributional assumptions, and Gene can take much of the credit for this as
well, whether through his feedback in seminars, suggestions on written work,
comments in referee reports, or the advice he has given his many Ph.D.
students over the years.
The possibility of extreme outcomes is certainly
important for things like risk management, option pricing, and many
complicated "arbitrage" strategies. Investors should also recognize the
potential effect of outliers when assessing the distribution of future
returns on their portfolios. None of this implies, however, that the
existence of outliers undermines modern portfolio theory or asset pricing
theory. And the central implications of modern portfolio theory and asset
pricing—the benefits of diversification and the trade-off between risk and
return—remain valid under any reasonable distribution of returns.
"How Dragon Kings Could Trump Black Swans Power laws have a hidden
structure that reveals why extreme events are more common than we'd thought,"
MIT's Technology Review, August 4, 2009 ---
http://www.technologyreview.com/blog/arxiv/
Sornette gives as an example the distribution of
city sizes in France which follows a classic power law, meaning that there
are many small cities and only a few large ones. On a log-log scale, this
distribution gives a straight line. Except for Paris, which is an outlier,
many times larger than it ought to be if it were to follow the power law.
Paris is an outlier because it has been hugely
influential in the history of France and so has benefited from various
positive feedback mechanisms that have ensured its outsize growth.
Apparently London occupies a similarly outlying position in the distribution
of cities in the UK.
Sornette goes on to identify a number of data sets
showing power laws with outliers that he says are the result of positive
feedback mechanisms that make them much larger than their peers. He calls
these events dragon kings. What's interesting about them is that they are
entirely unaccounted for by a current understanding of power laws, from
which Nassim Nicholas Taleb built the idea of black swans.
The special characteristic of dragon kings is that
a positive feedback mechanism creates faster-than-exponential growth making
them larger than expected.
So what to make of this? Sornette makes one
interesting observation. The seemingly ubiquitous existence of these dragon
kings in all kinds of data sets means that extreme events are significantly
more likely than power laws alone suggest.
That's important. If you've ever wondered why we've
experienced not just a single 100-year financial crises in the last couple
of decades but two or three, here's your answer. It also implies that you'll
experience a few more before your time is up.
But Sornette goes further. He argues that dragon
kings may have properties that make them not only identifiable in real time
but also predictable. He puts it like this: "These processes provide clues
that allow us to diagnose the maturation of a system towards a crisis."
That's much more speculative. It's one thing to
identify the feedback mechanisms that cause faster-than-exponential growth
(and it's not clear that Sornette can do even this) but quite another to
spot the event that trigger a crash.
Sornette looks to be onto something interesting
with his notion of dragon kings: outliers that exist beyond the usual realm
of power laws. That could be a hugely infuential. But his contention that
these outliers are in some way more easily predictable than other events
smacks more of wishful thinking than good science.
For example, in the figures below I’ve plotted
the Fama-French 25 (portfolios ranked on size and book-to-market)
against beta.
In the first figure, I plot the average excess
return to the FF 25 against the average excess return one would expect,
given beta.
If you’d like to see how I calculated the
charts above, please reference the excel file
here.
Given such a poor track record, is
anyone still using the CAPM?
Lot’s of people, apparently…
Welch (2008) finds that ~75% of professors
recommend the use of the model when estimating the cost of capital, and
Graham and Harvey (2001) find that ~74% of
CFOs use the CAPM in their work.
A few quotes from Graham and Harvey 2001 sum up
common sentiment regarding the CAPM:
“While the CAPM is popular, we show later
that it is not clear that the model is applied properly in practice.
Of course, even if it is applied properly, it is not clear that the
CAPM is a very good model [see Fama and French (1992)].
“…practitioners might not apply the CAPM or
NPV rule correctly. It is also interesting that CFOs pay very little
attentionto risk factors based on momentum and
book-to-market-value.”
Of course, there are lots of arguments to
consider before throwing out the CAPM. Here are a few:
Everyone learns about it and knows how to
use it (although, Graham and Harvey suggest that many practitioners
don’t even apply the CAPM theory correctly)
Data is easy to obtain on betas.
Roll’s critique–maybe the CAPM isn’t a
junk theory, rather, the empirical tests showing the CAPM doesn’t
work are bogus.
Regardless, being that this blog is dedicated
to empirical data and evidence, and not about ‘mentally masturbating
about theoretical finance models,’ we’ll operate under the assumption
that the CAPM is dead until new data comes available.
The Fama French Alternative?
Given the CAPM doesn’t work that well in
practice, perhaps we should look into the Fama French model (which isn’t
perfect or cutting edge, but a solid workhorse nonetheless). And while
the FF model inputs are highly controversial, one thing is clear: the FF
3-factor model does a great job explaining the variability of returns.
For example, according to
Fama French 1993, the 3-factor model explains
over 90% of the variability in returns, whereas the CAPM can only
explain ~70%!
The 3-factor model is great, but how the
heck does one estimate the FF factors?
Dartmouth Professor Ken French comes in for the
rescue!
Bob, It is astonishing that we are still having
this debate. What always goes unremarked in these debates is the
underlying political motivation for the development of EMH. It is not a
coincidence that devotees of a free market ideology were the inventors
of both EMH (randomness connotes irrationality so let's make randomness
rational) and principal-agent theory (Berle and Means raised the
prospect of managerial power, so let's construct a fable that concludes
that concentrated economic power is still efficient). The mathematician
David Orrell, in his book The Future of Everything, uses EMH as an
example of misguided belief in modeling/prediction. As he notes: "In its
insistence on rationality, the EMH is therefore a strange inversion of
reality. Its primary aim, it appears, is not to predict the future, but
to make it look like we all know what we're doing. This is dangerous for
two reasons (p. 264)." The first reason Orrell cites is the one familiar
from the work of Taleb, much discussed on this network. Less discussed,
but perhaps more important is the second: "
The second danger comes from the insidious idea
that "the market is always right," that it is some kind of
hyper-rational being that can outwit any speculator or government
regulator. This view of the economy, enshrined in EMH, turns the market
into a deity who is watched over, granted legitimacy, and explained to
the rest of us by the economic priesthood (ibid)." This priesthood
includes most of accounting scholarship (the "rigorous research"
(accountics) crowd) at least in the U.S. This theology has had
disastrous consequences -- Alan Greenspan, a true believer, expressed
some remorse over how wrong he was about the god he worshipped. Markets,
particularly financial ones, left to their own devices, do not
self-regulate, are not omnicient, and should never be left without
public control (Adam Smith was quite adamant about this particularly
with respect to "projectors" (18th jargon for "speculators"). The lack
of innovation in accounting scholarship that AAA president Greg Waymire
has made his presidential theme (Seeds of Innovation) is largely
attributable to the EMH dogma that has held the AMerican academy in its
thrall for over 40 years. Dogmas don't innovate; indeed innovation is
characterized by the destruction of dogmas. "Ah, but faith tis pleasant
'til tis past; the trouble is, twill not last."
I’ve just uploaded the first 8 lectures in my
Behavioral Finance class for 2012. The first few lectures are very
similar to last year’s, but the content changes substantially by about
lecture 5 when I start to focus more on Schumpeter’s approach to
endogenous money ---
http://www.debtdeflation.com/blogs/2012/09/23/behavioral-finance-lectures/
Jensen Comment
This seems to coincide with the hypothesis that "Too Big to Lose" is
distorting the auditing system worldwide.
Question
Remember the days when Professor Abe Briloff was scouring annual reports and
publishing red flags in Barron's about departures from GAAP and GAAS that
sometimes immediately affected stock prices of companies, warnings that
might otherwise have been overlooked by analysts less diligent than
Professor Briloff and his students? ---
http://faculty.trinity.edu/rjensen/Theory01.htm#Briloff
Barron's is still scouring quarterly and annual reports for red flags
without the aid of Professor Briloff who is now over 90 years old and blind.
Abstract
Investors are often concerned that managers might hide negative
information in filings. With advances in textual analysis and widespread
document availability, individuals can now easily search for phrases
that might be red flags indicating questionable behavior. We examine the
impact of 13 suspicious phrases identified by a Barron's article in a
large sample of 10-Ks. There is evidence that phrases like unbilled
receivables signal a firm may subsequently be accused of fraud. At the
10-K filing date, phrases like substantial doubt are linked with
significantly lower filing date excess stock returns, higher volatility,
and greater analyst earnings forecast dispersion.
Jensen Question
This seems to beg the question of how accountants can contribute information
to irrational people with an underlying goal of helping their markets
themselves be more rational.
Just one further point. I’ve pointed out before
that defenders of the EMH in their arguments often switch between two
meanings of the idea. One is that the markets are unpredictable and hard to
beat, the other is that markets do a good job of valuing assets and
therefore lead to efficient resource allocations. The trick often employed
is to present evidence for the first meaning — markets are hard to predict —
and then take this in support of the second meaning, that markets do a great
job valuing assets. Rubinstein follows this pattern as well, although in a
slightly modified way. At the outset, he begins making various definitions
of the “rational market”: Miguel, Founder of SimoleonSense
"Late last month, the Securities and Exchange
Commission brought an unusual and colorful insider-trading case: It
accused two employees who worked in the rail yard of Florida East Coast
Industries and their relatives of making more than $1 million by trading
on inside information about the takeover of the company.
How did these employees — a mechanical engineer
and a trainman — know their company was on the block (for a
merger or acquisition)?
Well, they were very observant.
They noticed “there were an unusual number of
daytime tours” of the rail yard, the S.E.C. said in its complaint, with
“people dressed in business attire.”
Continued in article
Jensen Comment
There are three broad classes of securities market inefficiencies with
"insider trading" being the worst of the worst classification. But it
appears that this classification has some fuzzy edges and possibly some
implications with the already beaten down CAPM.
As employee shareholders, should we contact our lawyers or brokers if
there are an unusual number of external CPA auditors with somber faces, dark
suits, and high heels?
An insider trading investigation typically
requires the S.E.C. to subpoena records to determine what information a
person who traded or tipped had at a particular point in time, and who
the person communicated with. Once it gathers the relevant documents,
the S.E.C. usually takes the testimony of those who may have been
involved in the transaction, which could require questioning
representatives and senators about the likelihood of legislative action
to establish the information was material.
The House and Senate bills specifically
prohibit trading on “pending or prospective legislative action,” which
means a focal point of any insider trading inquiry will be on
information generated as part of the legislative process. But that
information is at the heart of the Speech or Debate Clause protection,
which prevents any questioning of members of Congress or their staff
about that process to preserve the independence of the legislative
branch.
Passing the legislation would do little good if
the S.E.C. and the Justice Department would be stymied in trying to
conduct an investigation by an assertion of the Speech or Debate Clause
to stop the case dead in its tracks. Congress could try to waive the
constitutional protection in advance as part of any law it passes, but
it is not clear whether that would prevent an individual member from
asserting it in a particular case in the future. Opening Congress to the
possibility of a wide-ranging S.E.C. or Justice Department inquiry is
unlikely to go over well with members suspicious of the motives of the
executive branch.
Passing a law for the sake of public perception
when it could not be enforced would be the height of cynicism. Before
extending the prohibition on insider trading based on legislative
information, Congress will have to grapple with the question whether it
is willing to open itself up to being investigated if any of its members
and their staff misuse that information for personal gain.
Financial journalist and best-selling author
Roger Lowenstein didn't mince words in a piece for the Washington Post
this summer: "The upside of the current Great Recession is that it could
drive a stake through the heart of the academic nostrum known as the
efficient-market hypothesis." In a similar vein, the highly respected
money manager and financial analyst Jeremy Grantham wrote in his
quarterly letter last January: "The incredibly inaccurate efficient
market theory [caused] a lethally dangerous combination of asset
bubbles, lax controls, pernicious incentives and wickedly complicated
instruments [that] led to our current plight."
But is the Efficient Market Hypothesis (EMH)
really responsible for the current crisis? The answer is no. The EMH,
originally put forth by Eugene Fama of the University of Chicago in the
1960s, states that the prices of securities reflect all known
information that impacts their value. The hypothesis does not claim that
the market price is always right. On the contrary, it implies that the
prices in the market are mostly wrong, but at any given moment it is not
at all easy to say whether they are too high or too low. The fact that
the best and brightest on Wall Street made so many mistakes shows how
hard it is to beat the market.
This does not mean the EMH can be used as an
excuse by the CEOs of the failed financial firms or by the regulators
who did not see the risks that subprime mortgage-backed securities posed
to the financial stability of the economy. Regulators wrongly believed
that financial firms were offsetting their credit risks, while the banks
and credit rating agencies were fooled by faulty models that
underestimated the risk in real estate.
After the 1982 recession, the U.S. and world
economies entered into a long period where the fluctuations in variables
such as gross domestic product, industrial production, and employment
were significantly lower than they had been since World War II.
Economists called this period the "Great Moderation" and attributed the
increased stability to better monetary policy, a larger service sector
and better inventory control, among other factors.
The economic response to the Great Moderation
was predictable: risk premiums shrank and individuals and firms took on
more leverage. Housing prices were boosted by historically low nominal
and real interest rates and the development of the securitized subprime
lending market.
According to data collected by Prof. Robert
Shiller of Yale University, in the 61 years from 1945 through 2006 the
maximum cumulative decline in the average price of homes was 2.84% in
1991. If this low volatility of home prices persisted into the future, a
mortgage security composed of a nationally diversified portfolio of
loans comprising the first 80% of a home's value would have never come
close to defaulting. The credit quality of home buyers was secondary
because it was thought that underlying collateral—the home—could always
cover the principal in the event the homeowner defaulted. These models
led credit agencies to rate these subprime mortgages as "investment
grade."
But this assessment was faulty. From 2000
through 2006, national home prices rose by 88.7%, far more than the
17.5% gain in the consumer price index or the paltry 1% rise in median
household income. Never before have home prices jumped that far ahead of
prices and incomes.
This should have sent up red flags and cast
doubts on using models that looked only at historical declines to judge
future risk. But these flags were ignored as Wall Street was reaping
large profits bundling and selling the securities while Congress was
happy that more Americans could enjoy the "American Dream" of home
ownership. Indeed, through government-sponsored enterprises such as
Fannie Mae and Freddie Mac, Washington helped fuel the subprime boom.
Neither the rating agencies' mistakes nor the
overleveraging by the financial firms in the subprime securities is the
fault of the Efficient Market Hypothesis. The fact that the yields on
these mortgages were high despite their investment-grade rating
indicated that the market was rightly suspicious of the quality of the
securities, and this should have served as a warning to prospective
buyers.
With few exceptions (Goldman Sachs being one),
financial firms ignored these warnings. CEOs failed to exercise their
authority to monitor overall risk of the firm and instead put their
faith in technicians whose narrow models could not capture the big
picture. One can only wonder if the large investment banks would have
taken on such risks when they were all partnerships and the lead partner
had all his wealth in the firm, as they were just a few decades ago.
The misreading of these economic trends did not
just reside within the private sector. Former Fed Chairman Alan
Greenspan stated before congressional committees last December that he
was "shocked" that the top executives of the financial firms exposed
their stockholders to such risk. But had he looked at their balance
sheets, he would have realized that not only did they put their own
shareholders at risk, but their leveraged positions threatened the
viability of the entire financial system.
As home prices continued to climb and subprime
mortgages proliferated, Mr. Greenspan and current Fed Chairman Ben
Bernanke were perhaps the only ones influential enough to sound an alarm
and soften the oncoming crisis. But they did not. For all the deserved
kudos that the central bank received for their management of the crisis
after the Lehman bankruptcy, the failure to see these problems building
will stand as a permanent blot on the Fed's record.
Our crisis wasn't due to blind faith in the
Efficient Market Hypothesis. The fact that risk premiums were low does
not mean they were nonexistent and that market prices were right.
Despite the recent recession, the Great Moderation is real and our
economy is inherently more stable.
But this does not mean that risks have
disappeared. To use an analogy, the fact that automobiles today are
safer than they were years ago does not mean that you can drive at 120
mph. A small bump on the road, perhaps insignificant at lower speeds,
will easily flip the best-engineered car. Our financial firms drove too
fast, our central bank failed to stop them, and the housing deflation
crashed the banks and the economy.
Dr. Siegel, a professor of finance at the University of
Pennsylvania's Wharton School, is the author of "Stocks for the Long
Run," now in its 4th edition from McGraw-Hill.
Jensen Question
This seems to beg the question of how accountants can contribute information
to irrational people with an underlying goal of helping their markets
themselves be more rational.
Peter J. Hammond
Department of Economics, Stanford
University, CA 94305-6072, U.S.A.
e-mail:
hammond@leland.stanford.edu
http://www.warwick.ac.uk/~ecsgaj/ratEcon.pdf
1 Introduction and Outline
Rationality is one of the most
over-used words in economics. Behaviour can be rational, or irrational. So
can decisions, preferences, beliefs, expectations, decision procedures, and
knowledge. There may also be bounded rationality. And recent work in game
theory has considered strategies and beliefs or expectations that are “rationalizable”.
Here I propose to assess how
economists use and mis-use the term “rationality.”
Most of the discussion will concern
the normative approach to decision theory. First, I shall consider single
person decision theory. Then I shall move on to interactive or multi-person
decision theory, customarily called game theory. I shall argue that, in
normative decision theory, rationality has become little more than a
structural consistency criterion. At the least, it needs supplementing with
other criteria that reflect reality. Also, though there is no reason to
reject rationality hypotheses as normative criteria just because people do
not behave rationally, even so rationality as consistency seems so demanding
that it may not be very useful for practicable normative models either.
Towards the end, I shall offer a
possible explanation of how the economics profession has arrived where it
is. In particular, I shall offer some possible reasons why the rationality
hypothesis persists even in economic models which purport to be descriptive.
I shall conclude with tentative suggestions for future research —about where
we might do well to go in future.
2 Decision Theory with Measurable Objectives
In a few cases, a decision-making
agent may seem to have clear and measurable objectives. A football team,
regarded as a single agent, wants to score more goals than the opposition,
to win the most matches in the league, etc. A private corporation seeks to
make profits and so increase the value to its owners. A publicly owned
municipal transport company wants to provide citizens with adequate mobility
at reasonable fares while not requiring too heavy a subsidy out of general
tax revenue. A non-profit organization like a university tends to have more
complex objectives, like educating students, doing good research, etc. These
conflicting aims all have to be met within a limited budget.
Measurable objectives can be measured,
of course. This is not always as easily as keeping score in a football match
or even a tennis, basketball or cricket match. After all, accountants often
earn high incomes, ostensibly by measuring corporate profits and/or
earnings. For a firm whose profits are risky, shareholders with well
diversified portfolios will want that firm to maximize the expectation of
its stock market value. If there is uncertainty about states of the world
with unknown probabilities, each diversified shareholder will want the firm
to maximize subjective expected values, using the shareholder’s subjective
probabilities. Of course, it is then hard to satisfy all shareholders
simultaneously. And, as various recent spectacular bank failures show, it is
much harder to measure the extent to which profits are being made when there
is uncertainly.
In biology, modern evolutionary theory
ascribes objectives to genes —so the biologist Richard Dawkins has written
evocatively of the
Selfish Gene.
The measurable objective of a gene is the extent to which the gene survives
because future organisms inherit it. Thus, gene survival is an objective
that biologists can attempt to measure, even if the genes themselves and the
organisms that carry them remain entirely unaware of why they do what they
do in order to promote gene survival.
Early utility theories up to about the
time of Edgeworth also tried to treat utility as objectively measurable. The
Age of the Enlightenment had suggested worthy goals like “life, liberty, and
the pursuit of happiness,” as mentioned in the constitution of the U.S.A.
Jeremy Bentham wrote of maximizing pleasure minus pain, adding both over all
individuals. In dealing with risk, especially that posed by the St.
Petersburg Paradox, in the early 1700s first Gabriel Cramer (1728) and then
Daniel Bernoulli (1738) suggested maximizing expected utility; most previous
writers had apparently considered only maximizing expected wealth.
3 Ordinal Utility and Revealed Preference
Over time, it became increasingly
clear to economists that any behaviour as interesting and complex as
consumers’ responses to price and wealth changes could not be explained as
the maximization of some objective measure of utility. Instead, it was
postulated that consumers maximize unobservable subjective utility
functions. These utility functions were called “ordinal” because all that
mattered was the ordering between utilities of different consumption
bundles. It would have been mathematically more precise and perhaps less
confusing as well if we had learned to speak of an
ordinal equivalence
class of utility functions.
The idea is to regard two utility functions as equivalent if and only if
they both represent the same
preference ordering
— that is, the same
reflexive, complete, and transitive binary relation. Then, of course, all
that matters is the preference ordering — the choice of utility function
from the ordinal equivalence class that represents the preference ordering
is irrelevant. Indeed, provided that a preference ordering exists, it does
not even matter whether it can be represented by any utility function at
all.
Key takeaways from Sornette's forecasting method which he calls the
Financial Bubble Experiment
There are good reasons to think that stock
markets are fundamentally unpredictable. Many econophysicists believe
for example, that the data from these markets bear a startling
resemblance to other data from seemingly unconnected phenomena, such as
the size of earthquakes, forest fires and avalanches, which defy all
efforts of prediction.
Sornette says there are two parts to his
forecasting method. First, he says bubbles are markets experiencing
greater-then-exponential growth. That makes them straightforward to
spot, something that surprisingly hasn't been possible before.
Second, he says these bubble markets display the tell signs of the human
behaviour that drives them. In particular,
people tend to follow each other and this result in a kind of
herding behaviour that causes prices to fluctuate in a periodic fashion.
That's when Sornette announced an brave way of
test his forecasting method which he calls the Financial Bubble
Experiment. His idea is to make a forecast but keep it secret. He posts
it in encrypted form to the arXiv which time stamps it and ensures that
no changes can be made.
Then, six months later, he reveals the forecast and analyses how
successful it has been. Today, we can finally see the analysis of his
first set of predictions made 6 months ago.
It's tempting to imagine that this extra
information would have a calming effect on otherwise volatile markets.
But the real worry is that it could have exactly the opposite effect:
that predictions of the imminent collapse whether accurate or not would
lead to violent corrections. That will have big implications for
econophysics and those who practice it.
"Econophysicist Accurately Forecasts Gold Price Collapse: The first
results from the Financial Bubble Experiment will have huge implications for
econophysics," MIT's Technology Review, June 2, 2010 ---
http://www.technologyreview.com/blog/arxiv/25269/?nlid=3065
There are good reasons to think that stock
markets are fundamentally unpredictable. Many econophysicists believe
for example, that the data from these markets bear a startling
resemblance to other data from seemingly unconnected phenomena, such as
the size of earthquakes, forest fires and avalanches, which defy all
efforts of prediction.
Some go as far as to say that these phenomena are governed by the same
fundamental laws so that if one is unpredictable, then they all are.
And yet financial markets may be different. Last year, this blog covered
an extraordinary forecasts made by Didier Sornette at the Swiss Federal
Institute of Technology in Zurich, who declared that the Shanghia
Composite Index was a bubble market and that it would collapse within a
certain specific period of time.
Much to this blog's surprise, his prediction turned out to be uncannily
correct.
Sornette says there are two parts to his forecasting method. First, he
says bubbles are markets experiencing greater-then-exponential growth.
That makes them straightforward to spot, something that surprisingly
hasn't been possible before.
Second, he says these bubble markets display the tell signs of the human
behaviour that drives them. In particular, people tend to follow each
other and this result in a kind of herding behaviour that causes prices
to fluctuate in a periodic fashion.
However, the frequency of these fluctuations increases rapidly as the
bubble comes closer to bursting. It's this signal that Sornette uses in
predicting a change from superexponential growth to some other regime
(which may not necessarily be a collapse).
While Sornette's success last year was remarkable it wasn't entirely
convincing as this blog pointed out at the time
"The problem with this kind of forecast is that it is difficult
interpret the results. Does it really back Sornette's hypothesis that
crashes are predictable? How do we know that he doesn't make these
predictions on a regular basis and only publicise the ones that come
true? Or perhaps he modifies them as the due date gets closer so that
they always seem to be right (as weather forecasters do). It's even
possible that his predictions influence the markets: perhaps they
trigger crashes Sornette believes he can spot."
That's when Sornette announced an brave way of test his forecasting
method which he calls the Financial Bubble Experiment. His idea is to
make a forecast but keep it secret. He posts it in encrypted form to the
arXiv which time stamps it and ensures that no changes can be made.
Then, six months later, he reveals the forecast and analyses how
successful it has been. Today, we can finally see the analysis of his
first set of predictions made 6 months ago.
Back then, Sornette and his team identified four markets that seemed to
be experiencing superexponential growth and the tell tale signs of an
imminent bubble burst.
These were:the IBOVESPA Index of 50 brazillian stocks, a Merrill Lynch
Corporate Bond Indexthe spot price of goldcotton futures
These predictions had mixed success. First let's look at the failures.
Sornette says that it now turns out that the Merill Lynch Index was in
the process of collapse when Sornette made the original prediction six
months ago. So that bubble burst long before Sornette said it would. And
cotton futures are still climbing in a bubble market that has yet to
collapse. So much for those forecasts.
However, Sornette and his team were spot on with their other
predictions. Both the IBOVESPA Index and the spot price of gold changed
from superexponential growth to some other kind of regime in the time
frame that Sornette predicted. That's an impressive result by anybody's
standards.
And the team says it can do better. They point out that they learnt a
substantial amount during the first six months of the experiment. They
have used this experience to develop a tool called a "bubble index"
which they can use to determine the probability that a market that looks
like a bubble actually is one.
This should help to make future forecasts even more accurate. Had this
tool been available six months ago, for example, it would have clearly
showed that the Merrill Lynch index had already burst, they say. If
Sornette continues with this type of success it's likely that others
will want to copy his method. An interesting question is what will
happen to the tell tale herding behaviour once large numbers of analysts
start looking for and betting on it.
It's tempting to imagine that this extra information would have a
calming effect on otherwise volatile markets. But the real worry is that
it could have exactly the opposite effect: that predictions of the
imminent collapse whether accurate or not would lead to violent
corrections. That will have big implications for econophysics and those
who practice it.
Either way, Sornette is continuing with the experiment. He has already
sealed his set of predictions for the next six months and will reveal
them on 1 November. We'll be watching.
Jensen Comment
If there is anything at all to Sornette's forecasting theory, it most likely
cannot be extended to markets where insiders play a key role such as the
price bubble of a particular company's common shares. Insiders can, and
often do, manipulate markets. But in deep commodities markets such as the
price of gold or stock index prices, Sornette may have something that is
rooted in his herding behavior theory. The problem of course is in
identifying false positives.
Abstract:
This paper investigates whether media attention systematically affects
stock prices by analyzing price and volume reactions to 6,937 CEO
interviews that were broadcast on CNBC between 1997 and 2006. We
document a significant positive abnormal return of 162 basis points
accompanied by abnormally high trading volume over the [-2, 0] trading
day window. After the interviews, prices exhibit strong mean reversion;
over the following ten trading days, the cumulative abnormal return is
negative 108 basis points. The pattern is robust even after controlling
for the announcements of major corporate events and surrounding news
articles. We also find that one standard deviation larger abnormal
viewership is associated with a 0.5% higher event day abnormal return
and 0.5% larger post-event reversals. Furthermore, we find evidence that
enthusiastic individual investors are more likely to trade purely based
on CNBC interviews not confounded by any events or news articles. These
price and volume dynamics suggest that the financial news media is able
to generate transitory buying pressure by catching the attention of
enthusiastic individual investors.
Jensen Comment
I suspect it is safe to extrapolate (somewhat at least) these results to CEO
comments in other similar and widely watched media services on stock picking
in such places as the WSJ, NYT, Yahoo Finance, Motley Fools, etc.
Gamblers who think they have a “hot hand,”
only to end up walking away with a loss, may nonetheless be making
“rational” decisions, according to new research from University of
Minnesota psychologists. The study finds that because humans are
making decisions based on how we think the world works, if erroneous
beliefs are held, it can result in behavior that looks distinctly
irrational.
Important Excerpts (Via Science Daily)
“Where
people go astray is when they base their decisions on beliefs that
are different than what is actually present in the world,”
says Green. “In the coin example, if you toss a coin five times and
all five times are heads, should you pick heads or tails on the next
flip? Assuming the coin is fair, it doesn’t matter — the five
previous heads don’t change the probability of heads on the next
flip — it’s still 50 percent — but people nevertheless act as though
those previous flips influence the next one.”
“This
demonstrates that given the right world model, humans are more than
capable of easily learning to make optimal decisions,” Green says.
Eugene Fama Lecture: Masters of Finance, Oct 2, 2009
Videos Fama Lecture: Masters of Finance From the American Finance
Association's "Masters in Finance" video series, Eugene F. Fama presents a
brief history of the efficient market theory. The lecture was recorded at
the University of Chicago in October 2008 with an introduction by John
Cochrane.
http://www.dimensional.com/famafrench/2009/10/fama-lecture-masters-of-finance.html#more
Fama Video on Market Efficiency in a Volatile Market
Widely cited as the father of the efficient market hypothesis and one of its
strongest advocates, Professor Eugene Fama examines his groundbreaking idea
in the context of the 2008 and 2009 markets. He outlines the benefits and
limitations of efficient markets for everyday investors and is interviewed
by the Chairman of Dimensional Fund Advisors in Europe, David Salisbury.
http://www.dimensional.com/famafrench/2009/08/fama-on-market-efficiency-in-a-volatile-market.html#more
Warren Buffett did a lot of almost fatal damage to the EMH
If you really want to understand the problem you’re apparently wanting to
study, read about how Warren Buffett changed the whole outlook of a great
econometrics/mathematics researcher (Janet Tavkoli). I’ve mentioned this
fantastic book before ---Dear Mr.
Buffett. What opened her eyes is how Warren Buffet built his vast,
vast fortune exploiting the errors of the sophisticated mathematical model
builders when valuing derivatives (especially options) where he became the
writer of enormous option contracts (hundreds of millions of dollars per
contract). Warren Buffet dared to go where mathematical models could not or
would not venture when the real world became too complicated to model.
Warren reads financial statements better than most anybody else in the world
and has a fantastic ability to retain and process what he’s studied. It’s
impossible to model his mind.
I finally grasped what Warren was saying. Warren has such a wide body of
knowledge that he does not need to rely on “systems.” . . . Warren’s
vast knowledge of corporations and their finances helps him identify
derivatives opportunities, too. He only participates in derivatives
markets when Wall Street gets it wrong and prices derivatives (with
mathematical models) incorrectly. Warren tells everyone that he only
does certain derivatives transactions when they are mispriced.
Wall Street derivatives traders construct trading models with no clear
idea of what they are doing. I know investment bank modelers with
advanced math and science degrees who have never read the financial
statements of the corporate credits they model. This is true of some
credit derivatives traders, too.
Janet Tavakoli, Dear Mr. Buffett, Page 19
Bob, et al,
I never cease to marvel at the powers of rationalization defenders of
sacred institutions can muster. The above characterization of EMH was
certainly not the version pedaled by its accounting disciples (notably
Bill Beaver) back in the late 60s and early 70s. An accounting research
industry was created based on a version of EMH that was decidedly more
certain that securities were "properly priced." [Why else do studies to
debunk the Briloff effect?].
Given the interpretation offered above,
"Information Content Studies" make no sense. The whole idea of this
methodology was that accounting data that correlated with prices implied
market participants found it useful for setting prices based on publicly
available data, which implied such prices were the ones that would exist
in an idealized world of perfectly informed investors. Thus, this data
met the test of being information and was to be preferred to other
"non-information" to which the market did not react.
But now we are told that this latest version of
EMH does not justify such sanguinity because "...the prices in the
market are mostly wrong...", thus prices are not an indicator of the
value of data, i.e., just because there is a price effect we still don't
know if that data is truly "information." Think of the millions and
millions of taxpayer dollars that have been wasted over the last forty
years subsidizing people to search for something that is indeterminate
given the methodology they are employing.
And for this the AAA awarded Seminal
Contributions. Jim Boatsman had an ingenious little paper in Abacus eons
ago titled, "Why Are There Tigers and Things," that cast serious doubts
on the whole enterprise of "testing" market efficiency. It addressed the
issue Carl Devine harped on about needing an independent definition of
"information." And this is related to the logical slight of hand EMH
required of surmising there is a way to know what the "true" price is
since we glibly talk about over and under and mis-priced securities.
But there is no way to know this, since
security prices are CREATED by the institution of the securities market.
There does not exist a natural process against which market performance
can be compared. "Market value," which is what a price is, is a value
established by the market. The market is all there is. To paraphrase
NC's current governor's favorite expression, "The price is what it is."
It isn't over or under or mis or proper or
anything else, other than what a particular institution created by us at
one moment in time determines it is. If we lived in a society in which
mob rule settled issues of justice, it would make little sense to argue
that someone the mob hung was "not guilty." Of course he was guilty,
because the mob hung him!!
In the great book Dear Mr. Buffett, Janet Tavakoli shows how
Warren Buffet learned value (fundamentals) investing while taking Benjamin
Graham's value investing course while earning a masters degree in economics
from Columbia University. Buffet also worked for Professor Graham.
The following book supposedly takes the Graham approach to a new level
(although I've not yet read the book). Certainly the book will be
controversial among the efficient markets proponents like Professors Fama
and French.
Purportedly a Great, Great Book on Value Investing From Simoleon Sense, November 16, 2009 ---
http://www.simoleonsense.com/
OMG Did I Die & Go to heaven?
Just Read, Applied Value Investing, My Favorite Book of the Past
5 Years!!
Listen To This Interview!
I have a confession, I might have read the best
value investing book published in the past 5 years!
The book is called
Applied Value Investing By Joseph Calandro Jr.
In the book Mr. Calandro applies the tenets of value investing via
(real) case studies. Buffett, was once asked how he would teach a class
on security analysis, he replied, “case studies”. Unlike other books
which are theoretical this book provides you with the actual steps for
valuing businesses.
Without a doubt, this book ranks amongst the
best value investing books (with SA, Margin of Safety, Buffett’s letters
to corporate America, and Greenwald’s book) & you dont have to take my
word for it. Seth Klarman, Mario Gabelli and many top investors have
given the book a plug!
In the paper, Inefficiencies in the Information
Thicket: A Case Study of Derivative Disclosures During the Financial
Crisis, which was recently made publicly available on SSRN, I provide an
empirical examination of the effect of enhanced derivative disclosures
by examining the disclosure experience of the monoline insurance
industry in 2008. Conventional wisdom concerning the causes of the
Financial Crisis posits that insufficient disclosure concerning firms’
exposure to complex credit derivatives played a key role in creating the
uncertainty that plagued the financial sector in the fall of 2008. To
help avert future financial crises, regulatory proposals aimed at
containing systemic risk have accordingly focused on enhanced derivative
disclosures as a critical reform measure. A central challenge facing
these proposals, however, has been understanding whether enhanced
derivative disclosures can have any meaningful effect given the
complexity of credit derivative transactions.
Like AIG Financial Products, monoline insurance
companies wrote billions of dollars of credit default swaps on
multi-sector CDOs tied to residential home mortgages, but unlike AIG,
their unique status as financial guarantee companies subjected them to
considerable disclosure obligations concerning their individual credit
derivative exposures. As a result, the experience of the monoline
industry during the Financial Crisis provides an ideal setting with
which to test the efficacy of reforms aimed at promoting more elaborate
derivative disclosures.
Overall, the results of this study indicate
that investors in monoline insurers showed little evidence of using a
firm’s derivative disclosures to efficiently resolve uncertainty about a
monoline’s exposure to credit risk. In particular, analysis of the
abnormal returns to Ambac Financial (one of the largest monoline
insurers) surrounding a series of significant, multi-notch rating
downgrades of its insured CDOs reveals no significant stock price
reactions until Ambac itself announced the effect of these downgrades in
its quarterly earnings announcements. Similar analyses of Ambac’s
short-selling data and changes in the cost of insuring Ambac debt
securities against default also confirm the absence of a market reaction
following these downgrade announcements.
Based on a qualitative examination of how
investors process derivative disclosures, to the extent the complexity
of CDOs impeded informational efficiency, it was most likely due to the
generally low salience of individual CDOs as well as the logistic
(although not necessarily analytic) challenge of processing a CDO’s
disclosures. Reform efforts aimed at enhancing derivative disclosures
should accordingly focus on mechanisms to promote the rapid collection
and compilation of disclosed information as well as the psychological
processes by which information obtains salience.
This illustrates how difficult it is to teach, let alone do
accountics, research given the unknowns about impacts of variations in
methodology. How do professors who teach from a few of their chosen studies
prepare students about the simplifications inherent in any one model?
It would seem that students have to be pretty sophisticated to understand
the limitations of the accountics harvests.
"The Cross-Section of Expected Stock Returns: What Have We Learnt from
the Past Twenty-Five Years of Research," by Avanidhar Subrahmanyam
University of California, Los Angeles - Finance Area, European Financial
Management, Forthcoming
Abstract:
I review the recent literature on cross-sectional predictors of stock
returns. Predictive variables used emanate from informal arguments,
alternative tests of risk-return models, behavioral biases, and
frictions. More than fifty variables have been used to predict returns.
The overall picture, however, remains murky, because more needs to be
done to consider the correlational structure amongst the variables, use
a comprehensive set of controls, and discern whether the results survive
simple variations in methodology.
VERY good review article on the ability of
financial models (CAPM, APT, Fama-French, etc) to predict and explain
cross sectional stock returns).
Super short version: While we have progressed,
we have done so down different paths and there needs to be some
standardization, testing for robustness, and checks for correlations
across the many variables that have been used in past models.
From Introduction:
"The predictive variables are motivated
principally in one of four ways. These are: • Informal Wall Street
wisdom (such as “value-investing”) • Theoretical motivation based on
risk-return (RR) model variants • Behavioral biases or misreaction by
cognitively challenged investors • Frictions such as illiquidity or
arbitrage constraints"
AN ABSOLUTE MUST FOR CLASSES.
Jensen Comment
I think leading academic
researchers avoid applied research for the profession because making
seminal and creative discoveries that practitioners have not already
discovered is enormously difficult.
Accounting academe is
threatened by the twin dangers of fossilization and scholasticism
(of three types: tedium, high tech, and radical chic)
From
http://faculty.trinity.edu/rjensen/395wpTAR/Web/TAR395wp.htm
“Knowledge and competence
increasingly developed out of the internal dynamics of esoteric
disciplines rather than within the context of shared perceptions
of public needs,” writes Bender. “This is not to say that
professionalized disciplines or the modern service professions
that imitated them became socially irresponsible. But their
contributions to society began to flow from their own
self-definitions rather than from a reciprocal engagement with
general public discourse.”
Now, there is a definite note of sadness in Bender’s narrative –
as there always tends to be in accounts
of theshift from Gemeinschaft
to Gesellschaft.Yet it
is also clear that the transformation from civic to disciplinary
professionalism was necessary.
“The new disciplines offered relatively precise subject matter
and procedures,” Bender concedes, “at a time when both were
greatly confused. The new professionalism also promised
guarantees of competence — certification — in an era when
criteria of intellectual authority were vague and professional
performance was unreliable.”
But in the epilogue to Intellect and Public Life,
Bender suggests that the process eventually went too far. “The
risk now is precisely the opposite,” he writes. “Academe is
threatened by the twin dangers of fossilization and
scholasticism (of three types: tedium, high tech, and radical
chic).
The agenda for the next decade, at least as I see it, ought to
be the opening up of the disciplines, the ventilating of
professional communities that have come to share too much and
that have become too self-referential.”
Federal regulators are proposing tighter
oversight for so-called "dark pools," trading systems that don't
publicly provide price quotes and compete with major stock exchanges.
The Securities and Exchange Commission voted
Wednesday to propose new rules that would require more stock quotes in
the "dark pool" systems to be publicly displayed. The changes could be
adopted sometime after a 90-day public comment period.
The alternative trading systems, private
networks matching buyers and sellers of large blocks of stocks, have
grown explosively in recent years and now account for an estimated 7.2
percent of all share volume. SEC officials have identified them as a
potential emerging risk to markets and investors.
The SEC initiative is the latest action by the
agency seeking to bring tighter oversight to the markets amid questions
about transparency and fairness on Wall Street. The SEC has floated a
proposal restricting short-selling - or betting against a stock - in
down markets.
Last month, the agency proposed banning "flash
orders," which give traders a split-second edge in buying or selling
stocks. A flash order refers to certain members of exchanges - often
large institutions - buying and selling information about ongoing stock
trades milliseconds before that information is made public.
Institutional investors like pension funds may
use dark pools to sell big blocks of stock away from the public scrutiny
of an exchange like the New York Stock Exchange or Nasdaq Stock Market
that could drive the share price lower.
"Given the growth of dark pools, this lack of
transparency could create a two-tiered market that deprives the public
of information about stock prices," SEC Chairman Mary Schapiro said
before the vote at the agency's public meeting.
Republican Commissioners Kathleen Casey and
Troy Paredes, while voting to put out the proposed new rules for public
comment, cautioned against rushing to overly broad regulation that could
have a negative impact on market innovation and competition.
Dark pools might decide to maintain stock
trading at levels below those that trigger required public display under
the proposed rules, Paredes said. "Darker dark pools" could be worse
than the current situation, he suggested.
When investors place an order to buy or sell a
stock on an exchange, the order is normally displayed for the public to
view. With some dark pools, investors can signal their interest in
buying or selling a stock but that indication of interest is
communicated only to a group of market participants.
That means investors who operate within the
dark pool have access to information about potential trades which other
investors using public quotes do not, the SEC says.
The SEC proposal would require indications of
interest to be treated like other stock quotes and subject to the same
disclosure rules.
Jensen Comment
We need only look at the billions lost by Warren Buffett to anecdotally note
that it is very difficult for anybody but insiders (who are not allowed by law
to steal from the public) to consistently exploit less sophisticated investors
who rely upon price movements and whims more than detailed financial analysis.
Big winners are usually big risk takers and/or just darn lucky even if market
researchers find, in retrospect, instances where the EMH falters.
The above article advises that investors put their money in index funds. This
bothers me a bit, however, since large numbers of investors have to be buying
and selling actual shares of companies in order to set the prices upon which
index fund values are derived. If everybody invested in index funds it would be
like gambling on race horses who never entered the races.
When I teach investments, there's always a section
on market efficiency. A key point I try to make is that any test of market
efficiency suffers from the "joint hypothesis" problem - that the test is
not tests market efficiency, but also assumes that you have the correct
model for measuring the benchmark risk-adjusted return.
In other words, you can't say that you have "alpha" (an abnormal return)
without correcting for risk.
In my book
Finding Alpha I describe these strategies, as
they are built on the fact that alpha is a residual return, a
risk-adjusted return, and as 'risk' is not definable, this gives people
a lot of degrees of freedom. Further, it has long been the case that
successful people are good at doing one thing while saying they are
doing another.
Even better, he's got a pretty good video on the topic
(it also touches on other topics). Enjoy.
Analyzing Apple: How Accountants Think (Since more
often than not prices of shares instantly reflect (impound) public information,
this is not necessarily a recommendation to immediately invest in Apple Corp.)
Apple’s (AAPL) fiscal third quarter earnings are
due out Tuesday, July 21, and once again the Street is focused on the big
numbers — revenues, earnings and units sold for the Mac, iPhone and iPod.
But savvy analysts will be paying closer attention
to the number that is the best measure of a firm’s
profitability: gross
margin, expressed as the ratio of profits to revenues. Or
(Revenue – Cost of sales) / Revenue
Apple’s gross margins, which have averaged 34.8%
over the past eight quarters, are the envy of the industry. Dell’s (DELL)
first quarter GM, by contrast, was 17.6% and the company warned Wall Street
last week that it is expecting a “modest decline” next quarter.
In its April earnings call, Apple low-balled its
guidance numbers as usual, forecasting a sharp drop in gross margins over
the next 6 months. Specifically, it warned analysts to expect no better than
33% in Q3 and “about 30%” in Q4.
But Turley Muller, for one, doesn’t buy those
numbers, and he should know.
Muller, who publishes a blog called Financial
Alchemist, is one of a small group of amateur analysts who track Apple
closely and publish quarterly estimates that are as good as — and often
better than — the professionals’. In fact Muller’s earnings estimates for Q2
were the best of the lot, missing the actual results by just one penny (see
here.)
For Q3, he’s expecting Apple to report earnings of
$1.35 per share on revenue of $8.3 billion — far higher than the Street’s
consensus ($1.16 on $8.16 billion).
Why the discrepancy?
“Again the story appears to be gross margin,” he
writes. “Just like last quarter, when Apple blew out the GM number with
36.4% (just as I had predicted) this quarter’s GM (3Q) should be roughly the
same as last quarter.
The secret, he says, is in the profitability of the
iPhone, “which is through the roof.”
“Apple tries to deflect that,” he says, but the
evidence is right there, buried in a chart he found in Apple’s SEC filings
(see below). It shows Apple’s schedule for deferred costs and revenue for
the iPhone and Apple TV, which for legal reasons are spread out over 24
months rather than being recorded at the time of sale. Because Apple TV
revenue is so small relative to the iPhone, this chart is a pretty good
proxy for the iPhone alone.
This is complicated stuff, but the bottom line, as
Muller points out, is that iPhone profitability has been rising to the point
where gross margins on the device are over 50%.
Are mutual fund managers with "superior skills" earning their keep?
For 1984-2006...mutual funds on average and the
average dollar invested in funds underperform three-factor and four-factor
benchmarks by about the amount of costs (fees and expenses). Thus, if there are
fund managers with skill that enhances expected returns relative to passive
benchmarks, they are offset by managers whose stock picks lower expected
returns. We attempt to identify the presence of skill via bootstrap simulations.
The tests for net returns say that even in the extreme right tails of the
cross-sections of three-factor and four-factor t(α) estimates,
there is no evidence of fund managers with skill
sufficient to cover costs.
Eugene F. Fama and Kenneth R. French, "Luck versus Skill in the Cross
Section of Mutual Fund Alpha Estimates," SSRN, March 9, 2009 ---
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1356021
Abstract:
The aggregate portfolio of U.S. equity mutual funds is close to the market
portfolio, but the high costs of active management show up intact as lower
returns to investors. Bootstrap simulations produce no evidence that any
managers have enough skill to cover the costs they impose on investors. If
we add back costs, there is some evidence of inferior and superior
performance (non-zero true alpha) in the extreme tails of the cross section
of mutual fund alpha estimates. The evidence for performance is, however,
weak, especially for successful funds, and we cannot reject the hypothesis
that no fund managers have skill that enhances expected returns.
Does anybody know where
"informed" traders get their advanced information before "uninformed"
investors?
I love when two ideas are in
direct competition and are testable. For instance, suppose you have
information that you want to trade on. If you trade too aggressively you
will move the market (and if it is inside information get caught!). On the
other hand, if you wait too long, the information is released to the public
and your advantage is gone.
A new working paper by Hsiao-Fen Yang looks at this and finds evidence that
seems to sugest that informed traders are sneaky at first, but as the
information release date gets closer, they get more aggressive. Which is a
really cool story.
"Because informed traders
expect their information advantage will disappear after the
announcements, this information event provides a unique opportunity to
test whether informed traders become more impatient and use more
aggressive orders when the announcement is approaching. Our results show
that when the information will be released soon but there is still
enough time for the execution (from day -10 to day -6), informed
investors use small orders and limit orders to trade stealthily and
reduce price risk. Within five days right before the announcements,
informed investors trade more aggressively. They start using large
market orders to ensure the execution...."
Ok, so this is just an
abstract, so it may or may not be a good paper, but I will take the chance
given the author has done quite a bit of work in the market-microstructure
field and it is a nice intuitive story. Unfortunately I have not seen the
paper. I will email the author and update this link if I find a version
online.
I love when two ideas are in
direct competition and are testable. For instance, suppose you have
information that you want to trade on. If you trade too aggressively you
will move the market (and if it is inside information get caught!). On the
other hand, if you wait too long, the information is released to the public
and your advantage is gone.
A new working paper by Hsiao-Fen Yang looks at this and finds evidence that
seems to sugest that informed traders are sneaky at first, but as the
information release date gets closer, they get more aggressive. Which is a
really cool story.
"Because informed traders
expect their information advantage will disappear after the
announcements, this information event provides a unique opportunity to
test whether informed traders become more impatient and use more
aggressive orders when the announcement is approaching. Our results show
that when the information will be released soon but there is still
enough time for the execution (from day -10 to day -6), informed
investors use small orders and limit orders to trade stealthily and
reduce price risk. Within five days right before the announcements,
informed investors trade more aggressively. They start using large
market orders to ensure the execution...."
Ok, so this is just an
abstract, so it may or may not be a good paper, but I will take the chance
given the author has done quite a bit of work in the market-microstructure
field and it is a nice intuitive story. Unfortunately I have not seen the
paper. I will email the author and update this link if I find a version
online. ******End Quotation
What is not clear is what
makes a trader "informed" versus "uninformed." They could be informed
legally versus illegally using insider information. By law, any inside
information given to any outsider must be shared with the public. The
following quotation is from Page 3 of the working paper:
To investigate what type of
orders informed traders use, we need to identify who are in- formed traders.
We assume that informed traders know the direction of the upcoming earnings
announcements and trade based on their private information. That is,
informed investors will submit buy (sell) orders before good (bad) news. On
the contrary, noisy traders can place both buy and sell orders before good
or bad news. As a result, people who trade in the correct direction can be
informed or noisy traders; while people who trade in the wrong direction are
only noisy traders. If a certain type of orders is more likely to have the
correct direction than other types of orders, that is the one informed
traders prefer. We determine the direction of the quarterly earnings
announcements based on the 3-day cumulative market-adjusted return from day
-1 to day 1. When the 3-day cumulative return is positive (negative), we
assume the announcements conveys good (bad) news to the public.
What is not clear is that
the upcoming earnings announcement direction ("movement") is obtained
legally or illegally. It’s possible that these traders became "informed"
from public information sources that the financial press just did not pick
up on to report to investors at large.
Does anybody know where
"informed" traders get their advanced information before "uninformed"
investors?
Other Questions
Should you believe these many claims that the equity capital markets are
inefficient and that it's worth investing the time and money to beat the
market?
Answer --- Taken from
http://faculty.trinity.edu/rjensen/theory01.htm
A Dartmouth College finance professor would have us conclude that in recent
years the equity markets are a bit like Las Vegas. It's possible to leave
Las Vegas more than a million dollars ahead if you take high risks, but the
odds are decidedly in favor of the casinos. Similarly, it's possible to beat
the stock index funds if you take the risks, but the odds are definitely
against beating the index funds.
This
we return to the age old paradox. It's rather useless to carefully conduct a
financial analysis of audited accounting reports in an effort to gain
superior knowledge to take advantage of more naive investors. On the other
hand if a sufficiently large number of investors did not make a sufficient
number of "sophisticated-knowledge" buys and sells the equity markets might
be less efficient. The sophisticated investors (apart from insiders) cannot
take advantage of naive investors because there are so many sophisticated
investors. Of course insiders can exploit efficient markets, but the SEC
spends most of its budget trying to prevent insider trading. If the SEC was
not successful in this effort by and large, the equity capital markets would
cease to exist.
"Can
You Beat the Market? It’s a $100 Billion Question," by Mark Hulbert, The New York Times, March 9,
2008 ---
Click Here
The study, “The Cost of Active
Investing,” began circulating earlier this year as an academic working
paper. Its author is Kenneth R. French, a finance professor at Dartmouth; he
is known for his collaboration with Eugene F. Fama, a finance professor at
the University of Chicago, in creating the Fama-French model that is widely
used to calculate risk-adjusted performance.
In his new study, Professor
French tried to make his estimate of investment costs as comprehensive as
possible. He took into account the fees and expenses of domestic equity
mutual funds (both open- and closed-end, including exchange-traded funds),
the investment management costs paid by institutions (both public and
private), the fees paid to hedge funds, and the transactions costs paid by
all traders (including commissions and bid-asked spreads). If a fund or
institution was only partly allocated to the domestic equity market, he
counted only that portion in computing its investment costs.
Professor French then deducted
what domestic equity investors collectively would have paid if they instead
had simply bought and held an index fund benchmarked to the overall stock
market, like the Vanguard Total Stock Market Index fund, whose retail
version currently has an annual expense ratio of 0.19 percent.
The difference between those
amounts, Professor French says, is what investors as a group pay to try to
beat the market.
In 2006, the last year for
which he has comprehensive data, this total came to $99.2 billion. Assuming
that it grew in 2007 at the average rate of the last two decades, the amount
for last year was more than $100 billion. Such a total is noteworthy for its
sheer size and its growth over the years — in 1980, for example, the
comparable total was just $7 billion, according to Professor French.
The growth occurred despite
many developments that greatly reduced the cost of trading, like deeply
discounted brokerage commissions, a narrowing in bid-asked spreads, and a
big reduction in front-end loads, or sales charges, paid to mutual fund
companies.
These factors notwithstanding,
Professor French found that the portion of stocks’ aggregate market
capitalization spent on trying to beat the market has stayed remarkably
constant, near 0.67 percent. That means the investment industry has found
new revenue sources in direct proportion to the reductions caused by these
factors.
What are the investment
implications of his findings? One is that a typical investor can increase
his annual return by just shifting to an index fund and eliminating the
expenses involved in trying to beat the market. Professor French emphasizes
that this typical investor is an average of everyone aiming to outperform
the market — including the supposedly best and brightest who run hedge
funds.
Professor French’s study can
also be used to show just how different the investment arena is from a
so-called zero-sum game. In such a game, of course, any one individual’s
gains must be matched by equal losses by other players, and vice versa.
Investing would be a zero-sum game if no costs were associated with trying
to beat the market. But with the costs of that effort totaling around $100
billion a year, active investing is a significantly negative-sum game. The
very act of playing reduces the size of the pie that is divided among the
various players.
Even that, however,
underestimates the difficulties of beating an index fund. Professor French
notes that while the total cost of trying to beat the market has grown over
the years, the percentage of individuals who bear this cost has declined —
precisely because of the growing popularity of index funds.
From 1986 to 2006, according to
his calculations, the proportion of the aggregate market cap that is
invested in index funds more than doubled, to 17.9 percent. As a result, the
negative-sum game played by active investors has grown ever more negative.
The bottom line is this: The
best course for the average investor is to buy and hold an index fund for
the long term. Even if you think you have compelling reasons to believe a
particular trade could beat the market, the odds are still probably against
you.
Jensen Comment
I don’t like the above advice for the “average investor” because if too many
investors prefer investing in index funds rather than in business debt and
equity, then there will be no underlying commerce to support the index fund
concept. It becomes like betting on NHL games before that season a few years ago
when all NHL games were cancelled. Index funds aren’t so hot if all commerce is
cancelled.
Pat Walters stated:
“I just want to know if the people who
want to go back to historical cost for financial instruments will be the
first in line to buy bank stocks when they have no clue what the value of
the banks 'assets" are. Not me.”
Hi Pat,
You may not be maximizing your net worth, and you
aren't explaining why sophisticated investors (your CREF account investors?)
may be buying bank stocks after the FASB lightened up on allowing banks more
freedom to overlook the fair value stench of toxic investments with more
Level 3 historical cost measurement use in FAS 157 (And Wells Fargo and
other banks jumped on Level 3 as fast as its auditors would allow).
Why do some very clever investors pay a price well
above what they think something is worth in an efficient market? It’s
because they think the market will be inefficient at some point where they
can find a fool to sell it to at a profit. It’s called a Fool’s Fooling
Game, and when played well, smart fools beat the dumb fools
The Motley Fool
is a very popular commercial Website about stocks, investing, and personal
finance ---
http://en.wikipedia.org/wiki/Motley_Fool
Did you ever wonder about the “Fool” part of the company’s name?
The Gardner brothers considered themselves “fools” that were smarter than
some foxes. Although at many times the Gardners have shown that fools can
fool wannabe foxes, the Gardners brothers have at times also been out foxed.
My point here, Pat, is that people who
buy Wells Fargo Bank shares just because the price went up following an
accounting change (accounting change from Level 1 to Level 3 covered up the
smell of Wells Fargo’s enormous toxic loan portfolio) may not be ignorant
that accounting changes don’t really offset pending toxic deaths in the long
run.
Some “fools” buying Wells Fargo Bank
shares just think there are many fools more foolish than themselves.
Either way you look at it, investing is
a bit of a fools game with fools trying to outfool one another. The premise
is, however, that sophisticated fools ultimately win. That's most certainly
the case with casinos.
You’re
correct when you stated that Yang’s informed traders are taking huge
risks if they are only “informed” about public information.”
The
Efficient Markets Hypothesis asserts that public information is
instantly impounded in stock prices such that over the long run in
repeated trading it’s impossible for informed traders to exploit
uninformed investors. When informed traders win in the short run it’s
like beating the casino in the short run, but in the long run gamblers
cannot beat the casino in a “fair game.”
Even if
the market for a particular security becomes slightly inefficient
(unfair game), it’s unlikely that that expected returns are positive
after transactions costs of trading are factored in. Traders who turn
stocks frequently are taking enormous risks for the long run in large
measure because transactions costs eat their lunch.
Traders
who are informed with inside information can take advantage of other
investors, but such trading is illegal. The majority of the SEC’s budget
is spent on detection of investors trading on inside information. The
odds of getting caught increase with the size and frequency of the
trades such that when traders are “informed” with inside information
they are advised to not get greedy.
I think
Yang’s paper is more about trader behavior for traders playing the game
of being more quickly “informed” about public information than the
investors they are trading against. However, if the public information
is instantly impounded in the trading prices then it is not possible to
take advantage of other investors’ ignorance of public information. The
fact that they trade instantly on public information, however, helps
make the market efficient. The problem for them is that there are so
many “informed” investors that it’s virtually impossible to consistently
get in at the speed of light ahead of competing “informed” investors
trading on the same public news releases.
Hence I
think Yang’s study is more like observing the behavior of a casino
gambler than it is like studying the long-term net winnings or losses of
a casino gambler
Because
of transactions costs I don’t think Yang’s informed traders can beat the
odds in the long run unless they are being informed about illegal inside
information, which then concerns the stronger-form EMH ---
http://en.wikipedia.org/wiki/Market_efficiency
Fund
investors that earn abnormal returns are earning those abnormal returns
with strategies that work in particular circumstances such as the bubble
of technology stock prices in the 1990s or real estate prices before
2008. They also accepted small odds of huge crashes, which is why
Harvard’s roaring endowment crashed so heavily in the latest unlikely
huge economic crash. Harvard’s fund managers, however, were too smart to
be traders in the context of Yang’s traders going in and out of stocks
daily. That would never be a winning strategy for Harvard.
Bob Jensen
Hi Murat,
If wolves
in an inefficient market slaughter all the sheep in the world there will
be no sheep left to slaughter.
If
passive investors are wiped out all the time by informed traders there
will be no more passive investors to wipe out.
The only
wolves to get away with superior sheep slaughtering are casinos, which
is why the majority of the people will not gamble in a casino. The small
proportion that consistently gamble with all their savings in a casino
are mentally ill and eventually get slaughtered unless they seek help
before it’s too late.
Most
players who consistently gamble in a casino know they are being had,
limit the amounts they can lose, and receive many thrills along the way
such as the bright lights, plush carpets, people watching, bells
ringing, occasional jackpots, etc. They do not receive all these thrills
when investing in an IRA, and most assuredly they will not put most of
their money in a stock/commodities market that consistently loses in an
inefficient and unfair game.
The SEC
and all the investment firms know that great inefficiencies in the stock
market will put an end to the stock market.
Inefficiencies in the stock market do arise from time to time, and I
think the most serious inefficiencies arise from smart insider trading
that is not detected by the SEC or Justice Department. Crime does pay
for some people some of the time. But there are lots of unemployed
insider-information traders impoverished by fines and prison time. They
were not so smart and probably got too greedy. Those that did not get
caught may have shortened their lives with hypertension. There are
various kinds of justice in this world.
Investing
is a little like eating. We know that the food we eat is not 100% pure
all the time. We try to be prudent about what we eat and take small
risks. The same can be said for investing. We know that the stock market
is not 100% pure, but we generally consider it pure enough for much of
our investing since safer investments like CDs are really unwise in the
long run due to inflation or are not sufficiently liquid, e.g, real
estate investing that subjects us to years of property taxes,
maintenance, and insurance before earning uncertain returns.
Bob Jensen
In
retrospect between 2001 and the credit derivatives fiasco of 2008 (where Wall
Street had millions of such contracts) is that Janet M. Tavakoli’s credit
derivative models in 2001 looked almost perfect but ignored the Black Swan of
2008 that some might argue helped to bring down the world of finance to the
extent that so many credit derivatives were used, in a failing effort, to insure
against investment failures. This, of course, was a much larger specification
problem than the Euclidean difference between cylinders and cones. I wonder how
Ms. Tavokoli is sleeping these days. See
http://faculty.trinity.edu/rjensen/2008Bailout.htm#Bailout
Abstract:
Where
the problem is not expert underestimation of randomness, but more: the
tools themselves used in regression analyses and similar methods
underestimate fat tails, hence the randomness in the data. We should
avoid imparting psychological explanations to errors in the use of
statistical methods.
Question for Fama and French ---
http://www.dimensional.com/famafrench/2009/03/qa-confidence-in-the-bell-curve.html#more
It would be very enlightening if you would comment on the Nassim Nicholas Taleb
("The Black Swan") attack on the use of Gaussian (normal bell curve) mathematics
as the foundation of finance. As you may know, Taleb is a fan of Mandelbrot,
whose mathematics account for fat tails. He argues that the bell curve doesn't
reflect reality. He is also quite critical of academics who teach modern
portfolio theory because it is based on the assumption that returns are normally
distributed. Doesn't all this imply that academics should start doing
reality-based research?
Answer from Gene Fama (Chicago)
EFF: Half of my 1964 Ph.D. thesis is tests of market efficiency, and the
other half is a detailed examination of the distribution of stock returns.
Mandelbrot is right. The distribution is fat-tailed relative to the normal
distribution. In other words, extreme returns occur much more often than
would be expected if returns were normal.
There was lots of interest in this issue for about
ten years. Then academics lost interest. The reason is that most of what we
do in terms of portfolio theory and models of risk and expected return works
for Mandelbrot's stable distribution class, as well as for the normal
distribution (which is in fact a member of the stable class). For passive
investors, none of this matters, beyond being aware that outlier returns are
more common than would be expected if return distributions were normal.
For other applications, however, the difference can
be critical. Risk management by financial institutions is a good example.
For example, portfolio insurance, which was the rage in the early 1980s,
bombed in the crash of October 1987, because this was an event that was
inconceivable in their normality based return model. The normality
assumption is also likely to be a serious problem in various kinds of
derivatives, where lots of the price is due to the probability of extreme
events. For example, news story accounts suggest that AIG blew up because
its risk model for credit default swaps did not properly account for outlier
events.
Answer from Kenneth French (Dartmouth)
KRF: I agree with Gene, but want to make another point that he is
appropriately reluctant to make. Taleb is generally correct about the
importance of outliers, but he gets carried away in his criticism of
academic research. There are lots of academics who are well aware of this
issue and consider it seriously when doing empirical research. Those of us
who used Gene's textbook in our first finance course have been concerned
with this fat-tail problem our whole careers. Most of the empirical studies
in finance use simple and robust techniques that do not make precise
distributional assumptions, and Gene can take much of the credit for this as
well, whether through his feedback in seminars, suggestions on written work,
comments in referee reports, or the advice he has given his many Ph.D.
students over the years.
The possibility of extreme outcomes is certainly
important for things like risk management, option pricing, and many
complicated "arbitrage" strategies. Investors should also recognize the
potential effect of outliers when assessing the distribution of future
returns on their portfolios. None of this implies, however, that the
existence of outliers undermines modern portfolio theory or asset pricing
theory. And the central implications of modern portfolio theory and asset
pricing—the benefits of diversification and the trade-off between risk and
return—remain valid under any reasonable distribution of returns.
"How Dragon Kings Could Trump Black Swans Power laws have a hidden
structure that reveals why extreme events are more common than we'd thought,"
MIT's Technology Review, August 4, 2009 ---
http://www.technologyreview.com/blog/arxiv/
Sornette gives as an example the distribution of
city sizes in France which follows a classic power law, meaning that there
are many small cities and only a few large ones. On a log-log scale, this
distribution gives a straight line. Except for Paris, which is an outlier,
many times larger than it ought to be if it were to follow the power law.
Paris is an outlier because it has been hugely
influential in the history of France and so has benefited from various
positive feedback mechanisms that have ensured its outsize growth.
Apparently London occupies a similarly outlying position in the distribution
of cities in the UK.
Sornette goes on to identify a number of data sets
showing power laws with outliers that he says are the result of positive
feedback mechanisms that make them much larger than their peers. He calls
these events dragon kings. What's interesting about them is that they are
entirely unaccounted for by a current understanding of power laws, from
which Nassim Nicholas Taleb built the idea of black swans.
The special characteristic of dragon kings is that
a positive feedback mechanism creates faster-than-exponential growth making
them larger than expected.
So what to make of this? Sornette makes one
interesting observation. The seemingly ubiquitous existence of these dragon
kings in all kinds of data sets means that extreme events are significantly
more likely than power laws alone suggest.
That's important. If you've ever wondered why we've
experienced not just a single 100-year financial crises in the last couple
of decades but two or three, here's your answer. It also implies that you'll
experience a few more before your time is up.
But Sornette goes further. He argues that dragon
kings may have properties that make them not only identifiable in real time
but also predictable. He puts it like this: "These processes provide clues
that allow us to diagnose the maturation of a system towards a crisis."
That's much more speculative. It's one thing to
identify the feedback mechanisms that cause faster-than-exponential growth
(and it's not clear that Sornette can do even this) but quite another to
spot the event that trigger a crash.
Sornette looks to be onto something interesting
with his notion of dragon kings: outliers that exist beyond the usual realm
of power laws. That could be a hugely infuential. But his contention that
these outliers are in some way more easily predictable than other events
smacks more of wishful thinking than good science.
The second is the comment that Joan
Robinson made about American Keynsians: that their theories were so flimsy
that they had to put math into them. In accounting academia, the shortest
path to respectability seems to be to use math (and statistics), whether
meaningful or not. Professor Jagdish Gangolly, SUNY
Albany
I don't think it's ready for IFRS prime time with the quants, but
improvements are being suggested for Black Swan fat tails.
The quants are more desperate at Senator Spector (now a lame duck)
running to save their jobs.
We might facetiously assert that its all for the birds.
Do we forecast? You bet. Do we have
confidence in our forecasts? Never! Confidence about a non-linear chaotic
system can only come in degrees, and even those degrees of confidence are
guesses. Not all hope is lost. There are times when it seems our ability to
predict is better than others. Thus we need to take advantage of it if we
see it. Trading ranges, pivot points, support and resistance, and the like
can help, and do help the trader. Michael Covel, Trading Black
Swans, September 2009 ---
http://www.michaelcovel.com/pdfs/swan.pdf
The credit crisis would not have been as bad if
investment banks’ risk management systems worked well. But the systems
rely on sophisticated mathematical models that have a fundamental flaw:
they grossly underestimate a factor called “tail risk.” This problem can
be solved fairly easily.
In a way, this is a highly technical dispute
about the arcane details of the calculation of Value at Risk, the prime
measure of the riskiness of trading books.
To nonmathematicians, the possible answers
sound daunting: Gaussian, Cauchy and Pareto-Levy. But the underlying
question is straightforward: how often and how badly do markets blow up?
On a day to day basis, financial asset prices
seem to go up and down at random, or in response to news. But the rocket
scientists of finance analyze thousands of movements to identify
patterns.
The answer is what is known as a stable
“Paretian distribution.” Picture a curve that looks like a cross-section
of a hat, with a brim that is wide and thin and a great big crown in the
middle.
The crown represents the days that prices don’t
move very much. It is high because most days are like that. On those
calm days, holders cannot lose much money. The brim represents the days
of big losses or gains. The further from the center of the crown, the
bigger the loss or gain. The wider the brim, the more often the big
moves occur.
The argument is about the shape of the hat
brim. The standard model employed by banks — named for the German
mathematician Carl Friedrich Gauss — is one in which really bad days
happen rarely and horrible days almost never.
How rarely? Well, in August 2007 David Viniar,
the chief financial officer of Goldman Sachs, said, “We were seeing
things that were 25 standard deviation moves, several days in a row.”
Standard deviations are a measure of the
distance from the center of the hat, or, to use the common image in the
trade, the length of the tail. If those days were really 25 standard
deviations away, they would not be expected to come around in the
lifetime of a billion universes.
But the 2007-style collapse had many precedents
in the last few centuries, well within the life of this one universe.
The Gaussian model is too optimistic about
market stability, because it uses an unrealistically high number for the
key variable, the exponential rate of decay, known to its friends as
alpha (not the alpha of performance measurement).
Gauss is at 2. If markets worked with an alpha
of zero — known as the Cauchy distribution for its founder, Augustin-Louis
Cauchy — the 2007 days would come around every 2.5 months. That is
unrealistic in the other direction.
In 1962, the mathematician Benoit Mandelbrot
demonstrated that an alpha of 1.7 provided the best fit with a 100-year
series of cotton prices.
More recent market history — the 1987 crash,
the Long Term Capital Management debacle and the 2007-8 crisis — suggest
big bad events occur about once a decade.
That goes better with an alpha of 0.5, the
Pareto-Levy distribution. This is the model used by the Options Clearing
Corporation to assess option trading counterparty risk for margin
purposes.
The Clearing Corporation has no incentive to
allow counterparty risk to build up. But for investment banks, more
conservative measures of the chance of big market drops would reduce
returns on capital, because they would have to put aside more capital to
protect against the possibility.
The lure of maximizing trading positions,
profits and bonuses in noncrash years could well distort the experts’
judgment. Indeed, one way to look at the exotic financial instruments
that have proliferated in recent years is as a sort of statistical
arbitrage.
If alpha were calculated correctly, the tails
for portfolios of complex derivatives and the like would be fat and long
— more gains in the good times and bigger losses in the bad — and more
capital would be needed. But the measure that is actually used, the
Gaussian alpha, hides the actual risk.
Regulators should get a better handle on that
risk, but by using less Gauss and more Pareto-Levy. That would reduce
the chance that a pretty predictable market blowup wrecks the entire
financial system.
Garbage Research in Stock Pricing Correlations and Equity Premiums
Seriously that smelly kind of garbage you pay to have hauled away A new measure of consumption -- garbage -- is more
volatile and more correlated with stocks than the standard measure, NIPA
consumption expenditure. A garbage-based CCAPM matches the U.S. equity premium
with relative risk aversion of 17 versus 81 and evades the joint equity
premium-risk-free rate puzzle. These results carry through to European data. In
a cross section of size, value, and industry portfolios, garbage growth is
priced and drives out NIPA expenditure growth. Alexi Savov, University of Chicago Booth School of Business. "Asset
Pricing with Garbage, SSRN, February 17, 2009 ---
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1345470
Statistics Lesson: Spanking is a cause of lower IQ?
U.S. children who were spanked had lower IQs four years
later than those not spanked, researchers found. University of New Hampshire
Professor Murray Straus, who is presenting the findings Friday at the
14th International Conference on Violence, Abuse
and Trauma, in San Diego, called the study
"groundbreaking." "The results of this research have major implications for the
well being of children across the globe," Straus said in a statement. "It is
time for psychologists to recognize the need to help parents end the use of
corporal punishment and incorporate that objective into their teaching and
clinical practice." "How often parents spanked
made a difference. The more spanking the, the slower the development of the
child's mental ability," Straus said. "But even small amounts of spanking made a
difference."
"Study: Spanking linked to lower IQ," Breitbart, September
25, 2009 ---
http://www.breitbart.com/article.php?id=upiUPI-20090925-121520-9596&show_article=1&catnum=0
Jensen Comment
I think Straus was frequently spanked as a child. Could it be that lower IQ
students get more frustrated and are inclined toward greater degrees of misbehavior?
Jensen Comment
We need only look at the billions lost by Warren Buffett to anecdotally note
that it is very difficult for anybody but insiders (who are not allowed by law
to steal from the public) to consistently exploit less sophisticated investors
who rely upon price movements and whims more than detailed financial analysis.
Big winners are usually big risk takers and/or just darn lucky even if market
researchers find, in retrospect, instances where the EMH falters.
The above article advises that investors put their money in index funds. This
bothers me a bit, however, since large numbers of investors have to be buying
and selling actual shares of companies in order to set the prices upon which
index fund values are derived. If everybody invested in index funds it would be
like gambling on race horses who never entered the races.
For much of the last 25 years, most of the
investment management world has promoted the idea that individual
investors can't beat the market. To beat the market, stock pickers of
course have to discover mispricings in stocks, but the Nobel-acclaimed
Efficient Market Hypothesis (EMH) claims that
the market is a ruthless mechanism acting instantly to arbitrage away
any such opportunities, claiming that the current price of a stock is
always the most accurate estimate of its value (known as
"informational efficiency"). If this is true, what hope can there be for
motivated stock pickers, no matter how much they sweat and toil, vs.
low-cost index funds that simply mechanically track the market? As it
turns out, there's plenty!
The (absurd) rise of the Efficient
Market Hypothesis
First proposed in University of Chicago
professor Eugene Fama’s 1970 paper
Efficient Capital Markets: A Review of Theory and Empirical Work,
EMH has evolved into a concept that a stock price
reflects all available information in the market, making it impossible
to have an edge. There are no undervalued stocks, it is argued, because
there are smart security analysts who utilize all available information
to ensure unfailingly appropriate prices. Investors who seem to beat the
market year after year are just lucky.
However, despite still being widely taught in
business schools, it is increasingly clear that the efficient market
hypothesis is "one of the most remarkable errors in the history of
economic thought" (Shiller). As Warren Buffett famously quipped, "I'd be
a bum on the street with a tin cup if the market was always efficient."
Similarly, ex-Fidelity fund manager and
investment legend
Peter Lynch said in a 1995 interview with
Fortune magazine: “Efficient markets? That’s a bunch of junk, crazy
stuff.”
So what's so bogus about EMH?
Firstly, EMH is based on a set of absurd
assumptions about the behaviour of market participants that goes
something like this:
Investors can trade stocks freely in any
size, with no transaction costs;
Everyone has access to the same
information;
Investors always behave rationally;
All investors share the same goals and the
same understanding of intrinsic value.
All of these assumptions are clearly
nonsensical the more you think about them but, in particular, studies in
behavioural finance initiated by Kahneman, Tversky and Thaler has shown
that the premise of shared investor rationality is a seriously flawed
and misleading one.
Secondly, EMH makes predictions that do not
accord with the reality. Both the Tech Bubble and the Credit
Bubble/Crunch show that that the market is subject to fads, whims and
periods of irrational exuberance (and despair) which can not be
explained away as rational. Furthermore, contrary to the predictions of
EMH, there have been plenty of individuals who have managed to
outperform the market consistently over the decades.
Question for Fama and French ---
http://www.dimensional.com/famafrench/2009/03/qa-confidence-in-the-bell-curve.html#more
It would be very enlightening if you would comment on the Nassim Nicholas Taleb
("The Black Swan") attack on the use of Gaussian (normal bell curve) mathematics
as the foundation of finance. As you may know, Taleb is a fan of Mandelbrot,
whose mathematics account for fat tails. He argues that the bell curve doesn't
reflect reality. He is also quite critical of academics who teach modern
portfolio theory because it is based on the assumption that returns are normally
distributed. Doesn't all this imply that academics should start doing
reality-based research?
Answer from Gene Fama (Chicago)
EFF: Half of my 1964 Ph.D. thesis is tests of market efficiency, and the
other half is a detailed examination of the distribution of stock returns.
Mandelbrot is right. The distribution is fat-tailed relative to the normal
distribution. In other words, extreme returns occur much more often than
would be expected if returns were normal.
There was lots of interest in this issue for about
ten years. Then academics lost interest. The reason is that most of what we
do in terms of portfolio theory and models of risk and expected return works
for Mandelbrot's stable distribution class, as well as for the normal
distribution (which is in fact a member of the stable class). For passive
investors, none of this matters, beyond being aware that outlier returns are
more common than would be expected if return distributions were normal.
For other applications, however, the difference can
be critical. Risk management by financial institutions is a good example.
For example, portfolio insurance, which was the rage in the early 1980s,
bombed in the crash of October 1987, because this was an event that was
inconceivable in their normality based return model. The normality
assumption is also likely to be a serious problem in various kinds of
derivatives, where lots of the price is due to the probability of extreme
events. For example, news story accounts suggest that AIG blew up because
its risk model for credit default swaps did not properly account for outlier
events.
Answer from Kenneth French (Dartmouth)
KRF: I agree with Gene, but want to make another point that he is
appropriately reluctant to make. Taleb is generally correct about the
importance of outliers, but he gets carried away in his criticism of
academic research. There are lots of academics who are well aware of this
issue and consider it seriously when doing empirical research. Those of us
who used Gene's textbook in our first finance course have been concerned
with this fat-tail problem our whole careers. Most of the empirical studies
in finance use simple and robust techniques that do not make precise
distributional assumptions, and Gene can take much of the credit for this as
well, whether through his feedback in seminars, suggestions on written work,
comments in referee reports, or the advice he has given his many Ph.D.
students over the years.
The possibility of extreme outcomes is certainly
important for things like risk management, option pricing, and many
complicated "arbitrage" strategies. Investors should also recognize the
potential effect of outliers when assessing the distribution of future
returns on their portfolios. None of this implies, however, that the
existence of outliers undermines modern portfolio theory or asset pricing
theory. And the central implications of modern portfolio theory and asset
pricing—the benefits of diversification and the trade-off between risk and
return—remain valid under any reasonable distribution of returns.
"How Dragon Kings Could Trump Black Swans Power laws have a hidden
structure that reveals why extreme events are more common than we'd thought,"
MIT's Technology Review, August 4, 2009 ---
http://www.technologyreview.com/blog/arxiv/
Sornette gives as an example the distribution of
city sizes in France which follows a classic power law, meaning that there
are many small cities and only a few large ones. On a log-log scale, this
distribution gives a straight line. Except for Paris, which is an outlier,
many times larger than it ought to be if it were to follow the power law.
Paris is an outlier because it has been hugely
influential in the history of France and so has benefited from various
positive feedback mechanisms that have ensured its outsize growth.
Apparently London occupies a similarly outlying position in the distribution
of cities in the UK.
Sornette goes on to identify a number of data sets
showing power laws with outliers that he says are the result of positive
feedback mechanisms that make them much larger than their peers. He calls
these events dragon kings. What's interesting about them is that they are
entirely unaccounted for by a current understanding of power laws, from
which Nassim Nicholas Taleb built the idea of black swans.
The special characteristic of dragon kings is that
a positive feedback mechanism creates faster-than-exponential growth making
them larger than expected.
So what to make of this? Sornette makes one
interesting observation. The seemingly ubiquitous existence of these dragon
kings in all kinds of data sets means that extreme events are significantly
more likely than power laws alone suggest.
That's important. If you've ever wondered why we've
experienced not just a single 100-year financial crises in the last couple
of decades but two or three, here's your answer. It also implies that you'll
experience a few more before your time is up.
But Sornette goes further. He argues that dragon
kings may have properties that make them not only identifiable in real time
but also predictable. He puts it like this: "These processes provide clues
that allow us to diagnose the maturation of a system towards a crisis."
That's much more speculative. It's one thing to
identify the feedback mechanisms that cause faster-than-exponential growth
(and it's not clear that Sornette can do even this) but quite another to
spot the event that trigger a crash.
Sornette looks to be onto something interesting
with his notion of dragon kings: outliers that exist beyond the usual realm
of power laws. That could be a hugely infuential. But his contention that
these outliers are in some way more easily predictable than other events
smacks more of wishful thinking than good science.
For example, in the figures below I’ve plotted
the Fama-French 25 (portfolios ranked on size and book-to-market)
against beta.
In the first figure, I plot the average excess
return to the FF 25 against the average excess return one would expect,
given beta.
If you’d like to see how I calculated the
charts above, please reference the excel file
here.
Given such a poor track record, is
anyone still using the CAPM?
Lot’s of people, apparently…
Welch (2008) finds that ~75% of professors
recommend the use of the model when estimating the cost of capital, and
Graham and Harvey (2001) find that ~74% of
CFOs use the CAPM in their work.
A few quotes from Graham and Harvey 2001 sum up
common sentiment regarding the CAPM:
“While the CAPM is popular, we show later
that it is not clear that the model is applied properly in practice.
Of course, even if it is applied properly, it is not clear that the
CAPM is a very good model [see Fama and French (1992)].
“…practitioners might not apply the CAPM or
NPV rule correctly. It is also interesting that CFOs pay very little
attentionto risk factors based on momentum and
book-to-market-value.”
Of course, there are lots of arguments to
consider before throwing out the CAPM. Here are a few:
Everyone learns about it and knows how to
use it (although, Graham and Harvey suggest that many practitioners
don’t even apply the CAPM theory correctly)
Data is easy to obtain on betas.
Roll’s critique–maybe the CAPM isn’t a
junk theory, rather, the empirical tests showing the CAPM doesn’t
work are bogus.
Regardless, being that this blog is dedicated
to empirical data and evidence, and not about ‘mentally masturbating
about theoretical finance models,’ we’ll operate under the assumption
that the CAPM is dead until new data comes available.
The Fama French Alternative?
Given the CAPM doesn’t work that well in
practice, perhaps we should look into the Fama French model (which isn’t
perfect or cutting edge, but a solid workhorse nonetheless). And while
the FF model inputs are highly controversial, one thing is clear: the FF
3-factor model does a great job explaining the variability of returns.
For example, according to
Fama French 1993, the 3-factor model explains
over 90% of the variability in returns, whereas the CAPM can only
explain ~70%!
The 3-factor model is great, but how the
heck does one estimate the FF factors?
Dartmouth Professor Ken French comes in for the
rescue!
The city of Greensboro, N.C., has experimented with
a program designed for teenage mothers. To prevent these teens from having
another child, the city offered each of them $1 a day for every day they
were not pregnant. It turns out that the psychological power of that small
daily payment is huge. A single dollar a day was enough to push the rate of
teen pregnancy down, saving all the incredible costs — human and financial —
that go with teen parenting.
Cass Sunstein, President Obama's pick to head the
Office of Information and Regulatory Affairs, was a vocal supporter of the
program, because it was an economic policy that shaped itself around human
psychology. Sunstein is just one of a number of high-level appointees now
working in the Obama administration who favors this kind of approach.
All are devotees of behavioral economics — a school
of economic thought greatly influenced by psychological research — which
argues that the human animal is hard-wired to make errors when it comes to
decision-making, and therefore people need a little "nudge" to make
decisions that are in their own best interests.
And that is exactly what Obama administration
officials plan to do: By taking account of human psychology, they hope to
save you from yourself.
This is the story of how obscure psychological
research into human decision-making first revolutionized economics and now
appears poised to remake the relationship between the government and its
citizens.
How Behavioral Economics Came To Be
The ideas that underlie the Obama administration's
approach to social policies got their start in 1955 with Daniel Kahneman.
Then a young psychologist in the Israeli army, Kahneman's primary job was to
try to figure out which of his fellow soldiers might make good officers. To
do this, Kahneman ran the men through an unusual exercise: He organized them
into groups of eight, took away all their insignia so know one knew who had
a higher rank, and told them to lift an enormous telephone pole over a
6-foot wall.
Kahneman felt the exercise was incredibly
revealing. "We could see who was a leader, who was taking charge," Kahneman
says. "We could see who was a quitter, who gave up. And we thought that what
we saw before us is how they would behave in combat."
Certain of their wisdom, Kahneman and his fellow
psychologists would make recommendations after the exercise. The chosen men
would Go to officer school, and Kahneman would move on to the next batch of
soldiers. There was only one problem: Kahneman and his colleagues were
terrible at it.
Every month or so, Kahneman would get feedback from
the school about his picks, and "there was absolutely no relationship
between what we saw and what people saw who examined them for six months in
officer training school," he says.
But here's the remarkable thing: Despite the
negative feedback, Kahneman's faith in his own ability was unshaken.
"The next day after getting those statistics, we
put them there in front of the wall, gave them a telephone pole, and we were
just as convinced as ever that we knew what kind of officer they were going
to be."
People Make Irrational Choices
Kahneman was surprised by the pure visceral power
of his own certainty. He eventually coined a phrase for it: "illusion of
validity."
It's a problem that afflicts us all, says Kahneman,
who won the 2002 Nobel Prize in economics for his work on this subject. From
stockbrokers to baseball scouts, people have a huge amount of confidence in
their own judgment, even in the face of evidence that their judgment is
wrong.
But that mistake is just one of many cognitive
errors identified by Kahneman and his frequent collaborator, psychologist
Amos Tversky. For more than a decade, the two worked together cataloging the
ways the human mind systematically misjudges the world around it.
For instance, Kahneman and Tversky identified
"anchoring bias." It turns out that whenever you are exposed to a number,
you are influenced by that number whether you intend to be influenced or
not.
This is why, for example, the minimum payments
suggested on your credit card bill tend to be low. That number frames your
expectation, so you pay less of the bill than you might otherwise, your
interest continues to grow, and your credit card company makes more money
than if you had not had your expectations influenced by the low number.
Through their research, Kahneman and Tversky
identified dozens of these biases and errors in judgment, which together
painted a certain picture of the human animal. Human beings, it turns out,
don't always make good decisions, and frequently the choices they do make
aren't in their best interest.
In the realm of academic psychology, this isn't
much of a revelation — psychologists see people as flawed in all kinds of
ways. So, if the ideas of Kahneman and Tversky had simply stayed in the
realm of academic psychology, there wouldn't be much of a story to tell.
Nobel
Prize-winning psychologist Daniel Kahneman addresses the
Georgetown class of 2009 about the merits of behavioral
economics.
He deconstructs the assumption that people always act
rationally, and explains how to promote rational
decisions in an irrational world.
Topics Covered:
1. The
Economic Definition Of Rationality
2.
Emphasis on Rationality in Modern Economic Theory
3. Examples of Irrational Behavior (watch this part)
4. How
to encourage rational decisions
Speaker Background (Via Fora.Tv)
Daniel
Kahneman - Daniel Kahneman is Eugene Higgins Professor
of Psychology and Professor of Public Affairs Emeritus
at Princeton University. He was educated at The Hebrew
University in Jerusalem and obtained his PhD in
Berkeley. He taught at The Hebrew University, at the
University of British Columbia and at Berkeley, and
joined the Princeton faculty in 1994, retiring in 2007.
He is best known for his contributions, with his late
colleague Amos Tversky, to the psychology of judgment
and decision making, which inspired the development of
behavioral economics in general, and of behavioral
finance in particular. This work earned Kahneman the
Nobel Prize in Economics in 2002 and many other honors
Video 2: Nancy Etcoff is part of a new vanguard of cognitive researchers
asking: What makes us happy? Why do we like beautiful things? And how on earth
did we evolve that way? Simoleon Sense, June 10, 2009
http://www.simoleonsense.com/science-of-happiness/
Abstract:
The precise origin of the accounting records and reports outlined by
Pacioli in 1494 and used in the Italian Republics is presently unknown.
Historical evidence preserved in Turkey and Egypt indicates that
accounting records and reports developed in the early Islamic State were
similar to those used in the Italian Republics as outlined by Pacioli in
1494. Furthermore, some of the records and reports used in different
parts of the Islamic State are comparable to modern-day books and
reports. The religious requirement of Zakat (religious levy) and the
increasing responsibilities of the Islamic State were the force behind
the development of accounting records and reports by Muslims. The
Islamic State was established in 622, and Zakat was imposed on Muslims
in the year 2 Hijri'iah (H) (623). The enactment of Zakat necessitated
the establishment of the Diwan (office where accounts are held) and the
initial development of accounting records and reports. These records
were further developed in Addawlatul Abbasi'iah (Abbaside Caliphate)
between 132-232 H (750-847) whereby seven accounting specializations
were known and practiced. Auditing played a very important role in the
Islamic State and was designated as one of the accounting
specializations. This paper argues that it is most likely that the
commercial links between Muslim traders and their Italian counterparts
influenced the development of accounting books in the Italian Republics.
CHRISTOPHER NAPIER and ROSZAINI HANIFFA (editors), Islamic Accounting
(Cheltenham, Glos, U.K.: Edward Elgar Publishing Limited, 2011, ISBN
978-1-84844-220-7, pp. xx, 740).
Reviews by Simon Archer in The Accounting Review, March 2013 ---
http://aaajournals.org/doi/full/10.2308/accr-10324
You must scroll down and down and down.
External Sharī‘ah Auditors in Islamic Banking
and Finance Industry: Challenges of Qualification and Professional
Competency
This short
study provides an overview of the present circumstances regarding the
importance of External Sharī‘ah Audit in Islamic banking market and major
challenges. The main challenge to this industry is lack of skilful and
qualified man power. Realizing the current curricula of reputed Accountancy
Institutions who produce certified Accountants and auditors lacks the topics
related to Islamic banking products and services, besides as suggested by
the State Bank of Pakistan the audit firms should hire Sharī‘ah scholars on
the basis of “Shahadatul Almiya Fil Uloomal Arabia wal Islamia” or Takhasus
fil Fiqh wal Ifta or Sharī‘ah background. (Ayub, Shahzad, and Rehman 2019)
These persons will not have adequate knowledge and experience of accounting
and auditing knowledge as per FAPC. (State Bank of Pakistan 2018) However
the Accounting and Auditing Organization for Islamic Financial Institutions
(AAOIFI) has suggested a solution regarding the qualification of an external
Sharī‘ah auditor.
"Developing a Conceptual
Framework to Appraise the Corporate Social Responsibility Performance of
Islamic Banking and Finance Institutions," by M. Mansoor Khan,
Accounting and the Public Interest, American Accounting Association,
Volume 13, Issue 1 (December 2013) ---
http://aaajournals.org/doi/abs/10.2308/apin-10375
Abstract
This paper fills some of theoretical and empirical deficiencies
regarding Corporate Social Responsibility (CSR) dimensions in Islamic
Banking and Financial Institutions (IBFIs). The firms' CSR initiatives
are the key to secure success in modern business and society, and there
is a scope to develop a broader understanding of CSR in globally
integrated business and financial markets. This paper provides the
Islamic perspective of CSR, which is etho-religious based and, thus,
more meaningful and intensified. It proposes a CSR framework for IBFIs
based on principles of Islamic economics and society. The proposed
framework urges IBFIs to engage in community-based banking, work toward
the betterment of the poor, ensure the most efficient and socially
desirable utilization of financial resources, develop their
institutional frameworks, infrastructures, and innovative products to
facilitate the wider circulation of wealth and sustainable development
in the world. This paper observes that IBFIs have failed to deal with
underlying CSR challenges due to lack of commitment and expertise in the
field. The CSR-based outlook of IBFIs can only ensure their legitimacy,
sustainability, and long-term success.
The Islamic finance industry has grown quickly
in recent years. Yet while standards for financial instruments that
comply with Islamic law are well-developed, the adoption of specialized
Islamic accounting methods is lagging, according to the head of the
Bahrain-based
Accounting and Auditing Organization for Islamic Financial Institutions,
one of the world’s biggest Islamic
standards-setting bodies.
“For Shariah standards [AAOIFI] is dominating
the market,” Khaled Al Fakih, the body’s secretary general and chief
executive, said on Tuesday. “Everyone is referring to AAOIFI when
applying their standards. As for accounting, this is the big problem.”
Many Islamic banks in the Arab Gulf already use
AAOIFI’s Islamic accounting standards. But plenty of lenders that do a
combination of Islamic financing and conventional lending continue to
use the popular IFRS or U.S. GAAP standards. The main difference between
conventional and Islamic financing is the prohibition on charging or
paying interest in Islamic structures.
Banks’ failure to use Islamic accounting
standards is a problem because the conventional methods don’t classify
Islamic structures accurately, Mr. Al Fakih said. A deposit at a bank,
for example, is considered a liability under conventional accounting
rules: a bank has to pay that money back, after all. An Islamic deposit,
however, isn’t technically as secure.
“Islamic bank deposits are not
capital-guaranteed – depositors are contributing to an investment and
are willing to bear a loss,” Mr. Al Fakih said. “They’re quasi-equity.”
If banks were to reclassify their Islamic
deposits, he added, they could benefit from reduced charges on their
capital, freeing up more money to put toward new financing. The
fundamental issue, though, is one of accuracy. “The substance of the
contract should be properly reflected,” Mr. Fakih said.
“When you go to IFRS or U.S. GAAP, the Islamic
transaction is not there,” he said. “Everything is about lending and
borrowing.”
The rapid global growth in Islamic finance has brought increased
international attention to the questions of what Islamic finance is,
how it differs from conventional finance and and whether accounting
for Islamic and conventional finance transactions can be harmonised.
The papers
for the AAOIFI - World Bank Annual Conference on Islamic
Banking and Finance held earlier this month and recently
posted to the AAOIFI (Accounting and Auditing Organisation for
Islamic Financial Institutions) website offer a good overview of
current topics in Islamic Finance. However, they also illustrate
that the definitions of Sharia-compliant operations are still
diverse and can differ from jurisdiction to jurisdiction, which
make a single approach to accounting difficult. Yet, as one of
the speakers at the conference pointed out: "Ethics,
transparency and accountability are values not alien to [the]
Islamic world view." Please click for
access to the conference papers on the AAOFI website.
The need to
harmonise the treatment of Islamic finance first in itself and
then with international standards has lead to the publication of
a series of papers over the last months. In
September 2012, the Islamic Financial
Services Board (IFSB) published a report from a high-level
roundtable offered jointly with the International Organisation
of Securities Commissions (IOSCO), which was to be a first step
towards the development of international regulatory standards
for Islamic capital market products. In
November 2012, the Malaysian
Accounting Standards Board (MASB) published a staff paper
discussing Islamic finance, accounting treatments for various
Islamic finance instruments, and the reasons why the MASB chose
to require Islamic financial institutions to follow Malaysian
Financial Reporting Standards, which are equivalent to IFRS.
Finally,
the Association of Chartered Certified Accountants (ACCA)
followed suit with a report published on its
website calling on the International
Accounting Standards Board (IASB) and the Islamic finance
industry to work together to develop guidance, standards and
educate the investor community on key issues. ACCA points out
that:
the IASB
should consider issuing guidance on the application of IFRSs
to the accounting for certain Islamic financial products;
it should
also consider issuing guidance on additional disclosures in
relation to Sharia-compliant operations;
the IASB
should work with leading Islamic Finance standard-setters
and regulators in establishing differences and developing
harmonised solutions; and
the Islamic
Finance Institutes (IFIs) should support the IASB by forming
an expert advisory group.
The IASB
has responded to the repeated calls and has asked the MASB to
help with setting up an expert advisory group on Islamic
accounting. This development was first announced at the fourth
meeting of the Asian-Oceanian Standard-Setters Group (AOSSG) at
the
end of November 2012 in Kathmandu
where the IASB staff briefed the members on the plans. The IASB
has since confirmed these plans in the
feedback-statement to the agenda consultation:
The IASB could
benefit from learning more about Islamic (Shariah-compliant)
transactions and instruments - neither the IASB nor our
staff have expertise in this area. The IASB is establishing
a consultative group to assess the relationship between
Shariah-compliant transactions and instruments and IFRS and
to help educate the IASB, mainly through public education
sessions. Work undertaken by some standard-setters suggests
that IFRS provides relevant information about Shariah-compliant
transactions and that there is little, if anything, the IASB
would need to do to bring this sector of the economy within
IFRS. However, the IASB needs more information before it can
make that assessment itself. We have asked the Malaysian
Accounting Standards Board to assist us with setting up this
group, reflecting the helpful analysis they provided to the
AOSSG on Shariah-compliant matters.
More information on
developments in Islamic accounting and useful links are
available on our
dedicated IAS Plus page.
Following financial crises in the US and
Europe, investors are increasingly attracted to raising funds for
investments through Islamic bonds called “sukuk.”
Sukuk are an alternative to conventional bonds
that governments and companies sell regularly to raise funds. They
comply with sharia law, the moral code of conduct based on the Quran,
which prohibits charging interest and trading in debt.
Ernst & Young’s Global Islamic Banking Centre
of Excellence projects that global demand for sukuk is likely to triple
to $900 billion in 2017. Here are a few
reasons for the surge:
The world’s Muslim population is growing
at about twice the rate of the non-Muslim population, the
Pew Research Center estimates, driving the
growth of the Islamic banking industry.
Banks in the Middle East are flush with
cash because of high oil prices. Islamic banks, particularly those
that were not hard hit by the financial crises in the US and Europe,
are looking for opportunities to park their cash. Worldwide, Islamic
assets held by banks account for an estimated $1.1 trillion,
according to Ernst & Young’s
Islamic banking report. Their share of all
commercial bank assets varies from country to country. In the Middle
East and North Africa, Islamic assets constitute an average 14% of
banks’ assets.
Muslim countries have increased government
spending to stimulate, develop and sustain economic activity since
the beginning of the Arab Spring.
Investors worldwide are seeking safer
investments following global financial crises. Sukuk are unsecured,
asset-based loans. Unlike asset-backed loans, which use buildings,
land or patents as collateral, sukuk must be based at least 51% on
an asset that generates rent, such as a building. The sukuk issuer
can make amortised payments or a bullet payment at the end to pay
off the sukuk. While the majority of the payments must come from the
rent, a smaller portion can come from profits that a business
generated.
“Would the growth be the same if the US and the
European market weren’t in crisis? Perhaps yes, but not at the rate you
see now,” said Rizwan Kanji, a lawyer who specialises in sukuk
transactions in the Dubai office of the law firm King & Spalding. “… The
growth of sukuk will continue while the Western markets recover.”
Establishing a global standardised sukuk
trading platform that is open to all financial institutions would go a
long way toward spurring more supply, according to Ashar Nazim, E&Y’s
MENA Islamic finance services leader.
Accounting Standards for financial reporting by
Islamic financial institutions have to be developed because in some
cases Islamic financial institutions encounter accounting problems
because the existing accounting standards such as IFRSs or local GAAP
were developed based on conventional institutions, conventional product
structures or practices, and may be perceived to be insufficient to
account for and report Islamic financial transactions. Shariah compliant
transactions that observe the prohibition to charge interest may not
have parallels in conventional financing and therefore, there may be
significant accounting implications. Likewise, the Islamic finance
industry is under considerable pressure to enhance practice and improve
risk management systems and protect investors.
On this page, we maintain a history of recent
developments in Islamic accounting requirements and practices.
August 24, 2011 message from Mohammad Asim Raza
Hi Robert -
Read your response on the AECM listserv - I think you would find the Thomas
McElwain's writing on interest in his Islam in Bible to be interesting. Here
is excerpt.
Usury
Islamic banking is well-known in the financial
world and is becoming popular as an investment alternative even outside the
sphere of Islam. The prohibition of usury or charging interest on any
lending is described in the literature of every Islamic school of
jurisprudence. In justification of the prohibition Ali (1988, 141a) quotes
Qur'an 2:275 `Those who swallow interest will not (be able to) stand (in
resurrection) except as standeth one whom Satan hath confounded with his
touch.'
The Bible is also very clear on the matter of
usury. It is in perfect harmony with Islam. The Arabic term for usury, raba,
is rather neutral, coming from a root meaning to remain over or increase.
The Biblical term for usury, neshek, is strongly negative, coming from a
root whose basic meaning is to strike as a serpent.
The term neshek itself is used twelve times in the
Bible, but related words are used several times as well. All of them either
prohibit usury or speak of it in deprecating terms.
Leviticus 25:36,37. `Take thou no usury of him, or
increase: but fear thy God; that thy brother may live with thee. Thou shalt
not give him thy money upon usury, nor lend him thy victuals for increase.'
The Hebrew term for increase here, tarbath, is a cognate of the Arabic riba.
The word `or' in the translation of verse 36 is an interpretation of the
undesignated copula we-. This is an example of the typical Hebrew habit of
pairing synonyms.
Exodus 22:25. `If thou lend money to any of my
people that is poor by thee, thou shalt not be to him as a usurer, neither
shalt thou lay upon him usury.' This text already brings up the question of
whether usury in general is prohibited, or merely usury of a brother, that
is one under the covenant of God. The Torah has been interpreted to permit
usury from unbelievers.
Deuteronomy 23:19-20. 'Thou shalt not lend upon
usury to thy brother; usury of money, usury of victuals, usury of any thing
that is lent upon usury: Unto a stranger thou mayest lend upon usury; but
unto thy brother thou shalt not lend upon usury: that the Lord thy God may
bless thee in all that thou settest thine hand to in the land whither thou
goest to possess it.'
Here the import of the passage in Exodus becomes
clear. Usury is prohibited from those under the covenant, but permitted from
strangers, that is, unbelieving heathens. Beyond this clarification there is
an interesting remark on economy. The strength and well-being of the
economic situation is considered to depend on the avoidance of usury.
Psalm 15:1-5. `Lord, who shall abide in thy
tabernacle? Who shall dwell in thy holy hill? He that putteth not out his
money to usury...' The prohibition of usury in the Psalms is universal,
whether the loan is made to believers or unbelievers.
Jeremiah 15:10. `Woe is me, my mother, that thou
has borne me a man of strife and a man of contention to the whole earth! I
have neither lent on usury, nor men have lent to me on usury; yet every one
of them doth curse me.' The words of Jeremiah imply not only a prohibition
on lending with interest, but on borrowing with interest as well. The guilt
is thus attached to both parties in the transaction.
As part of the divine definition of justice we find
in Ezekiel 18:8-9, `He that hath not given forth upon usury, neither hath
taken any increase... he is just, he shall surely live, saith the Lord God.'
This is a positive approach to the problem, as well as another affirmation
that neshek and tarbith are equivalent.
Ezekiel 18:13 makes the point negatively, `Hath
given forth upon usury, and hath taken increase: shall he then live? he
shall not live: he hath done all these abominations; he shall surely die;
his blood shall be upon him.' The context suggests that the abomination of
usury is one of the sins provoking the Babylonian captivity. Verses
seventeen and eighteen release the innocent children of the effects of their
parents' sins in taking usury.
Ezekiel 22:12. `In thee have they taken gifts to
shed blood; thou has taken usury and increase, and thou hast greedily gained
of thy neighbours by extortion, and hast forgotten me, saith the Lord God.'
The taking of usury is equated here with bribes in judgement resulting in
the execution of the innocent, and with extortion. Ezekiel thus defines more
carefully what he means by `abominations' in chapter eighteen.
After the captivity the matter of usury arose
again, and was put to a quick end by the intervention of Nehemiah.
Nehemiah's argument is not based on fear of renewed captivity as a result of
usury. Rather, he appeals directly to law and justice. Having authority as
governor, his measures were met with success: Nehemiah five.
The Gospel references to usury are neither
legislative nor normative. In a parable we find Jesus quoting a master
scolding a servant for neglecting his property. Matthew 25:27 'Thou oughtest
therefore to have put my money to the exchangers, and then at my coming I
should have received mine own with usury.' The same story is repeated in
Luke 19:23. Jesus makes no comment here on usury as such. The text does
reveal that Jesus' hearers were familiar with the practice and that at least
some, those having capital, approved of it. The context might well be
lending to unbelievers.
In sum, usury is prohibited in the Torah when
between believers. The prophets suggest usury to be one of the factors
resulting in the Babylonian captivity. Ezekiel uses very strong language
against usury, equating it with bribery and extortion. The Psalms seem to
apply the prohibition not merely within the context of believers but in
general.
Although it appears that the Torah at least might
permit usury in some contexts, the sum of Biblical teaching comes down
firmly against it. The Islamic form of banking finds support not only in the
Qur'an but in the Bible as well.
Regards, Mohammad Asim Raza, CPA
Baltimore, MD 21208
August 25, 2011 reply from Bob Jensen
Hi Mohammad,
I don't want to get into any religious debates over debt versus equity or
how nations of Islam participate in global capital markets today. I think
Islamic finance ministers have become masters of structured finance that
avoid the terms "interest" and "usury"---
http://en.wikipedia.org/wiki/Structured_finance
I do think a "rose" by any other name is still a "rose" such that a
changed definition of lending will not change lending in and of itself. For
example, deferred-collection sales contracts are a form of interest-bearing
debt even if the word "interest" is never mentioned when negotiating
deferred payment prices.
What we do know is that there should be a trade-off between risk and
return so as to attract varied investors who are willing to take on varied
levels of risk and expected returns. If investors are not allowed to lend
(say by buying U.S, Treasury Bonds that earn the closest thing we have to
risk free returns) then the governments of virtually all nations will have
to find some other way to finance long-term projects and deficits.
If equity investors cannot obtain financial leverage with debt, this will
greatly affect willingness to invest in ownership shares.
I totally disagree with Robert Walker about debt if he will not agree to
a risk-return variation in investment alternatives. If virtually risk-free
investing is still an alternative then I think we just have a rose by
another name.
Will Robert Walker also ban deferred collection sales contracts?
What Robert Walker fails to mention is that the modern economic world has
entered into the realm of "structured financing" where old definitions of
debt versus equity become blended in very complex ways, often with
derivative financial instruments and hedging management of risk ---
http://en.wikipedia.org/wiki/Structured_finance
Respectfully,
Bob Jensen
August 25, 2011 reply from Mohammad Asim Raza
Hi Bob - there is no doubt that Islam prohibit the
use of interest - but does allow mark up which in principle is not interest.
Interest and interest on interest is prohibited in Islam. My mention of the
link was due the fact that other scriptures also are negative or against the
use of interest as mentioned by McElwain.
There is an on going debate on the topic of
interest whether it is paid on money or capital. Muslim scholars recognize
that the loaned funds either create debt or asset. The question is if they
are used to create additional wealth then why should the lender only be
remunerated a fraction of money, interest in this case, since justice would
require that the lender be compensated to the extent of involvement of
financial capital in creating the incremental wealth - the point that well
made by Dr Abbas Mirakhor.
Ps see the remarkable work on Islamic Economics by
Baqir AsSadr (Pls note that there is no such thing as Islamic Economics,
wrote it for convenience, in Islam the term is Iqtisad which is derived from
qasdis-sabil, i.e., the straigh path. Other meanings of Iqtisad are straight
and upright, maintaining a moderate attitude and holding neither less or
more). The book covers several important topics and was his original work on
the subject.
That said, Islamic finance is still developing
(read: not perfect) and there are quite a hurdles to over come from the
practical (there are much more traditional banks to work with) point of view
- pls see the two attached documents - on Islamic Securitization, and
Islamic home ownership in the US. The third attachment is a recent research
mostly focusing on Australia, but provides a table indicating the activities
of Islamic banking from asset percentage point of view in comparing to
regular banking.
Not but least, Islam allows several arrangements as
I am sure you must be aware of Mudaraba (commenda) and Musaraka
(partnership), Beneficence loans (Al Qard al Hassan, as Quran mentions it) -
non interest bearing loans to those who are in need, deferred payment sale
(bay Muajjal), deferred payment installment in which the price of the
product is agreed to between buyer and seller at the time of the sale and
can not be changed for deferring payments, leasing (Ijara), cost plus sale,
service charge, just to name a few. My friend Muath is covering some of the
developments that have beeen taking place
http://islamicfinance2009.blogspot.com/
So, Islamic financing is still developing and
scholars are working on the alternatives - there is no doubt that interest
causes ill and perpetuate greed in general.
Thank you for your reply, Bob, I may not be able to
quickly reply to you as you know I am currently working on my dissertation
work which is taking a whole lot of time.
Respectfully,
Raza
August 27, 2011 reply from Bob Jensen
Hi Raza,
When you invest proceeds of bond debt into "capital," your debt still
remains along with the bond debt's cash flow or fair value risk that can
never be simultaneously eliminated (shifted) until the debt is paid off.
What you do with the proceeds can never shift both types of risk. It's
impossible to shift both types of risk even though you keep harping on "risk
shifting" with proceeds into "capital investment" without being perfectly
clear about what type of risk is being shifted with such an investment.
It's impossible to simultaneously eliminate both a debt's cash flow and
fair value risks no matter whether or not you created a "capital" investment
with the bond proceeds. And these risks exist apart from insolvency risk.
The bonds can be risk-free in terms of insolvency risk and still have cash
flow or fair value interest rate risk.
It's also questionable whether you've created capital with some uses of
the proceeds?
What if you borrow in U.S. dollars for the purposes of speculating in
options on Euros where the bond proceeds go to paying for options on Euros?
Is this a capital investment?
What if you borrow U.S. dollars to speculate in U.S. Treasury Bond
options on interest rates? Is paying $1 million in option premiums of
interest rate options a capital investment?
One added point that should perhaps be shared with the AECM is that your
supposed risk shifting from debt to capital means that this capital
investments must be tied to particular contracts in the capital structure of
a firm..
This was one of the main reasons Modigliani won the Nobel Prize in
Economics. It will be earth shaking if you can convince economists that
you've refuted that theory. Keep up the good work even if you can't convince
me about the relevancy of capital structure.
August 27, 2011 reply from Raza
Hi Bob - you seem still confused (or want to get
your last word in, just like in every other post) and harping on the side
topics. The money is only a potential capital. For the money to become a
capital, there has to be entrepreneurial effort. In other words you get
interest on your debt while return on your capital. Debt is unsustainable,
interest is bad, and also corresponds to your biblical values considering
you are a conservative.
Respectfully,
Raza
Jensen Comment
I never mentioned my "biblical values" in this or any other thread in my life.
Somebody sent this to me. Please note that I did not add any of the
yellow highlights or comments.
Nor do I have the slightest idea who added these yellow highlights or
comments.
Nor do I defend the implication in Footnote 3(f) that Special Income Revenue
and Expense and Special Income Rate Swaps are the equivalent as interest as
defined in the Western world.
Nor do I have any idea who the counterparties are to these contracts or if
they viewed Special Income Revenue and Expense as Interest Income and
Expense.
I especially found Footnote B.1-1 interesting on how changes in Special
Commission Rates will affect future cash flows or fair values. This is on
printed Page 46 (also Page 49 on my reader).
Islamic
finance may face its biggest shake-up in years
as a top standard-setting body seeks to reform the way the industry does
business, including the role of highly paid scholars in enforcing
religious principles.
Khaled Al Fakih, the new secretary-general of
the Bahrain-based Accounting and Auditing Organisation for Islamic
Financial Institutions (AAOIFI), outlined plans for a sweeping review of
its guidelines in an interview with Reuters.
Some of AAOIFI's reforms may prove
controversial by challenging entrenched interests in the fast-growing
business. Islamic financial assets hit $1.3 trillion globally last year,
a 150 percent rise in the past five years as the industry expanded
beyond core markets in the Middle East and Malaysia, financial lobby
group TheCityUK estimates.
"We would like to see insightful debate...that
can help us develop standards that can benefit the industry," Fakih said
by email from Bahrain, ahead of AAOIFI's annual meeting there on May 7
and 8.
His organization plans to start consultations
on reforming the operations of sharia boards, the groups of Islamic
scholars which rule on whether financial institutions' activities and
products are religiously acceptable, by the middle of this year. A final
draft of the reforms is not expected to be ready before the end of next
year at the earliest.
AAOIFI will also work on a new framework for
disclosing financial data, and will look at revising standards for
takaful (Islamic insurance), investment accounts and other products.
Fakih, a Lebanese-born commercial banker who
took over at AAOIFI in February, said basic elements of Islamic finance
such as murabaha, mudaraba and ijara - structures designed to permit
investment while obeying religious bans on paying interest and pure
monetary speculation - would be reviewed next year.
CONTROVERSY
For many in the industry, AAOIFI's review
cannot come too soon. Although far smaller than conventional banking,
which has tens of trillions of dollars of assets, Islamic finance has
grown much more quickly in the last few years, so its flaws could start
to affect banking systems and economies.
Much of its growth has occurred because it can
count on the support of large pools of sharia-compliant funds in the
booming Gulf and southeast Asia, which have not pulled back during the
global financial crisis as Western funds have.
Last year's Arab Spring uprisings in the Middle
East promise a fresh wave of growth; new, Islamist-led governments want
to promote the industry after their authoritarian predecessors
discouraged it for ideological reasons.
But the growth has exposed weaknesses in
Islamic finance. One is the lack of a clear consensus on what products
and procedures are permissible; the sharia boards of individual banks
and investment firms can issue conflicting rulings.
This can create big controversies. When Goldman
Sachs (GS.N)
announced last October that it planned a $2
billion sukuk issue, which would make it one of the first top Western
banks to raise money in that way, its own sharia advisors approved the
plan. But some other scholars criticized it; six months later, the sukuk
has not been issued and it is not clear when it might be.
The sharia board system is open to accusations
of conflict of interest because scholars are paid handsomely - in some
cases, with hourly fees of $1,000 or more - by the very firms whose
behavior they are supervising.
The ambiguity in regulation has let some
Islamic financial institutions, such as Kuwait's Investment Dar, argue
in court that contracts into which they had entered were not valid
because they were not sharia-compliant in the first place.
AAOIFI plans to improve the operations of
sharia boards by strengthening the certification process for scholars,
Fakih said. The organisation currently offers scholars two professional
credentials, but they have been criticized as not sufficiently rigorous
and too easy to obtain.
In addition, AAOIFI is developing new guidance
on the relationship between Islamic financial firms and their sharia
boards, "similar to international best practices on terms of reference
for financial institutions' board of directors".
One way to reduce conflicts of interest might
be to limit the length of scholars' tenure at individual firms, to
prevent them from forming excessively close relationships with their
employers that might compromise their objectivity. However, Fakih did
not mention this idea. Current AAOIFI standards acknowledge "engagement
over a prolonged period of time may pose a threat to independence", but
do not prescribe specific limits.
AAOIFI will also look at ways of fostering the
rise of a new, younger generation of Islamic scholars, through steps
such as training courses, Fakih said. This could remove a bottleneck to
growth in the industry by loosening the dominance of about two dozen
veteran scholars who have practiced for decades and hold multiple board
positions.
RESISTANCE
It is not yet clear whether reformers in AAOIFI
will be able to push through changes over the potential opposition of
many veteran scholars and financiers who profit from the status quo.
Yasser Dalhawi, chief executive of Syariah
Review Bureau, an Islamic finance advisory firm in
Saudi Arabia, said change would be difficult.
But he added that many people in the wider industry would support change
as a way of ensuring growth and bringing Islamic finance closer to its
religious principles.
A survey of customers' attitudes to sharia
boards, conducted a few years ago by a Gulf financial firm, found
widespread dissatisfaction which was expressed in some cases with
expletives, one prominent scholar told Reuters, declining to be named
because of the sensitivity of the issue.
To balance opposition to change within AAOIFI,
Fakih seems to want to involve the widest possible range of industry
interests in the debate; he called for "rigorous and meaningful
discussions...not only among scholars but also with all participants of
Islamic finance."
The genie out of a modern day bottle is the
first home purchase plan approved by the Financial Services Authority
(FSA) for the mainstream UK market, rather than a specialised market. It
demonstrates that the religious principles underlying Islamic products
are relevant in the ethical and social finance marketplace; that Islamic
principles can inspire and enhance the finance products being developed
to meet these challenging times in the residential domestic market.
Natalie Elphicke, head of structured housing finance, partner,
international law firm Stephenson Harwood gives her take on the
application of Shari’a principles to ethically-charged social housing
and the investment opportunities that arise from it.
Risk sharing, not profiting unjustly or
unfairly, not charging excessive charges; in a residential purchase
context, allowing part rent, part purchase, sharing equity upside,
sharing downside property risks. These characteristics apply equally to
an approved Islamic home finance plan as they do to a new conventional
purchase plan designed for a housing association in the north east of
England.
What does this matter? For many years it has
been felt that Western finance constructs have been squeezed and shaped
to meet the requirements of the fatwa (approval) for Islamic finance.
One result of this has been an understandable reluctance to provide an
Islamic checklist to those structured financiers who specialise in
dressing a product to fit a market, rather than perhaps understanding
and applying the underlying intentions and principles. The desire to
conform to those Islamic standards is being driven by a desire to access
a rich seam of devout consumers prepared to pay a premium for
compliance, and to harness rich Islamic investment funds, rather than
shape and deliver products or investments which enhance and develop the
lives of Muslims within their beliefs and philosophy.
The tide is turning. In ethical and social
investment arenas there is significant interest in three areas of
Islamic finance: Ijara, Musharaka and Mudaraba. Musharaka is the basis
for property transactions which allow shared equity participation within
a trust holding, providing much more flexibility to manage changes in
lifestyle and more fairly share market rises and falls in residential
property over a longer period of time. This can provide a much more
transparent and fairer approach than Western style 100% mortgage finance
or the more limited traditional shared ownership structures.
There are similarities between partnership
finance structures of Mudaraba, and ljara leases. In the former, some
people provide labour and others money, in a plethora of 'Big Society'
style co-operatives and social enterprises, bringing together those who
work, and give their 'sweat equity'. Then there are those who provide
funding and those who share in a financial loss/gain Ijara- based
lease-purchase contracts, which can offer a fairer sort of hire-and
hire-purchase arrangement of equipment, such as washing machines and
other household appliances.
If there is an interest from ethical and social
residential property to engage with and be inspired by Islamic based
principles, how interested are Islamic funds in residential property,
especially student, affordable or social housing?
The evidence is mixed. There is also anecdotal
evidence of a tightening of conditions for investment funding to reflect
wider, purposive beliefs of Islamic funds. One such interesting example
is the financing of student halls of residence. The usual student bar
and pool table on the ground floor is being replaced by a coffee bar,
with a restrictive covenant on the space becoming licensed, as a
condition to access to that investment funding.
Housing associations have started dialogues
with Islamic funds which have financed other UK core infrastructure and
utilities, such as ports and airports, water and electricity. Social
housing can offer a solid investment yield. Not racy but solid and
responsible, reflecting the core values of a mature residential
regulated housing industry worth around £100bn.
Continued in article
Derivative deals done using a unique Spot/Spot commodity trading mechanism,
which is fully compliant with Islamic Sharia principles ---
http://www.ameinfo.com/100675.html
Recent events, from the start of Ramadan, to the
Pope’s controversial remarks about Islam, to the discovery of a new tape by
two of the September 11 attackers, to the release of Bob Woodward’s latest
book, have once more made Islam a topic of conversation. Beyond the
headlines, however, exists a complex religious and social system that
affects far more people than just Muslims. Islamic finance, particularly
Islamic banking, insurance and accounting, is playing a growing role around
the globe, especially in the business world.
Islamic accounting is generally defined as an alternative accounting system
which aims to provide users with information enabling them to operate
businesses and organizations according to Shariah, or Islamic law. With
little doubt, the greatest challenges to Islamic accounting and finance in
the United States stem from a lack of knowledge and understanding of Islam
and the intricacies of its financial laws and concerns regarding terrorism,
combined with the U.S. regulatory framework and guiding principles of
American business. The Muslim and Islamic financial markets within the U.S.
and around the world, currently represent an enormous opportunity for those
willing to overcome these challenges.
Islam & Islamic Financial Laws
“To professional accountants who have been
brought-up on the idea of accounting as an ‘objective’, technical and
value-free discipline, the idea of attaching a religious adjective to
accounting may seem embarrassing, unprofessional and even dangerous,” Dr.
Shahul Hameed bin Mohamed Ibrahim says in Islamic Accounting – A Primer.
Both conventional and Islamic accounting provide
information and define how that information is measured, valued, recorded
and communicated. Conventional accounting provides information about
economic events and transactions, measuring resources in terms of assets and
liabilities, and communicating that information through financial statements
users, typically investors, rely on to make decisions regarding their
investments. Islamic accounting, however, identifies socio-economic events
and transactions measured in both financial and non-financial terms and the
information is used to ensure Islamic organizations of all types adhere to
Shariah and achieve the socio-economic objectives promoted by Islam. This is
not to say, or imply, Islamic accounting is not concerned with money, rather
it is not concerned only with money.
Islamic accounting, in many ways, is more holistic.
Shariah prohibits interest-based income or usury and also gambling, so part
of what Islamic accounting does is help ensure companies do not harm others
while making money and achieve an equitable allocation and distribution of
wealth, not just among shareholders of a specific corporation but also among
society in general. Of course, as with conventional accounting, this is not
always achieved in practice, as an examination of the wide variances in
wealth among the populations of Arab nations, particularly those with
majority Muslim populations shows.
In addition, because a significant part of
operating within Shariah means delivering on Islam’s socio-economic
objectives, Islamic organizations have far wider interests and engage in
more diverse activities than their non-Islamic counterparts.
Concerns About Terrorism
The diverse activities and interests organizations
pursue under Shariah is a cause for concern when applying conventional
accounting to Islamic organizations. After all, conventional accounting can
be used to disguise unethical and even illegal activities within the very
organizations they were intended to provide information about. Imagine how
easy it is to overlook or just not identify such information when employing
an accounting system not designed for use with the type of organization it
is being applied to.
In the past, the issues raised by this mismatch
focused on the ability of users beyond the Muslim world to make appropriate
decisions regarding investments. Since September 11, 2001, however, the
concern has changed from the potential loss of investment to the possibility
of supporting terrorism.
This concern is particularly significant for
non-profit organizations involved in providing humanitarian relief outside
the U.S.. Fortunately, the U.S. Department of the Treasury (DoT) has issued
updated Anti-Terrorist Financing Guidelines: Voluntary Best Practices for
U.S.-based Charities (Guidelines).
“The abuse of charities by terrorist organizations
is a serious and urgent matter, and the Guidelines reinforce the need
for the U.S. Government and the charitable sector alike, to keep this
challenge at the forefront of our complementary efforts,” Pat O’Brien,
Assistant Secretary for the Treasury’s Office of Terrorist Financing and
Financial Crime, said in a statement announcing the updated guidelines. The
Treasury Department is committed to protecting and enabling legitimate and
vital charity worldwide, and will continue to work with the sector to
advance our mutual goals.”
The Guidelines urge charities to take a
proactive, risk-based approach to protecting against illicit abuse and are
intended to be applied by those charities vulnerable to such abuse, in a
manner commensurate with the risks they face and the resources with which
they work. At the request of the charitable sector, the Guidelines
contain extensive anti-terrorist financing guidance, as well as guidance on
sound governance and financial practices that helps prevent the exploitation
of charities.
Regulatory Issues
The regulatory environment Islamic individuals and
organizations are most concerned with, considering the current political
climate, are those relating to anti-terrorism and anti-money laundering. Yet
the tensions arising from regulatory requirements within the U.S. related to
American business practices often prove more difficult to resolve.
It is in trying to balance the expectations of
distinct business cultures that the differences between conventional and
Islamic accounting are most notable. For instance, depending upon the type
of transactions the organizations are engaged in, the roles,
responsibilities and rights assigned to each party can be contradictory and
even in direct conflict. In some situations, such as transactions involving
private equity, venture capital, profit sharing and liquidations,
organizations and individuals employing conventional accounting may actually
find they prefer Islamic accounting. Other issues, such as those related to
taxation, require significant effort to resolve. The inherent flexibility of
Shariah is a benefit under these circumstances, since the complexity of the
American tax code is highly inflexible.
The number of Muslim consumers, investors and
business owners has grown along with the Muslim American population which is
currently estimated to be between six and seven million. Although demand for
Islamic financial products and services has increased, both the supply and
the number of providers remain insufficient. It should also be noted that
Islamic orthodoxy, expressed as the desire to implement Shariah as the sole
legal foundation of a nation, is actually associated with progressive
economic principles, including increasing government for the poor, reducing
income inequality and increasing government ownership of industries and
industries, especially in the poorer nations of the Muslim world.
“While it is common to associate traditional
religious beliefs with conservative political stances on a wide range of
issues, this is only partly true,” said Robert V. Robinson, Chancellor’s
Professor and chair of Indiana University’s Department of Sociology. “The
Islamic orthodox are more conservative on issues having to do with gender,
sexuality and the family, but more liberal or left on economic issues.
The Islamic Accounting Website is a project of the
Department of Accounting, Kulliyah of Economics and Management Sciences,
International Islamic University Malaysia, Kuala Lumpur. This project is
under the direction of Dr. Shahul Hameed bin Mohamed Ibrahim, Assistant
Professor and the current Head of the Department. The philosophy of the
University is to Islamize knowledge to solve the crisis in Muslim thinking
brought about by the secularization of knowledge and furthermore
contributing as a centre of educational excellence to revive the dynamism of
the Muslim Ummah in knowledge, learning and the professions. The Department
of Accounting is fully committed to this vision and strives to Islamicise
Accounting.
TO SEE Islamic
finance in action, visit the mutating coastline of the Gulf. Diggers claw
sand out of the sea off Manama, Bahrain’s capital, for a series of
waterfront developments that are part-funded by Islamic instruments. To the
east, Nakheel, a developer that issued the world’s largest Islamic bond (or
sukuk) in 2006, is using the money to reorganise the shoreline of
Dubai into a mosaic of man-made islands.
Finance is
undertaking some Islamic construction of its own. Islamic banks are opening
their doors across the Gulf and a new platform for sharia-compliant
hedge funds has attracted names such as BlackRock. Western law firms and
banks, always quick to sniff out new business, are beefing up their
Islamic-finance teams.
Governments are
taking notice too. In July Indonesia, the most populous Muslim country, said
it would issue the nation’s first sukuk. The British government,
which covets a position as the West’s leading centre for Islamic finance, is
also edging towards issuing a short-term sovereign sukuk. France
has begun its own charm offensive aimed at Islamic investors.
Set against ailing
Western markets such vigour looks impressive. The oil-fuelled liquidity that
has pumped up Middle Eastern sovereign-wealth funds is also buoying demand
for Islamic finance. Compared with the ethics of some American subprime
lending, Islamic finance seems virtuous as well as vigorous. It frowns on
speculation and applauds risk-sharing, even if some wonder whether the
industry is really doing anything more than mimicking conventional finance
and, more profoundly, if it is strictly necessary under Islam (see
article).
Sukuks in the souk
As the buzz around
the industry grows, so do expectations. The amount of Islamic assets under
management stands at around $700 billion, according to the Islamic Financial
Services Board, an industry body. Standard & Poor’s, a rating agency, thinks
that the industry could control $4 trillion of assets. Others go further,
pointing out that Muslims account for 20% of the world’s population, but
Islamic finance for less than 1% of its financial instruments—that gap, they
say, represents a big opportunity. With tongue partly in cheek, some say
that Islamic finance should by rights displace conventional finance
altogether. Western finance cannot service capital that wants to find a
sharia-compliant home; but Islamic finance can satisfy everyone.
Confidence is one
thing, hyperbole another. The industry remains minute on many measures: its
total assets roughly match those of Lloyds TSB, Britain’s fifth-largest bank
(though some firms that meet sharia-compliant criteria may attract
Islamic investors without realising it). The assets managed by Islamic rules
are growing at 10-15% annually—not to be sniffed at, but underwhelming for
an industry that attracts so much attention. Most of all, the industry’s
expansion is tempered by its need to address the tensions between its two
purposes: to serve God and to make as much money as it can.
That is a stiff
test. A few devout Muslims, many of them in Saudi Arabia, will pay what Paul
Homsy of Crescent Asset Management calls a “piety premium” to satisfy
sharia. But research into the investment preferences of Muslims shows
that most of them want products that benefit their savings, as well as their
souls—rather as ethical investors in the West want funds that do no harm,
but are also at least as profitable as other investments.
A combination of
ingenuity and persistence has enabled Islamic finance to conquer some of the
main obstacles. Take transaction costs which tend to be higher in complex
Islamic instruments than in more straightforward conventional ones.
Sharia-compliant mortgages are typically structured so that the lender
itself buys the property and then leases it out to the borrower at a price
that combines a rental charge and a capital payment. At the end of the
mortgage term, when the price of the property has been fully repaid, the
house is transferred to the borrower. That additional complexity does not
just add to the direct costs of the transaction, but can also fall foul of
legal hurdles. Since the property changes hands twice in the transaction, an
Islamic mortgage is theoretically liable to double stamp duty. Britain
ironed out this kink in 2003 but it remains one of the few countries to have
done so.
However, just as
in conventional finance, as more transactions take place the economies of
scale mean that the cost of each one rapidly falls. Financiers can recycle
documentation rather than drawing it up from scratch. The contracts they now
use for sharia-compliant mortgages in America draw on templates
originally drafted at great cost for aircraft leases.
Islamic financiers
can also streamline their processes. When Barclays Capital and Shariah
Capital, a consultancy, developed the new hedge-fund platform, they had to
screen the funds’ portfolios to make sure that the shares they pick are
sharia-compliant. That sounds as if it should be an additional cost,
but prime brokers already screen hedge funds to make sure that risk
concentrations do not build up. The checks they make for their Islamic hedge
funds can piggyback on the checks they make for their conventional hedge
funds.
Mohammed Amin of
PricewaterhouseCoopers, a consulting firm, says the extra transaction costs
for a commonly used Islamic financing instrument, called commodity
murabaha, total about $50 for every $1m of business. That is small
enough to be recouped through efficiencies in other areas, or to be absorbed
in lenders’ profit margins. In addition, bankers privately admit that less
competition helps keep margins higher than in conventional finance.
“Conceptually, Islamic finance should cost more, as it involves more
transactions,” says Mr Amin. “The actual cost is tiny and can be lost in the
wash.”
The other area of
substantive development has been in redefining sharia-compliance.
New products require scholars to cast sharia in fresh, and
occasionally uncomfortable, directions. Some investors express surprise at
the very idea of Islamic hedge funds, for example, because of prohibitions
in sharia on selling something that an investor does not actually
own.
“You encounter a
wall of scepticism whenever you do something new,” says Eric Meyer of
Shariah Capital. “It is no different in Islamic finance.” He says that it
took eight long years to bring his idea of an Islamic hedge-fund platform to
fruition, applying a technique called arboon to ensure that
investors, in effect, take an equity position in shares before they sell
them short. Industry insiders describe an iterative process, in which
scholars, lawyers and bankers work together to understand new instruments
and adapt them to the requirements of sharia.
Differences in interpretation of sharia between countries can
still hinder the economies of scale. Moreover, the scholars can sometimes
push back. Earlier this year, the chairman of the Accounting and Auditing
Organisation for Islamic Financial Institutions (AAOIFI), an industry body,
excited controversy by criticising a common form of sukuk issuance that
guarantees the price at which the issuer will buy back the asset
underpinning the transaction, thereby enabling investors’ capital to be
repaid. Such behaviour contravened an AAOIFI standard demanding that assets
be bought back at market prices, in line with the sharia principle of
risk-sharing. The sukuk market has enjoyed years of rapid growth (see
chart), but early signs are that the AAOIFI judgment has dented demand.
Although Islamic finance has done well to reduce its costs and
broaden its product range, it has yet to clear plenty of other hurdles.
Scholars are the industry’s central figures, but recognised ones are in
short supply. A small cadre of 15-20 scholars repeatedly crops up on the
boards of Islamic banks that do international business. That partly reflects
the role, which demands a knowledge of Islamic law and Western finance, as
well as fluency in Arabic and English. It also reflects the comfort that
this handful of recognised names brings to investors and customers.
There are plenty of initiatives to nurture more scholars but for
the moment, the stars are pressed for time. That can be a problem when banks
are chasing their verdict on bespoke transactions. It takes a scholar about
a day to wade through the documentation connected with a sukuk issue, for
example. But scholars are not always immediately available. “You’ve got to
have the scholar’s number programmed into your mobile phone and be able to
get hold of them,” says a banker in the Gulf. “That is real competitive
advantage.”
Assets are another bottleneck. The ban on speculation means that
Islamic transactions must be based on tangible assets, such as commodities,
buildings or land. Observers say that exotic derivatives in intangibles such
as weather or terrorism risk could not have an Islamic equivalent. But in
the Middle East, at least, the supply of assets is limited. “Lots of
companies in the Gulf are young and don’t have assets such as buildings to
use in transactions,” says Geert Bossuyt of Deutsche Bank. This limits the
scope for securitisation, a modern financing technique that is backed by
assets and is thus seen by sharia scholars as authentically Islamic. There
are not enough properties to bundle into securities.
Governments have more assets to play with. The Indonesians have
approved the use of up to $2 billion of property owned by the finance
ministry in their planned sukuk issuance later this year. But oil-rich
governments in the Gulf have little need to issue debt when they are flush
with cash. That is a problem. Sovereign debt would establish benchmarks off
which other issues can be priced. It would also add to the depth of the
market, which would help solve another difficulty: liquidity.
It may seem odd to worry about liquidity when lots of Muslim
countries are flush with cash, but many in Islamic finance put liquidity at
the top of their watchlist. The chief concern is the mismatch between the
duration of banks’ liabilities and their assets. The banks struggle to raise
long-term debt. In a youthful industry, their credit histories are often
limited; they also lack the sort of inventory of assets that corporate sukuk
issuers have.
Desert liquidity
As a result, Islamic banks depend on short-term deposit funding,
which, as Western banks know all too well, can disappear very rapidly. “Lots
of assets are generally of longer term than most deposits,” says Khairul
Nizam of AAOIFI. “Banks have to manage this funding gap carefully.” If there
were a liquidity freeze like the one that struck Western banks a year ago,
insiders say that the damage among Islamic banks would be greater.
There are initiatives to develop a sharia-compliant repo market
but for the time being the banks have only limited scope for getting hold of
money fast. Loans and investments roll over slowly. The lack of sharia-compliant
assets and a tendency for Islamic investors to buy and hold their
investments have stunted the secondary market. The shortest-term
money-management instruments available today are inflexible. Cash reserves
are high, but inefficient. Western banks with Islamic finance units, or
“windows”, are just as troubled by tight liquidity as purely Islamic
institutions are: their sharia-compliant status requires them to hold assets
and raise funds separately from their parent banks.
There are other sources of danger, too. Because Islamic banks
face constraints on the availability and type of instruments they can invest
in, their balance-sheets may concentrate risk more than those of
conventional banks do. The industry’s ability to steer its way through
stormy waters is largely untested, although Malaysian banks do have memories
of the Asian financial crisis in the 1990s to draw on.
None of these tensions need derail the growth of Islamic finance
just yet. There is plenty of demand, whether from oil-rich investors, the
faithful Muslim minorities in Western countries or the emerging middle
classes in Muslim ones. There is lots of supply, in the form of
infrastructure projects that need to be financed, Western borrowers looking
for capital and ambitious rulers eager to set up their own Islamic-finance
hubs. The industry is innovative; new products keep expanding the range of
sharia-compliant instruments. And as in conventional finance, the economics
of the Islamic kind improve as it gains scale.
But further growth itself contains a threat. The AAOIFI ruling on
sukuk earlier this year neatly captured the contradictory pressures on the
industry. On the one hand, bankers are worried that the narrow enforcement
of sharia standards is liable to stifle growth; on the other some observers
fear that Islamic finance is becoming so keen to drum up business that its
products, with all their ingenuity, are designed to evade strict sharia
standards. This presents a dilemma. If the industry introduces too many new
products, cynics will argue that sharia is being twisted for economic
ends—the scholars are being paid for their services, after all. But if it
fails to innovate, the industry may look too medieval to play a full part in
modern finance.
Balancing these imperatives will become even harder as
competition grows fiercer. Anouar Hassoune of Moody’s, a credit-rating
agency, believes that unscrupulous newcomers could harm the reputation of
the entire industry, “like the space shuttle undone by something the size of
a 50 cent coin”. Islamic finance serves two masters: faith and economics.
The success of the industry depends on satisfying both, even if the price of
that is a bit more inefficiency and a bit less growth.
The Islamic finance industry has often
battled with the question: How Islamic is Islamic banking?
The question's pertinence was raised in March
last year, when Sheikh Muhammad Taqi Usmani, of the Accounting and
Auditing Organization for Islamic Finance Institutions (AAOIFI), a
Bahrain-based regulatory institution that sets standards for the global
industry, said that 85% of Sukuk, or Islamic bonds, were un-Islamic.
Usmani is the granddaddy of modern-day Islamic
finance, so having him make this statement is synonymous with Adam Smith
saying that free-markets are inefficient.
Because Sukuk underpin the modern-day Islamic
financial system, one of its pre-eminent proponents arguing that the
epicentre of the system was flawed sent shockwaves through the industry.
It also gave ammunition to the many critics who
see Islamic finance as an industry more driven by cultural identity than
practical problem solving: as a hodgepodge of incoherent, incomplete,
impractical and irrelevant ideas.
Recognisable products
The products that modern-day Islamic bankers
have created are very similar to conventional products.
This immediately creates a problem for Islamic
banks, as conventional banks charge borrowers an interest rate through
which they can reward their depositors and make some profit for being
the broker.
With interest ruled out it is harder to make
money.
The modern Islamic banker has found a way
around this prohibition, however.
As in many Islamic products, the bank enters a
partnership with its depositors and invests his money in a Sharia
compliant business.
The profit from this investment is then shared
between the depositor and the bank after a set time.
In many cases this "profit rate" is competitive
with the conventional banking system's interest rate for savers.
Lease agreements
Alternatively, an Islamic banker might enter
into a lease agreement for a car or a house with an individual.
The bank would buy a vehicle outright and then
lease it back to the person who wanted it, over a time period that would
ensure that the capital was repaid and the bank made a profit.
Alternatively the bank would enter into a
partnership with a person wanting to buy a house. The bank would buy 70%
of the house, the individual 30%.
The bank then rents its share of the house back
to the individual until the house is fully paid for.
The bank makes a profit on the rent, which
would be higher than equivalent rents in the area, but on an annualised
percentage basis, would look very much like a conventional mortgage
interest rate.
To the casual observer, a spade is a spade.
Whether the product is dressed up in Arabic
terminology, such as Mudarabah, or Ijarah, if it looks and feels like a
mortgage, it is a mortgage and to say anything else is semantics.
Sophisticated finance
The potential wealth locked up in oil-rich Gulf
states encouraged the conventional banks to enter Islamic finance.
HSBC established the Amanah Islamic Finance
brand in 1998 and Deutsche Bank, Citi, UBS and Barclays quickly joined
the fray, all offering interest-free products for wealthy Arabs.
However, this new generation of Islamic bankers
had cut their teeth in the City and Wall Street, and were used to
creating sophisticated financial products.
They often bumped heads with the Sharia
scholars who authorised their products as Sharia compliant.
However, these bankers had a way of dealing
with this, as one investment banker based in Dubai, working for a major
Western financial organisation explains:
"We create the same type of products that we do
for the conventional markets. We then phone up a Sharia scholar for a
Fatwa [seal of approval, confirming the product is Shari'ah compliant].
"If he doesn't give it to us, we phone up
another scholar, offer him a sum of money for his services and ask him
for a Fatwa. We do this until we get Sharia compliance. Then we are free
to distribute the product as Islamic."
No consensus
This "Fatwa shopping", which was carried out by
some institutions, brings us back to the Sharia scholars.
Even these scholars do not agree all the time,
which means that in some cases a product is deemed Sharia compliant in
one market and not in another.
This is especially the case with Malaysian
products, which are often deemed not Sharia complaint in the more
austere Gulf.
"Often no rulings exist for modern day
problems, such as use of narcotics," Alamad explains.
"In Islam intoxication by wine is forbidden,
but at the time of the Prophet Mohammed there was no crack cocaine."
Modern scholars had to interpret the rules on
intoxication, and the consensus was that crack should also be forbidden
to Muslims, as it is a dangerous intoxicant.
"This is how we make rulings, whether in
finance or societal," Alamad says. "The consensus rules, which usually
will become mandatory for all Muslims to follow, but there are some
opinions and sometimes scholars are not in the consensus."
Banking is banking
This makes it more important to be in the
consensus, and so getting a favourable ruling from a leading Sharia
scholar is important for a product manager.
That is why the top scholars can earn so much
money - often six-figure sums for each ruling.
The most creative scholars are the ones in the
most demand, says Tarek El Diwany, analyst at London-based Islamic
financial consultancy Zest Advisory.
"To date, most Islamic financiers have been
looking at examples of financing in Islamic history and figuring out how
to apply them Go today's financial products."
Alternative (conventional accounting) rules may, for
the individual citizen, mean the difference between employment and unemployment,
reliable products and dangerous ones, enriching experiences and oppressive ones,
stimulating work environments and dehumanising ones, care and compassion for the
old and sick versus intolerance and resentment.
Tony Tinker, 1985
Financial Reporting should provide information that
is useful to present and potential investors and creditors and other users in
making rational investment, credit and similar decisions ...(through the
provision of information that will help them to assess)..... the amount, timing
and uncertainty of net cash inflows to the related enterprise
FASB Concept Number 1 of the Conceptual Framework, 1978
The
SEC has been one of the most prominent
and well-respected of federal agencies
during most of its history. Strict
adherence to a focused mission on
disclosure in regards to the regulation
of financial reporting by public
companies has been its trademark.
Having said that, however, the SEC has
been far from pristine in implementing a
disclosure-only policy. Certain actions
could be characterized by some as a form
of “merit regulation”—some companies may
have been unfairly subject to undue
scrutiny, and others may have received
an undeserved pass. The SEC has also
used its broad powers to make rules
requiring added disclosures in some
circumstances, and allowing abbreviated
disclosures in others. For example, the
SEC has added disclosure requirements to
the offering documents of “blank check”
companies, and also provided disclosure
accommodations to smaller and foreign
companies.
But, if some were to criticize the SEC
for merit regulation, cavils of this
sort are on the fringes of SEC
activity. And, most important to the
criticisms I'm fixin' to deliver, they
all relate to the regulatory activities
concerning disclosures by
companies to the SEC. But now, an SEC
official -- the chair, no less -- has
seen fit to make gratuitous disclosures
for certain
public companies.
Here's the situation. Last Tuesday
(March 11, 2008), SEC Chair Christopher
Cox made the following statement to
reporters: "We have a good deal of
comfort about the capital cushions that
these firms [the five largest investment
banks, which included Bear Stearns] have
been on." (http://www.cnbc.com/id/23576630)
At the time,
Bear's stock was at $60, a five-year
low, and just the day before, Bear
issued a press release denying rumors of
liquidity problems. The stock tumbled
to $30 early Friday, and over the
weekend, JP Morgan struck a deal to buy
Bear Stearns for a paltry $2 per share.
(For reasons I don't want to cover here,
the current market price as I write this
is around $5 per share.)
It's a serious thing that investors may
have relied on false and misleading
information issued by
Bear Stearns, but it is quite another
for the SEC to have issued information
for Bear
Stearns. (I am trying to making a
principled statement here, so that fact
that investors who relied on that
information got taken to the cleaners is
notable, though not the sole basis of my
critique.) Heretofore, a company either
complies with the disclosure rules, or
it doesn’t; the SEC doesn’t make
congratulatory announcements for
companies it finds to have been
exemplary compliers, disclosers, or what
have you. But if you fail to comply,
then that’s when the SEC will tell the
world about you; there are thousands of
examples of the consistent
implementation of this policy.
I imagine that Cox would defend himself
on the basis that the SEC is in a
curious position with respect to
companies like Bear Stearns. One of the
many jobs given to the SEC by Congress
is to monitor the “capital adequacy” of
broker-dealers. The objective is to
provide a form of protection for the
assets of clients who have deposited
cash and securities with
broker-dealers. Thus, the SEC is
serving two masters, having very
different interests in Bear Stearns:
clients and shareholders.
When Cox chose to speak about Bear
Stearns last Tuesday, both groups of
Bear Stearns stakeholders were
listening, and at least some in each
group responded with diametrically
opposite courses of action:
• Some clients of Bear may have
been calmed, but too many disregarded
Cox’s assurances, took their money and
ran;
•
Some investors on the verge of selling
their shares had a change of mind -- and
some may have even bought stock based on
his assurances.
Cox should have known that he was
unavoidably sending a signal of
encouragement to jittery investors who
were trying to decide whether or not to
buy, hold, or sell shares of Bear
Stearns. If SEC history is any guide,
it was simply not appropriate for him to
have done so. Just as a real estate
agent cannot claim to represent parties
on both sides of a transaction, the SEC
cannot claim to be "the investor's
advocate" at the same moment they are
functioning as the public relations
spokesperson for the investee. It would
have been far better to have left the
public relations role to other
government officials.
The question of how much SEC credibility
has been lost is difficult for me to
judge. Assuming this were an isolated
instance, it would be significant. But
seen as the latest in a series of
questionable actions reflecting the
SEC's stance on investor protection, the
Bear Stearns case is just more
confirming evidence of an altered SEC
culture. I am sad to say that the
process of restoring credibility to a
once peerless agency cannot begin until
there is a new chair.
Jensen Comment
As pointed out above, Islamic accounting is really in the realm of social
accounting by whatever name you want to call it. It is primarily concerned with
accounting for all constituencies without investors and creditors necessarily
being the primary constituencies. Certainly investors and creditors must provide
capital. But employees must provide their labor, customers must purchase
outputs, suppliers must provide the inputs, and society must provide an
environment within which all constituencies are to flourish.
See
http://en.wikipedia.org/wiki/Social_Responsibility
Also see
http://en.wikipedia.org/wiki/AccountAbility_%28Institute_of_Social_and_Ethical_AccountAbility%29
The problem with Islamic accounting is that it has never delved
deeply into the details of accounting for complex contracts of structured
financing, derivative financial instruments, hedging, collateralized debt,
convertible debt, and intangibles accounting. Hence it is not yet a place where
one goes for learning about such contracting and theories of accounting for such
contracts. It is naive to think such complex contracting should be banned in
Islam, because business leaders in Islam must manage risks and hedge just like
everybody else.
Among other things he says:
"So to sum up, this is what you need to know from the SEC's standpoint:
IFRS is coming. XBRL is coming. And mutual recognition is coming."
From this and many other recent activities at the SEC, FASB, Congress
and elsewhere, it appears that both IFRS and XBRL are nearer than some
might have imagined. And educators should be taking these developments
into consideration now, or may be left behind.
Denny Beresford
SEC releases new XBRL analytical tool XBRL US, Inc., the nonprofit consortium dedicated to
the adoption of XBRL (eXtensible Business Reporting Language), a technology
standard for the reporting of financial and business information in the U.S.,
strongly supports the Securities and Exchange Commission's launch of an online,
interactive tool that allows investors to instantly extract, compare, and
analyze executive compensation for the largest 500 companies in the United
States . . . This tool relies on the power of XBRL for the compensation data and
underscores the flexibility and usefulness of "tagged" data. The SEC
announcement comes a year after it adopted stricter rules on executive pay
disclosure that now require more detail in annual shareholder proxy statements.
The new application uses XBRL data created by the SEC and allows investors and
researchers to immediately create reports showing salary, bonus, stock awards,
option awards, non-equity incentive plan compensation, change in pension value,
and other compensation figures for executives at the top 500 companies.
"SEC releases new XBRL analytical tool," AccountingWeb, January 10, 2008
---
http://www.accountingweb.com/item/104442
1. Accounting rules need to be simplified. "The
accounting scandals that our nation and the world have now mostly
weathered were made possible in part by the sheer complexity of the
rules." "The sheer accretion of detail has, in time, led to one of the
system's weaknesses - its extreme complexity. Convolution is now
reducing its usefulness."
2. The concentration of auditing services in
the Big 4 "quadropoly" is bad for the securities markets. The SEC will
try to do more to encourage the use of medium size and smaller firms
that receive good inspection reports from the PCAOB.
3. The SEC will continue to push XBRL. "The
interactive data that this initiative will create will lead to vast
improvements in the quality, timeliness, and usefulness of information
that investors get about the companies they're investing in."
A very interesting talk - one that seems to
promise a high level of cooperation with the accounting profession.
XBRL is no longer something we only play with in academe. It is now
available to investors around the world, although it may take a while for
some companies to add the XBRL tags to their financial statements. Some
things that are now being done in XBRL such as time graphs and ratio graphs
can be done with things other than XBRL. What XBRL does, however, is make
it possible to:
(1) Compare different companies in a Web browser
(2)
Perform customized analyses if the XBRL statements are downloaded into
Excel
(3) Conduct easy searches that do not yield thousands of unwanted and
extraneous hits
Bob Jensen's New Video Tutorial on XBRL (about 30
minutes) It's the XBRLdemos2005.wmv file at
http://www.cs.trinity.edu/~rjensen/video/Tutorials/ But first read
the following and watch the KOSDAQ video before watching the above video.
Question
What are the two most significant events in the history of accounting,
financial reporting, and financial statement analysis?
Answers Double Entry Bookkeeping and
XBRL
The origins of double entry bookkeeping are unknown.
It goes back over 100 years before
Luca Pacioli
made it famous by
algebraically describing it in the world's first algebra book called
Summa written in 1494. Pacioli's basic equation A=L+E simply shows
how recorded asset values in total equal the double-entry sum of creditor
liabilities plus owner equities in those assets. For over 500 years
accounting disputes mainly lie in defining the A, L, and E concepts and
measuring them in financial statements. Pacioli gave us the algebra
without the crucial and operational definitions of terms. Bob Jensen's
brief summary of the history of accounting is at
http://faculty.trinity.edu/rjensen//theory/00overview/theory01.htm
XBRL stands for eXtensible Business Reporting Language in
XML that can now be interpreted by every Web browser such as Microsoft's
Internet Explorer. In the future, virtually every all academic
disciplines such as Chemistry, Physics, and History will probably develop
their own taxonomies for XML reporting on the Web.
Hence, we one day may have XCHEM, XPHYS, and XHIST
eXtensible reporting languages.
Whereas the famous HTML tags on data are not extensible and
are more or less fixed in scope and time, XML extensible meta-tags will
become the world's most popular way of creating customized "meta-tags" that
attach to virtually every piece of Web data and describe attributes of each
piece of data. The history of data tags and meta-tags is briefly
outlined at
http://faculty.trinity.edu/rjensen/XBRLandOLAP.htm
I also highly recommend the XBRL history and news site at XBRL headquarters
at http://www.xbrl.org/Home/
XBRL is a taxonomy for XML meta-tags to be placed on
virtually every number in a set of financial statements. For over a
decade, efforts have been made by huge companies and accounting firms to
develop standardized XBRL tags for key taxonomies in accounting. These
taxonomies may vary as to a particular set of accounting generally accepted
accounting principles (GAAP) such as International GAAP or US GAAP.
Once a company or user selects which GAAP taxonomy to use, it's financial
statements can be "marked up" with XBRL meta-tags that facilitate
comparative financial statement analysis. Users may also take any set
of financial statements and add tags for a chosen set of GAAP tags.
For example, see Drag and Tag from Rivet Corporation ---
http://www.rivetsoftware.com/
Also see
http://www.xbrl.org/eu/CEBS-3/Rivet_Industry Day_Brussels_14 Sept 2005.pdf
Because adding XBRL meta-tags to a given set of financial
statements is time consuming, most large companies are in the process of
adding these tags to their own financial data so that investors will not
have to do their own tagging. The major stock exchanges of the world
are now urging companies to send in their financial reports marked up in
XBRL. Soon they will require all listed companies to submit XBRL-tagged
financial statements.
Bob Jensen's Old XBRL Video Tutorial called XBRLdemos.wmf
About four years ago (I can't remember exactly when) I prepared a XBRL
tutorial on how to use XBRL in financial statement analysis. The
tutorial itself was actually developed by NASDAQ, Microsoft, and PwC in a
NMP partnership. NASDAQ selected 20 companies and marked up their
financial statements in XBRL. Microsoft wrote a fancy Excel program to
analyze those financial statements in Excel. PwC served up the data on
the Web. This NMP tutorial was intended to have a short life since the
plan was eventually to use XBRL directly in Web browsers without having to
use Excel. Indeed, PwC no longer serves up this tutorial. Bob
Jensen probably has the only recorded history of this NMP tutorial on video
in the file XBRLdemos.wfm at
http://www.cs.trinity.edu/~rjensen/video/Tutorials/
Bob Jensen's New 2005 XBRL Video Tutorial called
XBRLdemos2005.wmf XBRL is now marked up on many financial statements on the Web and can be
used for financial statement analysis in Web browsers. I found a set
of such statements for various (Star) companies on the Korean KOSDAQ stock
exchange homepage.
My new video is mainly a tutorial about how I learned to use
the XBRL financial statements made available by KOSDAQ for actual use by
investors in companies listed on the KOSDAQ stock exchange.
In particular, my new video shows how to perform the
following steps at the KOSDAQ site.
Go to http://km.krx.co.kr/
You do not have to install
the Korean language pack
Note that it may take some time for the upper menu to
appear
Click on the English button in the upper right corner
after the menu appears
Third
Go directly to
http://english.kosdaq.com/
Click on the "XBRL Service" on the right side of the
screen
Click on a company's logo (ignore any pop ups to
install a language pack)
If you do not see a graph on the left side of a
company's report,
click
on the button/instruction below the graph's border
After you see a graph,
click
on the various financial statement line items to the right
of the graph
(Your mouse pointer will now be a small bar
graph)
Go to the bottom of the page and click on
"Ratios"
If your pointer is still a small graph,
click
on the ratios that you want to see in the graph
Go to the bottom of the page and click on
"Comparison"
Options for comparisons are given (they are also
demonstrated in my video)
Go to the bottom of the page and read about the
Excel Analyzer
See what you can download if you really get
interested in the analysis options
I followed the instructions you plan to give
your students for Monday and found a few bugs you might want to know
about.
The Demos link at XBRL.org is not on the
home page. They need to know that this site requires them to navigate to
"Showcase" to find the Demo.
http://km.krx.co.kr/
selected English and then XBRL Services,
then chose the company. The graph is only available if you agree to
download and install additional software on your PC. If they do not have
administrator rights, this is not going to be an option for your
students. (say on college lab and classroom computers).
The company I selected, LG Micron, had an
obvious defect in the financial data being presented for this
demonstration. XBRL is clearly not going to minimize any human mistakes,
and the printed financials will still have to be carefully scrutinized
by management and the auditors. Do the math on the Trade Receivables at
Net. Demerits for any student who doesn't find the error. If you Go to
the bottom of the table and select "Get these financials in XBRL" you
may get an XML Parsing Error. This is probably a higher version of XMl
required, and again the student would need administrator rights to
upgrade the software or install patches and plug ins.
Regards,
Deborah Johnson
October 30, 2005 reply from Bob Jensen
Hi Deborah,
I agree with all your points and thank you for providing
some clarifications. With respect to needing administrative rights
to view the graphs (say on college lab computers and on classroom
computers), it behooves faculty to ask administrators to install the
software that can be downloaded free by clicking below the graph frame
for any company in the demo.
If students do not have administrative rights on a
college lab or classroom computer, I guess this makes my video tutorial
even more valuable since students can see what will happen if they try
this on their own computers where they automatically have administrative
rights.
Thanks,
Bob
From the Publisher of the AccountingWeb on June 19,
2008
Some friends of ours are currently on vacation in
Russia, which got me to thinking, "I wonder what it's like to be an
accountant in Russia?" I have no idea. It wasn't all that long ago that
International Financial Reporting Standards were adopted by the Russian
Finance Ministry, so it's probably been a rather challenging profession as
of late! If you have any first-hand knowledge of accounting in the Russian
Federation, please
e-mail me so we can
share it with AccountingWEB readers.
In the meantime, here are some key Russian facts:
Population: 142 million
Largest city (and capital): Moscow
Second largest city:
St. Petersburg
Size: the largest country in the world by more
than 2.5 million square miles
Ethnic groups:
Russian 79.8%,
Tatar 3.8%,
Ukrainian 2%,
other 14.4%
Russia now has offices of the
Big 4 accounting firms and maybe other Western CPA firms as well. One of my
former students accepted a transfer to the PwC office in Moscow. It proved
to be a fast-track to becoming a partner in PwC. Russian companies are
seeking equity investors throughout the world, and to do so they have to add
accounting assurances much like the other companies in the global economy
seek assurances.
Bob Jensen's threads on GAAP comparisons (with particular stress upon
derivative financial instruments accounting rules) are at
http://faculty.trinity.edu/rjensen/caseans/canada.htm
The above site also links to more general GAAP comparison guides between
nations.
More Detailed Differences
(Comparisons) between FASB and IASB Accounting Standards
2011 Update
"IFRS and US GAAP: Similarities and Differences" according to PwC
(2011 Edition)
http://www.pwc.com/us/en/issues/ifrs-reporting/publications/ifrs-and-us-gaap-similarities-and-differences.jhtml
Note the Download button!
Note that warnings are given throughout the document that the similarities and
differences mentioned in the booklet are not comprehensive of all similarities
and differences. The document is, however, a valuable addition to students of
FASB versus IASB standard differences and similarities.
It's not easy keeping track of what's changing and
how, but this publication can help. Changes for 2011 include:
Revised introduction reflecting the current
status, likely next steps, and what companies should be doing now (see page 2);
Updated convergence timeline, including
current proposed timing of exposure drafts, deliberations, comment
periods, and final standards
(see page 7);
More current analysis of the differences
between IFRS and US GAAP -- including an assessment of the impact
embodied within the differences
(starting on page 17); and
Details incorporating authoritative standards
and interpretive guidance issued through July 31, 2011
(throughout).
This continues to be one of PwC's most-read
publications, and we are confident the 2011 edition will further your
understanding of these issues and potential next steps.
For further exploration of the similarities and
differences between IFRS and US GAAP, please also visit our
IFRS Video Learning Center.
To request a hard copy of this publication, please contact your PwC
engagement team or
contact us.
Jensen Comment
My favorite comparison topics (Derivatives and Hedging) begin on Page 158
The booklet does a good job listing differences but, in my opinion, overly
downplays the importance of these differences. It may well be that IFRS is more
restrictive in some areas and less restrictive in other areas to a fault. This
is one topical area where IFRS becomes much too subjective such that comparisons
of derivatives and hedging activities under IFRS can defeat the main purpose of
"standards." The main purpose of an "accounting standard" is to lead to greater
comparability of inter-company financial statements. Boo on IFRS in this topical
area, especially when it comes to testing hedge effectiveness!
One key quotation is on Page 165
IFRS does not specifically discuss the methodology
of applying a critical-terms match in the level of detail included within
U.S. GAAP.
Then it goes yatta, yatta, yatta.
Jensen Comment
This is so typical of when IFRS fails to present the "same level of detail" and
more importantly fails to provide "implementation guidance" comparable with the
FASB's DIG implementation topics and illustrations.
I have a
huge beef with the lack of illustrations in IFRS versus the many illustrations
in U.S. GAAP.
I have a
huge beef with the lack of illustrations in IFRS versus the many illustrations
in U.S. GAAP.
I have a huge beef with the lack of illustrations in
IFRS versus the many illustrations in U.S. GAAP.
"Canadian regulator decides against allowing early adoption of recent
IFRSs by certain entities," IAS Plus, November 1, 2011 ---
http://www.iasplus.com/index.htm
. . .
In making its decision, the OSFI considered a
number of factors such as industry
consistency, OSFI policy positions on
accounting and capital, operational capacity and resource constraints of
Federally Regulated Entities (FREs), the ability to benefit from
improved standards arising from the financial crisis and the
notion of a level playing field with other
Canadian and international financial institutions.
OSFI concluded that FREs should not early adopt the following new or
amended IFRSs, but instead should adhere to their mandatory effective
dates:
Continued
Jensen Comment
The clients, auditors, and the AICPA clamoring that U.S. firms should be
able to voluntarily choose IFRS instead of U.S. GAAP even before it has not
been decided that IFRS will ever replace FASB standards seem to ignore the
problems that voluntary choice of IFRS might cause for investors and
analysts. The above reasoning by the OSFI makes sense to me.
But then outfits like the AICPA have a self-serving interest in earning
millions of dollars selling IFRS training courses and materials.
November 2, 2011 reply from Patricia Walters
Does that mean you oppose options to early adopt standards in
general, not just IFRSs?
Pat
November 2, 2011 reply from Bob Jensen
Hi Pat,
It's hard to say regarding early adoption of a particular national or
international standard, because there can be unique circumstances. For
example, FAS 123R simply altered how to make disclosures rather than
alter the disclosures themselves since employee option expenses had to
be disclosed before the FAS 123R adoption date. But even here early
adoption of FAS 123R by Company A versus late adoption by Company B made
simple comparisons of eps and P/E ratios between these companies less
easy.
There's a huge difference between early adoption of a particular
standard and early adoption of an entire system of standards like
switching from FASB accounting standards to IFRS.
I think the Canadian position of early adoption of IFRS is probably
correct because of the mess early adoption of IFRS makes with
comparisons of companies using different accounting standards and the
added costs of regulation of more than one set of standards. Also think
of the added burden placed upon the courts to adjudicate disputes when
differing sets of standards are being used.
Even though we allow IFRS for SEC registered foreign companies, I think
it would be a total mess for the SEC, the PCAOB, investors, analysts,
educators, trainers, auditing, and even the IRS (where tax and reporting
treatments must sometimes be reconciled) if our domestic corporations
could choose between FASB versus IASB standards.
There are hundreds of differences between FASB and IASB standards.
Allowing companies domestic companies to cherry pick which system they
choose before it is even known if there will ever be official
replacement of FASB standards by IASB standards would be very, very
confusing. What if there never is a decision to replace FASB standards?
Do want to simply allow companies to choose to bypass FASB standards at
their own discretion?
Of course, if information were costless it might be ideal to require
financial reporting where FASB and IASB outcomes are reconciled. But
clients and auditors generally contend that the cost of doing this
greatly exceeds benefits. And teaching financial accounting would become
exceedingly complicated if we had to teach two sets of standards on an
equal basis.
I would certainly hate to face a CPA examination that had nearly equal
coverage of both FASB and IASB standards simultaneously. I say this
especially after viewing the hundreds of pages of complicated
differences between the two standards systems.
"Global Finance Leaders Release Comprehensive Proposals to Strengthen the
Financial Industry and Financial Markets," Institute for International
Finance, July 17, 2008 ---
http://www.iif.com/press/press+75.php
The world’s leading financial services firms today
released a far-reaching report 1 detailing best practice reforms for the
industry. The report represents the global industry’s response to the
turmoil in financial markets that was triggered by the U.S. subprime
mortgage market crisis in mid-2007. Today’s 200-page report is published by
the Institute of International Finance, the association of leading financial
services firms with more than 380 members across the world. The report
proposes Principles of Conduct together with Best Practice Recommendations
on critical issues such as risk management, compensation policies, valuation
of assets, liquidity management, underwriting and the rating of structured
products as well as boosting transparency and disclosure
Deloitte's IFRS Global Office
has published a new
Comparison of International Financial Reporting
Standards and United States GAAP
(PDF 208k, 36 pages) as of 28
February 2007. While this comparison is
comprehensive, it does not attempt to capture all of
the differences that exist or that may be material
to a particular entity's financial statements. Our
focus is on differences that are commonly found in
practice. The significance of the differences
enumerated in this pubilcation – and others not
included – will vary with respect to individual
entities depending on such factors as the nature of
the entity's operations, the industry in which it
operates, and the accounting policy choices it has
made. We
are pleased to grant permission for accounting
educators and students to make copies for
educational purposes.
If you click on the Search tab and enter something like (IFRS AND China)
to compare IFRS with the domestic standards of a given nation ---
http://www.iasplus.com/index.htm
SERIOUS Doubts Over Proposed Changes to FAS 133 and IAS 39
The FASB proposes dubious changes in FAS 133 on Accounting for Derivative
Financial Instruments and Hedging Activities while the IASB is studying similar
changes in IAS 39. With the SEC currently sitting on the fence in deciding if
and when to replace FASB standards with IASB standards, I fully predict that IAS
39 will pretty much follow the revise FAS 133 as it did when IAS 39 was
initially adopted, although IAS 39 will continue to have wider coverage of
financial instruments in general whereas FAS 133 will narrowly focus on
derivative financial instruments and hedge accounting.
When the FASB initially signaled possible revisions for changing hedge
accounting rules in FAS 133, a wave of protests from industry hit the fan. The
article below is the response of Ira Kawaller who serves on the FASB's
Derivatives Implementation Group (DIG) and who is one of the leading consultants
on FAS 133 and hedging in general which is his where he has historic roots as a
PhD in economics ---
http://www.kawaller.com/about.shtml
Ira has written nearly 100 trade articles on FAS 133. I don't think he consults
on IAS 39. Ira's home page is at
http://www.kawaller.com/about.shtml
Ira also maintains a small hedge fund where he walks the talk about interest
rate hedging. However, I'm no expert on hedge funds and will not comment on any
particular hedge fund.
I might note in passing for enthusiasts of the new FASB Codification Database
for all FASB standards that FAS 133 coverage in the Codification database is
relatively sparse. Professionals and students in hedge accounting most likely
will have to connect back to original (non-codified) FASB literature. For
example, none of the wonderful illustrations in Appendices A and B of FAS 133
are codified. And the extremely helpful, albeit complicated, pronouncements of
the FASB's Derivatives Implementation Group (DIG) are excluded from the
Codification database ---
http://www.fasb.org/derivatives/
Most of the DIG pronouncements are included in context at
http://faculty.trinity.edu/rjensen/acct5341/speakers/133glosf.htm
I will never have a lot of respect for the Codification database until it
includes much, much more on FAS 133.
Below is a publication in which Dr. Kawaller presents serious doubts
regarding revisions to FAS 133 that the FASB is now considering (and the IASB is
now considering for IAS 39).
The problem is even more severe for entities
with fixed-rate exposures. In this case, there’s a clear disconnect between what
swaps are designed to do versus what the FASB requires for hedge accounting.
"Paved With Good Intentions: The Road to Better
Accounting for Hedges," The CPA Journal, August 2009 ---
http://www.kawaller.com/pdf/CPA_Paved_w_Good_Intent_Aug_2009.pdf
With 10 years of experience under the current
regime of accounting for derivative contracts and hedging transactions, the
FASB has determined that it’s time to make some adjustments. Accountants
should be wary of the changes. Besides affecting the accounting procedure
relating to these instruments and activities, the proposed changes may also
seriously impact the manner in which certain derivative hedges are
structured— particularly in connection with interest rate risk management
activities.
Accounting rules for derivatives and hedging
transactions were put forth by the FASB in SFAS 133, Accounting for
Derivative Instruments and Hedging Activities. This standard was initially
issued in June 1998. It has been amended twice since then, with relatively
minor adjustments, but in 2008 the FASB issued a more substantive exposure
draft with significant proposed changes. Although the comment period on this
exposure draft is over, the project appears to be in limbo. Proposed changes
have neither been accepted nor rejected. Further adjustments are likely to
be made as the FASB moves to harmonize U.S. accounting guidance with
International Financial Reporting Standards (IFRS). When attention turns to
derivatives, this latest exposure draft could very likely serve as a
starting point. The prospective decisions about the accounting treatment for
these derivatives could have a profound impact on the structure and
composition of derivatives transactions
The Current Standard SFAS 133 has long been
recognized as one of the most complicated accounting standards the FASB has
ever issued. A core principle of this standard is that derivative
instruments must be recognized on the balance sheet as assets or liabilities
at their fair market value. The critical issue, then, is the question of how
to handle gains or losses. Should they be reported in current income or
elsewhere? Ultimately, SFAS 133 ended up providing different answers for
different situations. The “normal” treatment simply requires gains and
losses recognized in earnings. This treatment, however, is often problematic
for companies that use derivatives for hedging purposes. For such entities,
the preferred treatment would recognize gains or losses of derivatives
concurrently with the earnings impacts of the items being hedged. The normal
accounting treatment generally won’t yield this desired result, but the
alternative “hedge accounting” will.
For purposes of this discussion, attention is
restricted to the two primary hedge accounting types: cash flow and fair
value. For cash flow hedges, the exposure being hedged (i.e., the hedged
item) must be an uncertain cash flow, forecasted to occur in a later time
period. In these cases, effective gains or losses on derivatives are
originally recorded in other comprehensive income (OCI) and later
reclassified from OCI to earnings when the hedged item generates its
earnings impact. Ineffective results are recorded directly in earnings. In
essence, this accounting treatment serves to defer the derivatives’ gains or
losses—but only for the portion of the derivatives’ results that are deemed
to be effective—thus pairing the earnings recognition for the derivative and
the hedged item in a later accounting period.
Continued in article
Bob Jensen and Tom Selling have been having an active, to say the least,
exchange over hedge accounting where Tom Selling advocates elimination of all
hedge accounting (by carrying all derivatives at fair value with changes in
value being posted to current earnings). Bob Jensen thinks this is absurd,
especially for derivatives that hedge unbooked transactions such as forecasted
transactions or unbooked purchase contracts for commodities. Not having hedge
accounting causes asymmetric distortions of earnings where the changes in value
of the hedging contracts cannot be offset by changes in value of the (unbooked)
hedged items. You can read more about our exchanges under the terms "Insurance
Contracts" at
http://faculty.trinity.edu/rjensen/acct5341/speakers/133glosf.htm#I-Terms
Scroll down to "Insurance Contracts"
While the push toward merged accounting standards
has gained considerable momentum in recent months, finance chiefs may not
need to start boning up on principles-based accounting—yet. In fact,
Securities and Exchange Commission chairman Christopher Cox stated last week
that U.S. generally accepted accounting principles (GAAP) aren’t going away
anytime soon.
Speaking at an American Institute of Certified
Public Accountants conference, Mr. Cox said the Financial Accounting
Standards Board will not be replaced for many years. He said that the
current push merely aims to converge U.S. accounting standards with
international ones. “I worry that people think there is something imminent
here,” he said. “U.S. GAAP is deeply entrenched in the United States.”
Mr. Cox stressed that there are too many
imperfections in international accounting standards to switch wholesale to
IFRS at this point. Additional work must be done—including changing language
in the Sarbanes-Oxley Act—before the SEC would be able to recognize the
International Accounting Standards Board as the sole accounting regulator.
That’s probably good news for Robert Herz, chairman
of FASB. Last month, Mr. Herz cautioned against switching to international
standards too swiftly. “We have to get beyond just common accounting
standards, we have to get to a common reporting system,” he said. “Standards
are a big element of this, but it requires common application of the
standards, common disclosures, audit practices, regulatory review, training.
We ain’t there yet.”
Nevertheless, some finance executives say the
switch to international standards could pay unexpected dividends. “We see
this as more of an opportunity if this [convergence] trend continues,” said
PepsiCo controller Peter Bridgman. About 30 of the company’s reporting
entities are already using IFRS. “We will be able to set up regional
accounting centers,” noted Mr. Bridgman, “be able to consolidate training
onto one platform, and we can simplify our auditing processes.”
Comments like that may explain, in part, why the
SEC has been working to end the need for companies to reconcile their
financial reports between the two standards. The commission is now
considering a plan that would allow U.S. companies to use IFRS. In November,
the regulatory agency voted to allow foreign companies raising capital in
U.S. markets to include addendums explaining the differences between IFRS
and U.S. GAAP.
Another sign of convergence: The International
Accounting Standards Board late last week published revised rules on mergers
and acquisitions. The new rules basically realign IASB’s standards for M&A
with U.S. GAAP. The new standards take effect in July 2009, though companies
can adopt them sooner.
During his speech at the AICPA meeting, Mr. Cox
noted that the fledgling XBRL reporting format—more widely embraced in
Europe—goes hand in hand with the shift to international accounting
standards. An internal cost-benefit study by the SEC of a two-year pilot
program, in which companies were allowed to voluntarily file using XBRL
taxonomies, is expected to be completed by the end of February.
“IFRS is coming,” the SEC chairman said. “XBRL is
coming. And mutual recognition [of foreign exchanges and securities
regulators] is coming.”
Standard Setting and Securities Markets: U.S. Versus Europe
Some similarities to Chair of SEC, but some
important differences. SEC has direct regulatory powers over securities
markets, entities that offer securities in those markets, broker/dealers in
securities, auditors, and others. SEC can impose penalties on those it
regulates.
In Europe there is no pan-European securities
regulator equivalent to the SEC with direct regulatory powers similar to the
SEC's. Rather, there are 27 securities regulators (one from each member
state) who have that power. Here's a link to the list:
There is a coordinating body of European securities
regulators called CESR (the Committee of European Securities Regulators
(http://www.cesr-eu.org/)
but CESR's role is advisory, not regulatory.
When the European Parliament adopts legislation
(such as securitieslegislation) the legislation first has to be transposed
(legally adopted) into the national laws of the Member States. Commissioner
McCreevy's role is to propose policies and propose legislation to adopt
those policies in Europe, oversee implementation of the legislation in the
27 Member States (plus 3 EEA countries), and (through both persuasion and
some legal authority) try to ensure consistent and coordinated
implementation. The Commissioner also has outreach and liaison
responsibilities outside the European Union. Because there is no
pan-European counterpart to the SEC Chairman, Commissioner McCreevy
generally handles top level policy liaison between the SEC and Europe.
Like the Chair of the SEC, EU Commissioners are
political appointees.
Question
Will the U.S. adopt all IFRS international standards while the European Union
cherry picks which standards it will adopt?
From The Wall Street Journal Accounting Weekly Review on
April 27, 2007
"SEC to Mull Letting U.S. Companies Use International Accounting Rules,"
by David Reilly, The Wall Street Journal, Page: C3 ---
http://snipurl.com/WSJ0425
SUMMARY: The article describes the SEC's willingness to consider allowing
U.S. companies to use USGAAP or International Financial Reporting Standards (IFRS)
in their filings. This development stems from the initiative to allow
international firms traded on U.S. exchanges to file using IFRS without
reconciling to USGAAP-based net income and stockholders' equity as is now
required on Form 20F. "SEC Chairman Christopher Cox said the agency remains
committed to removing the reconciliation requirement by 2009. Such a move was
the subject of an SEC roundtable and is being closely watched by European Union
officials." The SEC will accept comments this summer on its proposal to
eliminate the reconciliation requirements. If the agency does implement this
change, then it will consider allowing U.S. companies the same alternative.
QUESTIONS:
1.) What is a "foreign private issuer" (FPI)? Summarize the SEC's current filing
requirements for these entities.
2.) Why is the SEC considering allowing U.S. companies to submit filings
under IFRS rather than U.S. GAAP?
3.) Why might the SEC's decision in this matter "spell the demise of USGAAP"?
4.) Define "principles-based standards" and contrast with "rules-based
standards." Give an example in either USGAAP or IFRS requirements for each of
these items.
5.) "Some experts don't think a move away from U.S. GAAP would necessarily be
bad." Who do you think would hold this opinion? Who would disagree? Explain.
6.) Define the term convergence in relation to global standards. Who is
working towards this goal?
Reviewed By: Judy Beckman, University of Rhode Island
Jensen Comment
Canada has already decided to adopt the IFRS in place of domestic Canadian
standards.
Also don't assume that the European Union automatically adopts
each IASB international standard. For example, the EU may not adopt IFRS 8 ---
http://www.iasplus.com/standard/ifrs08.htm
I just finished reading a brief, highly
readable and interesting article by a
Columbia Law School professor, John C.
Coffee, Jr., entitled A Theory of
Corporate Scandals: Why the U.S. and
Europe Differ.* The purpose of
this post is to piggyback on his
framework to also provide an explanation
for the difference in basic approaches
between U.S. GAAP and IFRS; and most
importantly, why political pressure to
trash U.S. GAAP and adopt IFRS should be
resisted.
How and Why, According to
Coffee, U.S. and European Scandals
Differ
Coffee's thesis is that corporate
governance of majority-owned
corporations (predominant in Europe)
should be fundamentally different than
corporate governance of corporations
that lack a controlling shareholder
group (predominant in the U.S.). It's
not necessarily because there are fewer
incentives to rip off other
shareholders, but the feasible means to
do so will differ.
Scandals in Europe involving
majority-owned corporations usually do
not feature an accounting manipulation.
First, financial reporting is less
important to the majority owners because
they rarely sell shares; and if they do,
they usually receive a control premium
that is uncorrelated with recent
earnings (and generally larger than
control premia in U.S. transactions).
Second, fraud is more easily
accomplished by misappropriation of the
private benefits of control:
authorization of related-party
transactions at advantageous prices,
below-market tender offers, are prime
examples. Any trading that takes place
between minority owners has less to do
with recent earnings reports, and more
to do with an assessment of how minority
shareholders will be treated by
controlling interests.
In dispersed-ownership corporations,
managers do not possess private benefits
of control. Moreover, a significant
portion of manager's compensation may be
in the form of stock options or other
forms of equity. Therefore, stock price
can have a significant effect on a
manager's compensation, providing them
with strong incentives to manipulate
accounting earnings.
The Implications for Accounting
Professor Coffee's thesis is that
differences in ownership patterns have
important implications for the selection
of gatekeepers: auditors, analysts,
independent directors, etc. His
observations and recommendations are
interesting, but I want to advance a
related thesis, namely that different
ownership patterns call for different
types of accounting regimes.
It stands to reason that accounting
should be difficult to manipulate, if it
can be used to rip off shareholders.
Thus, the evolution of U.S. GAAP can be
seen as a response to the need for
specific rules that minimized the role
of management judgment because of their
strong self-interest in the reported
earnings and financial position. This
has occurred in part because U.S.
gatekeepers have shown themselves to
often lack sufficient resolve or power
to prevent management from
under-reserving, overvaluing, or just
plain ole making up numbers. U.S.
managers effectively control the
"independent" directors and auditors;
and prior to Regulation FD, analysts
bartered glowing assessment in exchange
for tidbits inside information. Without
empowered gatekeepers to prevent
accounting fraud, we have had to place
our hopes on very inflexible accounting
rules, and sheriffs like the SEC and
private attorneys to catch the cases
where management has attempted to
surreptitiously cross the bright line.
Thus, it should be self-evident that
IFRS-style accounting, replete with gray
areas, would be a gift to U.S.
managers. Outright fraud would be
replaced by more subtle means of
"earnings management," rendering the SEC
and private attorneys much less potent.
Is it any wonder why U.S. corporations
and their auditors are practically
begging to have IFRS available to them?
In short, it would be a grave mistake to
adopt IFRS in the U.S. simply because it
seems to work well elsewhere. As
corporate ownership patterns in Europe
change, it may well be that IFRS may
evolve to look more like U.S. GAAP.
Only after that occurs may it make more
sense to have a single worldwide
financial reporting regime.
Imagine if Enron Had Applied
IFRS
One of the scapegoats of the Enron
scandal was "rules-based" U.S. GAAP.
The libel was that Andrew Fastow was a
mad genius, capable of walking an
accounting tightrope by creating complex
special-purpose entities (SPEs). But,
GAAP wasn't the culprit in the Enron
scandal. Frustrated Fastow was only able
to get the accounting treatment he
needed past the auditors by hiding from
them side agreements that unwound
critical provisions requiring the new
investors to have a sufficient amount of
capital at risk in the SPEs.
The enduring legacy of the libel is the
erroneous conventional wisdom that GAAP
is responsible for Enron; and what's
more, Enron et. al. might not have
happened if our financial reporting
system were more like IFRS. More
likely, if IFRS had been the basis of
accounting for Enron instead of GAAP, it
might have taken longer to discover the
fraud, or to pin the blame for the
fraud where it belonged.
Neither GAAP nor IFRS are
principles-based, but GAAP certainly has
more rules and bright lines. At least
there seems to be some method to the
madness, but it would be nice if more of
the rules were based on sound
principles.
-------------------------------
*There
are two versions of this paper. The
working paper is available at no charge
from the Social Sciences Research
Network electronic library at
http://ssrn.com/abstract=694581.
The published version is in Oxford
Review of Economic Policy, Vol. 21,
No. 2 (2005).
iGAAP (International GAAP) 2007 Financial Instruments: IAS 32,
IAS 39 and IFRS 7 Explained (Third Edition) Deloitte & Touche LLP (United Kingdom) has
developed iGAAP 2007 Financial Instruments: IAS 32, IAS 39 and IFRS
7 Explained (Third Edition), which has been published by CCH. This
publication is the authoritative guide for financial instruments
accounting under IFRSs. The 2007 edition expands last year's edition
with further interpretations, examples, discussions from the IASB
and the IFRIC, updates on comparisons of IFRSs with US GAAP for
financial instruments, as well as a new chapter on IFRS 7 Financial
Instruments Disclosures including illustrative disclosures. iGAAP
2007 Financial Instruments: IAS 32, IAS 39 and IFRS 7 Explained (628
pages, March 2007) can be purchased through
CCH Online or by phone at +44 (0) 870 777 2906 or by email:
customer.services@cch.co.uk
.
IAS Plus, March 24, 2007 ---
http://www.iasplus.com/index.htm
The Trinity University library has a single-user
license (with an academic discount) for PwC’s Comperio ---
http://www.pwcglobal.com/comperio
The single-user limitation really has not been problematic for us.
Our Library guru wrote some front end code that lets any Trinity
faculty member or student go directly into Comperio without having
to remember a password
Comperio
evolved out of a CD-Rom database that Price Waterhouse sold under
the name “Price Waterhouse Researcher.” Updated CDs were sent to us
each quarter in the old days before things were as networked on the
Web. Until 2015 it became known as Comperio. Now it is called
Inform. I think university discounts are still available.
Personally, I've always liked Comperio that had a single-user
license on the Trinity University campus.
Andersen had a
competing CD database called Research Manager. That was bought out after
Andersen fell. I think CCH purchased the Research Manager and still keeps it
updated.
I think
Andersen's Research Manager may have preceded the Price Waterhouse
Researcher in the marketplace.
Our Comperio accounting and auditing research
library is merging with another PwC-developed accounting and auditing
research library named Inform to form a single global platform. The
combined tool will be named ‘Inform’ and can be found at
inform.pwc.com. Inform is just as
intuitive as Comperio, and includes features to make it faster and
easier than ever to get the content you need. These features include:
mobile-friendly access for smartphone or
tablet
bookshelf of key documents
improved search and print functionality
create your own virtual documents and PDFs
more international and territory insight
Jensen Comment
I hate it when companies change the long-accustomed names of services. My
grandfather used to say "I yust learn't to say yam when they started calling
it yelly."
For
national and international accounting rulings and online research, it is best to
subscribe for a fee to one of the leading services shown below:
Free International
Auditing Standards
All documents issued by IFAC and the International Auditing
and Assurance Standards Board (IAASB) are now available for immediate download
at no charge. Visitors must simply fill out a one-time registration to gain
access to the documents. http://www.accountingweb.com/item/96952
IAS 39: Does
not define “net settlement” as being
required to be scoped into IAS 39 as a
derivative such as when interest rate swap
payments and receipts are not net settled
into a single payment.
FAS 133: Net
settlement is an explicit requirement to be
scoped into FAS 133 as a derivative
financial instrument.
Implications:
This is not a major difference since IAS 39
scoped out most of what is not net settled
such as Normal Purchases and Normal Sales (NPNS)
and other instances where physical delivery
transpires in commodities rather than cash
settlements. IAS 39 makes other concessions
to net settlement such as in deciding
whether a "loan obligation" is a derivative
Offsetting amounts due from and owed to
two different parties
IAS 39:
Required if legal right of set-off and
intent to settle net.
FAS 133:
Prohibited.
Multiple embedded derivatives in a single
hybrid instrument
IAS 39:
Sometimes accounted for as separate
derivative contracts
FAS 133: Always
combined into a single hybrid instrument.
Implications:
FAS 133 does not allow hybrid instruments to
be hedged items. This restriction can be
overcome in some instances by disaggregating
for implementation of IAS 39.
Subsequent reversal of an impairment loss
IAS 39:
Previous impairment losses may be reversed
under some circumstances.
FAS 133:
Reversal is not allowed for HTM and AFS
securities.
Implications:
The is a less serious difference since Fair
Value Options (FVOs) were adopted by both
the IASB and FASB. Companies can now avoid
HTM and AFS implications by adopting fair
values under the FVO hedged instrument.
Derecognition of financial assets
IAS 39: It is
possible, under restrictive guidelines, to
derecognise part of an a financial
instrument and no "isolation in bankruptcy"
test is required.
FAS 133:
Derecognise financial instruments when
transferor has surrendered control in part
or in whole. An isolation bankruptcy test is
required.
Status: This
inconsistency in the two standards will
probably be resolved in future amendments.
Hedging foreign currency risk in a
held-to-maturity investment
IAS 39: Can qualify
for hedge accounting for FX risk but not
cash flow or fair value risk.
FAS 133: Cannot
qualify for hedge accounting.
IAS 39 Hedging foreign currency risk in a
firm commitment to acquire a business in a
business combination
IAS 39: Can qualify
for hedge accounting.
FAS 133: Cannot
qualify for hedge accounting.
Assuming perfect effectiveness of a hedge
if critical terms match
IAS 39: Hedge
effectiveness must always be tested in order
to qualify for hedge accounting.
FAS 133: The
“Shortcut Method” is allowed for interest
rate swaps.
Implications:
This is am important difference that will
probably become more political due to
pressures from international bankers.
Use of "basis adjustment"
IAS 39: Fair value hedge: Basis is adjusted
when the hedge expires or is dedesignated. Cash flow hedge: Basis is adjusted
when the hedge expires or is dedesignated.
FAS 133: Fair value hedge: Basis is adjusted
when the hedged item is sold or otherwise
utilized in operations such as using raw
material in production (Para 24) Cash flow hedge of a transaction
resulting in an asset or liability: OCI
or other hedge accounting equity amount
remains in equity and is reclassified into
earnings when the earnings cycle is
completed such as when inventory is sold
rather than purchased or when inventory is
used in the production process. (Para 376)
IAS 39 Macro hedging
IAS 39: Allows
hedge accounting for portfolios having
assets and/or liabilities with different
maturity dates.
FAS 133: Hedge
accounting treatment is prohibited for
portfolios that are not homogeneous in
virtually all major respects.
Implications:
This is pure theory pitched against
practicality, politics, and how industry
hedges portfolios. It is a very sore point
for companies having lots and lots of items
in portfolios that make it impractical to
hedge each item separately.
Good News and Bad News: Update on IAS 39 Revisions
I call your attention to the IAS Plus summary of the
Notes from the IASB Special Board Meeting
October 6, 2009 ---
http://www.iasplus.com/index.htm
The IASB met for a special meeting relating to the IAS 39 replacement
project. Several Board members including the Chairman, FASB members, and
FASB staff joined the meeting via video link.
Many of these items are especially interesting when teaching IFRS, when
teaching contemporary issues in accountancy, and when teaching about accounting
for derivative financial instruments and hedge accounting (although recent
amendments of IAS 39 have taken this famous/infamous and very complicated standard beyond the scope
of the original IAS 39 and the current FAS 133 in the U.S.)
There are various items taken up in the October 6 IASB meeting not
discussed below. Hence if you're interested in the entire meeting Go to the IASB Special Board Meeting
summary:
October 6, 2009 ---
http://www.iasplus.com/index.htm
One significant difference that will arise between IAS 39 and FAS 133 lies in
the IAS decision to end the requirement of bifurcation of host contracts (such
as mortgage loans) from embedded derivatives (such as the embedded option to pay
the loan off before maturity) when the underlying (such as a LIBOR interest
rate) of the host contract is not "clearly and closely related" to the
underlying of the embedded derivative.
Accounting for embedded derivatives
The Board was presented with the alternative to
eliminate bifurcation of embedded derivatives. Several Board members were
concerned that this decision together with the frozen spread approach
adopted for measurement of financial liabilities would lead to hybrid
instruments with a financial liability as a host not to be valued at fair
value. By implication this means that the derivative part of the hybrid
instruments would be valued at the frozen spread approach and not fair
value. The staff defended this position by arguing that the credit
adjustment to the derivative portion of the hybrid contract would not be
significant. One Board member was particularly concerned about the effect of
this decision on convergence – a point reinforced by a FASB member who
expressed his view that such IASB decision would make convergence in this
area next to impossible.
Nonetheless, the Board narrowly approved the
elimination of bifurcation of financial liabilities as well as financial
assets.
The above decision will lead to fewer derivative financial instruments being
booked under FAS 39 relative to what would be booked under FAS 133. It seems to
me to be politically incorrect to bring about such changes at a time when the
SEC is still wavering to eliminate U.S. GAAP in favor of IASB standards.
What the IASB seems to have ignored is the valuation problems created by
unique (customized) instruments that are not traded in the markets. Suppose
Security AB with a "closely related" embedded Option B is Bond A that is
actively traded with the embedded embedded Option B for paying off the debt
before maturity. Early payoff embedded options are extremely common in bonds
that are actively traded in the securities markets. Usually the embedded options
for early payoff are deemed clearly and closely related under IAS 39 rules such
that the embedded Option B previously did not have to be bifurcated and
accounted for separately as a derivative financial instrument. Market values of
Security AB impound both the value of the security and its embedded
(non-bifurcated) option. Until the IASB changed its position on October 6,
however, embedded options that were not clearly and closely related had to be
bifurcated and accounted for separately.
For example, suppose Security ABXY is Security AB plus embedded Options X and
Y that are not "clearly and closely related" in terms of underlyings.
Further assume Options X and Y can be valued in their own options markets. In
other words there are deep and active markets for valuing Security AB, Option X,
and Option Y. There is no deep and active market for the customized Security
ABXY. Security ABXY is a unique, customized security that is not traded in an
active and deep market.
It is highly unlikely that the total value of Security ABXY is the additive
sum of the values of Security AB plus the value of Option X plus the value of
Option Y. These components of Security ABXY are likely to interact such that
valuation of Security ABXY becomes exceedingly difficult if the embedded Options
X and Y are not bifurcated. In terms of FAS 157, it is no longer possible to
apply the sought-after Level 1 valuation for Security ABXY, even though Level 1
can be applied if the embedded Option X and Options Y were bifurcated.
Alas, throughout history accountants have been very good at naively adding up
components of value that are not truly additive. For example, throughout the
history of accounting firms have added up balance sheet asset values and
reported the sum as the total value of Total Assets when the assets have
interactions (covariances) that are totally ignored in the summation process.
Only when buyers and sellers negotiate for the purchase/sale of the entire
bundle (in mergers and acquisitions) do accountants reveal that, in truth, they
understand that the accounting figure for "Total Assets" on the balance sheet is
sheer nonsense.
**********
I was especially intrigued by the following module in the IAS Plus Notes:
Application of cash flow hedge accounting
mechanics to fair value hedges
The Board considered the application of the Board's
September 2009 decision to replace fair value hedge accounting with a
mechanism that permitted recognition outside profit or loss of gains and
losses on financial instruments designated as hedging instruments – that is,
applying the mechanics of cash flow hedge accounting also to fair value
hedges. The major implication would be the application of the so-called
'lower-of test' to fair value hedges. The 'lower-of test', currently applied
to cash flow hedges only, ensures that only ineffectiveness due to excess
cash flows on the hedging instrument (that is, the derivative) is recognised
in profit or loss.
The Board members disagreed with the extension of
the 'lower-of test' to fair value hedges. The Board was concerned that it
was inconsistent with the nature of fair value hedging, could lead to
changes in eligibility of portions, could have unintended consequences in
the area of deliberately under-hedging, and in effect would lead to a
situation that there would be no ineffectiveness in fair value hedges as
such. A FASB member clarified that in the FASB approach to hedge accounting
(given the recent discussions over the issue) the 'lower of test' would not
be applied to fair value hedges.
After a short debate the Board decided by a bare
majority (8 votes) to retain the 'lower-of test' for cash flow hedges only.
A third of the Board members abstained in this vote.
Jensen Comment
Cash flow hedge accounting in FAS 133 and IAS 39 is relatively straight forward
when a derivative financial instrument (e.g., forward contract, futures
contract, swap, or option) is used to hedge cash flow risk in a hedged item
(forecasted transaction or a booked item subject to cash flow risk such as a
variable-rate bond or purchase contract setting the purchase price at an unknown
future spot price or rate).
Cash flow hedge accounting, like foreign exchange hedge accounting, entails
offsetting changes in value of the hedging derivative with a posting to an
equity account (FAS 133 requires posting to OCI). The simplifying feature of
cash flow hedge accounting is that it makes no difference whether the hedged
item is booked (e.g., a bond asset or liability having variable rate revenue) or
unbooked (e.g., a forecasted transaction to buy inventory or to buy/sell
fixed-rate bonds at a future date where the fixed-rate is currently unknown).
The reason cash flow hedging is not affected by a difference between a booked
or unbooked hedged item is that a hedged item subject to cash flow risk has no
future value risk. Consider a variable rate bond having a booked value of
$1,000. There is future cash flow risk, but the future value of the bond will
always be $1,000 assuming no change in credit risk (I am only considering a
hedge of cash flow risk here). Similarly, if Southwest Airlines has a forecasted
transaction to buy a million gallons of jet fuel at spot rates six months from
now, there is no risk that the value on the purchase will differ from the value
of jet fuel on that future date. Value risk arises when the forecasted
transaction is instead a firm commitment to buy at some price other than spot
rates. But if there is a firm commitment price there is no cash flow risk (only
value risk that the purchase price will differ from the spot price on the date
of the purchase).
Fair value hedge accounting is more complicated because it matters greatly
whether the hedged item is booked or not booked. For example, there is no cash
flow risk of booked inventory already bought and paid for in a warehouse. There
is, however, purchase-price value risk that the spot price of that inventory
diverge from the price already paid for the inventory. Companies frequently
hedge the fair value of inventory (although this is not necessarily a hedge of
profit if selling prices are not hedged and only purchase prices are hedged if
purchase and selling prices are not perfectly correlated).
Hedge accounting is not usually allowed (or called for) when hedging a booked
item carried at fair value. In theory the changes in value of the hedged item
should offset the changes in the value of the hedging derivative contract and
any hedging ineffectiveness should be charged to current earnings in any case.
If the hedged item is carried at historical cost, no such offset would arise and
hedge accounting is called for at least to the extent the hedge is effective.
Under FAS 133 and IAS 39, the hedge accounting for such a hedged item calls for
change the basis of accounting of the hedged item during the hedge accounting
period. Instead of the customary historical cost accounting (say for jet fuel
inventory), the hedge accounting rules call for a change to fair value
accounting of that inventory during the hedging period.
The most confusing part of fair value hedge accounting arises when the hedged
item is not booked. For example, purchase contracts are typically not booked in
accounting (never have been and hopefully never will be). For example, if
Southwest Airlines signs a firm commitment to buy jet fuel six months from now
at $2.89 per gallon the firm commitment is not booked. There is no cash flow
risk since the purchase price is fixed. There is value risk, however, that the
spot price in six months will be higher or lower than the $2.89 purchase
(forward, strike) price.
Now the accounting becomes complicated because there is no booked hedged item
value to be offset by a change in the booked hedging derivative change in value.
Fair value hedge accounting of unbooked hedged items calls for changes in the
value of the booked hedging contract to be offset by a posting to an equity
account. In FAS 133 the FASB recommends a badly-named equity account called Firm
Commitment. For example, to see how this works
03forfut.pps slide show file listed at
http://www.cs.trinity.edu/~rjensen/Calgary/CD/JensenPowerPoint/
The above slide show compares cash flow hedging versus fair value hedging of
booked items versus fair value hedging of unbooked (forecasted transaction)
hedged items.
Above I said that the "Firm Commitment" equity account called for in FAS 133
is badly named because changes in the value of fair value hedging contracts are
not firm commitments (although they may hedge a firm commitment unbooked hedged
item). I would've preferred some other name like "unrealized change in fair
value hedging contracts" as an equity account.
Now the debate centers on whether the "Firm Commitment" equity account used
for fair value hedge accounting of unbooked hedged items is tantamount to the "OCI"
equity account used for booked and unbooked cash flow and FX hedge accounting?
Firstly, there is a difference since fair value hedges to not impact any
equity account if the hedged items are booked and carried at fair value
themselves. Fair value hedges of unbooked items create the special and confusing
aspect of hedge accounting relief for fair value hedging.
What the IASB is currently debating with respect to amending IAS 39 is
whether hedge accounting would be greatly simplified by always offsetting
changes in hedge contact fair value to OCI (by whatever name) to the extent the
hedge is effective. Presumably the changes in the value of a booked hedged item
would also be charged to OCI (e.g., like available for sale investment changes
in value are currently accounted for under the amended FAS 115/130). Such
accounting could apply equally to cash flow, fair value, and FX hedges.
If the above simplification sounds too ideal, what is holding it up? Why did
the IASB turn down this simplification in the October 6, 2009 special board
meeting?
The reasoning of the IASB on October 6 seems to have been that the proposed
"simplification" of fair value hedge accounting is would not leave any hedge
ineffectiveness to be charged to current earnings for some fair value hedges
whereas all hedge ineffectiveness of cash flow and FX hedges is charged to
current earnings.
Hedges are often not fully effective at interim points in time. Options as
hedging derivatives, for example, are notoriously ineffective as hedges and
seldom meet the "80-125 percent test" of hedge effectiveness specified in
Paragraph BC 106 of IAS 39. One reason is that speculators are more often more
dominant in options trading markets vis-a-vis commodities markets themselves.
Option values are divided into two components --- time value plus intrinsic
value (equal the amount by which an option is in-the-money). Interim changes
(before option expiration) in total option hedging value seldom satisfy the
"80-125 percent test" or hedge effectiveness. It is common in hedge accounting
under FAS 133 and IAS 39 rules to charge all changes in an option's time value
to current earnings and only allow hedge accounting relief to changes in
intrinsic value (which are zero until if and when the option is in-the-money).
It would be a sorry state of affairs if the IASB had essentially voted for
hedge ineffectiveness to be ignored for fair value hedging. This would be
entirely inconsistent with hedge accounting for cash flow and FX hedges where
both FAS 133 ahd IAS 39 require that hedge ineffectiveness be posted to current
earnings. This is also required at present for fair value hedge ineffectiveness.
How sad it would be if the IASB voted in a huge inconsistency for treating hedge
ineffectiveness for fair value hedging relative to cash flow and FX hedge
accounting.
Whew! That was a close one that came within eight votes, at the IASB special
meeting on October 6, of injecting a huge inconsistency between fair value
hedging versus cash flow and FX hedge accounting. If the proposed amendment had
passed it would greatly simplify the accounting at the expense of greatly
complicating financial statement analysis.
I appreciate your discussion and explanation of
accounting for embedded derivatives. Considering all that we cover in
Intermediate Accounting and subsequent financial reporting courses,
where should we cover embedded derivatives and how deep should we go
with the discussion?
Rick Lillie
CalState San Bernardino
October 11, 2009 reply from Bob Jensen
Hi Rick,
This is hard to answer for most any module of FAS
133/IAS 39, including embedded derivatives.
First I should note that intermediate accounting
textbooks generally do a lousy job with FAS 133 and IAS 39, in part,
because I think the authors of these textbooks never bothered to learn
the complex finance required to really understand derivative financial
instruments and hedging activities. Often the undergraduate finance
courses cover these topics poorly as well.
We must realize (as you know better than me) that
intermediate accounting is currently filled to the brim and overflowing
with other topics. In intermediate accounting I think the best we can do
is to explain what hedge accounting really means, i.e., avoiding
unrealized fluctuations in earnings due to unsettled hedging contracts.
Then give some rather simple examples of cash flow, fair value, and FX
hedge accounting, perhaps along the lines that Pam Smith intended ---
http://faculty.trinity.edu/rjensen/CaseAmendment.htm
It might take two classes to cover this along with
a discussion of what types of contracts are and are not included in FAS
133/IAS 39.
The best first-time examples include forecasted
transactions of something like jet fuel. The hedged items are not booked
and hence changes in the value of jet fuel for the hedged items are not
booked. It impossible for changes in the value of the hedged items to
offset changes in the value of the hedge contracts such as forward or
futures or options contracts. Posting changes in value of the hedging
contracts to earnings is truly misleading since the offsets of a perfect
hedge is impossible if the hedged items are not booked. Earnings may
thus fluctuate wildly when, in fact, the purpose is to take the cash
flow risk out of future purchase prices. This is the easiest
illustrations of the need for hedge accounting that I can devise --- see
my 03forfut.pps PowerPoint show at
http://www.cs.trinity.edu/~rjensen/Calgary/CD/JensenPowerPoint/
When I taught FAS 133 and IAS 39 it was a third to
a half of a graduate-level accounting theory course ---
http://faculty.trinity.edu/rjensen/acct5341/acct5341.htm
I used one of the best finance textbooks every written and was able to
cover both the finance and accounting --- Derivatives: An Introduction by Robert A Strong (Thompson
South-Western)
This is the easiest book to read on how derivatives really work.
My approach in both my traveling dog and pony show
and in my course was to focus on the first ten examples in Appendix B of
FAS 133 (that are not in the Codification database). My Excel workbooks
on these examples can be found in the FAS133Appendix B folder at
http://www.cs.trinity.edu/~rjensen/Calgary/CD/
Schools of accounting are going to have to become
more like law schools that realize that law is just too complex to teach
in detail. The best we can do is give teach underlying
theory/philosophy, teach some good cases, and dwell more on the
legal/accounting search side of things that teaches more and more about
how to find answers than to try to teach everything in college. Leave it
up to the CPA Review courses to teach the details.
Having said this, we have an obligation to teach
enough of the language of accounting such that when students do searches
of something like Comperio they have a ghost of a chance of
comprehending what they read. Thus we teach more concepts of accounting
and financial contracting concepts and less on the rules (Pat Walters
will finally love me).
When it comes to teaching cases, one approach is to
begin with a rich 10-K and then back students up through the accounting
that led to the items in the 10-K, including those FAS 133 and IAS 39
booked items and footnotes.
The above approach if very much like the tremendous
AAA Innovation in Accounting Education Award-winning BAM approach first
conceived for "teaching" (actually not teaching) intermediate accounting
by Catenach, Kroll, and Grinaker at the University of Virginia. I'm
totally convinced this is the best pedagogy for student learning even
though it tends to burn out students and instructors and is very
hazardous to teaching evaluations ---
http://faculty.trinity.edu/rjensen/265wp.htm
BAM is too intensive to use for more than one or two courses in a
curriculum, but I think the perfect courses are Intermediate 1 and 2.
Catenach et al knew what they were doing when they chose intermediate
accounting.
By the way many of the learning materials that I
provide for learning FAS 133 and IAS 39 need not be used in class,
including the PowerPoint files. Students can study these on their own or
(better) in teams ---
http://www.cs.trinity.edu/~rjensen/Calgary/CD/JensenPowerPoint/
Bob Jensen
ASC = Accounting Standard Codification of the FASB
which
introduces the ASC. This video has potential value at the beginning of
the semester to acquaint students with the ASC. I am thinking about
posting the clip to AAA commons. But, where should it be posted and
does this type of thing get posted in multiple interest group areas?
Any
thoughts / suggestions?
Zane Swanson www.askaref.com
a handheld device source of ASC information
Jensen Comment
A disappointment for colleges and students is that access to the Codification
database is not free. The FASB does offer deeply discounted prices to colleges
but not to individual teachers or students.
This is a great video helper for learning
how to use the FASB.s Codification database.
An enormous disappointment to me is how the
Codification omits many, many illustrations in the
pre-codification pronouncements that are still available
electronically as PDF files. In particular, the best way to
learn a very complicated standard like FAS 133 is to study
the illustrations in the original FAS 133, FAS 138, etc.
The FASB paid a fortune for experts to develop
the illustrations in the pre-codification pronouncements. It's
sad that those investments are wasted in the Codification
database.
Why did the Commission
carve out the full fair
value option in the
original IAS 39
standard?
Do
prudential supervisors
support IAS 39 FVO as
published by the IASB?
When will the Commission
to adopt the amended
standard for the IAS 39
FVO?
Will companies be able
to apply the amended
standard for their 2005
financial statements?
Does the amended
standard for IAS 39 FVO
meet the EU endorsement
criteria?
What about the
relationship between the
fair valuation of own
liabilities under the
amended IAS 39 FVO
standard and under
Article 42(a) of the
Fourth Company Law
Directive?
Will the Commission now
propose amending Article
42(a) of the Fourth
Company Directive?
What about the remaining
IAS 39 carve-out
relating to certain
hedge accounting
provisions?
Convergence of foreign and domestic accounting rules could catch some U.S.
companies by surprise Although many differences remain between U.S. generally
accepted accounting principles (GAAP) and international financial reporting
standards (IFRS), they are being eliminated faster than anyone, even Herz or
Tweedie, could have imagined. In April, FASB and the IASB agreed that all major
projects going forward would be conducted jointly. That same month, the
Securities and Exchange Commission said that, as soon as 2007, it might allow
foreign companies to use IFRS to raise capital in the United States, eliminating
the current requirement that they reconcile their statements to U.S. GAAP. The
change is all the more remarkable given that the IASB was formed only four years
ago, and has rushed to complete 25 new or revamped standards in time for all 25
countries in the European Union to adopt IFRS by this year. By next year, some
100 countries will be using IFRS. "We reckon it will be 150 in five years,"
marvels Tweedie. "That leaves only 50 out."
Tim Reason, "The Narrowing GAAP: The convergence of foreign and domestic
accounting rules could catch some U.S. companies by surprise," CFO Magazine
December 01, 2005 ---
http://www.cfo.com/article.cfm/5193385/c_5243641?f=magazine_coverstory
Monumental Scholarship (The following book is not online.) The Early History of Financial Economics 1478-1776
by Geoffrey Poitras (Simon Fraser University) ---
http://www.sfu.ca/~poitras/photo_pa.htm
(Edward Elgar, Cheltenham, UK, 2000) --- http://www.e-elgar.co.uk/
Jack Anderson sent the following message:
A good book
on accounting history in the U.S. is
A
History of Accountancy in the United States by Gary John Previts and Barbara
Dubis Merino
It's
available through The Ohio State University Press (see web site
The FASB added Concepts and Standards at an
unprecedented rate.
FASB standards have become increasingly complex
and cause a great deal of confusion among both preparers and users of financial
statements. The most dramatic example is the almost-incomprehensible FAS 133 on
Accounting for Derivative Instruments. In fairness, however, it should be noted that
industry has brought on a lot of its own troubles with almost-incomprehensible financing
and employment contracts (many of which are designed for the main purpose of getting
around having to book and/or disclose expenses and debt).
The FASB has focused much more on the balance
sheet than on the income statement. Over one third of the standards deal with
industry OBSF schemes.
The FASB does take costs into consideration as
well as benefits of its accounting standards. For example, after studying investor
use of FAS 33 requiring supplemental statements on price-level adjusted statements and
current cost statements, the FASB rescinded FAS 33 with FAS 89.
The FASB also issued a costly and controversial
set of Accounting Concepts. After some dormancy, the FASB is once again adding to
these concepts with its first new concepts statement in over 16 years (Present Value Based
Measurements and Fair Value). Trinity University students may read about this at
J:\courses\Acct5341\readings\Present Value-Based Measurements and Fair
Value.htm.
The future of the FASB and all national standard
setters is cloudy due to the globalization of business and increasing needs for
international standards. The primary body for setting international standards was
the International Accounting Standards Committee (IASC) that evolved into the
International Accounting Standards Board (IASB) having a homepage at http://www.iasc.org.uk/ For a
brief review of its history and the history of its standards, I recommend going to http://faculty.trinity.edu/rjensen/acct5341/speakers/pacter.htm#003.04.
In 2001, the IASC was restructured into the new
and smaller International Accounting Standards Board (IASB). The majority of the
IASB members will be full-time, whereas the members of the IASC were only part-time and
did not have daily face-to-face encounters with other Board members or the IASC
staff. The IASB will operate more like the FASB in the U.S.
In the early years of its existence, the IASC
tended to avoid controversial issues and there was nothing to back up its standards
(except in the U.S. where lawyers will use almost anything to support litigation brought
by investors against corporations).
Times are changing at the IASC. It has been
restructured and is getting a much greater budget for accounting research. Most
importantly, IASC standards are becoming the standards required by large international
stock exchanges (IOSCO).
The Global Reporting Initiative (GRI) was established in late 1997 with the mission
of developing globally applicable guidelines for reporting on the economic,
environmental, and social performance, initially for corporations and eventually
for any business, governmental, or non-governmental organisation (NGO). Convened
by the Coalition for Environmentally Responsible Economies (CERES)
in partnership with the United Nations Environment Programme (UNEP),
the GRI incorporates the active participation of corporations, NGOs, accountancy
organisations, business associations, and other stakeholders from around the
world business plan --- http://www.globalreporting.org/
Jagdish Gangolly recommends the following book:
Dollars & scholars, scribes & bribes: The story of
accounting by Gary Giroux # Dame Publications, Inc (1996) # ASIN: B0006R6WQS
--- http://snipurl.com/Giroux
Jim McKinney recommends the following book;
It is not a lot more recent but I would consider the US centric text: A
History of Accountancy in the United States: The Cultural Significance of
Accounting by Previtz & Merino published in 1998. It is available in
paperback.
Accounting Research
Versus the Accountancy Profession "Why business ignores the business schools"
Some ideas for applied research
The second is the comment that Joan Robinson made
about American Keynsians: that their theories were so flimsy that they had to
put math into them. In accounting academia, the shortest path to respectability
seems to be to use math (and statistics), whether meaningful or not. Professor Jagdish Gangolly, SUNY
Albany
Why Bob Jensen is Trying to Hold His Head Higher I'm not inclined to walk off into the sunset with my head bowed because my
nearly
94 published accountics papers and books mostly failed to be noticed by
practicing accountants. Perhaps, in order to hold my head higher, I've made
presentations about the very practical side of FAS 133 and IAS 39 at hundreds of
companies and campuses reflects, in great measure, my guilt in simply writing
another esoteric paper on eigenvector scaling ---
http://faculty.trinity.edu/rjensen/resume.htm#Presentations And perhaps I carry my rants about accountics to a pitched level because I want
once again, like my good friends Denny Beresford, Steve Zeff, and Paul Williams,
wed academic accounting researchers with the practicing profession of
accountancy.
Free
Book Bridging the Gap between Academic Accounting Research and Professional
Practice
Edited by Elaine Evans, Roger Burritt and James Guthrie
Institute of Chartered Accountants in Australia's Academic Leadership Series
2011 http://www.charteredaccountants.com.au/academic
Why is academic accounting research still lacking impact and relevance? Why
is it considered so detached and worlds apart from practice and society?
These and many more questions are tackled in this new publication
commissioned by the Institute and the Centre for Accounting, Governance and
Sustainability (CAGS) in the School of Commerce at the University of South
Australia.
Each chapter provides fresh insights from leading accounting academics,
policy makers and practitioners. The book triggers a call for action, with
contributors unanimously agreeing more collaboration is needed between all
three elements that make up the accounting profession - researchers, policy
makers and practitioners.
Jensen
Comment
The other day, following a message from Denny Beresford complaining about
how Accounting Horizons is failing it's original mission statement as
clearly outlined by its first editor years ago, the messaging on the AECM
focused upon the complete lack of practitioners on the AH Editorial Board
and tendency to now appoint an editor or pair of co-editors who are in the
academy and are far afield from the practicing world.
Steve
Zeff recently compared the missions of the Accounting Horizons with
performances since AH was inaugurated. Bob Mautz faced the daunting tasks of
being the first Senior Editor of AH and of setting the missions of that
journal for the future in the spirit dictated by the AAA Executive Committee
at the time and of Jerry Searfoss (Deloitte) and others providing seed
funding for starting up AH.
August 18, 2012 message from Dennis Beresford
During the AAA annual conference I mentioned to
someone that I enjoyed going to the research workshops held at my
University even though I don't have the background to evaluate all of
the formulas, etc. However, I've found that more and more of the papers
presented by visitors seem to be far from what I would consider
"accounting related." The person I was talking to at the time challenged
me and suggested my background in public accounting and at the FASB
narrowed my thinking on this too much. But I said that I had developed a
personal policy of attending only workshops that I felt had something to
do with accounting, however I might interpret that.
Our first School of Accounting research
workshop for the fall semester is in two weeks. The paper being
presented is titled, "Voice Pitch Predicts Labor Market Success Among
Male Chief Executive Officers." I do not plan to attend.
I really miss the Golden Fleece Awards that
used to be given out by Senator Proxmire --- http://en.wikipedia.org/wiki/Golden_Fleece_Award
Many of these awards were for laughable research studies funded by
government.
I may have to seek out a term to replace
"accountics" if we get further and further away from accounting-based
research in accounting programs. Maybe we should have a contest on the
AECM, The condition is that the last three letters have to be "tics."
Too much medicine relies on fatally flawed research. Epidemiologist
John P.A. Ioannidis leads the charge to ensure health care you can count
on.
Last June, Stanford orthopedic surgeon Eugene Carragee and his
editorial team at the Spine Journal announced they had examined data
that Medtronic Inc. presented a decade ago to get approval for the
spinal bone graft product sold as Infuse.
Not only did the team find that evidence for Infuse's benefits over
existing alternatives for most patients was questionable; they also
discovered in a broad array of published research that risks of
complications (including cancer, male sterility and other serious side
effects) appeared to be 10 to 50 times higher than 13 industry-sponsored
studies had shown. And they learned that authors of the early studies
that found no complications had been paid between $1 million and $23
million annually by the company for consulting, royalties and other
compensation. Carragee, MD '82, estimates Medtronic has sold several
billion dollars' worth of Infuse for uses both approved and "off label."
Medtronic issued a statement saying it believed the product was safe for
approved use and gave a $2.5 million grant to Yale University
researchers to review the data. Their analysis is expected this year.
Continued in article
Question
In a 2010 AAA Plenary Session, what did Harvard's Bob Kaplan accuse
accountics scientists of getting wrong?
Answer
What accountics scientists got wrong, according to Bob, is limiting the
scope of their research to accountics epidemiology and not enough focus on
the clinical side of accountancy.
"Accounting Scholarship that Advances Professional Knowledge and
Practice," AAA Presidential Scholar Address by Robert S. Kaplan, The
Accounting Review, March 2011, pp. 372-373 (emphasis added)
I am less pessimistic than Schön about whether
rigorous research can inform professional practice (witness the
important practical significance of the Ohlson accounting-based
valuation model and the Black-Merton-Scholes options pricing model), but
I concur with the general point that academic scholars spend too much
time at the top of Roethlisberger’s knowledge tree and too little time
performing systematic observation, description, and classification,
which are at the foundation of knowledge creation. Henderson 1970,
67–68 echoes the benefits from a more balanced approach based on the
experience of medical professionals:
both theory and practice are necessary
conditions of understanding, and the method of Hippocrates is the
only method that has ever succeeded widely and generally. The first
element of that method is hard, persistent, intelligent,
responsible, unremitting labor in the sick room, not in the library
… The second element of that method is accurate observation of
things and events, selection, guided by judgment born of familiarity
and experience, of the salient and the recurrent phenomena, and
their classification and methodical exploitation. The third element
of that method is the judicious construction of a theory … and the
use thereof … [T]he physician must have, first, intimate, habitual,
intuitive familiarity with things, secondly, systematic knowledge of
things, and thirdly an effective way of thinking about things.
More recently, other observers of business
school research have expressed concerns about the gap that has opened up
in the past four decades between academic scholarship and professional
practice.
Examples include: Historical role of
business schools and their
faculty is as evaluators of, but not creators or originators of,
business practice. (Pfeffer
2007, 1335) Our journals are replete with an examination of issues
that no manager would or should ever care about, while concerns that
are important to practitioners are being ignored. (Miller et al.
2009, 273)
In summary, while much has been accomplished
during the past four decades through the application of rigorous social
science research methods to accounting issues, much has also been
overlooked. As I will illustrate later in these remarks, we have missed
big opportunities to both learn from innovative practice and to apply
innovations from other disciplines to important accounting issues. By
focusing on these opportunities, you will have the biggest potential for
a highly successful and rewarding career.
Integrating Practice and Theory: The
Experience of Other Professional Schools
Other professional schools, particularly medicine, do not disconnect
scholarly activity from practice. Many scholars in medical and public
health schools do perform large-scale statistical studies similar to
those done by accounting scholars. They estimate reduced-form
statistical models on cross-sectional and longitudinal data sets to
discover correlations between behavior, nutrition, and health or
sickness. Consider, for example, statistical research on the effects of
smoking or obesity on health, and of the correlations between automobile
accidents and drivers who have consumed significant quantities of
alcoholic beverages. Such large-scale statistical studies are at the
heart of the discipline of epidemiology.
Some scholars in public health schools also
intervene in practice by conducting large-scale field experiments on
real people in their natural habitats to assess the efficacy of new
health and safety practices, such as the use of designated drivers to
reduce alcohol-influenced accidents. Few academic accounting scholars,
in contrast, conduct field experiments on real professionals working in
their actual jobs (Hunton and Gold [2010] is an exception). The
large-scale statistical studies and field experiments about health and
sickness are invaluable, but, unlike in accounting scholarship, they
represent only one component in the research repertoire of faculty
employed in professional schools of medicine and health sciences.
Many faculty in medical schools (and also in
schools of engineering and science) continually innovate. They develop
new treatments, new surgeries, new drugs, new instruments, and new
radiological procedures. Consider, for example, the angiogenesis
innovation, now commercially represented by Genentech’s Avastin drug,
done by Professor Judah Folkman at his laboratories in Boston Children’s
Hospital (West et al. 2005). Consider also the dozens of commercial
innovations and new companies that flowed from the laboratories of
Robert Langer at MIT (Bowen et al. 2005) and George Whiteside at Harvard
University (Bowen and Gino 2006). These academic scientists were
intimately aware of gaps in practice that they could address and solve
by applying contemporary engineering and science. They produced
innovations that delivered better solutions in actual clinical
practices. Beyond contributing through innovation, medical school
faculty often become practice thought-leaders in their field of
expertise. If you suffer from a serious, complex illness or injury, you
will likely be referred to a physician with an appointment at a leading
academic medical school. How often, other than for expert testimony, do
leading accounting professors get asked for advice on difficult
measurement and valuation issues arising in practice?
One study (Zucker and Darby 1996) found that
life-science academics who partner with industry have higher academic
productivity than scientists who work only in their laboratories in
medical schools and universities. Those engaged in practice innovations
work on more important problems and get more rapid feedback on where
their ideas work or do not work.
These examples illustrate that some of the best
academic faculty in schools of medicine, engineering, and science,
attempt to improve practice, enabling their professionals to be more
effective and valuable to society. Implications for Accounting
Scholarship To my letter writer, just embarking on a career as an
academic accounting professor, I hope you can contribute by attempting
to become the accounting equivalent of an innovative, worldclass
accounting surgeon, inventor, and thought-leader; someone capable of
advancing professional practice, not just evaluating it. I do not want
you to become a “JAE” Just Another Epidemiologist . My vision for the
potential in your 40 year academic career at a professional school is
to develop the knowledge, skills, and capabilities to be at the leading
edge of practice. You, as an academic, can be more innovative than a
consultant or a skilled practitioner. Unlike them, you can draw upon
fundamental advances in your own and related disciplines and can
integrate theory and generalizable conceptual frameworks with skilled
practice. You can become the accounting practice leader, the “go-to”
person, to whom others make referrals for answering a difficult
accounting or measurement question arising in practice.
But enough preaching! My teaching is most
effective when I illustrate ideas with actual cases, so let us explore
several opportunities for academic scholarship that have the potential
to make important and innovative contributions to professional practice.
Continued in article
Added Jensen Comment
Of course I'm not the first one to suggest that accountics science referees
are inbred. This has been theme of other AAA presidential scholars
(especially Anthony Hopwood), Paul Williams, Steve Zeff, Joni Young, and
many, many others that accountics scientists have refused to listen to over
past decades.
"The Absence of Dissent," by Joni J.
Young, Accounting and the Public Interest 9 (1), 2009 ---
Click Here
“An Analysis of the Evolution of Research Contributions by The
Accounting Review: 1926-2005,” (with Jean Heck), Accounting
Historians Journal, Volume 34, No. 2, December 2007, pp. 109-142.
"The Impact of Academic Accounting Research on Professional Practice:
An Analysis by the AAA Research Impact Task Force," by Stephen R.
Moehrle, Kirsten L. Anderson, Frances L. Ayres, Cynthia E. Bolt-Lee, Roger
S. Debreceny, Michael T. Dugan, Chris E. Hogan, Michael W. Maher, and
Elizabeth Plummer, Accounting Horizons, December 2009, pp. 411- 456.
SYNOPSIS:
The accounting academy has been long recognized as the premier developer
of entry-level talent for the accounting profession and the major
provider of executive education via master’s-level curricula and
customized executive education courses. However, the impact that the
academy’s collective ideas have had on the efficiency and effectiveness
of practice has been less recognized. In this paper, we summarize key
contributions of academic accounting research to practice in financial
accounting, auditing, tax, regulation, managerial accounting, and
information systems. Our goal is to increase awareness of the effects of
academic accounting research. We believe that if this impact is more
fully recognized, the practitioner community will be even more willing
to invest in academe and help universities address the escalating costs
of training and retaining doctoral-trained research faculty.
Furthermore, we believe that this knowledge will attract talented
scholars into the profession. To this end, we encourage our colleagues
to refer liberally to research successes such as those cited in this
paper in their classes, in their textbooks, and in their presentations
to nonacademic audiences.
Jensen Comment
This paper received the AAA's 2010 Accounting Horizon's best paper
award. However, I don't find a whole lot of recognition of work in
practitioner journals. My general impression is one of disappointment. Some
of my comments are as follows:
Unsubstantiated Claims About the Importance of Accountics Event
Studies on Practitioners
The many citations of accounting event studies are more like a listing of
"should-have-been important to practitioners" rather than demonstrations
that these citations were "actually of great importance to practitioners."
For example, most practitioners for over 100 years have known that earnings
numbers and derived ratios like P/E ratios impact investment portfolio
decisions and acquisition-merger decisions. The findings of accountics
researchers in these areas simply proved the obvious to practitioners if
they took the time and trouble to understand the complicated mathematics of
these event studies. My guess is that most practitioners did not delve
deeply into these academic studies and perhaps do not pay any attention to
complicated studies that prove the obvious in their eyes. In any case, the
authors of the above studies did not contact practitioners to test out
assumed importance of accountics research in these events studies. In other
words, this AAA Task Force did not really show, at least to me, that these
events studies had a great impact on practice beyond what might've been used
by standard setters to justify positions that they probably would've taken
with or without the accountics research findings.
Mention is made about how the FASB and government agencies included
accounting professors in some deliberations. This is well and good but the
study does not do a whole lot to document if and how these collaborations
found accountics research of great practical value.
Practitioner Journal Citations of Accountics Research
The AAA Task Force study above did not examine practitioner journal
citations of accountics research journals like TAR, JAR, and JAE. The
mentions of practitioner journals refer mostly to accounting professors who
published in practitioner journals such as when Kenney and Felix published a
descriptive piece in the 1980 Journal of Accountancy or
Altman/McGough and Hicks published 1974 pieces in the Journal of
Accountancy. Some mentions of practitioner journal citations have to go
way back in time such as the mention of the Mautz and Sharaf. piece in the
1961 Journal of Accountancy.
Accountics professors did have some impact of auditing practice,
especially in the areas of statistical sampling. The types of sampling used
such as stratified sampling were not invented by accounting academics, but
auditing professors did make some very practical suggestions on how to use
these models in both audit sampling and bad debt estimation.
Communication with Users
There is a very brief and disappointing section in the AAA Task Force
report. This section does not report any Task Force direct communications
with practitioners. Rather it cites two behavioral studies using real-world
subjects (rather than students) and vague mention studies related to SAS No.
58.
Unsubstantiated Claims About the Importance of Mathematical Models on
Management Accounting Practice
To the extent that mathematical models may or may not have had a significant
impact on managerial accounting is not traced back to accounting literature
per se. For example, accounting researchers did not make noteworthy advances
of linear programming shadow pricing or inventory decision models
originating in the literature of operations research and management science.
Accounting researcher advances in these applications are hardly noteworthy
in the literature of operations research and management science or in
accounting practitioner journal citations.
No mention is made by the AAA Task Force of how the AICPA funded the
mathematical information economics study Cost
Determination: A Conceptual Approach, and then the AICPA refused to
publish and distanced itself from this study that was eventually picked up
by the Iowa State University Press
in1976. I've seen no evidence that this research had an impact on practice
even though it is widely cited in the accountics literature. The AICPA
apparently did not think it would be of interest to practitioners.
The same can be said of regression models used in forecasting. Business
firms do make extensive applications of regression and time series models in
forecasting, but this usage can be traced back to the economics, finance,
and statistics professors who developed these forecasting models. Impacts of
accounting professors on forecasting are not very noteworthy in terms of
accounting practice.
Non-Accountics Research
The most valid claims of impact of accounting academic research on practice
were not accountics research studies. For example, the balanced score card
research of Kaplan and colleagues is probably the best cited example of
accounting professor research impacting practice, but Bob Kaplan himself is
a long-time critic of resistance to publishing his research in TAR, JAR, and
JAE.
There are many areas where AIS professors interact closely with
practitioners who make use of their AIS professor software and systems
contributions, especially in the areas of internal control and systems
security. But most of this research is of the non-accountics and even
non-mathematical sort.
One disappointment for me in the AIS area is the academic research on
XBRL. It seems that most of the noteworthy creative advances in XBRL theory
and practice have come from practitioners rather than academics.
Impact of Academic Accountants on Tax Practice
Probably the best section of the AAA Task Force report cites links between
academic tax research and tax practice. Much of this was not accountics
research, but credit must be given its due when the studies having an impact
were accountics studies.
Although many sections of the AAA Task force report disappointed me, the
tax sections were not at all disappointing. I only wish the other sections
were of the same quality.
For me the AAA Task Force report is a disappointment except where noted
above. If we had conducted field research over the past three years that
focused on the A,B,C,D, or F grades practitioners would've given to academic
accounting research, my guess is that most practitioners would not even know
enough about most of this research to even assign a grade. Some of them may
have learned about some of this research when they were still taking courses
in college, but their interest in this research, in my opinion, headed south
immediately after they received their diplomas (unless they returned to
college for further academic studies).
One exception might be limited exposure to academic accounting research
given by professors who also teach CEP courses such as CEP courses in audit
sampling, tax, audit scorecard, ABC costing, and AIS. I did extensive CEP
teaching on the complicated topics of FAS 133 on accounting for derivative
financial instruments and hedging activities. However, most of my academic
research citations were in the areas of finance and economics since there
never has been much noteworthy research on FAS 133 in the accountics
literature.
Is there much demand for CEP courses on econometric modeling and capital
markets research?
Most practitioners who are really into valuation of business firms are
critical of the lack of relevance of Residual Income models and Free Cash
Flow models worshipped ad nauseum in the academic accounting research
literature.
During the past several decades, many leading B
schools have quietly adopted an inappropriate --- and ultimately
self-defeating --- model of academic excellence. Instead of measuring
themselves in terms of the competence of their graduates, or by how well
their faculties understand important drivers of business performance, they
measure themselves almost solely by the rigor of their scientific research.
They have adopted a model of science that uses abstract financial and
economic analysis, statistical regressions, and laboratory psychology. Some
of the research produced is excellent, but because so little of it is
grounded in actual business practices. the focus of graduate business
education has become increasingly circumscribed --- and less and less
relevant to practitioners ...We are not advocating a return to the days when
business schools were glorified trade schools. In every business, decision
making requires amassing and analyzing objective facts, so B schools must
continue to teach quantitative skills. The challenge is to restore balance
to the curriculum and the faculty: We need rigor and relevance. The dirty
little secret at most of today's best business schools is that they chiefly
serve the faculty's research interests and career goals, with too little
regard for the needs of other stakehollders. Warren G. Bennis and James O'Toole,
"How Business Schools Lost Their Way," Harvard Business Review,
May 2005.
The FMA (and its main journals (Financial Management and the
Journal of Applied Finance) was formed at a time when the American
Finance Association (and its Journal of Finance) was deemed too
esoteric in mathematical economics and growing out of touch with the
industry of finance. Some would argue today that the quants are also taking
over the FMA, but that's a topic I will leave to the membership of the FMA.
Finance practitioners have generally been more respectful of their quants
than accounting practitioners are respectful of their quants in academia.
One simple test would be to ask some random practitioners to name ten quants
who have had an impact on industry. Finance practitioners could probably
name ten (e.g., Markowitz, Modigliani, Arrow, Sharp, Lintner, Merton,
Scholes, Fama, French, etc.). Accounting practitioners could probably only
name one or two from their alma maters at best and then not because of
awareness of anything practical that ever came out of accountics.
Accounting professors avoiding applied research for practitioners and
failure to attract practitioner interest in academic research journals
Many practitioners are now lurkers on the AECM, including some from each
of the Big Four who frequently send me private messages but do not want
their messages forwarded in their own names.
I think there are many ways for getting practitioners more involved in
academic research.
A consideration in this "debate" about top accountics science research
journal refereeing is the inbreeding that has taken in a very large stable
of referees that virtually excludes practitioners. Ostensibly this is
because practitioners more often than not cannot read the requisite
equations in submitted manuscripts. But I often suspect that this is also
because of fear about questions and objections that practitioner scholars
might raise in the refereeing process.
Sets of accountics science referees are very inbred largely because
editors do not invite practitioner "evaluators" into the gene pool. Think of
how things might've been different if practitioner scholars suggested more
ideas to accountics science authors and, horrors, demanded something that
some submissions be more relevant to the professions.
The argument that practitioners cannot read all the requisite equations
in some AAA journals like TAR is a hollow argument to me. Scholarly
practitioners can penetrate the professional value of most articles that
contain equations.
The problem is that scholarly practitioners are usually very busy
professionals who hesitate to giving free time pro bono to AAA journal
refereeing. To get more practitioners into the refereeing process it will
take appeals (pressures?) from their supervisors.
One thing the largest accounting firm CEOs want is great relations with
the AAA, which is often the reason they help fund many AAA programs,
meetings, and publications. What it will take to get more practitioner
scholars on AAA journal editorial boards is an appeal from the Executive
Committee of the AAA to the CEOs of accounting firms and some leading
corporations to encourage their leading employee scholars to volunteer to be
on editorial boards of AAA journals.
This is what it will take to diversify the gene pool of AAA journal
editorial boards.
And I can hear accountics scientists groaning already at this idea. Many
of them shake in fear that practitioners will have a say in judging the
relevance of their research. The best accountics science researchers,
however, have no such fears and have confidence that their research is
relevant to the profession of accountancy.
Bob Jensen
January 22, 2012 reply from Jagdish Gangolly
Bob,
In the early days, there was a thriving
collaboration between the accountants in practice and academicians,
accounting or otherwise. A classic example is the cllaborative work of
Kenneth Stringer (Deloitte) and Professor Frederick F. Stephan of
Princeton University Institute for Advanced Study that led to the
development of what is today called dollar-unit sampling, which
implements a procedure that does not depend on assumptions of normal
approximation of sampling distribution and yet provides "a reasonable
inference of population error when al items in the sample are error
free" (See http://www.nap.edu/openbook.php?record_id=1363&page=9; the US
National Academy Commission on Physical Sciences, Mathematics, and
Applications was alerted to the possibility of such applications not by
academic accountants but by an IRS employee!). This glorious tradition
of practitioners contributing to the academia was continued in: Leslie,
Donald A., Albert D. Teitlebaum, and Rodney J. Anderson, DOLLAR-UNIT
SAMPLING: A PRACTICAL GUIDE FOR AUDITORS (1979) (Teitelbaum is a
statistician at McGill, Leslie and Anderson are practitioners.
Somewhere along the way, we lost our way and
accounting academia became insular, almost xenophobic, introverted
(except for Economics and Finance), and regimented philosophically.
If the practitioners can not understand the
equations, then the fault lies in US academicians and not practice. If
Einstein could explain the complexities of relativity in terms that even
a high school student can understand, and JBS Haldane could explain the
marvelous complexities of genetics and evolution that even uneducated
working classes in England in the thirties could understand, there is no
reason that we academicians can not make simple equations used in most
accounting journals intelligible to educated intelligent practitioners
of accounting. Parsimony is a very good idea when it comes to the use of
mathematics in a field like accounting. Mathematics should not be used
like the lamppost that a drunk leans on for support.
Let alone the practitioners, it would not be a
bad idea to have some grandmas on the panel of reviewers for
submissions.
This January, the American Institute of CPAs
(AICPA) and Chartered Institute of Management Accountants (CIMA)
announced the recipients of the American Accounting Association's (AAA)
Greatest Potential Impact on Management Accounting Practice Award for
2012. The award was presented to Ramji Balakrishnan, Eva Labro, and
Konduru Sivaramakrishnan for their paper, Product Costs as Decision
Aids: An Analysis of Alternative Approaches, which was published in
Accounting Horizons, an AAA publication.
The award was presented at the AAA 2013
Management Accounting Section Conference in New Orleans, Louisiana,
January 10-12, 2013, by Anne Farrell, PricewaterhouseCoopers-endowed
assistant professor chair in accountancy, Farmer School of Business,
Miami University, Oxford, Ohio; chair of the selection committee; and
AAA Management Accounting Section (MAS) liaison to the AICPA Business &
Industry Executive Committee.
According to the AICPA, the award recognizes
academic papers that are considered the most likely to have a
significant impact on management accounting practice. It is sponsored by
the AICPA and CIMA, who are "working to elevate management accounting
around the world and together created the Chartered Global Management
Accountant (CGMA) designation to distinguish professionals who excel in
the field."
Eligible papers must have been published within
the previous five years and submitted by the authors or nominated by
peers. The sponsorship value is $2,000.
Balakrishnan he and his colleagues are
especially appreciative of both institutes' commitment to supporting
academic research in the area of management accounting.
"A lot of academic research in accounting today
is in the realm of financial reporting, with a focus on publically
listed firms for which extensive data sets are available for large-scale
archival research," Balakrishnan said. "We are grateful for AICPA and
CIMA's support of management accounting research because it provides the
needed impetus to direct some of the research focus on measurement
issues and decision tools that are key to enhancing operational
efficiencies of any firm, whether public or private and of all sizes."
The award was created in 2009 to support the
next generation of management accounting researchers and to recognize
the importance of research to practice and the profession. Management
accounting is a core discipline for the institute's members in business,
industry, and government, according to the AICPA.
Continued in article
Jensen Comment
Although this research has not yet shown evidence of adoption in business
firms around the world, it certainly becomes a candidate for addition to the
following table.
I would like to challenge subscribers of the AECM to fill out the following
table:
This challenge is very easy for practitioner clinical applications in
medicine, natural science, social science, computer science, engineering, and
finance. It's not so easy to find where inventions/discoveries by accounting
professors made splashes in the practitioner pond. It might be questioned
whether Bob Kaplan invented all the components of the popular Balanced Scorecard
widely applied by corporations around the world. An earlier version in 1987 was
invented by a practitioner named Art Schneiderman. But I think Bob Kaplan
beginning in 1990 made so many seminal contributions to the scorecard that I
will give him credit for the invention that made a huge splash in the
practitioner pond.
When I was the 1986 Program Director for
NYCAnnual
Meetings of American Accounting Association I posed this challenge to Joel
Demski to address in his plenary session (shared with Bob Kaplan). Joel
suggested the practitioner applications of Dollar-Value LIFO. Subsequently,
accounting historian Dale Flesher dug into this and discovered that DVL was
invented by Herbert T. McAnly who retired in 1964 as a partner at Ernst & Ernst
after 44 years with the firm
The Seminal Contributions to Accounting Literature Award of the American
Accounting Association are as follows ---
http://aaahq.org/awards/awrd2win.htm
2007 — "Relevance Lost: The Rise and Fall of Management
Accounting"
by H. Thomas Johnson and Robert S. Kaplan Harvard Business School Press 1987
2004 — "Towards a Positive Theory of the Determination of
Accounting Standards"
by Ross L. Watts and Jerold L. Zimmerman The Accounting Review (January) 1978
1994 — "Economic Incentives in budgetary Control Systems"
by Joel S. Demski and Gerald A. Feltham The Accounting Review (April) 1978
1989 — "Information Content of Annual Earnings Announcements"
by William H. Beaver Journal of Accounting Research 1968
1986 — "An Empirical Evaluation of Accounting Income Numbers"
by Ray Ball and Philip Brown Journal of Accounting Research 1968
These are all tremendous contributions to the academic side of accountancy.
However, none of the inventions of Professors Demski and Feltham to my knowledge
made a splash in the practitioner pond. ABC costing focused upon by Johnson and
Kaplan made a splash in the practitioner pond, but ABC costing was invented by
cost accountants at John Deere.
The contributions of Watts, Zimmerman, Beaver, Ball, and Brown made splashes
of sorts in the practice pond, but I have difficulty calling them seminal
"inventions." In these instances the authors were extending into accounting
inventions attributed earlier to professors and practitioners in economics and
finance.
There are many other accounting professors who made seminal contributions to
the academic side of accountancy. For example, Yuji Ijiri is a Hall of Famer who
had many noteworthy accountancy inventions. However, to my knowledge Yuji did
not make a ripple in the practitioner pond except maybe for selected
practitioners trying to fend against the takeover of historical cost accounting
by fair value accounting. Many seminal inventions of Yuji, like the "Force,"
were just not deemed practical.
My own published research is best described as extensions and/or applications
invented by others ---
http://faculty.trinity.edu/rjensen/Resume.htm#Published
To my knowledge none of my extensions made so much as a ripple in the
practitioner pond.
January 19, 2013 reply from Dan Stone
A great idea.... which would probably be better in
a research paper than on a list.
Anna Cianci and Bob Ashton published a paper a few
years ago demonstrating how the KPMG audit research support initiative led
to changes in auditor / audit firm practices.
So maybe:
idea: the application of cognitive biases and
decision aiding to audit practice Professors: a large cast many of whom got
their PhD at Univ. of Illinois in the 1960s and 1970s including Bob Ashton,
Bob Libby, Kathryn Kadous, and many, many others
idea: the risk based audit Professors: KPMG
monograph by Howard Thomas, Ira Solomon, Marc Peecher (along with many
others)
Dan Stone
January 20, 2013 reply from Bob Jensen
Hi Dan,
Thanks for the added considerations.
Among other things, your post suggests that some "inventions" do not have
short names.
Some of your suggestions do need further research into where credit can be
given for the very first inventions of what eventually made a splash in the
practitioner pond.
For example, does anybody (Miklos?) on the AECM know of where the concept of
Risk-Based Auditing had its original starting point? I fear that it may be
like Dollar Based LIFO where accounting professors picked up on the seminal
idea of a practitioner. For example, did some employee of the Arthur
Andersen accounting firm, that took risk-based auditing to its own demise,
also invent the concept itself?
Robert Knechel (University of Florida) supposedly traced
the history of risk-based auditing, but I've not seen his paper in
this regard.
Business professors are great at writing
jargon-filled, hard-to-digest research papers. But every once and a
while, they knock it out of the park with the general public. A small
pool of research achieved such blockbuster status in 2012 by becoming
the most read, most downloaded, or most written-about pieces authored by
professors at top business schools. Tax evasion, finding a job, and the
benefits of teaching employees Spanish are some of the topics that got
non-students reading.
At
Harvard Business School, an
excerpt
from Clayton Christensen’s book How Will You
Measure Your Life? was the year’s most read preview of forthcoming
research. The passage uses the downfall of Blockbuster and the rise of
Netflix (NFLX)
as an analogy for how we may end up paying a high cost for small
decisions.
Continued in article
MIT, like Harvard, places enormous value on having both feet planted
in the real world
The professions of architecture, engineering, law, and medicine are
heavily dependent upon the researchers in universities who focus on needs
for research on the problems of practitioners working in the real world.
If accountics scientists want to change their ways and focus more on
problems of the accounting practitioners working in the real world, one
small step that can be taken is to study the presentations scheduled for a
forthcoming MIT Sloan School Conference.
Learning best practice from the best
practitioners
MIT Sloan invites more than 400 of the world’s
finest leaders to campus every year. The most anticipated of these
visits are the talks given as part of the Dean’s Innovative Leader
Series, which features the most dynamic movers and shakers of our day.
At a school that places enormous value on
having both feet planted in the real world, the Dean’s Innovative Leader
Series is a powerful learning tool.
Students have the rare privilege of engaging in frank and meaningful
discussions with the leaders who are shaping the present and future
marketplace.
Bridging the Gap Between Academic Accounting Research and Audit Practice
"Highlights of audit research: Studies examine auditors' industry
specialization, auditor-client negotiations, and executive confidence
regarding earnings management,". By Cynthia E. Bolt-Lee and D. Scott
Showalter, Journal of Accountancy, August 2012 ---
http://www.journalofaccountancy.com/Issues/2012/Jul/20125104.htm
Jensen Comment
This is a nice service of the AICPA in attempting to find accountics science
articles most relevant to the practitioner world and to translate (in
summary form) these articles for a practitioner readership.
Sadly, the service does not stress that research is of only limited
relevance until it is validated in some way at a minimum by encouraging
critical commentaries and at a maximum by multiple and independent
replications by scientific standards for replications ---
http://faculty.trinity.edu/rjensen/TheoryTAR.htm
To my knowledge there is no equivalent journal for undergraduate
accounting research. However, accountants can and do on occasion participate
in the National Conferences of Undergraduate Research --- http://www.ncur.org/
Nearly 20 years ago Trinity University hosted the annual NCUR conference.
There were no accounting student submissions to be refereed that year and in
most years. We were told that accounting students rarely contribute
submissions. So I wrote a paper about this with the two Trinity University
faculty members who coordinated the NCUR presentations on Trinity's campus
that year.
"Undergraduate Student Research Programs: Are They as Viable for
Accounting as They are in Science, Humanities, and Other Business
Disciplines?" (by Bob Jensen, Peter A. French and Kim R. Robertson), Critical Perspectives on Accounting ,
Volume 3, 1992, 337-357.
James Irving's Working Paper entitled "Integrating
Academic Research into an Undergraduate Accounting Course"
College of William and Mary, January 2010
ABSTRACT:
This paper describes my experience incorporating academic research into
the curriculum of an undergraduate accounting course. This
research-focused curriculum was developed in response to a series of
reports published earlier in the decade which expressed significant
concern over the expected future shortage of doctoral faculty in
accounting. It was also motivated by prior research studies which find
that students engaging in undergraduate research are more likely to
pursue graduate study and to achieve graduate school success. The
research-focused curriculum is divided into two complementary phases.
First, throughout the semester, students read and critique excerpts from
accounting journal articles related to the course topics. Second,
students acquire and use specific research skills to complete a formal
academic paper and present their results in a setting intended to
simulate a research workshop. Results from a survey created to assess
the research experience show that 96 percent of students responded that
it substantially improved their level of knowledge, skill, and abilities
related to conducting research. Individual cases of students who follow
this initial research opportunity with a deeper research experience are
also discussed. Finally, I supply instructional tools for faculty who
might desire to implement a similar program.
I recently completed the
first draft of a paper which describes my experience integrating
research into an undergraduate accounting course. Given your prolific
and insightful contributions to accounting scholarship, education, etc.
-- I am a loyal follower of your website and your commentary within the
AAA Commons -- I am wondering if you might have an interest in reading
it (I also cite a 1992 paper published in Critical Perspectives in
Accounting for which you were a coauthor).
The paper is attached
with this note. Any thoughts you have about it would be greatly
appreciated.
I posted the paper to my
SSRN page and it is available at the following link:
http://ssrn.com/abstract=1537682 . I appreciate your willingness to
read and think about the paper.
Jim
January 18, 2010 reply from Bob Jensen
Hi Jim,
I’ve given your paper a
cursory overview and have a few comments that might be of
interest.
You’ve overcome much of the
negativism about why accounting students tend not to participate
in the National Conferences on Undergraduate Research (NCUR).
Thank you for citing our old paper.
French, P., R. Jensen, and K. Robertson. 1992.
Undergraduate student research programs:re they as viable for
accounting as they are in science and humanities?"
Critical Perspectives on Accounting3
(December): 337-357. ---
Click Here
Abstract
This paper reviews a recent thrust in academia to stimulate
more undergraduate research in the USA, including a rapidly
growing annual conference. The paper also describes programs
in which significant foundation grants have been received to
fund undergraduate research projects in the sciences and
humanities. In particular, selected humanities students
working in teams in a new “Philosophy Lab” are allowed to
embark on long-term research projects of their own choosing.
Several completed projects are briefly reviewed in this
paper.
In April
1989, Trinity University hosted the Third National
Conference on Undergraduate Research (NCUR) and purposely
expanded the scope of the conference to include a broad
range of disciplines. At this conference, 632 papers and
posters were presented representing the research activities
of 873 undergraduate students from 163 institutions. About
40% of the papers were outside the natural sciences and
included research in music and literature. Only 13 of those
papers were in the area of business administration; none
were even submitted by accounting students. In 1990 at Union
College, 791 papers were presented; none were submitted by
accountants. In 1991 at Cal Tech, the first accounting paper
appeared as one of 853 papers presented.
This paper
suggests a number of obstacles to stimulating and
encouraging accounting undergraduates to embark on research
endeavours. These impediments are somewhat unique to
accounting, and it appears that accounting education
programs are lagging in what is being done to break down
obstacles in science, pre-med, engineering, humanities, etc.
This paper proposes how to overcome these obstacles in
accounting. One of the anticipated benefits of accounting
student research, apart from the educational and creative
value, is the attraction of more and better students seeking
creativity opportunities in addition to rote learning of CPA
exam requirements. This, in part, might help to counter
industry complaints that top students are being turned away
from accounting careers nationwide.
In particular you seem to have picked up on
our suggestions in the third paragraph above and seemed to be
breaking new ground in undergraduate accounting education.
I am truly amazed by you're
having success when forcing undergraduate students to actually
conduct research in new knowledge.
Please keep up the good work and maintain your
enthusiasm.
1
Firstly, I would suggest that you focus on the topic of
replication as well when you have your students write
commentaries on published academic accounting research ---
http://faculty.trinity.edu/rjensen/TheoryTAR.htm
I certainly would not expect intermediate
accounting students to attempt a replication effort. But it
should be very worthwhile to introduce them to the problem of
lack of replication and authentication of accountancy analytic
and empirical research.
2
Secondly, the two papers you focus on are very old and were
never replicated.. Challenges to both papers are private and in
some cases failed replication attempts, but those challenges
were not published and came to me only by word of mouth. It is
very difficult to find replications of empirical research in
accounting, but I suggest that you at least focus on some papers
that have some controversy and are extended in some way.
For example, consider the controversial paper:
"Costs of Equity and Earnings Attributes," by Jennifer Francis,
Ryan LaFond, Per M. Olsson and Katherine Schipper ,The
Accounting Review, Vol. 79, No. 4 2004 pp. 967–1010.
Also see
http://www.entrepreneur.com/tradejournals/article/179269527.html
Then consider
"Is Accruals Quality a Priced Risk Factor?" by John E. Core,
Wayne R. Guay, and Rodrigo S. Verdi, SSRN, December
2007 ---
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=911587
This paper was also published in JAE in 2007 or 2008.
Thanks to Steve Kachelmeier for pointing this controversy (on
whether information quality (measured as the noise in accounting
accruals) is priced in the cost of equity capital) out to me.
It might be better for your students to see
how accounting researchers should attempt replications as
illustrated above than to merely accepted published accounting
research papers as truth unchallenged.
3.
Have your students attempt critical thinking with regards to
mathematical analytics in "Plato's Cave" ---
http://faculty.trinity.edu/rjensen/TheoryTAR.htm#Analytics
This is a great exercise that attempts to make them focus on
underlying assumptions.
4.
In Exhibit 1 I recommend adding a section on critical thinking
about underlying assumptions in the study. In particular, have
your students focus on internal versus external validity ---
http://faculty.trinity.edu/rjensen/TheoryTAR.htm#SocialScience .
5.
I suggest that you set up a hive at the AAA Commons for
Undergraduate Research Projects and Commentaries. Then post your
own items in this hive and repeatedly invite professors and
students from around the world to add to this hive.
One of the more surprising things
I have learned from my experience as Senior Editor of
The Accounting
Review is just how often a
‘‘hot
topic’’
generates multiple
submissions that pursue similar research objectives. Though one might
view such situations as enhancing the credibility of research findings
through the independent efforts of multiple research teams, they often
result in unfavorable reactions from reviewers who question the
incremental contribution of a subsequent study that does not materially
advance the findings already documented in a previous study, even if the
two (or more) efforts were initiated independently and pursued more or
less concurrently. I understand the reason for a high incremental
contribution standard in a top-tier journal that faces capacity
constraints and deals with about 500 new submissions per year.
Nevertheless, I must admit that I sometimes feel bad writing a rejection
letter on a good study, just because some other research team beat the
authors to press with similar conclusions documented a few months
earlier. Research, it seems, operates in a highly competitive arena.
Fortunately, from time to time, we
receive related but still distinct submissions that, in combination,
capture synergies (and reviewer support) by viewing a broad research
question from different perspectives. The two articles comprising this
issue’s forum are a classic case in point. Though both studies reach the
same basic conclusion that material weaknesses in internal controls over
financial reporting result in negative repercussions for the cost of
debt financing, Dhaliwal et al. (2011) do so by examining the public
market for corporate debt instruments, whereas Kim et al. (2011) examine
private debt contracting with financial institutions. These different
perspectives enable the two research teams to pursue different secondary
analyses, such as Dhaliwal et al.’s examination of the sensitivity of
the reported findings to bank monitoring and Kim et al.’s examination of
debt covenants.
Both studies also overlap with yet
a third recent effort in this arena, recently published in the
Journal of
Accounting Research by Costello
and Wittenberg-Moerman (2011). Although the overall
‘‘punch
line’’
is similar in all three studies (material
internal control weaknesses result in a higher cost of debt), I am
intrigued by a ‘‘mini-debate’’
of sorts on the different
conclusions reache by Costello and Wittenberg-Moerman (2011) and
by Kim et al. (2011) for the effect of material weaknesses on debt
covenants. Specifically, Costello and Wittenberg-Moerman (2011, 116)
find that ‘‘serious,
fraud-related weaknesses result in a significant decrease in financial
covenants,’’
presumably because banks substitute more
direct protections in such instances, whereas Kim et al.
Published Online: July 2011
(2011) assert from their cross-sectional
design that company-level material weaknesses are associated with
more
financial covenants
in debt contracting.
In reconciling these conflicting
findings, Costello and Wittenberg-Moerman (2011, 116) attribute the Kim
et al. (2011) result to underlying
‘‘differences
in more fundamental firm characteristics, such as riskiness and
information opacity,’’
given that, cross-sectionally, material
weakness firms have a greater number of financial covenants than do
non-material weakness firms even
before the disclosure of the
material weakness in internal controls. Kim et al. (2011) counter that
they control for risk and opacity characteristics, and that advance
leakage of internal control problems could still result in a debt
covenant effect due to internal controls rather than underlying firm
characteristics. Kim et al. (2011) also report from a supplemental
change analysis that, comparing the pre- and post-SOX 404 periods, the
number of debt covenants falls for companies both with
and without
material weaknesses
in internal controls, raising the question of whether the
Costello and Wittenberg-Moerman
(2011) finding reflects a reaction to the disclosures or simply a more
general trend of a declining number of debt covenants affecting all
firms around that time period. I urge readers to take a look at both
articles, along with Dhaliwal et al. (2011), and draw their own
conclusions. Indeed, I believe that these sorts . . .
Continued in article
Jensen Comment
Without admitting to it, I think Steve has been embarrassed, along with many
other accountics researchers, about the virtual absence of validation and
replication of accounting science (accountics) research studies over the
past five decades. For the most part, accountics articles are either ignored
or accepted as truth without validation. Behavioral and capital markets
empirical studies are rarely (ever?) replicated. Analytical studies make
tremendous leaps of faith in terms of underlying assumptions that are rarely
challenged (such as the assumption of equations depicting utility functions
of corporations).
Accounting science thereby has become a pseudo
science where highly paid accountics professor referees are protecting each
others' butts ---
"574 Shields Against Validity Challenges in Plato's Cave" ---
http://faculty.trinity.edu/rjensen/TheoryTAR.htm
The above link contains Steve's rejoinders on the replication debate.
In the above editorial he's telling us that there is a middle ground for
validation of accountics studies. When researchers independently come to
similar conclusions using different data sets and different quantitative
analyses they are in a sense validating each others' work without truly
replicating each others' work.
I agree with Steve on this, but I would also argue that these types of
"validation" is too little to late relative to genuine science where
replication and true validation are essential to the very definition of
science. The types independent but related research that Steve is discussing
above is too infrequent and haphazard to fall into the realm of validation
and replication.
When's the last time you witnesses a TAR author criticizing the research
of another TAR author (TAR does not publish critical commentaries)?
Are TAR articles really all that above criticism? Even though I admire Steve's scholarship,
dedication, and sacrifice, I hope future TAR editors will work harder at
turning accountics research into real science!
A top level, I mean really top level, an accountics researcher who is not
especially fond of my rants about accountics research wrote (privately) today
(November 10, 2009) as follows appealing once again for me to me to stop using
the word "accountics" which he thought I'd invented:
So, while you clearly did not invent
“accountics” (for which I again apologize for not know that you did not coin
the term), it strikes me that part of your proposed rejuvenation of the term
could be as a rhetorical device to attach a narrow-sounding label to
accounting research. This was the tenor of my original point, even if I did
misunderstand the history. At least if I am any example, most of us out
there do not know that Charles Sprague coined the term “accountics” in 1887.
But we do know that it doesn’t sound particularly flattering in 2010. XXXXX, Well known accountics
researcher at a prestigious university
Just before commencing to watch a movie this afternoon, one of the paragraphs
I wrote back to Professor XXXXX was as follows about the importance of the term
"accountics" dating back to the very beginning of The Accounting Review
(TAR):
Accountics is a historical term relating way back
to the time TAR was formed. There was in fact a heated debate at the early
1920s whether TAR would take an “accountics” track that mostly excluded the
practicing profession or a professional track that encouraged publication of
practitioner articles. Practitioners won out 1925-1958. The “accountics”
domination did not even commence again until 1958 when a “perfect storm”
commenced as noted in Heck and Jensen (2007).
Bob Jensen
It has often been fortuitous in my life that things enter into my life just
at the proper time as if predestined. Just after reading a longer message from
XXXXX defending the accountics bias of leading academic accounting journals for
the past four decades, I was watching a NetFlix mystery movie with Erika and,
during the movie, just happened to glance at the back cover of the November 13,
2009 edition of The Chronicle of Higher Education that arrived by mail
today. The title of the article was intriguing and very much relevant
historically Go today's private message from XXXXX who didn't have a clue about
the history of the term "accountics" coined by Charles Sprague in 1887.
The title of the November 13 article, by the way, is as follows: "Have Two National Reports Ruined Business Schools?,"
by Carter A. Daniel, Chronicle of Higher Education, November 13, 2009
(hard copy date) --- http://chronicle.com/article/How-Two-National-Reports-Ru/49055/
Two National Reports Dating Back 50 Years Ago What is interesting is that the "two national reports" referred to in the
current article above date back to the very crossroads of accounting and
business education just before 1960.
In a nutshell, in 1960, collegiate business education faced a fork in the
road and, unlike Yogi Berra, could not take both roads into the future. One road
led to professional business education much like law schools and medical
schools. That road leads away from the mainstream divisions of humanities and
science in a university and ties the faculty much closer to problems in the
respective practicing professions of law and medicine. Practitioners take their
troubles to the law schools and medical schools for help with issues facing the
street-level practitioners. The professional road led to more prestige in the
profession at the expense of carrying with it the former burden of being a
business "trade school" among scholars.
The other fork in the road led away from the profession back toward the
divisions of humanities and science, especially social science with its
economics, econometrics, psychometrics, and advanced mathematics and statistics.
Unlike the professional fork in the road, the academic fork in the road led to
more prestige and respect within the university.
Note especially the references to the Gordon and Howell (1959) and Pearson (1959)
reports below:
Heck and Jensen (2007) state the following at
An Analysis of the Contributions of The Accounting Review
Across 80 Years: 1926-2005 ---
http://faculty.trinity.edu/rjensen/395wpTAR/Web/TAR395wp.htm
Jean Heck and Robert E. Jensen, December 2007 edition of the
Accounting Historians Journal.
Accountics is the mathematical science of values.
Charles Sprague [1887] as quoted by McMillan [1998, p. 1][NH1]
Accounting professor Charles
Sprague of Columbia University (then called Columbia College)
coined the word "accountics" in 1887.
The word is not used today in accounting and has some
alternative meanings outside our discipline. However, in the
early 20th century, accountics was the centerpiece of
some unpublished lectures by Sprague. McMillan [1998, p. 11]
stated the following:
These claims were not a pragmatic strategy to legitimize the
development of sophisticated bookkeeping theories. Rather, this
development of a science was seen as revealing long-hidden
realities within the economic environment and the double-entry
bookkeeping system itself. The science of accounts, through
systematic mathematical analysis, could discover hidden thrust
of the reality of economic value. The term “accountics” captured
the imagination of the members of the IA, connoting advances in
bookkeeping that all these men were experiencing.
By 1900, there was a journal called Accountics
[Forrester, 2003]. Both the journal and the term “accountics”
had short lives, but the belief that mathematical analysis and
empirical research can “discover hidden thrust of the reality of
economic value” (see above) underlies much of what has been
published in TAR over the past three decades. Hence, we propose
reviving the term “accountics” to describe the research methods
and quantitative analysis tools that have become popular in TAR
and other leading accounting research journals. We essentially
define accountics as equivalent to the scientific study of
values in what Zimmerman [2001, p. 414] called “agency problems,
corporate governance, capital asset pricing, capital budgeting,
decision analysis, risk management, queuing theory, and
statistical audit analysis.”
The American Association of University Instructors of
Accounting, which in December 1935 became the American
Accounting Association, commenced unofficially in 1915 [Zeff,
1966, p. 5]. It was proposed in October of 1919 that the
Association publish a Quarterly Journal of Accountics. This
proposed accountics journal never got off the ground as leaders
in the Association argued heatedly and fruitlessly about whether
accountancy was a science. A quarterly journal called The
Accounting Review was subsequently born in 1925, with its
first issue being published in March of 1926. Its
accountics-like attributes did not commence in earnest until the
1960s.
Practitioner involvement, in a large measure, was the reason for
changing the name of the Association by removing the words “of
University Instructors.” Practitioners interested in accounting
education participated actively in AAA meetings. TAR articles in
the first several decades were devoted heavily to education
issues and accounting issues in particular industries and trade
groups. Research methodologies were mainly normative (without
mathematics), case study, and archival (history) methods.
Anecdotal evidence and hypothetical illustrations ruled the day.
The longest serving editor of TAR was a practitioner named
Eric Kohler,
who determined what was published in TAR between 1929 and 1943.
In those years, when the AAA leadership mandated that TAR focus
on the development of accounting principles, publications were
oriented to both practitioners and educators, Chatfield [1975,
p. 4].
Following World War II, practitioners outnumbered educators in
the AAA [Chatfield 1975, p. 4]. Leading partners from accounting
firms took pride in publishing papers and books intended to
inspire scholarship among professors and students. Over the
years, some practitioners, particularly those with scholarly
publications, were admitted into the Accounting Hall of Fame
founded by The Ohio State University. Prior to the 1960s,
accounting educators were generally long on practical experience
and short on academic credentials such as doctoral degrees.
A major catalyst for change in accounting research occurred when
the Ford Foundation poured millions of dollars into the study of
collegiate business schools and the funding of doctoral programs
and students in business studies. Gordon
and Howell [1959] reported that business faculty in
colleges lacked research skills and academic esteem when
compared to their colleagues in the sciences. The Ford
Foundation thereafter provided funding for doctoral programs and
for top quality graduate students to pursue doctoral degrees in
business and accountancy. The Foundation even funded publication
of selected doctoral dissertations to give doctoral studies in
business more visibility. Great pressures were also brought to
bear on academic associations like the AAA to increase the
scientific standards for publications in journals like TAR.
TAR BETWEEN 1956 AND 1985: NURTURING OF ACCOUNTICS
A perfect storm for change in accounting research arose in the
late 1950s and early1960s. First came the
critical Pierson Carnegie Report [1959] and the Gordon and
Howell Ford Foundation Report [1959]. Shortly thereafter, the
AACSB introduced a requirement requiring that a certain
percentage of faculty possess doctoral degrees for business
education programs seeking accreditation [Bricker
and Previts, 1990].
Soon afterwards, both a doctorate and publication in top
accounting research journals became necessary for tenure [Langenderfer,
1987].
A second component of this perfect storm for change was the
proliferation of mainframe computers, the development of
analytical software (e.g., early SPSS for mainframes), and the
dawning of management and decision “sciences.” The third huge
stimulus for changed research is rooted in portfolio theory
discovered by Harry Markowitz in1952 that became the core of his
dissertation at Princeton University, which was published in
book form in 1959. This theory eventually gave birth to the
Nobel Prize winning Capital Asset Pricing Model (CAPM) and a new
era of capital market research. A fourth stimulus was when the
CRSP stock price tapes became available from the University of
Chicago. The availability of CRSP led to a high number of TAR
articles on capital market event studies (e.g., earnings
announcements on trading prices and volumes) covering a period
of nearly 40 years.
This “perfect storm” roared into nearly all accounting and
finance research and turned academic accounting research into an
accountics-centered science of values and
mathematical/statistical analysis. After 1960, there was a shift
in TAR, albeit slow at first, toward preferences for
quantitative model building --- econometric models in capital
market studies, time series models in forecasting, advanced
calculus information science, information economics, analytical
models, and psychometric behavioral models. Chatfield [1975, p.
6] wrote the following:
Beginning in the 1960s the Review published many more articles
by non-accountants, whose contribution involved showing how
ideas or methods from their own discipline could be used to
solve particular accounting problems. The more successful
adaptations included matrix theory, mathematical model building,
organization theory, linear programming, and Bayesian analysis.
TAR was not alone in moving toward a more quantitative focus.
Accountics methodologies accompanied similar quantitative model
building preferences in finance, marketing, management science,
decision science, operations research, information economics,
computer science, and information systems. Early changes along
these lines began to appear in other leading research journals
between 1956-1965, with some mathematical modeling papers noted
by Dyckman and Zeff [1984, p. 229]. Fleming, Graci and Thompson
[2000, p. 43] documented additional emphasis on quantitative
methodology between 1966 and 1985. In particular, they note how
tenure requirements began to change and asserted the following:
The Accounting Review
evolved into a journal with demanding acceptance standards whose
leading authors were highly educated accounting academics who,
to a large degree, brought methods and tools from other
disciplines to bear upon accounting issues.
A number of new academic accountancy journals were launched in
the early 1960s, including the Journal of Accounting Research
(1963), Abacus (1965) and The International Journal of
Accounting Education and Research (1965). Clinging to its
traditional normative roots and trade-article style would have
made TAR appear to be a journal for academic luddites. Actually,
many of the new mathematical approaches to theory development
were fundamentally normative, but they were couched in the
formidable language and rigors of mathematics. Publication of
papers in traditional normative theory, history, and systems
slowly ground to almost zero in the new age of accountics.
These new spearheads in accountics were not without problems. It
is both humorous and sad to go back and discover how naïve and
misleading some of TAR’s bold and high risk thrusts were in
quantitative methods. Statistical models were employed without
regard to underlying assumptions of independence, temporal
stationarity, multicollinearity, homoscedasticity, missing
variables, and departures from the normal distribution.
Mathematical applications were proposed for real-world systems
that failed to meet continuity and non-convexity assumptions
inherent in models such as linear programming and calculus
optimizations. Some proposed applications of finite mathematics
and discrete (integer) programming failed because the fastest
computers in the world, then and now, could not solve most
realistic integer programming problems in less than 100 years.
After financial databases provided a beta covariance of each
security in a portfolio with the market portfolio, many capital
market events studies were published by TAR and other leading
accounting journals. In the early years, accounting researchers
did not challenge the CAPM’s assumptions and limitations ---
limitations that, in retrospect, cast doubt upon many of the
findings based upon any single index of market risk [Fama and
French, 1992].
Leading accounting professors lamented TAR’s preference for
rigor over relevancy [Zeff, 1978; Lee, 1997; and Williams, 1985
and 2003]. Sundem [1987] provides revealing information about
the changed perceptions of authors, almost entirely from
academe, who submitted manuscripts for review between June 1982
and May 1986. Among the 1,148 submissions, only 39 used archival
(history) methods; 34 of those submissions were rejected.
Another 34 submissions used survey methods; 33 of those were
rejected. And 100 submissions used traditional normative
(deductive) methods with 85 of those being rejected. Except for
a small set of 28 manuscripts classified as using “other”
methods (mainly descriptive empirical according to Sundem), the
remaining larger subset of submitted manuscripts used methods
that Sundem [1987, p. 199] classified these as follows:
292 General Empirical
172 Behavioral
135 Analytical modeling
119 Capital Market
97 Economic modeling
40 Statistical modeling
29 Simulation
It is clear that by 1982, accounting researchers realized that
having mathematical or statistical analysis in TAR submissions
made accountics virtually a necessary, albeit not sufficient,
condition for acceptance for publication. It became increasingly
difficult for a single editor to have expertise in all of the
above methods. In the late 1960s, editorial decisions on
publication shifted from the TAR editor alone to the TAR editor
in conjunction with specialized referees and eventually
associate editors [Flesher, 1991, p. 167]. Fleming et al. [2000,
p. 45] wrote the following:
The big change was in research methods. Modeling and empirical
methods became prominent during 1966-1985, with analytical
modeling and general empirical methods leading the way. Although
used to a surprising extent, deductive-type methods declined in
popularity, especially in the second half of the 1966-1985
period.
We were surprised that there was no reduction in accountics
dominance in TAR since 1986 in spite of changes in the
environment such as the explosion of communications networking,
interacting relational databases, and sophisticated accounting
information systems (AIS). Virtually no AIS papers were published
in TAR between 1986 and 2005. This practice was changed in 2006
by the appointment of a new AIS associate editor to encourage
publication of some AIS papers that often do not fit neatly into
the accountics mold. In an interesting aside, we note that the
AAA has become a leading international association of
accounting educators. Sundem [1987] reported that about 12
percent of the manuscripts submitted came from outside of North
America. The American Accounting Association is an international
association that provides publication opportunities to all
members, and manuscripts are submitted from many parts of the
world. In our opinion, this contributed significantly to the
rise in accountics studies worldwide
That Fork in the Road
In other words, due largely to the
Pierson
Carnegie Report [1959] and the Gordon and Howell Ford Foundation Report
[1959] coupled with the millions given to commence accounting and business
doctoral programs (as opposed to the assorted economics department doctoral
programs catering somewhat to accounting and business), business took took
the academic road at the 1960 fork rather than the professional road.
Fifty years ago this fall, an event took place that transformed
business education across the nation and beyond: the
simultaneous publication of two reports, by the Ford Foundation
and the Carnegie Corporation, on the state of business education
in America. Although generally regarded at the time as a
salutary development, the reports, considered half a century
later, can be more accurately described
as
something close to a catastrophe,
with consequences felt in every school of business every day.
While
not actually sensational in themselves, the reports were very
negative and critical. Four criticisms stood out: weak students,
inappropriately trained faculty members, unintellectual
curriculum, and poor research. The press picked up on the
criticisms and made the subject into a national furor.
Practically shouting, The New York Times wrote that business
schools had been "assailed" as "inferior" in a "double-barreled
attack." BusinessWeek echoed that view, saying that the attacks
would "knock the stuffing out of business schools" and, five
years later, that the schools "were still smarting from the
criticism."
The
aftermath of the foundation reports stands as an example of what
happens when well-intentioned outsiders meddle in a field they
don't understand.
The
authors of the reports, all from liberal-arts backgrounds
(psychology, economics, mathematics), showed little
understanding of the subject they were writing about, and they
foolishly chastised business departments for not being as
theoretical and academic as departments like English and
history. Their criticisms made little sense: It has long been
known that good grades in school often bear no correlation with
financial success in life, so it shouldn't have surprised
anybody that academically gifted students tended to study
Shakespeare and Einstein while less bookish ones were more
attracted to management and finance.
Further, since business is an eclectic and multifaceted
activity, it is entirely normal, reasonable, and desirable to
have psychologists, mathematicians, ethicists, sociologists,
economists, scientists, and others—not to mention businesspeople
themselves—bring their perspectives to the study of business.
And finally, since business is by nature practical, both the
curriculum and the research are inevitably going to reflect less
concern with history and theory than one would find in a field
like philosophy.
But—and
herein lies the catastrophe—instead of boldly fighting back
against their misguided detractors, the nation's business
schools uniformly cowered and began scurrying to conform to the
wishes of the reports' authors.
Business education could, and should, have adopted the model of
other professional schools, where theoretical-minded
practitioners and practice-minded theoreticians are the mentors,
and where both the curriculum and the research focus on the real
world. But instead of constantly striving to achieve that
delicate, razor's-edge balance between theory and practice,
business schools, frightened by the reports, retreated almost
entirely into theoretical camp. Doing so damaged several
important, distinct characteristics of business schools,
including:
Faculty
training, expertise, and background. Shortly after the reports
came out, leveling the criticism that some business professors
had doctorates in other fields or no doctorates at all,
universities across the nation scrambled to begin creating Ph.D.
programs specifically in business. No fewer than 50 such
doctoral programs were founded in the next 10 years—programs
that redefined the nature of the field. The number of business
doctorates awarded grew from 124 the year before the reports to
1,097 just a decade and a half later, and ever since it has been
virtually a requirement that business professors not only have
Ph.D.'s but have them specifically in business.
The
effect, however, has not been to make these professors more
capable but has merely ensured that people with business
experience, as well as people with knowledge of other
disciplines, are effectively discouraged from teaching in
business schools. Since experienced businesspeople seldom have
any reason to earn a Ph.D., and Ph.D. candidates seldom have any
time or inclination to work in business, the rise of the
doctorate requirement has served to separate theory and practice
instead of unify them, and has severely limited the perspectives
that are brought to bear on the subject.
Research. The foundations' reports criticized business schools
for producing too little research, and criticized what little
research there was for being too practical rather than
theoretical. As a result a whole new industry sprang up. The
number of academic journals in business tripled over the next 25
years, and the number of business books published each year more
than quadrupled. Their relevance and usefulness can't, of
course, be quantitatively proved or disproved, but it's
commonplace to hear businesspeople scoff that academic research
never has any influence on what they actually do in their
companies. Legal, medical, and engineering journals are written
and read by lawyers, doctors, and engineers, but business
journals consist almost wholly of articles written by professors
for other professors.
Undergraduate business programs. Several universities abolished
their undergraduate business programs in response to the
foundation reports' call for a strong grounding in the liberal
arts. But market forces were so strong in the opposite direction
that those universities soon had to change their minds, and they
ended up re-establishing undergraduate business programs. The
new programs, moreover, were often far less rigorous and
demanding than the old ones had been. A comparison of the
catalogs from today with those of the 1950s shows that current
programs lack the liberal-arts requirements that once existed.
Business schools have been trying now for many years to rebuild
their credibility on a professional model. They had been making
progress in that direction before 1959, and they are making
progress again today. But meddling from an ill-informed group of
outsiders set back the cause of reform by several decades. The
foundation reports should not have said what they said, and
business schools should not have responded as they did.
Educators can learn something from the whole sad
experience—mainly, that knowing our subject isn't enough. We
have to think deeply also about our field —its place in
education, in society, and in the spectrum of human thought, as
well as the most appropriate and effective ways to present it.
Then when we are attacked by ill-informed outsiders—whether
foundations, legislatures, trustees, newspapers, magazine
rankings, or even our own administrations—we will be prepared to
stand up and reply as the professionals we are, rather than
slink off into a barren desert with our tails between our legs.
Carter A. Daniel is director
of business-communication programs at the Rutgers Business
School and author of MBA: The First Century (Bucknell University
Press, 1998).
A few weeks ago, TechCrunch published a piece
arguing software is better at investing than 99% of human investment
advisors. That post, titled
Thankfully, Software Is Eating The Personal Investing World,
pointed out the advantages of engineering-driven
software solutions versus emotionally driven human judgment. Perhaps not
surprisingly, some commenters (including some financial advisors) seized
the moment to call into question one of the foundations of
software-based investing, Modern Portfolio Theory.
Given the doubts raised by a small but vocal
chorus, it’s worth spending some time to ask if we need a new investing
paradigm and if so, what it should be. Answering that question helps
show why MPT still is the best investment methodology out there; it
enables the automated, low-cost investment management offered by a new
wave of Internet startups including
Wealthfront
(which I advise),
Personal
Capital,
Future Advisor and
SigFig.
The basic questions being raised about MPT run
something like this:
Hasn’t recent experience – i.e., the
financial crisis — shown that diversification doesn’t work?
Shouldn’t we primarily worry about “Black
Swan” events and unforeseen risk?
Don’t these unknown unknowns mean we must
develop a new approach to investing?
Let’s begin by briefly laying out the key
insights of MPT.
MPT is based in part on the assumption that
most investors don’t like risk and need to be compensated for bearing
it. That compensation comes in the form of higher average returns.
Historical data strongly supports this assumption. For example, from
1926 to 2011 the average (geometric) return on U.S. Treasury Bills was
3.6%. Over the same period the average return on large company stocks
was 9.8%; that on small company stocks was 11.2% ( See 2012 Ibbotson
Stocks, Bonds, Bills and Inflation (SBBI) Valuation Yearbook,
Morningstar, Inc., page 23. ). Stocks, of course, are much riskier than
Treasuries, so we expect them to have higher average returns — and they
do.
One of MPT’s key insights is that while
investors need to be compensated to bear risk, not all risks are
rewarded. The market does not reward risks that can be “diversified
away” by holding a bundle of investments, instead of a single
investment. By recognizing that not all risks are rewarded, MPT helped
establish the idea that a diversified portfolio can help investors earn
a higher return for the same amount of risk.
To understand which risks can be diversified
away, and why, consider Zynga. Zynga hit $14.69 in March and has since
dropped to less than $2 per share. Based on what’s happened over the
past few months, the major risks associated with Zynga’s stock are
things such as delays in new game development, the fickle taste of
consumers and changes on Facebook that affect users’ engagement with
Zynga’s games.
For company insiders, who have much of their
wealth tied up in the company, Zynga is clearly a risky investment.
Although those insiders are exposed to huge risks, they aren’t the
investors who determine the “risk premium” for Zynga. (A stock’s risk
premium is the extra return the stock is expected to earn that
compensates for the stock’s risk.)
Rather, institutional funds and other large
investors establish the risk premium by deciding what price they’re
willing to pay to hold Zynga in their diversified portfolios. If a Zynga
game is delayed, and Zynga’s stock price drops, that decline has a
miniscule effect on a diversified shareholder’s portfolio returns.
Because of this, the market does not price in that particular risk. Even
the overall turbulence in many Internet stocks won’t be problematic for
investors who are well diversified in their portfolios.
Modern Portfolio Theory focuses on constructing
portfolios that avoid exposing the investor to those kinds of unrewarded
risks. The main lesson is that investors should choose portfolios that
lie on the Efficient Frontier, the mathematically defined curve that
describes the relationship between risk and reward. To be on the
frontier, a portfolio must provide the highest expected return (largest
reward) among all portfolios having the same level of risk. The Internet
startups construct well-diversified portfolios designed to be efficient
with the right combination of risk and return for their clients.
Now let’s ask if anything in the past five
years casts doubt on these basic tenets of Modern Portfolio Theory. The
answer is clearly, “No.” First and foremost, nothing has changed the
fact that there are many unrewarded risks, and that investors should
avoid these risks. The major risks of Zynga stock remain diversifiable
risks, and unless you’re willing to trade illegally on inside
information about, say, upcoming changes to Facebook’s gaming policies,
you should avoid holding a concentrated position in Zynga.
The efficient frontier is still the desirable
place to be, and it makes no sense to follow a policy that puts you in a
position well below that frontier.
Most of the people who say that
“diversification failed” in the financial crisis have in mind not the
diversification gains associated with avoiding concentrated investments
in companies like Zynga, but the diversification gains that come from
investing across many different asset classes, such as domestic stocks,
foreign stocks, real estate and bonds. Those critics aren’t challenging
the idea of diversification in general – probably because such an effort
would be nonsensical.
True, diversification across asset classes
didn’t shelter investors from 2008’s turmoil. In that year, the S&P 500
index fell 37%, the MSCI EAFE index (the index of developed markets
outside North America) fell by 43%, the MSCI Emerging Market index fell
by 53%, the Dow Jones Commodities Index fell by 35%, and the Lehman High
Yield Bond Index fell by 26%. The historical record shows that in times
of economic distress, asset class returns tend to move in the same
direction and be more highly correlated. These increased correlations
are no doubt due to the increased importance of macro factors driving
corporate cash flows. The increased correlations limit, but do not
eliminate, diversification’s value. It would be foolish to conclude from
this that you should be undiversified. If a seat belt doesn’t provide
perfect protection, it still makes sense to wear one. Statistics show
it’s better to wear a seatbelt than to not wear one. Similarly,
statistics show diversification reduces risk, and that you are better
off diversifying than not.
Timing the market
The obvious question to ask anyone who insists
diversification across asset classes is not effective is: What is the
alternative? Some say “Time the market.” Make sure you hold an asset
class when it is earning good returns, but sell as soon as things are
about to go south. Even better, take short positions when the outlook is
negative. With a trustworthy crystal ball, this is a winning strategy.
The potential gains are huge. If you had perfect foresight and
could time the S&P 500 on a daily basis, you could have turned $1,000 on
Jan. 1, 2000, into $120,975,000 on Dec. 31, 2009, just by going in and
out of the market. If you could also short the market when appropriate,
the gains would have been even more spectacular!
Sometimes, it seems someone may have a fairly
reliable crystal ball. Consider John Paulson, who in 2007 and 2008
seemed so prescient in profiting from the subprime market’s collapse. It
appears, however, that Mr. Paulson’s crystal ball became less reliable
after his stunning success in 2007. His Advantage Plus fund experienced
more than a 50% loss in 2011. Separating luck from skill is often
difficult.
Some people try to come up with a way to time
the market based on historical data. In fact a large number of
strategies will work well “in the back test.” The question is whether
any system is reliable enough to use for future investing.
There are at least three reasons to be cautious
about substituting a timing system for diversification.
First, a timing system that does not work
can impose significant transaction costs (including avoidable
adverse tax consequences) on the investor for no gain.
Second, an ill-founded timing strategy
generally exposes the investor to risk that is unrewarded. In other
words, it puts the investor below the frontier, which is not a good
place to be.
Third, a timing system’s success may
create the seeds of its own destruction. If too many investors
blindly follow the strategy, prices will be driven to erase any
putative gains that might have been there, turning the strategy into
a losing proposition. Also, a timing strategy designed to “beat the
market” must involve trading into “good” positions and away from
“bad” ones. That means there must be a sucker (or several suckers)
available to take on the other (losing) sides. (No doubt in most
cases each party to the trade thinks the sucker is on the other
side.)
Black Swans
What about those Black Swans? Doesn’t MPT
ignore the possibility that we can be surprised by the unexpected? Isn’t
it impossible to measure risk when there are unknown unknowns?
Most people recognize that financial markets
are not like simple games of chance where risk can be quantified
precisely. As we’ve seen (e.g., the “Black Monday” stock market crash of
1987 and the “flash crash” of 2010), the markets can produce extreme
events that hardly anyone contemplated as a possibility. As opposed to
poker, where we always draw from the same 52-card deck, in financial
markets, asset returns are drawn from changing distributions as the
world economy and financial relationships change.
Some Black Swan events turned out to have
limited effects on investors over the long term. Although the market
dropped precipitously in October 1987, it was close to fully recovered
in June 1988. The flash crash was confined to a single day.
This is not to say that all “surprise” events are transitory. The Great
Depression followed the stock market crash of 1929, and the effects of
the financial crisis in 2007 and 2008 linger on five years later.
The question is, how should we respond to
uncertainties and Black Swans? One sensible way is to be more diligent
in quantifying the risks we can see. For example, since extreme events
don’t happen often, we’re likely to be misled if we base our risk
assessment on what has occurred over short time periods. We shouldn’t
conclude that just because housing prices haven’t gone down over 20
years that a housing decline is not a meaningful risk. In the case of
natural disasters like earthquakes, tsunamis, asteroid strikes and solar
storms, the long run could be very long indeed. While we can’t capture
all risks by looking far back in time, taking into account long-term
data means we’re less likely to be surprised.
Some people suggest you should respond to the
risk of unknown unknowns by investing very conservatively. This means
allocating most of the portfolio to “safe assets” and significantly
reducing exposure to risky assets, which are likely to be affected by
Black Swan surprises. This response is consistent with MPT. If you worry
about Black Swans, you are, for all intents and purposes, a very
risk-averse investor. The MPT portfolio position for very risk-averse
investors is a position on the efficient frontier that has little risk.
The cost of investing in a low-risk position is
a lower expected return (recall that historically the average return on
stocks was about three times that on U.S. Treasuries), but maybe you
think that’s a price worth paying. Can everyone take extremely
conservative positions to avoid Black Swan risk? This clearly won’t
work, because some investors must hold risky assets. If all investors
try to avoid Black Swan events, the prices of those risky assets will
fall to a point where the forecasted returns become too large to ignore.
Continued in article
Jensen Comment
All quant theories and strategies in finance are based upon some
foundational assumptions that in rare instances turn into the
Achilles' heel of the entire superstructure. The classic example is the
wonderful theory and arbitrage strategy of Long Term Capital Management (LTCM)
formed by the best quants in finance (two with Nobel Prizes in economics).
After remarkable successes one nickel at a time in a secret global arbitrage
strategy based heavily on the Black-Scholes Model, LTCM placed a trillion
dollar bet that failed dramatically and became the only hedge fund that
nearly imploded all of Wall Street. At a heavy cost, Wall Street investment
bankers pooled billions of dollars to quietly shut down LTCM ---
http://faculty.trinity.edu/rjensen/FraudRotten.htm#LTCM
So what was the Achilles heal of the arbitrage strategy of LTCM? It was
an assumption that a huge portion of the global financial market would not
collapse all at once. Low and behold, the Asian financial markets collapsed
all at once and left LTCM naked and dangling from a speculative cliff.
There is a tremendous (one of the
best videos I've ever seen on the Black-Scholes Model) PBS Nova video called
"Trillion Dollar Bet" explaining why
LTCM collapsed. Go to
http://www.pbs.org/wgbh/nova/stockmarket/
This video is in the media libraries on most college campuses. I highly
recommend showing this video to students. It is extremely well done and
exciting to watch.
The principal
policy issue arising out of the events surrounding the near collapse of
LTCM is how to constrain excessive leverage. By increasing the chance
that problems at one financial institution could be transmitted to other
institutions, excessive leverage can increase the likelihood of a
general breakdown in the functioning of financial markets. This issue is
not limited to hedge funds; other financial institutions are often
larger and more highly leveraged than most hedge funds.
The video and above reports, however, do not delve into the tax shelter
pushed by Myron Scholes and his other LTCM partners. A nice summary of the
tax shelter case with links to other documents can be found at
http://www.cambridgefinance.com/CFP-LTCM.pdf
The above August
27, 2004 ruling by Judge Janet Bond Arterton rounds out the "Trillion Dollar
Bet."
The classic and enormous scandal
was Long Term Capital led by Nobel Prize winning Merton and Scholes
(actually the blame is shared with their devoted doctoral students). There
is a tremendous (one of the best videos I've ever seen on the Black-Scholes
Model) PBS Nova video ("Trillion Dollar Bet") explaining why LTC collapsed.
Go to
http://www.pbs.org/wgbh/nova/stockmarket/
Another illustration of the Achilles' heel of a popular mathematical
theory and strategy is the 2008 collapse mortgage-backed CDO financial risk
bonds based upon David Li's Gaussian copula function of risk diversification
in portfolios. The Achilles' heel was the assumption that the real estate
bubble would not burst to a point where millions of subprime mortgages would
all go into default at roughly the same time.
"For five years, Li's formula, known as a
Gaussian copula function, looked like an unambiguously positive
breakthrough, a piece of financial technology that allowed hugely
complex risks to be modeled with more ease and accuracy than ever
before. With his brilliant spark of mathematical legerdemain, Li
made it possible for traders to sell vast quantities of new
securities, expanding financial markets to unimaginable levels.
His method was adopted by everybody from
bond investors and Wall Street banks to ratings agencies and
regulators. And it became so deeply entrenched—and was making people
so much money—that warnings about its limitations were largely
ignored.
Then the model fell apart." The article goes on to show that
correlations are at the heart of the problem.
"The reason that ratings agencies and
investors felt so safe with the triple-A tranches was that they
believed there was no way hundreds of homeowners would all default
on their loans at the same time. One person might lose his job,
another might fall ill. But those are individual calamities that
don't affect the mortgage pool much as a whole: Everybody else is
still making their payments on time.
But not all calamities are individual, and
tranching still hadn't solved all the problems of mortgage-pool
risk. Some things, like falling house prices, affect a large number
of people at once. If home values in your neighborhood decline and
you lose some of your equity, there's a good chance your neighbors
will lose theirs as well. If, as a result, you default on your
mortgage, there's a higher probability they will default, too.
That's called correlation—the degree to which one variable moves in
line with another—and measuring it is an important part of
determining how risky mortgage bonds are."
I would highly recommend reading the entire thing that gets much more
involved with the
actual formula etc.
The
“math error” might truly be have been an error or it might have simply been
a gamble with what was perceived as miniscule odds of total market failure.
Something similar happened in the case of the trillion-dollar disastrous
1993 collapse of Long Term Capital Management formed by Nobel Prize winning
economists and their doctoral students who took similar gambles that ignored
the “miniscule odds” of world market collapse -- -
http://faculty.trinity.edu/rjensen/FraudRotten.htm#LTCM
The rhetorical question is whether the failure is ignorance in model
building or risk taking using the model?
ROBERT RUBIN was Bill Clinton’s
treasury secretary. He has worked at the top of Goldman Sachs and
Citigroup. But he made arguably the single most influential decision of
his long career in 1983, when as head of risk arbitrage at Goldman he
went to the MIT Sloan School of Management in Cambridge, Massachusetts,
to hire an economist called Fischer Black.
A decade earlier Myron Scholes, Robert
Merton and Black had explained how to use share prices to calculate the
value of derivatives. The Black-Scholes options-pricing model was more
than a piece of geeky mathematics. It was a manifesto, part of a
revolution that put an end to the anti-intellectualism of American
finance and transformed financial markets from bull rings into today’s
quantitative powerhouses. Yet, in a roundabout way, Black’s approach
also led to some of the late boom’s most disastrous lapses.
Derivatives markets are not new, nor
are they an exclusively Western phenomenon. Mr Merton has described how
Osaka’s Dojima rice market offered forward contracts in the 17th century
and organised futures trading by the 18th century. However, the growth
of derivatives in the 36 years since Black’s formula was published has
taken them from the periphery of financial services to the core.
In “The Partnership”, a history of
Goldman Sachs, Charles Ellis records how the derivatives markets took
off. The International Monetary Market opened in 1972; Congress allowed
trade in commodity options in 1976; S&P 500 futures launched in 1982,
and options on those futures a year later. The Chicago Board Options
Exchange traded 911 contracts on April 26th 1973, its first day (and
only one month before Black-Scholes appeared in print). In 2007 the
CBOE’s volume of contracts reached almost 1 trillion.
Trading has exploded partly because
derivatives are useful. After America came off the gold standard in
1971, businesses wanted a way of protecting themselves against the
movements in exchange rates, just as they sought protection against
swings in interest rates after Paul Volcker, Mr Greenspan’s predecessor
as chairman of the Fed, tackled inflation in the 1980s. Equity options
enabled investors to lay off general risk so that they could concentrate
on the specific types of corporate risk they wanted to trade.
The other force behind the explosion
in derivatives trading was the combination of mathematics and computing.
Before Black-Scholes, option prices had been little more than educated
guesses. The new model showed how to work out an option price from the
known price-behaviour of a share and a bond. It is as if you had a
formula for working out the price of a fruit salad from the prices of
the apples and oranges that went into it, explains Emanuel Derman, a
physicist who later took Black’s job at Goldman. Confidence in pricing
gave buyers and sellers the courage to pile into derivatives. The better
that real prices correlate with the unknown option price, the more
confidently you can take on any level of risk. “In a thirsty world
filled with hydrogen and oxygen,” Mr Derman has written, “someone had
finally worked out how to synthesise H2O.”
Poetry in Brownian motion
Black-Scholes is just a model, not a complete description of the world.
Every model makes simplifications, but some of the simplifications in
Black-Scholes looked as if they would matter. For instance, the maths it
uses to describe how share prices move comes from the equations in
physics that describe the diffusion of heat. The idea is that share
prices follow some gentle random walk away from an equilibrium, rather
like motes of dust jiggling around in Brownian motion. In fact,
share-price movements are more violent than that.
Over the years the “quants” have found
ways to cope with this—better ways to deal with, as it were, quirks in
the prices of fruit and fruit salad. For a start, you can concentrate on
the short-run volatility of prices, which in some ways tends to behave
more like the Brownian motion that Black imagined. The quants can
introduce sudden jumps or tweak their models to match actual share-price
movements more closely. Mr Derman, who is now a professor at New York’s
Columbia University and a partner at Prisma Capital Partners, a fund of
hedge funds, did some of his best-known work modelling what is called
the “volatility smile”—an anomaly in options markets that first appeared
after the 1987 stockmarket crash when investors would pay extra for
protection against another imminent fall in share prices.
The fixes can make models complex and
unwieldy, confusing traders or deterring them from taking up new ideas.
There is a constant danger that behaviour in the market changes, as it
did after the 1987 crash, or that liquidity suddenly dries up, as it has
done in this crisis. But the quants are usually pragmatic enough to
cope. They are not seeking truth or elegance, just a way of capturing
the behaviour of a market and of linking an unobservable or illiquid
price to prices in traded markets. The limit to the quants’ tinkering
has been not mathematics but the speed, power and cost of computers.
Nobody has any use for a model which takes so long to compute that the
markets leave it behind.
The idea behind quantitative finance
is to manage risk. You make money by taking known risks and hedging the
rest. And in this crash foreign-exchange, interest-rate and equity
derivatives models have so far behaved roughly as they should.
A muddle of mortgages Yet the idea
behind modelling got garbled when pools of mortgages were bundled up
into collateralised-debt obligations (CDOs). The principle is simple
enough. Imagine a waterfall of mortgage payments: the AAA investors at
the top catch their share, the next in line take their share from what
remains, and so on. At the bottom are the “equity investors” who get
nothing if people default on their mortgage payments and the money runs
out.
Despite theory, CDOs were
hopeless, at least with hindsight (doesn’t that phrase come easily?).
The cash flowing from mortgage payments into a single CDO had to filter
up through several layers. Assets were bundled into a pool, securitised,
stuffed into a CDO, bits of that plugged into the next CDO and so on and
on. Each source of a CDO had interminable pages of its own documentation
and conditions, and a typical CDO might receive income from several
hundred sources. It was a lawyer’s paradise.
This baffling complexity could hardly
be more different from an equity or an interest rate. It made CDOs
impossible to model in anything but the most rudimentary way—all the
more so because each one contained a unique combination of underlying
assets. Each CDO would be sold on the basis of its own scenario, using
central assumptions about the future of interest rates and defaults to
“demonstrate” the payouts over, say, the next 30 years. This central
scenario would then be “stress-tested” to show that the CDO was
robust—though oddly the tests did not include a 20% fall in house
prices.
This was modelling at its most feeble.
Derivatives model an unknown price from today’s known market prices. By
contrast, modelling from history is dangerous. There was no guarantee
that the future would be like the past, if only because the American
housing market had never before been buoyed up by a frenzy of CDOs. In
any case, there are not enough past housing data to form a rich
statistical picture of the market—especially if you decide not to
include the 1930s nationwide fall in house prices in your sample.
Neither could the models take account
of falling mortgage-underwriting standards. Mr Rajan of the University
of Chicago says academic research suggests mortgage originators, keen to
automate their procedures, stopped giving potential borrowers lengthy
interviews because they could not easily quantify the firmness of
someone’s handshake or the fixity of their gaze. Such things turned out
to be better predictors of default than credit scores or loan-to-value
ratios, but the investors at the end of a long chain of securities could
not monitor lending decisions.
The issuers of CDOs asked rating
agencies to assess their quality. Although the agencies insist that they
did a thorough job, a senior quant at a large bank says that the
agencies’ models were even less sophisticated than the issuers’. For
instance, a BBB tranche in a CDO might pay out in full if the defaults
remained below 6%, and not at all once they went above 6.5%. That is an
all-or-nothing sort of return, quite different from a BBB corporate
bond, say. And yet, because both shared the same BBB rating, they would
be modelled in the same way.
Issuers like to have an edge over the
rating agencies. By paying one for rating the CDOs, some may have laid
themselves open to a conflict of interest. With help from companies like
Codefarm, an outfit from Brighton in Britain that knew the agencies’
models for corporate CDOs, issuers could build securities with any risk
profile they chose, including those made up from lower-quality
ingredients that would nevertheless win AAA ratings. Codefarm has
recently applied for administration.
There is a saying on Wall Street that
the test of a product is whether clients will buy it. Would they have
bought into CDOs had it not been for the dazzling performance of the
quants in foreign-exchange, interest-rate and equity derivatives? There
is every sign that the issuing banks believed their own sales patter.
The banks so liked CDOs that they held on to a lot of their own issues,
even when the idea behind the business had been to sell them on. They
also lent buyers much of the money to bid for CDOs, certain that the
securities were a sound investment. With CDOs in deep trouble, the
lenders are now suffering.
Modern finance is supposed to be all
about measuring risks, yet corporate and mortgage-backed CDOs were a
leap in the dark. According to Mr Derman, with Black-Scholes “you know
what you are assuming when you use the model, and you know exactly what
has been swept out of view, and hence you can think clearly about what
you may have overlooked.” By contrast, with CDOs “you don’t quite know
what you are ignoring, so you don’t know how to adjust for its
inadequacies.”
Now that the world has moved far
beyond any of the scenarios that the CDO issuers modelled, investors’
quantitative grasp of the payouts has fizzled into blank uncertainty.
That makes it hard to put any value on them, driving away possible
buyers. The trillion-dollar bet on mortgages has gone disastrously
wrong. The hope is that the trillion-dollar bet on companies does not
end up that way too.
Continued in article
Closing Jensen Comment
So is portfolio diversification theory dead? I hardly think so. But if any
lesson is to be learned is that we should question those critical underlying
assumptions in Plato's Cave before worldwide strategies are implemented that
overlook the Achilles' heel of those critical underlying assumptions.
I spent a year in a think tank with Phil Zimbardo and found him to be
really fascinating scholar. Aside from becoming a multimillionaire from his
highly successful psychology textbook, Phil is known for creativity in
psychological experiments --- before and after his infamous Stanford prison
guard experiments blew up in his face.
If outside influences can make people
act badly, can they also be used to help people do good?
In "Too Hard for Science?" I interview
scientists about ideas they would love to explore that they don't think
could be investigated. For instance, they might involve machines beyond
the realm of possibility, such as particle accelerators as big as the
sun, or they might be completely unethical, such as lethal experiments
involving people. This feature aims to look at the impossible dreams,
the seemingly intractable problems in science. However, the question
mark at the end of "Too Hard for Science?" suggests that nothing might
be impossible.
The scientist:
Philip Zimbardo,
professor emeritus of psychology at Stanford University.
The idea: Zimbardo is likely
best known for the
Stanford
Prison Experiment, which revealed how even
good people can do evil, shedding light on how the subtle but powerful
influences of a situation can radically alter individual behavior. The
study randomly assigned two dozen normal, healthy young men as either
"prisoners" or "guards" in a mock jail in a basement in Stanford
University in 1971 to investigate the psychology of prison life. The
researchers discovered the volunteers quickly began acting out their
roles, with the guards becoming sadistic in only a few days, findings
recently detailed in Zimbardo's book, "The
Lucifer Effect."
After the Stanford Prison Experiment, Zimbardo
began exploring ways to create heroes instead of villains. "My idea is
sowing the earth with millions of everyday heroes trained to act wisely
and well when the opportunity presents itself," he says.
The problem: The greatest
challenge that Zimbardo thinks his idea of creating heroes en masse
faces is how "people think heroes are born, not made; that they can't be
heroes," he says. "The fact is that most heroes are ordinary people.
It's the heroic act that is extraordinary."
As an example, Zimbardo pointed out New York
construction worker
Wesley Autrey, who jumped onto subway tracks
and
threw himself over a seizure victim,
restraining him while a train hurtled an inch above their heads in 2007.
"We want to change the mentality of people away from the belief that
they're not the kind who do heroic deeds to one where they think
everyone has the potential to be heroic," he says. "Mentality plus
opportunity ideally equals heroic action."
The solution? Zimbardo and his
colleagues have created the
Heroic
Imagination Project, a nonprofit organization
devoted to advancing everyday heroism. By heroism, they do not simply
mean
altruism. "Heroism as we define it means
taking action on the behalf of others for a moral cause, aware of
possible risks and costs and without expectation of gain," he clarifies.
Their program has four sections. "First, we
want to fortify people against the dark side, to be aware of the
standard tactics used by perpetrators of evil, how they seduce good
people to doing bad things," Zimbardo says. "Using video clips, we'll
show how this happens — bystander inaction, diffusion of responsibility,
the power of the group, obedience to authority and the like."
"Once you learn these lessons, we then want to
inspire you to the bright side," he continues. "We want to give examples
of how people like you have done heroic things to inspire your heroic
imagination, and then train you to be a wise and effective hero. We want
you to think big and start small, giving tips on what to do each day on
this journey. We're saying, 'Here's how to be an agent of change, step
by step by step.'"
"For instance, heroes are sociocentric — they
come to others in need, make other people feel central — so a challenge
each day might be to make people feel special, give them a compliment,"
he explains. "It's not heroic, but it's focusing on the other, and once
you get used to it, you can develop other heroic habits. Also, heroes
are always deviants — in most group situations, the group does nothing,
so heroes have to learn how to break away from the pull of a group, be
positive deviants, dare to be different."
"We want people to think of themselves as
heroes-in-training, and make a public commitment to take on the hero
challenge, since research shows that making public commitments increases
the chances of intentions carried into action," Zimbardo says. "We also
want to invite people to sign up with one or two friends, make it a
social rather than a private event, since most heroes are effective in
networks. We're arguing that we can create a network of heroes, using
the power of the Web."
In the second part of the program, "we're
developing corporate initiatives, thinking about how to create cultures
of integrity," Zimbardo says. They are in talks with companies such as
Google, he notes. "Can you imagine avoiding disasters such as the
Deepwater oil spill if we had people in the right places willing to
speak up and act?" In the third, they will engage the public, sending
and receiving information through their Web site and promoting public
activities, such as Eco-Heroes, a program where young people work with
elders to save their environment; Health-Heroes, where one helps family
members exercise, quit smoking, eat responsibly, take medications and
the like; and the Heroic Disability Initiative, which aims to provide
the handicapped and disabled with examples of people like them who
performed heroic deeds, as well as ways to take part in community
programs.
In the last part of the program, "we're
research-centered," Zimbardo says. "We are
measuring changes in attitude, beliefs, values and critical behavior
with an education program in four different high schools in the San
Francisco Bay Area, from inner-city schools in Oakland to more
privileged ones in Palo Alto, trying out these strategies, seeing what
works, what doesn't. What does work we'll put on our Web site. We also
want to start a research scholar award program for graduate students to
do research on heroism. It's amazing that there's been research on evil
for years, but almost no research on heroism, and we want to do more of
that."
Manamatics is the study of only testable hypotheses required in leading
academic management accounting research journals. The same can be said for
Markematics in marketing, although neither term has the long history of the
term "accountics" defined in 1887 as "Accountics is the mathematical
[accounting] science of values."
An (really "the")
early 1960s leader in Manamatics, Markematics, and accountics was
Carnegie-Mellon University. One thing you can say for certain about
CMU is that it remains consistent after 50 years of hiring faculty.
A friend on November 10, 2009 forwarded the following Chronicle
of Higher Education advertisement for faculty ---
http://chronicle.com/jobs/0000615221-01/
Accounting Faculty Tenure-Track Positions
Tenure-track faculty opening at all ranks in Accounting,
commencing September 2010: Applicants for the assistant
professor rank should have completed (or nearly completed) a
Ph.D. in accounting or a related discipline and have a strong
training in economics, mathematics, and statistics and a
demonstrated potential for excellence in research and teaching.
Applicants for higher ranks should have an established record of
excellent research, teaching, and service. Teaching assignments
encompass undergraduate, MBA, and Ph.D. Programs. Interested
individuals must submit a current curriculum vitae and evidence
of research such as publications, working papers, or a
dissertation proposal electronically to accgroup@andrew.cmu.edu.
Additionally, three letters of recommendation must be submitted
(via the Postal Service) to Ms. Jessica Schaeffer, Faculty
Search Coordinator for Accounting, Carnegie Mellon University,
Tepper School of Business, Posner 350, 5000 Forbes Avenue,
Pittsburgh, PA 15213, Phone 412-268-3768. In order to ensure
full consideration, completed applications must be received by
JANUARY 15, 2010.
Accounting Faculty Tenure-Track Position Open to Economists
Tenure-track faculty opening at the Assistant Professor level in
Accounting, commencing September 2010: Applicants should have
completed (or nearly completed) a Ph.D. in economics, financial
economics, or a related discipline and have a strong training in
economics, mathematics, and statistics and a demonstrated
potential for excellence in research and teaching. Applicants
with interests in applied information economics (such as
contracts and disclosure), labor (such as managerial
compensation), or organization design (such as transfer pricing)
are encouraged. We particularly encourage applicants who combine
theoretical and empirical research methodologies (such as
structural estimation or calibration) to apply but would also
welcome applications with either a theoretical or empirical
methodological focus. Academic or professional background in
accounting is welcome but not required. Teaching assignments
encompass undergraduate, MBA, and Ph.D. Programs. Interested
individuals must submit a current curriculum vitae and evidence
of research such as publications, working papers, or a
dissertation proposal electronically to accgroup@andrew.cmu.edu.
Additionally, three letters of recommendation must be submitted
(via the Postal Service) to Ms. Jessica Schaeffer, Faculty
Search Coordinator for Accounting, Carnegie Mellon University,
Tepper School of Business, Posner 350, 5000 Forbes Avenue,
Pittsburgh, PA 15213, Phone 412-268-3768. In order to ensure
full consideration, completed applications must be received by
DECEMBER 11, 2009.
Carnegie Mellon is an equal opportunity/affirmative action
employer with particular interest in identifying women and
minority applicants for faculty positions
I wonder how the add would read if the
professional-school road had been taken by collegiate business/commerce
education at that 1960 fork in the road? Who knows? CMU instead became a
highly respected computer science and social science in the Tepper School of
Business on campus.
In answer to
Neal’s original question about the impact of accountics research on
standards, I would have to say that the best example in the past two decades
has been in the march of both the FASB and the IASB toward fair value
accounting. The push came not so much directly from accountics research
studies (that were probably never read by most of the standard setters) as
it did indirectly from the two leading accountics researchers who
successfully argued their case with the other standard setters.
The push is
hard to trace to accountics studies per se, but we have to point to leading
accountics researchers who ended up on the IASB (read that
Mary Barth
for a long time) and FASB (read that
Katherine Schipper
for a short time). There are no better advocates of fair value accounting
than Professor Barth and Professor Schipper.
An
Unlikely Debate Between Leading Accountics Researchers
Having said
this, one of the weirdest (in terms of being the most unlikely) debates
between leading accountics researchers in the history of accounting
took place at the 2008 AAA Meetings in Anaheim. The debate was one of the
highlights of my career (as an audience member with a camcorder) because it
became a pitched (lest I say heated?) debate between leading accountics
researchers (who normally do not succumb to a “vocational virus”) who took
up different sides on fair value accounting in theory and in practice. My
video of this debate is available in the National Library of the Accounting
Profession at the University of Mississippi ---
http://www.olemiss.edu/depts/accountancy/libraries.html
In that most
impressive debate Katherine Schipper was the very articulate advocate of
fair value accounting standards. On the negative side were the equally
articulate accountics researchers
Zoe-Vanna Palmrose
and
Ross Watts. This was in fact the most articulate speech I ever heard our
leading accountics researcher, Ross Watts, deliver. Zoe-Vanna was just
returning to USC after her stint at the SEC (where she no doubt provided
accountics findings to practical accountants).
Hi Amy, Don, and others
contributing to the thread on student activity reporting,
Don’t forget that for at
least a two week span, David Albrecht supplied us with a rather detailed and
sometimes opinionated report of his activities in the first semester in his
first year at Concordia College. Of course David is a 25-year veteran
accounting teacher, but this was his first semester at Concordia. David also
discusses other things like his blogging and opinions on IFRS replacing U.S.
GAAP.
Work sampling is worth
noting even though you would never be statistically formalized for student
activity reports:
For over four decades I’ve
tried in vain to get managerial/cost accounting courses and textbooks to
increase the emphasis on work sampling for indirect labor that has varying
duties. For example, when I was conducting my dissertation research at
Stanford University, my new wife worked as a medical lab technician at the
huge Veterans Administration Hospital in Palo Alto. Her duties were quite
varied in terms of the types of medical tests conducted on tissues and
liquids such as blood tests, urine tests, spinal tap fluid tests, etc. In
those days there were no big automated machines where you could put most
anything in one end and get printouts of the tests at the other end. She
also, on occasion, had to collect bloods on the floors of this enormous
hospital. By the way, this hospital was the one featured in the book and
movie (Jack Nicholson)
"One Flew Over the Cuckoo's Nest"
In those days most tests
had varied activities running tests on various specialized testing machines.
But it is terribly intrusive to make technicians keep detailed logs of their
time spend on many activities during each day.
She said that one of the
problems for hospital accountants was in computing the costs of each type of
test. That prompted me to think about how her time over each week could be
estimated for each type of test. While working on my dissertation (on
another topic) I developed some statistical inference testing procedures for
indirect labor work sampling.
The idea of work sampling
is to provide a signal (today it might be a small light on a wrist band or a
cell phone vibration) for each worker to report randomly what they are doing
at that instant (including a category for personal time that includes idle
gossiping). PDAs would be great to use these days for work sampling.
Shortly thereafter, while
at my first faculty appointment at Michigan State University where I started
out by teaching doctoral seminars, I persuaded one of my doctoral students
and Danish friend, Carl Thomsen, to help me polish my very rough draft on
work sampling procedures for indirect labor.
Jensen, R. E. and C. T Thomsen. 1968.
Statistical analysis in cost measurement and control. The Accounting
Review (January): 83-93. (JSTOR
link).
I was later fascinated by a
work sampling study done by faculty in the one of the Engineering
Departments at Purdue University. Before the study commenced, researchers
asked each faculty member to self report how much time each week was spent
on activities categorized as research versus teaching versus administrating
versus doing personal things. The initial reports for nearly all faculty
members was that they spend well over half their awake time in research.
The results of the
formalized work study experiments at Purdue found that in reality a low
percentage of time of awake time was spent on research. I can’t recall the
exact percentage but it was an average of something like 10%. A higher
percentage of time was in administrative activities of one type or another
as well as in teaching activities.
Having said this, I am
aware that faculty work time is quite different that lab tech work time. Lab
techs tend to perform routine tests with relatively consistent thinking
intensity. Faculty research time is quite varied in terms of intensity. A
half hour of thinking just before falling asleep for me was always much more
intense than hours spent roaming the library stacks just looking for obscure
books and journal articles (before the days of search engines). Hence, work
sampling has its limits in terms of varying intensities of thinking time.
Are you still teaching an obsolete Black-Scholes Model?
Abstract:
People
think by analogies and comparisons. Such way of thinking, termed coarse
thinking by Mullainathan et al [Quarterly Journal of Economics, May
2008] is intuitively very appealing. We derive a new option pricing
formula based on the notion that the market consists of coarse thinkers
as well as rational investors. The new formula, called the behavioral
option pricing formula is a generalization of the Black-Scholes formula.
The new formula not only provides explanations for the implied
volatility skew and term structure puzzles in equity index options but
is also consistent with the observed negative relationship between
contemporaneous equity price shocks and implied volatility.
Jensen Comment
Since valuation of options is required under FAS 133 and FAS 123-R, I think
many intermediate accounting instructors are still leaving their students
with the impression that the Black-Scholes formula is the appropriate
alternative for valuing options. It is a poor valuation model for FAS 133
and a really lousy valuation model for FAS 123-R where employees have great
aversion to the possibility that their stock options will tank out of the
money.
I've no thoughts yet on the appropriateness of the Siddiqi model proposed
above, but for years when I was still teaching accounting theory I made my
students learn the lattice model.
The
problem in theory and practice is that the Black-Scholes model that is
popular in financial markets for purchased options is not especially well
suited for employee stock options where employees tend to have greater fears
that option values will tank before expiration dates. It's a little like
having to put your salary in suspension and then losing it before you get it
back. As a result the lattice model described below may be more approprate.
"How
to “Excel” at Options Valuation," by Charles P. Baril, Luis
Betancourt, and John W. Briggs, Journal of Accountancy, December 2005
---
http://www.aicpa.org/pubs/jofa/dec2005/baril.htm This is one of the best articles for accounting
educators on issues of option valuation!
Research shows that employees value options at a small fraction of their
Black-Scholes value, because of the possibility that they will vest
underwater. ---
http://www.cfo.com/article.cfm/3014835
Deloitte & Touche (USA) has updated its book of guidance on FASB Statement
No. 123(R) Share-Based Payment: A Roadmap to Applying the Fair Value Guidance to
Share-Based Payment Awards (PDF 2220k).
This second edition reflects all authoritative
guidance on FAS 123(R) issued as of 28 April 2006. It includes over 60 new
questions and answers, particularly in the areas of earnings per share,
income tax accounting, and liability classification. Our interpretations
incorporate the views in SEC Staff Accounting Bulletin Topic 14 "Share-Based
Payment" (SAB 107), as well as subsequent clarifications of EITF Topic No.
D-98 "Classification and Measurement of Redeemable Securities" (dealing with
mezzanine equity treatment). The publication contains other resource
materials, including a GAAP accounting and disclosure checklist. Note that
while FAS 123 is similar to IFRS 2 Share-based Payment,
there are some measurement differences that areDescribed Here.
November 12,
2009 message sent by Bob Jensen to the AECM
I mentioned yesterday that I’ve been having a conversations with a
high-level accountics researcher who prefers at this juncture to remain
anonymous. I thought you might enjoy the (slightly edited) message that I
wrote to this accountics researcher.
************
Hi XXXXX,
Kudos to you for being more open with me than most accountics
researchers. I await your forthcoming article. You want “openness” when, if
you just look up from your computer, you will find that accountics
researchers are the least open cohort in accounting academe.
What I’ve discovered about most accountics researchers is that
they care little about TAR history and little about whether the profession
and industry lost all interest in their harvests. They’ve done little to
show the profession how their discoveries can benefit practice (Mary Barth
being an exception with her derivatives valuation research).
I challenged Joel Demski (when as Program Director of an AAA
annual meeting I made him a plenary speaker) to find one example where an
accountics discovery impacted on practice --- he failed miserably when
pointing to Dollar Value Lifo that was not even a discovery in academe. More
recently as a plenary speaker, Joel cynically called concern with applied
research for the practicing profession as a “vocational virus”
among some academics.
What I found about accountics researchers (especially the
positivists like Zimmerman) is that they refuse to face up to their
strongest critics like Steve Zeff and Bob Kaplan and Paul Williams and Bob
Jensen. They’re very happy just living in their highly-paid world of TAR,
JAR, and JAE Camelot reviewing each others’ papers. You won’t catch them
coming down with a
vocational virus ---
http://faculty.trinity.edu/rjensen/theory01.htm#DoctoralPrograms
They set up their fiefdom in TAR, JAR, and JAE and then made
virtually all doctoral programs in accountancy in their own image (Florida
now being Exhibit A).The leading goal of our doctoral programs is to
train/educate students to published in TAR, JAR, and JAE. For a time,
Accounting Horizons under Lipe was no different from TAR, although there
is some recent change in this regard recently.
Sure there are other publishing outlets for cases, field studies,
and discovery/applied research. But our doctoral students are taught early
on that these outlets are not likely to count much for promotion and tenure
and prestige at major research universities. I suspect you may know
University of Texas PhD Will Yancey. Will is now a multimillionaire
consultant who was denied tenure at TCU because publishing in the Journal
of Accountancy (including a cover story) just did not cut it compared to
his lack of publications in TAR, JAR, and JAE ---
http://faculty.trinity.edu/rjensen/Yancey.htm
By the way, his teaching evaluations were outstanding.
And TCU is not a major accounting research university.
Mostly what I hate about the accountics (testable hypothesis)
constraints of publishing in TAR, JAR, JAE, and AMR is that these journals
lost all focus on the difference between “search” and “research.” If you
want a good reference on this Go to
http://faculty.trinity.edu/rjensen/theory/00overview/GreatMinds.htm#Smith
Thanks to your very kind listing of “replications,” I’m looking
at capital markets study replications more seriously. Virtually all
behavioral experiments reported in TAR and JAR are not replicated
whatsoever, probably because nobody is really interested in those harvests
(due to the artificial nature of the experiments).
Please, please be careful what you call a “replication.” Capital markets events studies are more difficult to evaluate
because those studies do tend to build on each other. But I still have
difficulty finding examples that would pass a chemical researcher’s test of
what constitutes a genuine replication.
Suppose Chemist Q conducts research on the reaction of variable Y
to ingredients A, B, and C. If Chemist R wants to replicate the study, he
does so by testing the reaction of variable Y to ingredients A, B, and C to
test the veracity of the findings of Chemist Q. If Chemist R finds that
different outcomes arise from ingredients A, B, C, and D this is not a
replication study. If Chemist Q finds that Chemist R originally used a
corrupted Chemical C then this would be a replication when re-testing with a
pure Chemical C.
If ingredients A, B, and C are temporal and change with time, it
is not a replication when Chemist R examines the impact of ingredients A, B,
and C at a later point in time --- the supposed replication of Bradshaw’s
2004 outcomes in 2009. The problem in finance and accounting is that the
variables studied are seldom stationary over time or the systems in which
they operate are not stationary over time. For example, security analysts in
2009 are operating is quite different systems than security analysts in 1995
or even 2004.
In fairness, it’s very difficult to do replication studies in
accounting and finance at two different points in time because most of the
time the replications are confounded with non-stationary contexts.
Regulations may have changed. Corporate policies may have changed. Media
reporting may have changed behavior. A true replication uses the same data
at the same point in time unless the variables are not temporal (which
rarely happens outside the realm of the natural sciences).
Robert E. (Bob) Jensen
Trinity University Accounting Professor (Emeritus)
190 Sunset Hill Road
Sugar Hill, NH 03586
Tel. 603-823-8482
www.trinity.edu/rjensen
Have you ever
investigated how many of your former students who are now in CPA firms and
corporations eagerly read each new edition of TAR, JAR, JAE, or
Accounting Horizons for ideas that they can put into practice? How many
of them submitted articles to Accounting Horizons given that practitioners
seem to have virtually no interest in writing for Accounting Horizons
as was hoped for by Jerry Searfoss when he helped fund the startup of
Accounting Horizons.?
My priors are
that they, like most practitioners, could care less about accountics
harvests once they are serving their own real world clients. Of course there
are a few that will remain loyal to you. Perhaps some of your students (who
did not go into doctoral programs) showed an interest in accountics harvests
in your courses because it was self serving at the time for their grades.
Have you ever
investigated how many of your former students henceforth and forever more
decided not to spend five more years in a doctoral program learning how to
be econometricians so they could publish (with a 12% chance of success)
articles in for TAR? There are many practicing accountants who would
like studying accountancy in doctoral programs but cannot see themselves
spending five years of their lives becoming social scientists.
My guess is that
you are too caught up in accountics readings to really give the Journal
of Accountancy a fair shake. There are many nice applied research
studies and clever ideas in the JA, notably some of the technology
ideas put forth by Stanley. Be that as it may, the AICPA is entitled to its
own opinion as to how much benefit AICPA members received from AICPA Notable
Contributions to the Accounting Literature award nearly always going to
accountics research purportedly ignored by members (in the opinion of
the AICPA executive that appointed me to the incoming award Selection
Committee and Paul Williams to the incoming Screening Committee)
And I could tell
you some of the many ways that I’ve benefitted from the Journal of
Accountancy in the past two decades, far more than I benefitted from
TAR. One example is the tremendous article that sensibly puts down the
Black-Sholes Model for valuing employee stock options in favor of a very
practical lattice model that I cite repeatedly when advising clients on how
to value stock options ---
http://faculty.trinity.edu/rjensen/theory/sfas123/jensen01.htm
The article did not invent the lattice model but neither did most accountics
researchers really discover a practice problem that led to a new application
that impacted greatly on practice ---
http://en.wikipedia.org/wiki/Lattice_model_(finance)
"How to “Excel” at Options
Valuation," by Charles P. Baril, Luis Betancourt, and John W. Briggs,
Journal of Accountancy, December 2005 ---
http://www.aicpa.org/pubs/jofa/dec2005/baril.htm This is one of the best articles for accounting
educators on issues of option valuation!
Research shows that
employees value options at a small fraction of their Black-Scholes value,
because of the possibility that they will vest underwater. ---
http://www.cfo.com/article.cfm/3014835
Deloitte & Touche (USA) has updated its book of
guidance on FASB Statement No. 123(R) Share-Based Payment:
A Roadmap to Applying the Fair Value Guidance to Share-Based Payment Awards
(PDF 2220k). This second edition reflects all
authoritative guidance on FAS 123(R) issued as of 28 April 2006. It includes
over 60 new questions and answers, particularly in the areas of earnings per
share, income tax accounting, and liability classification. Our
interpretations incorporate the views in SEC Staff Accounting Bulletin Topic
14 "Share-Based Payment" (SAB 107), as well as subsequent clarifications of
EITF Topic No. D-98 "Classification and Measurement of Redeemable
Securities" (dealing with mezzanine equity treatment). The publication
contains other resource materials, including a GAAP accounting and
disclosure checklist. Note that while FAS 123 is similar to
IFRS 2 Share-based Payment, there are some
measurement differences that are
Described Here.
As I see it, there is one and
only one way to build practitioner interest in accounting research. It’s
called teaching. You are correct that maybe 95% of my students will forget
that “research nonsense” once they start earning a paycheck. But if I can
get through to 5% of them, I will sleep well at night. There is a reason why
we have jobs that both investigate and instruct. I liberally fold in
research insights into the undergraduate auditing classes I teach, and my
student teaching evaluations are 4.7 on a 5.0 scale, so it can’t be THAT
bad.
November 12. 2009 reply from Bob Jensen
I view lack of
practitioner interest in TAR as a tragedy. So do Zeff and Granof below.
I also think that most accounting teachers teach from textbooks, and most
textbooks do not feature a high proportion of accountics harvests except for
occasional footnote references. So if you want the teachers to teach the
accountics it must be put in the CPA and CMA examination so that textbook
writers at last view accountics research as important for their number one
priorities --- certification examinations.
Practitioners lost interest in TAR for a number of reasons, not the least
of which is the mathematics that became incomprehensible to them. But more
importantly is the problem that, like the AMR, the overwhelming majority of
TAR articles are limited to issues that have testable hypotheses.
This leaves out most of the interesting problems faced by the profession
itself that cannot be tested in a model.
Medical schools test a lot of hypotheses, but in their top journals they
are also willing to take on “search” issues as well as “research issues.”
Even law journals test hypotheses on occasion but they also recognize the
professional value of cases in their very top research journals.
You just can solve the missing variable problem of TAR with the best
teaching in the world. You must supply some of the missing variables that I
contend are the “search” variables as opposed to the small subset of
“research” variables ---
http://faculty.trinity.edu/rjensen/theory/00overview/GreatMinds.htm#Smith
Add good “search” papers to TAR and practitioners will perk up their eyes
and ears. And students might have a better chance adding creative thoughts
to search things than accountics models. This seems to work for law and
medicine. Why not accounting and business?
Seriously, it
would be interesting to somehow compare how lawyers utilize writings of top
academic law journals versus how CPA practitioners utilize top academic
accountics journals. This all relates back to the 1960 fork in the road
where schools of business had a chance of being more like law/medical
graduate islands in a university versus what is tantamount to a social
science undergraduate and graduate program as desired in the two famous
reports of the Carnegie and Ford foundations.
You also
should not judge all your accountics friends the same way you judge yourself
in terms of knowledge of accountancy.
After he gave his speech, Denny submitted his speech for publication to
Accounting Horizons. Referee A flatly rejected the Denny's submission
for the following reasons:
The paper provides specific recommendations for things that
accounting academics should be doing to make the accounting profession
better. However (unless the author believes that academics' time is a free
good) this would presumably take academics' time away from what they are
currently doing. While following the author's advice might make the
accounting profession better, what is being made worse? In other words,
suppose I stop reading current academic research and start reading news
about current developments in accounting standards. Who is made better off
and who is made worse off by this reallocation of my time? Presumably my
students are marginally better off, because I can tell them some new stuff
in class about current accounting standards, and this might possibly have
some limited benefit on their careers. But haven't I made my colleagues in
my department worse off if they depend on me for research advice, and
haven't I made my university worse off if its academic reputation suffers
because I'm no longer considered a leading scholar? Why does making the
accounting profession better take precedence over everything else an
academic does with their time? Referee A's rejection letter, Accounting Horizons, 2005
What riled me the most was the arrogance of Referee A.
I read into it that, whereas mathematicians and econometricians are true
"scholars," other accounting professors are little better than teachers of
bookkeeping and fairy tales. This is the same arrogant attitude held by
previous investment bankers trying to take advantage of Warren Buffet as
their counterparties in derivatives or other financial transactions.
Investment bankers and many accountics professors put
on superior airs because of their backgrounds in mathematics and science. To
hell with knowledge of fundamentals in accounting and finance apart from
mathematical models. To hell with reading and analyzing financial statements
in great depth. Accountics scholars, at least some of them who referee many
submissions to journals, don't waste their time on such mundane things.
Then you
read how Warren Buffet using fundamentals analysis repeatedly beats model
building competitors for billions of profits. The Dear Mr. Buffet
book by mathematician Janet Tavakoli should be required reading for all
accountics researcher.
Please don’t
totally ignore your long-standing critics (Steve Zeff and Mike Granof).
"Research on Accounting Should Learn From the Past,"
by Michael H. Granof and
Stephen A. Zeff, Chronicle of Higher Education, March 21,
2008
Starting in the
1960s, academic research on accounting became methodologically
supercharged — far more quantitative and analytical than in
previous decades. The results, however, have been paradoxical.
The new paradigms have greatly increased our understanding of
how financial information affects the decisions of investors as
well as managers. At the same time, those models have crowded
out other forms of investigation. The result is that professors
of accounting have contributed little to the establishment of
new practices and standards, have failed to perform a needed
role as a watchdog of the profession, and have created a
disconnect between their teaching and their research.
Before the 1960s,
accounting research was primarily descriptive. Researchers
described existing standards and practices and suggested ways in
which they could be improved. Their findings were taken
seriously by standard-setting boards, CPA's, and corporate
officers.
A
confluence of developments in the 1960s markedly changed the
nature of research — and, as a consequence, its impact on
practice. First, computers emerged as a means of collecting and
analyzing vast amounts of information, especially stock prices
and data drawn from corporate financial statements. Second,
academic accountants themselves recognized the limitations of
their methodologies. Argument, they realized, was no substitute
for empirical evidence. Third, owing to criticism that their
research was decidedly second rate because it was insufficiently
analytical, business faculties sought academic respectability by
employing the methods of disciplines like econometrics,
psychology, statistics, and mathematics.
In response to those
developments, professors of accounting not only established new
journals that were restricted to metric-based research, but they
limited existing academic publications to that type of inquiry.
The most influential of the new journals was the Journal of
Accounting Research, first published in 1963 and sponsored by
the University of Chicago Graduate School of Business.
Acknowledging the
primacy of the journals, business-school chairmen and deans
increasingly confined the rewards of publication exclusively to
those publications' contributors. That policy was applied
initially at the business schools at private colleges that had
the strongest M.B.A. programs. Then ambitious business schools
at public institutions followed the lead of the private schools,
even when the public schools had strong undergraduate and
master's programs in accounting with successful traditions of
practice-oriented research.
The unintended
consequence has been that interesting and researchable questions
in accounting are essentially being ignored. By confining the
major thrust in research to phenomena that can be mathematically
modeled or derived from electronic databases, academic
accountants have failed to advance the profession in ways that
are expected of them and of which they are capable.
Academic research
has unquestionably broadened the views of standards setters as
to the role of accounting information and how it affects the
decisions of individual investors as well as the capital
markets. Nevertheless, it has had scant influence on the
standards themselves.
The research is
hamstrung by restrictive and sometimes artificial assumptions.
For example, researchers may construct mathematical models of
optimum compensation contracts between an owner and a manager.
But contrary to all that we know about human behavior, the
models typically posit each of the parties to the arrangement as
a "rational" economic being — one devoid of motivations other
than to maximize pecuniary returns.
Moreover, research
is limited to the homogenized content of electronic databases,
which tell us, for example, the prices at which shares were
traded but give no insight into the decision processes of either
the buyers or the sellers. The research is thus unable to
capture the essence of the human behavior that is of interest to
accountants and standard setters.
Further, accounting
researchers usually look backward rather than forward. They
examine the impact of a standard only after it has been issued.
And once a rule-making authority issues a standard, that
authority seldom modifies it. Accounting is probably the only
profession in which academic journals will publish empirical
studies only if they have statistical validity. Medical
journals, for example, routinely report on promising new
procedures that have not yet withstood rigorous statistical
scrutiny.
Floyd Norris, the
chief financial correspondent of The New York Times, titled a
2006 speech to the American Accounting Association "Where Is the
Next Abe Briloff?" Abe Briloff is a rare academic accountant. He
has devoted his career to examining the financial statements of
publicly traded companies and censuring firms that he believes
have engaged in abusive accounting practices. Most of his work
has been published in Barron's and in several books — almost
none in academic journals. An accounting gadfly in the mold of
Ralph Nader, he has criticized existing accounting practices in
a way that has not only embarrassed the miscreants but has
caused the rule-making authorities to issue new and
more-rigorous standards. As Norris correctly suggested in his
talk, if the academic community had produced more Abe Briloffs,
there would have been fewer corporate accounting meltdowns.
The narrow focus of
today's research has also resulted in a disconnect between
research and teaching. Because of the difficulty of conducting
publishable research in certain areas — such as taxation,
managerial accounting, government accounting, and auditing —
Ph.D. candidates avoid choosing them as specialties. Thus, even
though those areas are central to any degree program in
accounting, there is a shortage of faculty members sufficiently
knowledgeable to teach them.
To be sure, some
accounting research, particularly that pertaining to the
efficiency of capital markets, has found its way into both the
classroom and textbooks — but mainly in select M.B.A. programs
and the textbooks used in those courses. There is little
evidence that the research has had more than a marginal
influence on what is taught in mainstream accounting courses.
What needs to be
done? First, and most significantly, journal editors, department
chairs, business-school deans, and promotion-and-tenure
committees need to rethink the criteria for what constitutes
appropriate accounting research. That is not to suggest that
they should diminish the importance of the currently accepted
modes or that they should lower their standards. But they need
to expand the set of research methods to encompass those that,
in other disciplines, are respected for their scientific
standing. The methods include historical and field studies,
policy analysis, surveys, and international comparisons when, as
with empirical and analytical research, they otherwise meet the
tests of sound scholarship.
Second, chairmen,
deans, and promotion and merit-review committees must expand the
criteria they use in assessing the research component of faculty
performance. They must have the courage to establish criteria
for what constitutes meritorious research that are consistent
with their own institutions' unique characters and comparative
advantages, rather than imitating the norms believed to be used
in schools ranked higher in magazine and newspaper polls. In
this regard, they must acknowledge that accounting departments,
unlike other business disciplines such as finance and marketing,
are associated with a well-defined and recognized profession.
Accounting faculties, therefore, have a special obligation to
conduct research that is of interest and relevance to the
profession. The current accounting model was designed mainly for
the industrial era, when property, plant, and equipment were
companies' major assets. Today, intangibles such as brand values
and intellectual capital are of overwhelming importance as
assets, yet they are largely absent from company balance sheets.
Academics must play a role in reforming the accounting model to
fit the new postindustrial environment.
Third, Ph.D.
programs must ensure that young accounting researchers are
conversant with the fundamental issues that have arisen in the
accounting discipline and with a broad range of research
methodologies. The accounting literature did not begin in the
second half of the 1960s. The books and articles written by
accounting scholars from the 1920s through the 1960s can help to
frame and put into perspective the questions that researchers
are now studying.
For example, W.A.
Paton and A.C. Littleton's 1940 monograph, An Introduction to
Corporate Accounting Standards, profoundly shaped the debates of
the day and greatly influenced how accounting was taught at
universities. Today, however, many, if not most, accounting
academics are ignorant of that literature. What they know of it
is mainly from textbooks, which themselves evince little
knowledge of the path-breaking work of earlier years. All of
that leads to superficiality in teaching and to research without
a connection to the past.
We fervently hope
that the research pendulum will soon swing back from the narrow
lines of inquiry that dominate today's leading journals to a
rediscovery of the richness of what accounting research can be.
For that to occur, deans and the current generation of academic
accountants must give it a push.
Michael
H. Granof is a professor of accounting at the McCombs School of
Business at the University of Texas at Austin. Stephen A. Zeff
is a professor of accounting at the Jesse H. Jones Graduate
School of Management at Rice University.
Steve Zeff has been saying this since
his stint as editor of The Accounting Review (TAR);
nobody has listened. Zeff famously wrote at least two editorials
published in TAR over 30 years ago that lamented the
colonization of the accounting academy by the intellectually
unwashed. He and Bill Cooper wrote a comment on Kinney's
tutorial on how to do accounting research and it was rudely
rejected by TAR. It gained a new life only when Tony Tinker
published it as part of an issue of Critical Perspectives in
Accounting devoted to the problem of dogma in accounting
research.
It has only been since less subdued
voices have been raised (outright rudeness has been the hallmark
of those who transformed accounting into the empirical
sub-discipline of a sub-discipline for which empirical work is
irrelevant) that any movement has occurred. Judy Rayburn's
diversity initiative and her invitation for Anthony Hopwood to
give the Presidential address at the D.C. AAA meeting came only
after many years of persistent unsubdued pointing out of things
that were uncomfortable for the comfortable to confront.
“An Analysis of the Evolution of Research
Contributions by The Accounting Review: 1926-2005,” by Jean Heck
and Robert E. Jensen, Accounting Historians Journal,
Volume 34, No. 2, December 2007, pp. 109-142
http://faculty.trinity.edu/rjensen/395wpTAR/Web/TAR395wp.htm
Jensen Comment
Note that this site includes a long listing of research in accounting,
finance, and economics, much of it based on positivism and financial
markets.
For what it's worth, my MBA
managerial accounting course features many such (accountics) harvests.
My syllabus is posted on AAA Commons at
http://commons.aaahq.org/posts/8bf3b52bb2
November 13, 2009 reply from Bob Jensen
One question I did not raise with accountics Professor XXXXX and will
now raise with you Richard is how accountics researcj can be taught to
undergraduate and MBA students who are not, as a group, likely to have
the knowledge of concepts, mathematics, econometrics, and mathematical
statistics prerequisites for understanding accountics, especially
financial accounting accountics papers in TAR, JAR, and JAE.
Here’s one student review who did not have the requisites needed to
understand Jerry’s textbook the textbook you use in your course Richard.
The student was an MBA student at the time but now claims to be in a
doctoral program.
The student in particular is not impressed with the end-of-chapter
material in this "worst book" in the entire MBA program. It would appear
that teaching accountics to undergraduate and MBA students entails a
great deal of add-on material to make up for textbook deficiencies in
accountics. And your textbook of choice undoubtedly has the most
widespread accountics coverage of any textbook designed for
undergraduate and MBA courses. I would expect no less from Jerry
Zimmerman.
Accounting for Decision Making and Control (Hardcover)
Beware ! This book does perhaps the poorest example explaining any
concepts. I have never had so much stress in my life than taking a
managerial accounting class with this book. I mean I actually couldn't
sleep because of this book!
I took this class last year and I just finished my MBA and I am working
on my Phd now, and I thought I would reflect and give some valuable
advice to you, my fellow students.
If you don't have a prior managerial accounting background, go read as
much as you can before you get into this book. Or you will be completely
stressed out, lost and feel that you are a dummy. This book makes smart
students feel dum. I mean really dum. You are not dum, the book just
lacks clear explanations.
This book deals mostly with managerial accounting. For example if you
are paid $100 per day at your job, really you are costing the company
more than what you are being paid, really you use resources, like from
human resources who hired you, electricity costs, phone costs, IT, etc,
so your true cost to the company broken down is probably $160 per day.
This is called cost allocation, in a crude example.
Easy concept right?, Just that you will not be able to learn this easily
from this book unless you have a deep prior background in this. The good
examples Zimmerman(author) gives are spoiled by the majority of his
jargon and bad examples.
I honestly found myself at one point reading 1 page for over an hour to
understand! (and I am a high A student). In my entire MBA program, I
never had a worse book, nor more stress!!!
Ultimately, I had to do many exhaustive Internet searches to learn cost
allocation theory.
Some reasons why this book is so bad:
(1) Does not explain many concepts with clear explanations
(2) Uses too much jargon
(3) Shows graphs and vital data one the next pages instead of including
them on the same page, Imagine as you read you have to constantly change
the page to see the graphs and charts, Very poor!
(4) Zimmeran doesn't want to teach, rather he wants to prove to you that
he is smart!
(5) THE WORST
Perhaps the worst is the homework problems in the back. Zimmerman (the
author) does not give sufficient examples of how to solve these
examples. Nor does the book give the answers. Also, some problems are
extremely hard, even the professor of the class had difficulty solving
and explaining this. What is the goal of a book if students have to
search elsewhere and be stressed out to learn?
I would say that this book is like taking a class in Algebra and having
questions and concepts explained in Calculus.
Again, if you don't have a prior background in any of this, go take a
class at a junior college on cost accounting to prepare for this book,
you will need it. Or you too will be so stressed out!!
Jerold Zimmerman, please don't take personal offense, you may be a smart
guy, but the art of education is explaining concepts easily and showing
your work, which in my opinion and my fellow students' opinion, overall
this book lacks.
GOOD LUCK to all students, and my prayers are with you if you have this
book.
I don't make a habit of citing Amazon book reviews or
RateMyProfessors.com because of the risk that publishers/professors
plant reviews and evaluations. In the above case, however, the review
sounded sincere and timely.
I used the Zimmerman book a long time ago. Stripped
to the bare essentials needed for the understanding, the students
appreciated the work.
However, the class discussions centered on whether
it merited the attention it got. ( I was then a lot more sympathetic to
positivist and/or accountics claptrap then, and did not mind defending the
work). Many students, however, were wondering if the work wasn't stating the
obvious in fanciful ways. In other words, whether all the economic mumbo
jumbo was a smokescreen to make the obvious academically respectable.
Even in the natural sciences, stripped of the
details, most profound ideas can be explained to any one with a high school
education. The objective of the details in such sciences is to ensure the
integrity of the statements, and the objective of the experimentation is to
ensure the validity of the statements.
I can give two examples:
1. The great American sociologist George Homans, a
long ago, did profound work on motivation and cohesion in human groups. You
do not see a single mathematical symbol in most of his works. Yet the beauty
of his generalisations is stunning. Herb Simon, in one of the articles in
"Models of Man", derived the same generalisations by studying the stability
of a dynamical system described by a system of differential equations. The
lack of mathematics in Homan's own work does not make his contributions any
less profound, and Simon's mathematicising of it does not add much to what
we already knew from Homans. However, Simon's work enables us to rely on the
veracity of Homan's conclusions without having to depend on Homan's
credibility as a social scientist.
2. Arguably one of the greatest biologists of the
20th century, JBS Haldane wrote a very simple but profound book titled "On
Being the Right Size", meant to be read by union workers in England with
little education (nowadays many college students probably would have as much
problems appreciating it as then union workers would have had with
today's popular music). One sentence says it all (he is trying to describe
that size of an animal usually determines the anatomy): "Insects, being so
small, do not have oxygen-carrying bloodstreams. What little oxygen their
cells require can be absorbed by simple diffusion of air through their
bodies. But being larger means an animal must take on complicated oxygen
pumping and distributing systems to reach all the cells." A modern systems
biologist would explain the same with a mathematical model.
In accountics, it is not sure to me what the
objectives are, but I suspect they are not the same as in the natural
sciences.
I think the main problem with accountics research
is the pervasiveness of Physics-envy. Giving the appearance of being a
"science" is more important than having the scientific spirit. That being
the case, use of quantitative methods in general has assumed a theological
orientation.
As I see it, the veracity of most accountics
generalisations depend almost entirely on the credibility of the authors,
and the "system" rather than the mathematisation or experimentation provides
it. Since the assertions are rarely, if ever, questioned (the only
questioning is by the referee gatekeepers with vested interest in
perpetuating their version of the "truth"), the whole enterprise resembles a
religion more than it does a "science".
The credibility of the entire accounting academia
is at stake. We are to the accounting profession what Physicists are to
engineering. Just as engineers not paying heed to physicists would indicate
lack of relevance (and possibly coherence) of Physics, the accounting
profession not paying heed to what ever it is we do is symptomatic of the
lack of relevance (and possibly coherence) of what we research. It does no
one service for us to pretend that what ever it is that we do is more
profound than the rest of the world (particularly the profession) is willing
to admit. It only signals our autistic tendencies.
Jagdish S. Gangolly Department of Informatics
College of Computing & Information State University of New York at Albany
Harriman Campus, Building 7A, Suite 220 Albany, NY 12222
Phone: 518-956-8251, Fax: 518-956-8247
Jensen Comment
Note that this site includes a long listing of research in accounting,
finance, and economics, much of it based on positivism and financial
markets.
This illustrates how difficult it is to teach, let alone do
accountics, research given the unknowns about impacts of variations in
methodology. How do professors who teach from a few of their chosen studies
prepare students about the simplifications inherent in any one model?
It would seem that students have to be pretty sophisticated to understand
the limitations of the accountics harvests.
"The Cross-Section of Expected Stock Returns: What Have We Learnt from
the Past Twenty-Five Years of Research," by Avanidhar Subrahmanyam
University of California, Los Angeles - Finance Area, European Financial
Management, Forthcoming
Abstract:
I review the recent literature on cross-sectional predictors of stock
returns. Predictive variables used emanate from informal arguments,
alternative tests of risk-return models, behavioral biases, and
frictions. More than fifty variables have been used to predict returns.
The overall picture, however, remains murky, because more needs to be
done to consider the correlational structure amongst the variables, use
a comprehensive set of controls, and discern whether the results survive
simple variations in methodology.
VERY good review article on the ability of
financial models (CAPM, APT, Fama-French, etc) to predict and explain
cross sectional stock returns).
Super short version: While we have progressed,
we have done so down different paths and there needs to be some
standardization, testing for robustness, and checks for correlations
across the many variables that have been used in past models.
From Introduction:
"The predictive variables are motivated
principally in one of four ways. These are: • Informal Wall Street
wisdom (such as “value-investing”) • Theoretical motivation based on
risk-return (RR) model variants • Behavioral biases or misreaction by
cognitively challenged investors • Frictions such as illiquidity or
arbitrage constraints"
AN ABSOLUTE MUST FOR CLASSES.
Jensen Comment
I think leading academic
researchers avoid applied research for the profession because making
seminal and creative discoveries that practitioners have not already
discovered is enormously difficult.
Accounting academe is
threatened by the twin dangers of fossilization and scholasticism
(of three types: tedium, high tech, and radical chic)
From
http://faculty.trinity.edu/rjensen/395wpTAR/Web/TAR395wp.htm
“Knowledge and competence
increasingly developed out of the internal dynamics of esoteric
disciplines rather than within the context of shared perceptions
of public needs,” writes Bender. “This is not to say that
professionalized disciplines or the modern service professions
that imitated them became socially irresponsible. But their
contributions to society began to flow from their own
self-definitions rather than from a reciprocal engagement with
general public discourse.”
Now, there is a definite note of sadness in Bender’s narrative –
as there always tends to be in accounts
of theshift from Gemeinschaft
to Gesellschaft.Yet it
is also clear that the transformation from civic to disciplinary
professionalism was necessary.
“The new disciplines offered relatively precise subject matter
and procedures,” Bender concedes, “at a time when both were
greatly confused. The new professionalism also promised
guarantees of competence — certification — in an era when
criteria of intellectual authority were vague and professional
performance was unreliable.”
But in the epilogue to Intellect and Public Life,
Bender suggests that the process eventually went too far. “The
risk now is precisely the opposite,” he writes. “Academe is
threatened by the twin dangers of fossilization and
scholasticism (of three types: tedium, high tech, and radical
chic).
The agenda for the next decade, at least as I see it, ought to
be the opening up of the disciplines, the ventilating of
professional communities that have come to share too much and
that have become too self-referential.”
The United States is doing an awful job controlling sucker punches in
governmental accounting and auditing so I will pass over this one other than
to point out where you can read about it and weep for the suckers ---
http://faculty.trinity.edu/rjensen/theory01.htm#GovernmentalAccounting
I like to think about accountancy standard setting like I think about
prize fighting or Olympic boxing. In prize fighting rules are established to
prevent such things as cheating about the weight classifications of fighters
and prevention of putting steel clamps inside boxing gloves. There are also
rules to prevent sucker punches such as hitting below the belt and before or
after the bell rings for each round. As fighters take advantages of
weaknesses in the rules, rule makers issue new rulings such as rulings on
performance enhancing drugs.
In the roaring technology firm era of the 1990s, there were many startup
companies that took advantages of weaknesses in FASB and SEC standards,
particularly weaknesses on newer ploys to mislead investors with sucker
punches in revenue accounting ---
http://faculty.trinity.edu/rjensen/ecommerce/eitf01.htm
The FASB made significant progress thus far in the 21st Century in
setting rules against some of the sucker punches that were invented in the
roaring 1990s. The IASB is still trying to catch up, and delays in catching
up for some sucker punches like securitization accounting are delaying the
SEC roadmap for eliminating US GAAP and replace it with international IASB
standards for preventing sucker punches.
All this now begs the question of how managers
of corporations are adapting to new accounting/financing rules with
innovative sucker punches.
HOW do you pump up the value of your company in
these difficult times? One tried and tested way is to hoodwink equity
analysts, according to a new study* of 1,300 corporate bosses, board
directors and analysts.
The authors found that chief executives
commonly respond to negative appraisals from Wall Street by managing
appearances, rather than making changes that actually improve corporate
governance: boards are made more formally independent, but without
actually increasing their ability to control management. This is
typically done by hiring directors who, although they may have no
business ties to the company, are socially close to its top brass.
According to James Westphal, one of the study’s co-authors, some 45% of
the members of nominating committees on the boards of large American
firms have “friendship” ties to the boss—though this varies widely from
company to company.
The tactic pays off with appreciably higher
ratings. At firms that make a strenuous effort to persuade analysts that
such board changes have boosted independence, and thus made management
more accountable, the likelihood of a subsequent stock upgrade rises by
36%, the study concluded. The chance of a downgrade, meanwhile, falls by
45%.
Why do analysts swallow this self-interested
narrative? Respondents acknowledged that social ties could undermine
independence, but most said they do not have the time to look into such
issues. It would help if companies disclosed such relationships in their
standard company literature, suggests Mr Westphal. He thinks they should
also list shared appointments—when the boss and a director sit together
on another firm’s board.
Depressingly, these market-distorting
shenanigans are part of a pattern. An earlier study found that public
companies commonly enjoy lasting share-price gains from plans that
please analysts, such as share buybacks and long-term incentive schemes
for executives, even when they fail to follow through on announcements.
Another concluded that the further a firm’s profits fall below consensus
forecasts, the more favours its managers bestow on analysts—such as
recommending them for jobs and even securing club memberships for
them—and the lower the likelihood of a further downgrade. If investors
rated analysts, those taken in by such blatant attempts at manipulation
would surely earn a “sell”.
From:
Jensen, Robert Sent: Wednesday, November 11, 2009 9:21 AM To: 'AECM@LISTSERV.LOYOLA.EDU' Subject: RE: The Immature Pseudo Sciences of Manamatics and Accountics
Hi again Neal,
Did you know about the 1960 fork in the road “catastrophe” of
collegiate business education?
Note what happened to me when Erika and I began to watch a NetFlix movie on
November 10.
Readers who want to read more about this “catastrophe” just
published in the Chronicle of Higher Education plus concurrences by Steve
Zeff and Mike Granof also published in the Chronicle of Higher Education
may read on about this the following threads:
November 11, 2009
message sent by Bob Jensen to the AECM
Hi Neal,
Just a few off-the-wall responses to your off-the-wall comments.
I’m certain that there are many, many published accountics papers that make good
points for the accounting profession and probably wind their way into the
profession directly or indirectly (practitioners don’t publish enough to remind
us of this). I find that these interesting points often arise in the early parts
of an accountics paper before the often-trivial hypothesis testing begins.
Sometimes an accountics paper is of genuine value in my writing
for practitioners. My best and valued example is Terry Shevlin’s work (with
friends) on accounting for tax benefits of employee options. Terry does good
accountics work on relevant issues.
Those closest to the FAS 33 at the time it was rescinded tell me
that empirical evidence in the accountics literature played a key role in the
FASB’s decision to deep six FAS 33. I think the FASB used to be closer to
academics in the early days than is the case today. Sometimes the early FASB
commissioned academic research and tracked it closer. Tom Dyckman and I worked
with the FASB a slight bit when “we” commissioned Rashad to do a FASB research
study on FAS 13. Bob Sprouse was on the FASB at the time and said the FASB would
be interested in most any study of the impact of FAS 13 on real-world decisions
as long as “we” excluded “behavioral experiments” (his words and his bias).
In response to your third question, I think one of the main
problems is that academic salaries in accounting attracted mathematical
economists long on econometrics skills and short on accounting knowledge (as
encouraged by accounting doctoral programs that started requiring less and less
accounting and more and more econometrics).
My best Exhibit A is Referee A who flatly rejected a submission
to Accounting Horizons by Denny Beresford wherein Denny suggested (very
politely) that perhaps academic accounting researchers should focus more on some
of the problems in the practicing profession. My oft repeated quotation is
below:
The
paper (by Dennis Beresford) provides specific
recommendations for things that accounting academics should be doing to make the
accounting profession better. However (unless the author believes that
academics' time is a free good) this would presumably take academics' time away
from what they are currently doing. While following the author's advice might
make the accounting profession better, what is being made worse? In other words, suppose I stop reading current academic
research and start reading news about current developments in accounting
standards. Who is made better off and who is
made worse off by this reallocation of my time? Presumably my students are
marginally better off, because I can tell them some new stuff in class about
current accounting standards, and this might possibly have some limited benefit
on their careers. But haven't I made my colleagues in my department worse off if
they depend on me for research advice, and haven't I made my university worse
off if its academic reputation suffers because I'm no longer considered a
leading scholar? Why does making the accounting profession better take
precedence over everything else an academic does with their time? Referee A's rejection letter,
Accounting Horizons, 2005
What riled me the most was the arrogance of Referee A. I
read into it that, whereas mathematicians and econometricians are true
"scholars," other accounting professors are little better than teachers of
bookkeeping and fairy tales. This is the same arrogant attitude held by
now-broken investment bankers trying to take advantage of Warren Buffet as their
counterparties in derivatives or other financial transactions. It tickled me
when, according to Janet Tavakoli, Warren took the model builders’ billions to
the bank because his deep fundamentals analysis beat the superficial models
almost all the time.
And there you have it. In 2010, the 1920s
debate regarding accountics versus practitioner dominance of TAR that raged
might've ignited once again if collegiate business education had more
seriously debated the social science versus law school paradigms in the
early 1960s. In the above article Carter Daniel writes:
But—and herein lies the
catastrophe—instead of boldly fighting back against their misguided
detractors, the nation's business schools uniformly cowered and began
scurrying to conform to the wishes of the reports' authors.
Business education
could, and should, have adopted the model of other professional schools,
where theoretical-minded practitioners and practice-minded theoreticians
are the mentors, and where both the curriculum and the research focus on
the real world. But instead of constantly striving to achieve that
delicate, razor's-edge balance between theory and practice, business
schools, frightened by the reports, retreated almost entirely into theoretical camp. Doing so damaged several important, distinct
characteristics of business schools, including . . .
Of course Joel Demski and Professor XXXXX proponents of accountics for the
last 50 years would strongly disagree that it was a "catastrophe" that business
education became more like social science and not like law.
As for me, I made out like a bandit. I was a frustrated ski bum doing tax
returns and audits for Ernst and Ernst in Denver when Stanford laundered Ford
Foundation money to turn me from a CPA into an operations researcher (OR) in
Stanford's new "accounting" (I use the term very loosely) doctoral program that admitted three candidates for
accounting. I took to mathematical programming like some preachers take to
evangelism. Conducting research and publishing papers in TAR, JAR, and the
Journal of Operations Research was easy compared to trying to create something
really of use to an accounting practitioner.
Meanwhile accounting practitioners, that at one time really enjoyed being
with and writing with professors, quickly resigned from the American
Accountics Association and never have rejoined us except for head hunters
who are seeking out our graduates. I defy you to point to a TAR paper
published in the past three decades that is remembered for greatly helping
practitioners on the street like leading law school and medical school
journals help the practicing side of their professions.
And to Professor XXXXX, who is indeed very kind in even listening to me
since most accountics researcher no longer speak to me, I say either make
The Accounting Review a real science "research" journal (complete with
verification of empirical results) or open it up to the "search journal" it
once was that encouraged
I reminded Professor XXXXX of the following report of the current Editor
of TAR.
"Annual Report and Editorial Commentary for The Accounting Review,"
by Steven J. Kachelmeier The University of Texas at Austin, The
Accounting Review, November 2009, Page 2056.
Jensen Comment 1
Please Read This First
An Appeal for Replication and Other Commentaries/Dialogs in an Electronic
Journal Supplemental Commentaries and Replication Abstracts With a Rejoinder from the Current Senior Editor of The Accounting
Review (TAR), Steven J. Kachelmeier
http://faculty.trinity.edu/rjensen/TheoryTAR.htm
The present TAR editor states the following on Page 2054:
Several authors (e.g., Bonner et al. 2006;
Heck and Jensen 2007;
Hopwood 2007; Tuttle and Dillard 2007) have
lamented the perceived narrowness of contemporary accounting
scholarship, mostly with respect to the perception that the discipline
is ‘‘consolidating around the area of financial accounting’’ (Tuttle and
Dillard 2007, 395), particularly of the empirical-archival ‘‘capital
markets’’ variety. Writings of this nature generally imply (if not
explicitly state) that accounting journals and editorial biases are part
of the problem. However, journals can only publish what they receive,
such that a more comprehensive analysis compels consideration of both
articles published and the underlying submission base rates. Former AAA
President Shyam Sunder told me once that journals are intellectual
mirrors of the scholarly communities they reflect.
To this I have one word --- hogwash! Editors reap what sow. Accountics
researcher editors are more interested in the tractors than in the harvests.
Clear back in 1987, TAR editor Gary Sundem reported very similar outcomes to
those shown above. If you've not accepted case studies, field studies,
surveys, normative papers, history papers, and theory mullings for over 20
years, what do you expect will be submitted?
Submitting to TAR takes time and money just to have a paper reviewed. Why
bother if there's virtually no chance of acceptance? Gene Heck and I
mistakenly submitted a history paper to TAR in 2006 that was resoundingly
rejected by referees who loudly proclaimed our critical of TAR and
accountics should never see the light of day. Then when it was accepted
by The Accounting Historians Journal it even one a monetary prize as
one of the top papers published in 2007: An Analysis of the Contributions of The
Accounting Review Across 80 Years: 1926-2005 ---
http://faculty.trinity.edu/rjensen/395wpTAR/Web/TAR395wp.htm
Jensen Comment 2
Along these lines I reviewed a forthcoming paper accepted by TAR that is not
yet published. It is a wonderful paper by a scholar who really understands
the professional accounting questions of interest. However, in order to
stretch it for publication in TAR, it had to focus on some uninspired and,
in my opinion, naive "testable hypotheses." However, when I overlooked the
rather useless statistical testing, I found the paper highly informative and
worthwhile. There are really some interesting items published in most of
TAR papers in the past 20 years. However, they are seldom reflected in the
accountics parts of the papers. Look for the history and the narratives
apart from the mathematics.
Jensen Comment 3
Accounting has not been alone among the business school disciplines.
Manamatics and Markamatics took over the leading management and marketing
research journals as well as a result of the
road taken at that fork in 1960.
"Research on Accounting Should Learn From the Past," by
Michael H. Granof and
Stephen A. Zeff, Chronicle of Higher Education, March 21,
2008
Starting in the 1960s, academic research on
accounting became methodologically supercharged — far more quantitative and
analytical than in previous decades. The results, however, have been
paradoxical. The new paradigms have greatly increased our understanding of
how financial information affects the decisions of investors as well as
managers. At the same time, those models have crowded out other forms of
investigation. The result is that professors of accounting have contributed
little to the establishment of new practices and standards, have failed to
perform a needed role as a watchdog of the profession, and have created a
disconnect between their teaching and their research.
Before the 1960s, accounting research was primarily
descriptive. Researchers described existing standards and practices and
suggested ways in which they could be improved. Their findings were taken
seriously by standard-setting boards, CPA's, and corporate officers.
A
confluence of developments in the 1960s markedly changed the nature of
research — and, as a consequence, its impact on practice. First,
computers emerged as a means of collecting and analyzing vast amounts of
information, especially stock prices and data drawn from corporate financial
statements. Second, academic accountants themselves recognized the
limitations of their methodologies. Argument, they realized, was no
substitute for empirical evidence. Third, owing to criticism that their
research was decidedly second rate because it was insufficiently analytical,
business faculties sought academic respectability by employing the methods
of disciplines like econometrics, psychology, statistics, and mathematics.
In response to those developments, professors of
accounting not only established new journals that were restricted to
metric-based research, but they limited existing academic publications to
that type of inquiry. The most influential of the new journals was the
Journal of Accounting Research, first published in 1963 and sponsored by the
University of Chicago Graduate School of Business.
Acknowledging the primacy of the journals,
business-school chairmen and deans increasingly confined the rewards of
publication exclusively to those publications' contributors. That policy was
applied initially at the business schools at private colleges that had the
strongest M.B.A. programs. Then ambitious business schools at public
institutions followed the lead of the private schools, even when the public
schools had strong undergraduate and master's programs in accounting with
successful traditions of practice-oriented research.
The unintended consequence has been that
interesting and researchable questions in accounting are essentially being
ignored. By confining the major thrust in research to phenomena that can be
mathematically modeled or derived from electronic databases, academic
accountants have failed to advance the profession in ways that are expected
of them and of which they are capable.
Academic research has unquestionably broadened the
views of standards setters as to the role of accounting information and how
it affects the decisions of individual investors as well as the capital
markets. Nevertheless, it has had scant influence on the standards
themselves.
The research is hamstrung by restrictive and
sometimes artificial assumptions. For example, researchers may construct
mathematical models of optimum compensation contracts between an owner and a
manager. But contrary to all that we know about human behavior, the models
typically posit each of the parties to the arrangement as a "rational"
economic being — one devoid of motivations other than to maximize pecuniary
returns.
Moreover, research is limited to the homogenized
content of electronic databases, which tell us, for example, the prices at
which shares were traded but give no insight into the decision processes of
either the buyers or the sellers. The research is thus unable to capture the
essence of the human behavior that is of interest to accountants and
standard setters.
Further, accounting researchers usually look
backward rather than forward. They examine the impact of a standard only
after it has been issued. And once a rule-making authority issues a
standard, that authority seldom modifies it. Accounting is probably the only
profession in which academic journals will publish empirical studies only if
they have statistical validity. Medical journals, for example, routinely
report on promising new procedures that have not yet withstood rigorous
statistical scrutiny.
Floyd Norris, the chief financial correspondent of
The New York Times, titled a 2006 speech to the American Accounting
Association "Where Is the Next Abe Briloff?" Abe Briloff is a rare academic
accountant. He has devoted his career to examining the financial statements
of publicly traded companies and censuring firms that he believes have
engaged in abusive accounting practices. Most of his work has been published
in Barron's and in several books — almost none in academic journals. An
accounting gadfly in the mold of Ralph Nader, he has criticized existing
accounting practices in a way that has not only embarrassed the miscreants
but has caused the rule-making authorities to issue new and more-rigorous
standards. As Norris correctly suggested in his talk, if the academic
community had produced more Abe Briloffs, there would have been fewer
corporate accounting meltdowns.
The narrow focus of today's research has also
resulted in a disconnect between research and teaching. Because of the
difficulty of conducting publishable research in certain areas — such as
taxation, managerial accounting, government accounting, and auditing — Ph.D.
candidates avoid choosing them as specialties. Thus, even though those areas
are central to any degree program in accounting, there is a shortage of
faculty members sufficiently knowledgeable to teach them.
To be sure, some accounting research, particularly
that pertaining to the efficiency of capital markets, has found its way into
both the classroom and textbooks — but mainly in select M.B.A. programs and
the textbooks used in those courses. There is little evidence that the
research has had more than a marginal influence on what is taught in
mainstream accounting courses.
What needs to be done? First, and most
significantly, journal editors, department chairs, business-school deans,
and promotion-and-tenure committees need to rethink the criteria for what
constitutes appropriate accounting research. That is not to suggest that
they should diminish the importance of the currently accepted modes or that
they should lower their standards. But they need to expand the set of
research methods to encompass those that, in other disciplines, are
respected for their scientific standing. The methods include historical and
field studies, policy analysis, surveys, and international comparisons when,
as with empirical and analytical research, they otherwise meet the tests of
sound scholarship.
Second, chairmen, deans, and promotion and
merit-review committees must expand the criteria they use in assessing the
research component of faculty performance. They must have the courage to
establish criteria for what constitutes meritorious research that are
consistent with their own institutions' unique characters and comparative
advantages, rather than imitating the norms believed to be used in schools
ranked higher in magazine and newspaper polls. In this regard, they must
acknowledge that accounting departments, unlike other business disciplines
such as finance and marketing, are associated with a well-defined and
recognized profession. Accounting faculties, therefore, have a special
obligation to conduct research that is of interest and relevance to the
profession. The current accounting model was designed mainly for the
industrial era, when property, plant, and equipment were companies' major
assets. Today, intangibles such as brand values and intellectual capital are
of overwhelming importance as assets, yet they are largely absent from
company balance sheets. Academics must play a role in reforming the
accounting model to fit the new postindustrial environment.
Third, Ph.D. programs must ensure that young
accounting researchers are conversant with the fundamental issues that have
arisen in the accounting discipline and with a broad range of research
methodologies. The accounting literature did not begin in the second half of
the 1960s. The books and articles written by accounting scholars from the
1920s through the 1960s can help to frame and put into perspective the
questions that researchers are now studying.
For example, W.A. Paton and A.C. Littleton's 1940
monograph, An Introduction to Corporate Accounting Standards, profoundly
shaped the debates of the day and greatly influenced how accounting was
taught at universities. Today, however, many, if not most, accounting
academics are ignorant of that literature. What they know of it is mainly
from textbooks, which themselves evince little knowledge of the
path-breaking work of earlier years. All of that leads to superficiality in
teaching and to research without a connection to the past.
We fervently hope that the research pendulum will
soon swing back from the narrow lines of inquiry that dominate today's
leading journals to a rediscovery of the richness of what accounting
research can be. For that to occur, deans and the current generation of
academic accountants must give it a push.
Michael H. Granof is a professor of accounting at the McCombs School
of Business at the University of Texas at Austin. Stephen A. Zeff is a
professor of accounting at the Jesse H. Jones Graduate School of Management
at Rice University.
Steve Zeff has
been saying this since his stint as editor of The Accounting Review
(TAR); nobody has listened. Zeff famously wrote at least two editorials
published in TAR over 30 years ago that lamented the colonization of the
accounting academy by the intellectually unwashed. He and Bill Cooper wrote
a comment on Kinney's tutorial on how to do accounting research and it was
rudely rejected by TAR. It gained a new life only when Tony Tinker published
it as part of an issue of Critical Perspectives in Accounting devoted
to the problem of dogma in accounting research.
It has only been since
less subdued voices have been raised (outright rudeness has been the
hallmark of those who transformed accounting into the empirical
sub-discipline of a sub-discipline for which empirical work is irrelevant)
that any movement has occurred. Judy Rayburn's diversity initiative and her
invitation for Anthony Hopwood to give the Presidential address at the D.C.
AAA meeting came only after many years of persistent unsubdued pointing out
of things that were uncomfortable for the comfortable to confront.
“An Analysis of the Evolution of Research Contributions by The Accounting
Review: 1926-2005,” by Jean Heck and Robert E. Jensen, Accounting Historians
Journal, Volume 34, No. 2, December 2007, pp. 109-142
http://faculty.trinity.edu/rjensen/395wpTAR/Web/TAR395wp.htm
The demarcation between science and pseudoscience
is part of the larger task to determine which beliefs are epistemically
warranted. The entry clarifies the specific nature of pseudoscience in
relation to other forms of non-scientific doctrines and practices. The major
proposed demarcation criteria are discussed and some of their weaknesses are
pointed out. In conclusion, it is emphasized that there is much more
agreement in particular issues of demarcation than on the general criteria
that such judgments should be based upon. This is an indication that there
is still much important philosophical work to be done on the demarcation
between science and pseudoscience.
1. The purpose of demarcations
2. The “science” of pseudoscience
3. The “pseudo” of pseudoscience
3.1 Non-, un-, and pseudoscience
3.2 Non-science posing as science
3.3 The doctrinal component
3.4 A wider sense of pseudoscience
3.5 The objects of demarcation 3.6 A time-bound demarcation
4. Alternative demarcation criteria
4.1 The logical positivists
4.2 Falsificationism
4.3 The criterion of puzzle-solving
4.4 Criteria based on scientific progress
4.5 Epistemic norms 4.6 Multi-criterial approaches
5. Unity in diversity Bibliography
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On June 15, 2013 David Johnstone wrote the following:
Dear all,
I worked on the logic and philosophy of hypothesis tests in the early 1980s
and discovered a very large literature critical of standard forms of
testing, a little of which was written by philosophers of science (see the
more recent book by Howson and Urbach) and much of which was written by
statisticians. At this point philosophy of science was warming up on
significance tests and much has been written since. Something I have
mentioned to a few philosophers however is how far behind the pace
philosophy of science is in regard to all the new finance and decision
theory developed in finance (e.g. options logic, mean-variance as an
expression of expected utility). I think that philosophers would get a rude
shock on just how clever and rigorous all this thinking work in “business”
fields is. There is also wonderfully insightful work on betting-like
decisions done by mathematicians, such as Ziemba and Cover, that has I think
rarely if ever surfaced in the philosophy of science (“Kelly betting” is a
good example). So although I believe modern accounting researchers should
have far more time and respect for ideas from the philosophy of science, the
argument runs both ways.
Jensen Comment
Note that in the above "cited works" there are no cited references in statistics
such as Ziemba and Cover or the better known statistical theory and statistical
science references.
This suggests somewhat the divergence of statistical theory from philosophy
theory with respect to probability and hypothesis testing. Of course probability
and hypothesis testing are part and parcel to both science and pseudo-science.
Statistical theory may accordingly be a subject that divides pseudo-science and
real science.
Etymology provides us with an obvious
starting-point for clarifying what characteristics pseudoscience has in
addition to being merely non- or un-scientific. “Pseudo-” (ψευδο-) means
false. In accordance with this, the Oxford English Dictionary (OED) defines
pseudoscience as follows:
“A pretended or spurious science; a collection of
related beliefs about the world mistakenly regarded as being based on
scientific method or as having the status that scientific truths now
have.”
June 5, 2013 reply to a long
thread by Bob Jensen
Hi Steve,
As usual, these AECM threads between you, me, and Paul Williams resolve
nothing to date. TAR still has zero articles without equations unless such
articles are forced upon editors like the Kaplan article was forced upon you
as Senior Editor. TAR still has no commentaries about the papers it
publishes and the authors make no attempt to communicate and have dialog
about their research on the AECM or the AAA Commons.
I do hope that our AECM threads will continue and lead one day to when
the top academic research journals do more to both encourage (1) validation
(usually by speedy replication), (2) alternate methodologies, (3) more
innovative research, and (4) more interactive commentaries.
I remind you that Professor Basu's essay is only one of four essays
bundled together in Accounting Horizons on the topic of how to make
accounting research, especially the so-called Accounting Sciience or
Accountics Science or Cargo Cult science, more innovative.
"Framing the Issue of Research Quality in a Context of Research
Diversity," by Christopher S. Chapman ---
"Accounting Craftspeople versus Accounting Seers: Exploring the
Relevance and Innovation Gaps in Academic Accounting Research," by
William E. McCarthy ---
"Is Accounting Research Stagnant?" by Donald V. Moser ---
Cargo Cult Science "How Can Accounting Researchers Become More
Innovative? by Sudipta Basu ---
I will try to keep drawing attention to these important essays and spend
the rest of my professional life trying to bring accounting research closer
to the accounting profession.
I also want to dispel the myth that accountics research is harder than
making research discoveries without equations. The hardest research I can
imagine (and where I failed) is to make a discovery that has a noteworthy
impact on the accounting profession. I always look but never find such
discoveries reported in TAR.
The easiest research is to purchase a database and beat it with an
econometric stick until something falls out of the clouds. I've searched for
years and find very little that has a noteworthy impact on the accounting
profession. Quite often there is a noteworthy impact on other members of the
Cargo Cult and doctoral students seeking to beat the same data with their
sticks. But try to find a practitioner with an interest in these academic
accounting discoveries?
Our latest thread leads me to such questions as:
Is accounting research of inferior quality relative to other
disciplines like engineering and finance?
Are there serious innovation gaps in academic accounting research?
Is accounting research stagnant?
How can accounting researchers be more innovative?
Is there an "absence of dissent" in academic accounting research?
Is there an absence of diversity in our top academic accounting
research journals and doctoral programs?
Is there a serious disinterest (except among the Cargo Cult) and
lack of validation in findings reported in our academic accounting
research journals, especially TAR?
Is there a huge communications gap between academic accounting
researchers and those who toil teaching accounting and practicing
accounting?
One fall out of this thread is that I've been privately asked to write a
paper about such matters. I hope that others will compete with me in
thinking and writing about these serious challenges to academic accounting
research that never seem to get resolved.
Thank you Steve for sometimes responding in my threads on such issues in
the AECM.
Respectfully,
Bob Jensen
June 16, 2013 message from
Bob Jensen
Hi Marc,
The mathematics of falsification is essentially the same
as the mathematics of proof negation.
If mathematics is a science
it's largely a science of counter examples.
Regarding real-real science versus
pseudo-science, one criterion is that of explanation (not just
prediction) that satisfies a community of scholars. One of the
best examples of this are the exchanges between two Nobel
economists --- Milton Friedman versus Herb Simon.
Jensen Comment
Interestingly, two Nobel economists slugged out the very
essence of theory some years back. Herb Simon insisted that
the purpose of theory was to explain. Milton Friedman went
off on the F-Twist tangent saying that it was enough if a
theory merely predicted. I lost some (certainly not all)
respect for Friedman over this. Deidre, who knew Milton,
claims that deep in his heart, Milton did not ultimately
believe this to the degree that it is attributed to him. Of
course Deidre herself is not a great admirer of Neyman,
Savage, or Fisher.
Friedman's essay "The
Methodology of Positive Economics"
(1953) provided the
epistemological pattern for
his own subsequent research and to a degree that of the
Chicago School. There he argued that economics as
science should be free of value judgments for it to
be objective. Moreover, a useful economic theory should
be judged not by its descriptive realism but by its
simplicity and fruitfulness as an engine of prediction.
That is, students should measure the accuracy of its
predictions, rather than the 'soundness of its
assumptions'. His argument was part of an ongoing debate
among such statisticians as
Jerzy Neyman,
Leonard Savage, and
Ronald Fisher.
You (Bob) have referenced sources that include
falsification and demarcation. A good idea. Also, AECM participants
discuss hypothesis testing and Phi-Sci topics from time to time.
I didn't make my purpose clear. My purpose is
to offer that falsification and demarcation are still relevant to
empirical research, any empirical research.
So,
What is falsification in mathematical form?
Why does falsification not demarcate science
from non-science?
And for fun: Did Popper know falsification
didn't demarcate science from non-science?
Marc
June 17, 2013 reply form
Bob Jensen
Hi Marc,
Falsification in science generally requires
explanation. You really have not falsified a
theory or proven a theory if all you can do is
demonstrate an unexplained correlation. In
pseudo-science empiricism a huge problem is that
virtually all our databases are not granulated
sufficiently to possibly explain the discovered
correlations or discovered predictability that
cannot be explained ---
http://www.cs.trinity.edu/~rjensen/temp/AccounticsGranulationCurrentDraft.pdf
Mathematics is
beautiful in many instances because theories are
formulated in a way where finding a counter
example ipso facto destroys theory.
This is not generally the case in the empirical
sciences where exceptions (often outliers) arise
even when causal mechanisms have been
discovered. In genetics those exceptions are
often mutations that infrequently but
persistently arise in nature.
The key difference
between pseudo-science and real-science, as I
pointed out earlier in this thread, lies in
explanation versus prediction (the F-twist) or
causation versus correlation. When a research
study concludes there is a correlation that cannot
be explained we are departing from a scientific
discovery. For an example, see
Data mining research in
particular suffers from inability to find causes if the
granulation needed for discovery of causation just is
not contained in the databases. I've hammered on this
one with a Japanese research data mining accountics
research illustration (from TAR) ---- "How Non-Scientific Granulation Can Improve
Scientific Accountics"
http://www.cs.trinity.edu/~rjensen/temp/AccounticsGranulationCurrentDraft.pdf
Another huge problem in accountics
science and empirical finance is statistical significance
testing of correlation coefficients with enormous data mining
samples. For example R-squared coefficients of 0.001 are deemed
statistically significant if the sample sizes are large enough : My
threads on Deidre McCloskey (the Cult of Statistical
Significance) and my own talk are at
http://www.cs.trinity.edu/~rjensen/temp/DeirdreMcCloskey/StatisticalSignificance01.htm
A problem with real-science is that
there's a distinction between the evolution of a theory and the
ultimate discovery of the causal mechanisms. In the evolution of a
theory there may be unexplained correlations or explanations that
have not yet been validated (usually by replication). But genuine
scientific discoveries entail explanation of phenomena. We like to
think of physics and chemistry are real-sciences. In fact they
deal a lot with unexplained correlations before theories can finally
be explained.
Perhaps a difference between a
pseudo-science (like accountics science) versus chemistry (a
real-science) is that real scientists are never satisfied until they
can explain causality to the satisfaction of their peers.
Accountics scientists are generally
satisfied with correlations and statistical inference tests that cannot
explain root causes:
http://www.cs.trinity.edu/~rjensen/temp/AccounticsGranulationCurrentDraft.pdf
Of course science is replete
with examples of causal explanations that are later
falsified or demonstrated to be incomplete. But the focus is
on the causal mechanisms and not mere correlations.
Of course social scientists
complain that the problem in social science research is that the
physicists stole all the easy problems.
Respectfully,
Bob Jensen
A Blast posted to SSRN on August 21, 2015 "Is There Any Scientific Basis for Accounting? Implications for Practice,
Research and Education,"
SSRN, August 21, 2015
Authors
Sudipta Basu, Temple University
- Department of Accounting
This essay is based on a keynote speech at the 2014
Journal of International Accounting Research (JIAR) Conference. That talk
was built upon a 2009 American Accounting Association (AAA) annual meeting
panel presentation titled “Is there any scientific legitimacy to what we
teach in Accounting 101?” I evaluate whether accounting practice,
regulation, research and teaching have a strong underlying scientific basis.
I argue that recent accounting research, regulation and teaching are often
based on unscientific ideology but that evolved accounting practice embeds
scientific laws even if accountants are largely unaware of them. Accounting
researchers have an opportunity to expand scientific inquiry in accounting
by improving their research designs and exploring uses of accounting outside
formal capital markets using field studies and experiments.
"Introduction for Essays on the State of
Accounting Scholarship," Gregory B. Waymire, Accounting Horizons,
December 2012, Vol. 26, No. 4, pp. 817-819 ---
"Framing the Issue of Research Quality in
a Context of Research Diversity," by Christopher S. Chapman,
Accounting Horizons, December 2012, Vol. 26, No. 4, pp. 821-831
"Accounting Craftspeople versus
Accounting Seers: Exploring the Relevance and Innovation Gaps in Academic
Accounting Research," by William E. McCarthy, Accounting Horizons,
December 2012, Vol. 26, No. 4, pp. 833-843
"Is Accounting Research Stagnant?" by
Donald V. Moser, Accounting Horizons, December 2012, Vol. 26, No. 4,
pp. 845-850
"How Can Accounting Researchers Become
More Innovative? by Sudipta Basu,
Accounting Horizons, December 2012, Vol. 26, No. 4, pp. 851-87
A Blast from the Past from 1997
"A Comparison of Dividend, Cash Flow, and Earnings Approaches to Equity
Valuation,"
SSRN, March 31, 1997
Authors
Stephen H. Penman, Columbia Business School - Department of Accounting
Theodore Sougiannis, University of Illinois at Urbana-Champaign - Department
of Accountancy
Abstract:
Standard formulas for valuing the equity of going
concerns require prediction of payoffs "to infinity" but practical analysis
requires that they be predicted over finite horizons. This truncation
inevitably involves (often troublesome) "terminal value" calculations. This
paper contrasts dividend discount techniques, discounted cash flow analysis,
and techniques based on accrual earnings when applied to a finite-horizon
valuation. Valuations based on average ex-post payoffs over various
horizons, with and without terminal value calculations, are compared with
(ex-ante) market prices to give an indication of the error introduced by
each technique in truncating the horizon. Comparisons of these errors show
that accrual earnings techniques dominate free cash flow and dividend
discounting approaches. Further, the relevant accounting features of
techniques that make them less than ideal for finite horizon analysis are
discovered. Conditions where a given technique requires particularly long
forecasting horizons are identified and the performance of the alternative
techniques under those conditions is examined.
Jensen Comment
It's good to teach accounting and finance students at all levels some of the
prize-winning literature (accountics scientists are always giving themselves
awards) in this type of valuation along with the reasons why these accountics
science models deriving equity valuation estimates from financial statements
have very little validity.
The main reason of course is that so many variables contributing to equity
valuation are not quantified in the financial statements, particularly
intangibles and contingencies.
Jensen Comment
The same applies to not over-relying on historical data in valuation. My
favorite case study that I used for this in
teaching is the following:
Questrom vs. Federated Department Stores, Inc.: A Question of Equity Value," by
University of Alabama faculty members by Gary Taylor, William Sampson,
and Benton Gup, May 2001 edition of Issues in Accounting Education ---
http://faculty.trinity.edu/rjensen/roi.htm
Jensen Comment
I want to especially thank David Stout,
Editor of the May 2001 edition of Issues in Accounting Education.
There has been something special in all the editions edited by David, but
the May edition is very special to me. All the articles in that edition are
helpful, but I want to call attention to three articles that I will use
intently in my graduate Accounting Theory course.
"Questrom vs. Federated Department Stores, Inc.: A Question of
Equity Value," by University of Alabama faculty members Gary Taylor,
William Sampson, and Benton Gup, pp. 223-256.
This is perhaps the best short case that I've ever read. It will
undoubtedly help my students better understand weighted average cost of
capital, free cash flow valuation, and the residual income model. The
three student handouts are outstanding. Bravo to Taylor, Sampson, and
Gup.
"Using the Residual-Income Stock Price Valuation Model to Teach and
Learn Ratio Analysis," by Robert Halsey, pp. 257-276.
What a follow-up case to the Questrom case mentioned above! I have long
used the Dupont Formula in courses and nearly always use the excellent
paper entitled "Disaggregating the ROE: A
New Approach," by T.I. Selling and C.P. Stickney,
Accounting Horizons, December 1990, pp. 9-17. Halsey's paper guides
students through the swamp of stock price valuation using the residual
income model (which by the way is one of the few academic accounting
models that has had a major impact on accounting practice, especially
consulting practice in equity valuation by CPA firms).
"Developing Risk Skills: An Investigation of Business Risks and
Controls at Prudential Insurance Company of America," by Paul Walker,
Bill Shenkir, and Stephen Hunn, pp. 291
I will use this case to vividly illustrate the "tone-at-the-top"
importance of business ethics and risk analysis. This is case is easy
to read and highly informative.
Does low inflation justify higher valuation
multiples? There are many valuation models for stocks. They mostly don’t
work very well, or at least not consistently well. Over the years, I’ve come
to conclude that valuation, like beauty, is in the eye of the beholder.
For many investors, stocks look increasingly
attractive the lower that inflation and interest rates go. However, when
they go too low, that suggests that the economy is weak, which wouldn’t be
good for profits. Widespread deflation would almost certainly be bad for
profits. It would also pose a risk to corporations with lots of debt, even
if they could refinance it at lower interest rates. Let’s review some of the
current valuation metrics, which we monitor in our Stock
Market Valuation Metrics & Models:
(1) Reversion to the mean. On Tuesday, the
forward P/E of the S&P 500 was 16.1. That’s above its historical average of
13.7 since 1978.
(2) Rule of 20. One rule of thumb is that the forward P/E of the
S&P 500 should be close to 20 minus the y/y CPI inflation rate. On this
basis, the rule’s P/E was 18.3 during October.
(3) Misery Index. There has been an inverse relationship between
the S&P 500’s forward P/E and the Misery Index, which is just the sum of the
inflation rate and the unemployment rate. The index fell to 7.4% during
October. That’s the lowest reading since April 2008, and arguably justifies
the market’s current lofty multiple.
(4) Market-cap ratios. The ratio of the S&P 500 market cap to
revenues rose to 1.7 during Q3, the highest since Q1-2002. That’s identical
to the reading for the ratio of the market cap of all US equities to nominal
GDP.
Today's Morning Briefing: Inflating
Inflation. (1) Dudley expects Fed to hit inflation target next
year. (2) It all depends on resource utilization. (3) What if demand-side
models are flawed? (4) Supply-side models explain persistence of
deflationary pressures. (5) Inflationary expectations falling in TIPS
market. (6) Bond market has gone global. (7) Valuation and beauty contests.
(8) Rule of 20 says stocks still cheap. (9) Other valuation models find no
bargains. (10) Cheaper stocks abroad, but for lots of good reasons. (11) US
economy humming along. (More
for subscribers.)
Accountics Scientists Failing to Communicate on the AAA Commons
"Frankly, Scarlett, after I get a hit for my resume in The Accounting Review
I just don't give a damn ."
www.cs.trinity.edu/~rjensen/temp/AccounticsDamn.htm
NEW HAVEN – I am one of the winners of this
year’s
Nobel Memorial Prize in Economic Sciences,
which makes me acutely aware of criticism of the prize by those who
claim that economics – unlike chemistry, physics, or medicine, for which
Nobel Prizes are
also awarded – is not a science. Are they right?
One problem with economics is that it is
necessarily focused on policy, rather than discovery of fundamentals.
Nobody really cares much about economic data except as a guide to
policy: economic phenomena do not have the same intrinsic fascination
for us as the internal resonances of the atom or the functioning of the
vesicles and other organelles of a living cell. We judge economics by
what it can produce. As such, economics is rather more like engineering
than physics, more practical than spiritual.
There is no Nobel Prize for engineering, though
there should be. True,
the chemistry prize this year looks a bit like
an engineering prize, because it was given to three researchers – Martin
Karplus, Michael Levitt, and Arieh Warshel – “for the development of
multiscale models of complex chemical systems” that underlie the
computer programs that make nuclear magnetic resonance hardware work.
But the Nobel Foundation is forced to look at much more such practical,
applied material when it considers the economics prize.
The problem is that, once we focus on economic
policy, much that is not science comes into play.
Politics becomes involved, and political
posturing is amply rewarded by public attention. The Nobel Prize is
designed to reward those who do not play tricks for attention, and who,
in their sincere pursuit of the truth, might otherwise be slighted.
The pursuit of truth
Why is it called a prize in “economic sciences”, rather than just
“economics”? The other prizes are not awarded in the “chemical sciences”
or the “physical sciences”.
Fields of endeavor that use “science” in their
titles tend to be those that get masses of people emotionally involved
and in which crackpots seem to have some purchase on public opinion.
These fields have “science” in their names to distinguish them from
their disreputable cousins.
The term political science first became popular
in the late eighteenth century to distinguish it from all the partisan
tracts whose purpose was to gain votes and influence rather than pursue
the truth. Astronomical science was a common term in the late nineteenth
century, to distinguish it from astrology and the study of ancient myths
about the constellations. Hypnotic science was also used in the
nineteenth century to distinguish the scientific study of hypnotism from
witchcraft or religious transcendentalism.
Crackpot counterparts
There was a need for such terms back then, because their crackpot
counterparts held much greater sway in general discourse. Scientists had
to announce themselves as scientists.
In fact, even
the term chemical science enjoyed some popularity in the nineteenth
century – a time when the field sought to distinguish itself from
alchemy and the promotion of quack nostrums. But the need to use that
term to distinguish true science from the practice of impostors was
already fading by the time the
Nobel Prizes were launched in 1901.
Similarly, the terms astronomical science and
hypnotic science mostly died out as the twentieth century progressed,
perhaps because belief in the occult waned in respectable society. Yes,
horoscopes still persist in popular newspapers, but they are there only
for the severely scientifically challenged, or for entertainment; the
idea that the stars determine our fate has lost all intellectual
currency. Hence there is no longer any need for the term “astronomical
science.”
Pseudoscience?
Critics of “economic sciences” sometimes refer to the development of a
“pseudoscience” of economics, arguing that it uses the trappings of
science, like dense mathematics, but only for show. For example, in his
2004 book, Fooled
by Randomness, Nassim Nicholas Taleb said
of economic sciences:
“You can disguise charlatanism under the
weight of equations, and nobody can catch you since there is no such
thing as a controlled experiment.”
But all the mathematics in economics is not, as
Taleb suggests, charlatanism.
Economics has an important quantitative side,
which cannot be escaped. The challenge has been to combine its
mathematical insights with the kinds of adjustments that are needed to
make its models fit the economy’s irreducibly human element.
The advance of behavioral economics is not
fundamentally in conflict with mathematical economics, as some seem to
think, though it may well be in conflict with some currently fashionable
mathematical economic models. And, while economics presents its own
methodological problems, the basic challenges facing researchers are not
fundamentally different from those faced by researchers in other fields.
As economics develops, it will broaden its repertory of methods and
sources of evidence, the science will become stronger, and the
charlatans will be exposed.
June 18, 2013 reply to David Johnstone by Jagdish Gangolly
David,
Your call for a dialogue between statistics and
philosophy of science is very timely, and extremely important
considering the importance that statistics, both in its probabilistic
and non-probabilistic incarnations, has gained ever since the
computational advances of the past three decades or so. Let me share a
few of my conjectures regarding the cause of this schism between
statistics and philosophy, and consider a few areas where they can share
in mutual reflection. However, reflection in statistics, like in
accounting of late and unlike in philosophy, has been on short order for
quite a while. And it is always easier to pick the low hanging fruit.
Albert Einstein once remarked, ""I have little patience with scientists
who take a board of wood, look for the thinnest part and drill a great
number of holes where drilling is easy".
1.
Early statisticians were practitioners of the
art, most serving as consultants of sorts. Gosset worked for Guiness,
GEP Box did most of his early work for Imperial Chemical Industries (ICI),
Fisher worked at Rothamsted Experimental Station, Loeve was an actuary
at University of Lyon... As practitioners, statisticians almost always
had their feet in one of the domains in science: Fisher was a biologist,
Gossett was a chemist, Box was a chemist, ... Their research was down to
earth, and while statistics was always regarded the turf of
mathematicians, their status within mathematics was the same as that of
accountants in liberal arts colleges today, slightly above that of
athletics. Of course, the individuals with stature were expected to be
mathematicians in their own right.
All that changed with the work of Kolmogorov
(1933, Moscow State, http://www.socsci.uci.edu/~bskyrms/bio/readings/kolmogorov_theory_of_probability_small.pdf),
Loeve (1960, Berkeley), Doob(1953, Illinois), and Dynkin(1963, Moscow
State and Cornell). They provided mathematical foundations for earlier
work of practitioners, and especially Kolmogorov provided axiomatic
foundations for probability theory. In the process, their work unified
statistics into a coherent mass of knowledge. (Perhaps there is a lesson
here for us accountants). A collateral effect was the schism in the
field between theoreticians and the practitioners (of which we
accountants must be wary) that has continued to this date. We can see a
parallel between accounting and statistics here too.
2.
Early controversies in statistics had to do
with embedding statistical methods in decision theory (Fisher was
against, Neyman and Pearson were for it), and whether the foundations
for statistics had to be deductive or inductive (frequentists were for
the former, Bayesians were for the latter). These debates were not just
technical, and had underpinnings in philosophy, especially philosophy of
mathematics (after all, the early contributors to the field were
mathematicians: Gauss, Fermat, Pascal, Laplace, deMoivre, ...). For
example, when the Fisher-Neyman/Pearson debates had ranged, Neyman was
invited by the philosopher Jakko Hintikka to write a paper for the
journal Synthese ( "Frequentist probability and Frequentist statistics",
1977).
3.
Since the early statisticians were
practitioners, their orientation was usually normative: in sample
theory, regression, design of experiments,.... The mathematisation of
statistics and later work of people like Tukey, raised the prominence of
descriptive (especially axiomatic) in the field. However, the recent
developments in datamining have swung the balance again in favour of the
normative.
4. Foundational issues in statistics have
always been philosophical. And treatment of probability has been
profoundly philosophical (see for example http://en.wikipedia.org/wiki/Probability_interpretations).
Regards,
Jagdish
June 18, 2018 reply from David Johnstone
Dear Jagdish, as usual your knowledge and
perspectives are great to read.
In reply to your points: (1) the early
development of statistics by Gossett and Fisher was as a means to an
end, i.e. to design and interpret experiments that helped to resolve
practical issues, like whether fertilizers were effective and different
genetic strains of crops were superior. This left results testable in
the real world laboratory, by the farmers, so the pressure to get it
right rather than just publish was on. Gossett by the way was an old
fashioned English scholar who spent as much time fishing and working in
his workshop as doing mathematics. This practical bent comes out in his
work.
(2) Neman’s effort to make statistics
“deductive” was always his weak point, and he went to great lengths to
evade this issue. I wrote a paper on Neyman’s interpretations of tests,
as in trying to understand him I got frustrated by his inconsistency and
evasiveness over his many papers. In more than one place, he wrote that
to “accept” the null is to “act as if it is true”, and to reject it is
to “act as if it is false”. This is ridiculous in scientific contexts,
since to act as if something is decided 100% you would never draw
another sample - your work would be done on that hypothesis.
(3) On the issue of normative versus
descriptive, as in accounting research, Harold Jeffreys had a great line
in his book, “he said that if we observe a child add 2 and 2 to get 5,
we don’t change the laws of arithmetic”. He was very anti learning about
the world by watching people rather than doing abstract theory. BTW I
own his personal copy of his 3rd edition. A few years ago I went to buy
this book on Bookfinder, and found it available in a secondhand bookshop
in Cambridge. I rand them instantly when I saw that they said whose book
it was, and they told me that Mrs Jeffreys had just died and Harold’s
books had come in, and that the 1st edition was sold the day before.
(4) I adore your line that “Foundational issues
in statistics have always been philosophical”. .... So must they be in
accounting, in relation to how to construct income and net assets
measures that are sound and meaningful. Note however that just because
we accept something needs philosophical footing doesn’t mean that we
will find or agree on that footing. I recently received a comment on a
paper of mine from an accounting referee. The comment was basically that
the effect of information on the cost of capital “could not be revealed
by philosophy” (i.e. by probability theory etc.). Rather, this is an
empirical issue. Apart from ignoring all the existing theory on this
matter in accounting and finance, the comment is symptomatic of the way
that “empirical findings” have been elevated to the top shelf, and
theory, or worse, “thought pieces”, are not really science. There is so
much wrong with this extreme but common view, including of course that
every empirical finding stands on a model or a priori view. Indeed,
remember that every null hypothesis that was ever rejected might have
been rejected because the model (not the hypothesis) was wrong. People
naively believe that a bad model or bad experimental design just reduces
power (makes it harder to reject the null) but the mathematical fact is
that it can go either way, and error in the model or sample design can
make rejection of the null almost certain.
Page 15
The doctor who cannot distinguish statistical significance from
substantive significance, an F-statistic from a heart attach, is
like an economist who ignores opportunity cost---what statistical
theorists call the loss function. The doctors of "significance" in
medicine and economy are merely "deciding what to say rather than
what to do" (Savage 1954, 159). In the 1950s Ronald Fisher published
an article and a book that intended to rid decision from the
vocabulary of working statisticians (1955, 1956). He was annoyed by
the rising authority in highbrow circles of those he called "the
Neymanites."
Continued on Page 15
pp. 28-31
An example is provided regarding how Merck manipulated statistical
inference to keep its killing pain killer Vioxx from being pulled
from the market.
Page 31
Another story. The Japanese government in June 2005 increased the
limit on the number of whales that may be annually killed in the
Antarctica---from around 440 annually to over 1,000 annually. Deputy
Commissioner Akira Nakamae explained why: "We will implement
JARPS-2 [the plan for the higher killing] according to the schedule,
because the sample size is determined in order to get statistically
significant results" (Black 2005). The Japanese hunt for the whales,
they claim, in order to collect scientific data on them. That and
whale steaks. The commissioner is right: increasing sample size,
other things equal, does increase the statistical significance of
the result. It is, fter all, a mathematical fact that statistical
significance increases, other things equal, as sample size
increases. Thus theoretical standard error of JAEPA-2,
s/SQROOT(440+560) [given for example the simple mean formula],
yields more sampling precision than the standard error JARPA-1,
s/SQROOT(440). In fact it raises the significance level to Fisher's
percent cutoff. So the Japanese government has found a formula for
killing more whales, annually some 560 additional victims, under the
cover of getting the conventional level of Fisherian statistical
significance for their "scientific" studies.
pp. 250-251
The textbooks are wrong. The teaching is wrong. The seminar you just
attended is wrong. The most prestigious journal in your scientific
field is wrong.
You are searching, we know, for ways to
avoid being wrong. Science, as Jeffreys said, is mainly a
series of approximations to discovering the sources of error.
Science is a systematic way of reducing wrongs or can be. Perhaps
you feel frustrated by the random epistemology of the mainstream and
don't know what to do. Perhaps you've been sedated by significance
and lulled into silence. Perhaps you sense that the power of a
Roghamsted test against a plausible Dublin alternative is
statistically speaking low but you feel oppressed by the
instrumental variable one should dare not to wield. Perhaps you feel
frazzled by what Morris Altman (2004) called the "social psychology
rhetoric of fear," the deeply embedded path dependency that keeps
the abuse of significance in circulation. You want to come out of
it. But perhaps you are cowed by the prestige of Fisherian dogma.
Or, worse thought, perhaps you are cynically willing to be corrupted
if it will keep a nice job
June 25, 2013 reply from Marc Dupree
With regard to the article Scott
recommended, "The Flawed Probabilistic Foundation of Law and
Economics," (https://law.northwestern.edu/journals/lawreview/v105/n1/199/LR105n1Stein.pdf),
there may be more interest in the discussion of research methods
than answering the question, "Is following the law the same as being
ethical?"
An excerpt:
Evidential Variety as a Basis for Inference
The logical composition of the two systems of
probability— mathematical, on the one hand, and
causative, on the other—reveals the systems’ relative
strengths and weaknesses. The mathematical system is
most suitable for decisions that implicate averages.
Gambling is a para- digmatic example of those decisions.
At the same time, this system em- ploys relatively lax
standards for identifying causes and effects. Moreover,
it weakens the reasoner’s epistemic grasp of her
individual case by requir- ing her to abstract away from
the case’s specifics. This requirement is im- posed by
the system’s epistemically unfounded rules that make
individual cases look similar to each other despite the
uniqueness of each case. On the positive side, however,
the mathematical system allows a person to concep-
tualize her probabilistic assessments in the
parsimonious and standardized language of numbers. This
conceptual framework enables people to form and
communicate their assessments of probabilities with
great precision.
The causative system of probability is not suitable for
gambling. It as- sociates probability with the scope, or
variety, of the evidence that confirms the underlying
individual occurrence. The causative system also employs
rigid standards for establishing causation.
Correspondingly, it disavows in- stantial multiplicity
as a basis for inferences and bans all other factual as-
sumptions that do not have epistemic credentials. These
features improve people’s epistemic grasps of their
individual cases. The causative system has a
shortcoming: its unstructured and “noisy” taxonomy. This
system in- structs people to conceptualize their
probability assessments in the ordinary day-to-day
language. This conceptual apparatus is notoriously
imprecise. The causative system therefore has developed
no uniform metric for grada- tion of probabilities.142
On balance, the causative system outperforms
mathematical probabili- ty in every area of fact-finding
for which it was designed. This system enables people to
perform an epistemically superior causation analysis in
both scientific and daily affairs. Application of the
causative system also improves people’s ability to
predict and reconstruct specific events. The
mathematical system, in contrast, is a great tool for
understanding averages and distributions of multiple
events. However, when it comes to an as- sessment of an
individual event, the precision of its estimates of
probability becomes illusory. The causative system
consequently becomes decisively superior.
Marc
June 25, 2013 reply from Marc Dupree
With regard to the article Scott
recommended, "The Flawed Probabilistic Foundation of Law and
Economics," (https://law.northwestern.edu/journals/lawreview/v105/n1/199/LR105n1Stein.pdf),
there may be more interest in the discussion of research methods
than answering the question, "Is following the law the same as being
ethical?"
An excerpt:
Evidential Variety as a Basis for Inference
The logical composition of the two systems of
probability— mathematical, on the one hand, and
causative, on the other—reveals the systems’ relative
strengths and weaknesses. The mathematical system is
most suitable for decisions that implicate averages.
Gambling is a para- digmatic example of those decisions.
At the same time, this system em- ploys relatively lax
standards for identifying causes and effects. Moreover,
it weakens the reasoner’s epistemic grasp of her
individual case by requir- ing her to abstract away from
the case’s specifics. This requirement is im- posed by
the system’s epistemically unfounded rules that make
individual cases look similar to each other despite the
uniqueness of each case. On the positive side, however,
the mathematical system allows a person to concep-
tualize her probabilistic assessments in the
parsimonious and standardized language of numbers. This
conceptual framework enables people to form and
communicate their assessments of probabilities with
great precision.
The causative system of probability is not suitable for
gambling. It as- sociates probability with the scope, or
variety, of the evidence that confirms the underlying
individual occurrence. The causative system also employs
rigid standards for establishing causation.
Correspondingly, it disavows in- stantial multiplicity
as a basis for inferences and bans all other factual as-
sumptions that do not have epistemic credentials. These
features improve people’s epistemic grasps of their
individual cases. The causative system has a
shortcoming: its unstructured and “noisy” taxonomy. This
system in- structs people to conceptualize their
probability assessments in the ordinary day-to-day
language. This conceptual apparatus is notoriously
imprecise. The causative system therefore has developed
no uniform metric for grada- tion of probabilities.142
On balance, the causative system outperforms
mathematical probabili- ty in every area of fact-finding
for which it was designed. This system enables people to
perform an epistemically superior causation analysis in
both scientific and daily affairs. Application of the
causative system also improves people’s ability to
predict and reconstruct specific events. The
mathematical system, in contrast, is a great tool for
understanding averages and distributions of multiple
events. However, when it comes to an as- sessment of an
individual event, the precision of its estimates of
probability becomes illusory. The causative system
consequently becomes decisively superior.
Marc
The Immature Pseudo Sciences of Manamatics and Accountics
Let's face, for purposes of tenure and promotion and prestige in top
business schools the only kind of research that counts are "testable
knowledge-based claims." Accounting and business professors are wasting
their time trying to do research on tough real-world problems that can't be
modeled and tested! This is a a sign of the immaturity of academic business
research.
Of course over in the science and humanities divisions, where creativity
is given more credence and researchers are encouraged to attack the most
difficult problems imaginable, top researchers can publish normative
reasoning and creative thinking, even poetic thinking, about problems not
yet amenable to testable hypotheses.
When the great scientists enter the land of testable hypotheses they
often discover that the poets have paved the roads. It's like the army
mopping up after the marines landed beforehand.
Manamatics (a play on "accountics") and the journal called The
Academy of Management Review
While the public clamors for the return of managerial
leadership in ethics and social responsibility, surprisingly little research
on the subject exists, and what does get published doesn't appear in the top
journals. The reasons are varied, but perhaps more than anything it's that
those journals are exclusively empirical: Take The Academy of Management
Review, the only top journal devoted to management theory.
Its mission statement says it publishes only "testable
knowledge-based claims." Unfortunately,
that excludes most of what counts as ethics, which is primarily a
conceptual, a priori discipline akin to law and philosophy. We wouldn't
require, for example, that theses on the nature of justice or logic be
empirically testable, although we still consider them "knowledge based."
Julian Friedland, "Where Business Meets Philosophy: the Matter of
Ethics," Chronicle of Higher Education, November 8, 2009 ---
http://chronicle.com/article/Where-Business-Meets/49053/
It remains to be seen if many business
professors will achieve tenure by doing ethics properly speaking. Most
of what now gets published in top business journals under the rubric of
"ethics" is limited to empirical studies of the success of various
policies presumed as ethical ("the effects of management consistency on
employee loyalty and efficiency," perhaps). Although valuable, such
research does precious little to hone the mission of business itself.
While the public clamors for the return of
managerial leadership in ethics and social responsibility, surprisingly
little research on the subject exists, and what does get published
doesn't appear in the top journals. The reasons are varied, but perhaps
more than anything it's that those journals are exclusively empirical:
Take The Academy of Management Review, the only top journal devoted to
management theory. Its mission statement says it publishes only
"testable knowledge-based claims." Unfortunately, that excludes most of
what counts as ethics, which is primarily a conceptual, a priori
discipline akin to law and philosophy. We wouldn't require, for example,
that theses on the nature of justice or logic be empirically testable,
although we still consider them "knowledge based."
The major business journals have a
responsibility to open the ivory-tower gates to a priori arguments on
the ethical nature and mission of business. After all, the top business
schools, which are a model for the rest, are naturally interested in
hiring academics who publish in the top journals. One solution is for at
least one or two of the top journals to rewrite their mission statements
to expressly include articles applying ethical theory to business. They
could start by creating special ethics sections in the same way that
some have already created critical-essay sections. Another solution is
for academics to do more reading and referencing of existing
business-ethics journals. Through more references in the wider
literature, those journals can rise to the top. Until such changes
occur, business ethics will largely remain a second-class area of
research, primarily concerned with teaching.
Meanwhile, although I seem to notice more
tenure-track positions in business ethics appearing every year—a step in
the right direction—many required business-ethics courses are taught by
relative outsiders. They are usually non-tenure-track hires from the
private sector or, like me, from various other academic disciplines,
such as psychology, law, and philosophy. In my years as a philosopher in
business schools, I've often held a place at once exalted and reviled.
It's provocative and alluring. But it can also be about as fitting as a
pony in a pack of wolves. During my three years at a previous college I
became accepted—even a valued colleague of many. But deans sometimes
treated me with the kind of suspicion normally suited to a double agent
behind enemy lines.
For a business-ethics curriculum to succeed, it
must be at least somewhat philosophical. And that is difficult to
establish in the university context, in which departments are loath to
give up turf. Not surprisingly, few business Ph.D. programs offer any
real training in ethical theory. Naturally, dissertations in applied
ethics are generally written in philosophy departments, and those
addressing business are rare, since few philosophers are schooled in
business practices. Business schools should begin collaborating with
centers for applied ethics, which seem to be cropping up almost
everywhere in philosophy departments. Conversely, philosophers in
applied ethics should reach out to business and law professors
interested in ethics. With that kind of academic infrastructure, real
prog ress can be made.
Perhaps then fewer business students will view
their major mainly as a means to gainful employment, and might instead
see it as a force of social prog ress. Colleges like mine, which root
their students in ethics and liberal arts, are training them to think
for themselves. Business schools that fail to do so are clinging to the
past.
Continued in article
Julian Friedland is an assistant professor of business ethics at
Eastern Connecticut State University and editor of "Doing Well and Good:
The Human Face of the New Capitalism" (Information Age Publishing,
2009).
A recent accountics science study suggests
that audit firm scandal with respect to someone else's audit may be a reason
for changing auditors.
"Audit Quality and Auditor Reputation: Evidence from Japan," by Douglas J.
Skinner and Suraj Srinivasan, The Accounting Review, September 2012,
Vol. 87, No. 5, pp. 1737-1765.
Our conclusions are subject
to two caveats. First, we find that clients switched away from ChuoAoyama in
large numbers in Spring 2006, just after Japanese regulators announced the
two-month suspension and PwC formed Aarata. While we interpret these events
as being a clear and undeniable signal of audit-quality problems at
ChuoAoyama, we cannot know for sure what drove these switches(emphasis added).
It is possible that the suspension caused firms to switch auditors for
reasons unrelated to audit quality. Second, our analysis presumes that audit
quality is important to Japanese companies. While we believe this to be the
case, especially over the past two decades as Japanese capital markets have
evolved to be more like their Western counterparts, it is possible
that audit quality is, in general, less important in Japan(emphasis added) .
Why genius lies in the selection of what is
worth observing.
"The Art of Observation and How to Master the Crucial Difference Between
Observation and Intuition," by Maria Popova, Brain Pickings,
March 29, 2013
http://www.brainpickings.org/index.php/2013/03/29/the-art-of-observation/
This selection has a number of historic photographs of well-known scientists
--- all women!
“In the field of observation,”
legendary disease prevention pioneer Louis Pasteur
famously proclaimed in 1854, “chance favors only the prepared mind.”“Knowledge comes form noticing resemblances and recurrences in the
events that happen around us,” neuroscience godfather
Wilfred Trotter asserted. That keen observation is what
transmutes information into knowledge is indisputable — look no further
than
Sherlock Holmes and his exquisite mindfulness
for a proof — but how, exactly, does one cultivate that critical
faculty?
It is important to realize that observation
is much more than merely seeing something; it also involves a mental
process. In all observations there are two elements : (a) the
sense-perceptual element (usually visual) and (b) the mental, which,
as we have seen, may be partly conscious and partly unconscious.
Where the sense-perceptual element is relatively unimportant, it is
often difficult to distinguish between an observation and an
ordinary intuition. For example, this sort of thing is usually
referred to as an observation: “I have noticed that I get hay fever
whenever I go near horses.” The hay fever and the horses are
perfectly obvious, it is the connection between the two that may
require astuteness to notice at first, and this is a mental process
not distinguishable from an intuition. Sometimes it is possible to
draw a line between the noticing and the intuition, e.g. Aristotle
commented that on observing that the bright side of the moon is
always toward the sun, it may suddenly occur to the observer that
the explanation is that the moon shines by the light of the sun.
Claude Bernard distinguished two types of
observation: (a) spontaneous or passive observations which are
unexpected; and (b) induced or active observations which are
deliberately sought, usually on account of an hypothesis. …
Effective spontaneous observation involves firstly noticing some
object or event. The thing noticed will only become significant if
the mind of the observer either consciously or unconsciously relates
it to some relevant knowledge or past experience, or if in pondering
on it subsequently he arrives at some hypothesis. In the last
section attention was called to the fact that the mind is
particularly sensitive to changes or differences. This is of use in
scientific observation, but what is more important and more
difficult is to observe (in this instance mainly a mental process)
resemblances or correlations between things that on the surface
appeared quite unrelated.
One cannot observe everything closely,
therefore one must discriminate and try to select the significant.
When practicing a branch of science, the ‘trained’ observer
deliberately looks for specific things which his training has taught
him are significant, but in research he often has to rely on his own
discrimination, guided only by his general scientific knowledge,
judgment and perhaps an hypothesis which he entertains.
We
close with a quotation from Scott McLemee demonstrating that what
happened among accountancy academics over the past four decades is not
unlike what happened in other academic disciplines that developed
“internal dynamics of esoteric disciplines,” communicating among
themselves in loops detached from their underlying professions.
McLemee’s [2006] article stems from Bender [1993].
“Knowledge and
competence increasingly developed out of the internal dynamics of
esoteric disciplines rather than within the context of shared
perceptions of public needs,” writes Bender. “This is not to say that
professionalized disciplines or the modern service professions that
imitated them became socially irresponsible. But their contributions to
society began to flow from their own self-definitions rather than from a
reciprocal engagement with general public discourse.”
Now, there is a definite note of sadness in Bender’s narrative – as
there always tends to be in accounts of theshift from Gemeinschaftto
Gesellschaft.Yet it is also clear that the
transformation from civic to disciplinary professionalism was necessary.
“The new disciplines offered relatively precise subject matter and
procedures,” Bender concedes, “at a time when both were greatly
confused. The new professionalism also promised guarantees of competence
— certification — in an era when criteria of intellectual authority were
vague and professional performance was unreliable.”
But in the epilogue to Intellect and Public Life, Bender
suggests that the process eventually went too far. “The risk now is
precisely the opposite,” he writes. “Academe is threatened by the twin
dangers of fossilization and scholasticism (of three types: tedium, high
tech, and radical chic). The agenda for the next decade, at least as I
see it, ought to be the opening up of the disciplines, the ventilating
of professional communities that have come to share too much and that
have become too self-referential.”
"Why business ignores the business schools," by Michael Skapinker,
Financial Times, January 7, 2008
Chief executives, on the other hand, pay little
attention to what business schools do or say. As long ago as 1993, Donald
Hambrick, then president of the US-based Academy of Management, described
the business academics' summer conference as "an incestuous closed loop", at
which professors "come to talk with each other". Not much has changed. In
the current edition of The Academy of Management Journal.
. . .
They have chosen an auspicious occasion on which to
beat themselves up: this year is The Academy of Management Journal's 50th
anniversary. A scroll through the most recent issues demonstrates why
managers may be giving the Journal a miss. "A multi-level investigation of
antecedents and consequences of team member boundary spanning behaviour" is
the title of one article.
Why do business academics write like this? The
academics themselves offer several reasons. First, to win tenure in a US
university, you need to publish in prestigious peer-reviewed journals.
Accessibility is not the key to academic advancement.
Similar pressures apply elsewhere. In France and
Australia, academics receive bonuses for placing articles in the top
academic publications. The UK's Research Assessment Exercise, which
evaluates university research and ties funding to the outcome, encourages
similarly arcane work.
But even without these incentives, many business
school faculty prefer to adorn their work with scholarly tables, statistics
and jargon because it makes them feel like real academics. Within the
university world, business schools suffer from a long-standing inferiority
complex.
The professors offer several remedies. Academic
business journals should accept fact-based articles, without demanding that
they propound a new theory. Professor Hambrick says that academics in other
fields "don't feel the need to sprinkle mentions of theory on every page,
like so much aromatic incense or holy water".
Others talk of the need for academics to spend more
time talking to managers about the kind of research they would find useful.
As well-meaning as these suggestions are, I suspect
the business school academics are missing something. Law, medical and
engineering schools are subject to the same academic pressures as business
schools - to publish in prestigious peer-reviewed journals and to buttress
their work with the expected academic vocabulary.
Perhaps I'm old and tired, but I always think that the chances of finding
out what really is going on are so absurdly remote that the only thing to do
is to say hang the sense of it and just keep yourself occupied. Douglas Adams
I think leading academic researchers avoid applied research for the
profession because making seminal and creative discoveries that practitioners
had not already discovered is enormously difficult.
Accounting academe is threatened by the twin dangers of fossilization and
scholasticism (of three types: tedium, high tech, and radical chic)
From
http://faculty.trinity.edu/rjensen/395wpTAR/Web/TAR395wp.htm
“Knowledge and competence increasingly developed
out of the internal dynamics of esoteric disciplines rather than within the
context of shared perceptions of public needs,” writes Bender. “This is not
to say that professionalized disciplines or the modern service professions
that imitated them became socially irresponsible. But their contributions to
society began to flow from their own self-definitions rather than from a
reciprocal engagement with general public discourse.”
Now, there is a definite note of sadness in Bender’s narrative – as there
always tends to be in accounts
of theshift from Gemeinschaftto
Gesellschaft.Yet it is also clear
that the transformation from civic to disciplinary professionalism was
necessary.
“The new disciplines offered relatively precise subject matter and
procedures,” Bender concedes, “at a time when both were greatly confused.
The new professionalism also promised guarantees of competence —
certification — in an era when criteria of intellectual authority were vague
and professional performance was unreliable.”
But in the epilogue to Intellect and Public Life, Bender
suggests that the process eventually went too far. “The risk now is
precisely the opposite,” he writes. “Academe is threatened by the twin
dangers of fossilization and scholasticism (of three types: tedium, high
tech, and radical chic).
The agenda for the next decade, at least as I see it, ought to be the
opening up of the disciplines, the ventilating of professional communities
that have come to share too much and that have become too self-referential.”
There are two explanations one can give for this
state of affairs here. The first is due to the great English economist Maurice
Dobb according to whom theory of value was replaced in the United States by
theory of price. May be, the consequence for us today is that we know the price
of everything but perhaps the value of nothing. Economics divorced from politics
and philosophy is vacuous. In accounting, we have inherited the vacuousness by
ignoring those two enduring areas of inquiry. Professor Jagdish Gangolly, SUNY
Albany
The second is the comment that Joan Robinson made
about American Keynsians: that their theories were so flimsy that they had to
put math into them. In accounting academia, the shortest path to respectability
seems to be to use math (and statistics), whether meaningful or not. Professor Jagdish Gangolly, SUNY
Albany
“Research should be problem driven rather than
methodologically driven," said Lisa Garcia Bedolla, a member of the task force
who teaches at the University of California at Berkeley. Scott Jascik ---
http://www.insidehighered.com/news/2009/09/04/polisci
"I understand your point, Jim." He could not identify one issue that (accountics)
researchers had been able to "put to bed" after
all that effort. P. Kothari, one of the Editors of JAE and a full professor at MIT,
as quoted by Jim Peters.
Why genius lies in the selection of what is worth
observing.
"The Art of Observation and How to Master the Crucial Difference Between
Observation and Intuition," by Maria Popova, Brain Pickings, March
29, 2013
http://www.brainpickings.org/index.php/2013/03/29/the-art-of-observation/
This selection has a number of historic photographs of well-known scientists ---
all women!
“In the field of observation,” legendary
disease prevention pioneer Louis Pasteur famously
proclaimed in 1854, “chance favors only the prepared mind.”
“Knowledge comes form noticing resemblances and recurrences in the events
that happen around us,” neuroscience godfather Wilfred Trotter
asserted. That keen observation is what transmutes information into
knowledge is indisputable — look no further than
Sherlock Holmes and his exquisite mindfulness
for a proof — but how, exactly, does one cultivate that critical faculty?
It is important to realize that observation is
much more than merely seeing something; it also involves a mental
process. In all observations there are two elements : (a) the
sense-perceptual element (usually visual) and (b) the mental, which, as
we have seen, may be partly conscious and partly unconscious. Where the
sense-perceptual element is relatively unimportant, it is often
difficult to distinguish between an observation and an ordinary
intuition. For example, this sort of thing is usually referred to as an
observation: “I have noticed that I get hay fever whenever I go near
horses.” The hay fever and the horses are perfectly obvious, it is the
connection between the two that may require astuteness to notice at
first, and this is a mental process not distinguishable from an
intuition. Sometimes it is possible to draw a line between the noticing
and the intuition, e.g. Aristotle commented that on observing that the
bright side of the moon is always toward the sun, it may suddenly occur
to the observer that the explanation is that the moon shines by the
light of the sun.
Claude Bernard distinguished two types of
observation: (a) spontaneous or passive observations which are
unexpected; and (b) induced or active observations which are
deliberately sought, usually on account of an hypothesis. … Effective
spontaneous observation involves firstly noticing some object or event.
The thing noticed will only become significant if the mind of the
observer either consciously or unconsciously relates it to some relevant
knowledge or past experience, or if in pondering on it subsequently he
arrives at some hypothesis. In the last section attention was called to
the fact that the mind is particularly sensitive to changes or
differences. This is of use in scientific observation, but what is more
important and more difficult is to observe (in this instance mainly a
mental process) resemblances or correlations between things that on the
surface appeared quite unrelated.
One cannot observe everything closely,
therefore one must discriminate and try to select the significant. When
practicing a branch of science, the ‘trained’ observer deliberately
looks for specific things which his training has taught him are
significant, but in research he often has to rely on his own
discrimination, guided only by his general scientific knowledge,
judgment and perhaps an hypothesis which he entertains.
We
close with a quotation from Scott McLemee demonstrating that what happened
among accountancy academics over the past four decades is not unlike what
happened in other academic disciplines that developed “internal dynamics of
esoteric disciplines,” communicating among themselves in loops detached from
their underlying professions. McLemee’s [2006] article stems from Bender
[1993].
“Knowledge and competence
increasingly developed out of the internal dynamics of esoteric disciplines
rather than within the context of shared perceptions of public needs,”
writes Bender. “This is not to say that professionalized disciplines or the
modern service professions that imitated them became socially irresponsible.
But their contributions to society began to flow from their own
self-definitions rather than from a reciprocal engagement with general
public discourse.”
Now, there is a definite note of sadness in Bender’s narrative – as there
always tends to be in accounts of theshift from Gemeinschaftto
Gesellschaft.Yet it is also clear that the transformation
from civic to disciplinary professionalism was necessary.
“The new disciplines offered relatively precise subject matter and
procedures,” Bender concedes, “at a time when both were greatly confused.
The new professionalism also promised guarantees of competence —
certification — in an era when criteria of intellectual authority were vague
and professional performance was unreliable.”
But in the epilogue to Intellect and Public Life, Bender
suggests that the process eventually went too far. “The risk now is
precisely the opposite,” he writes. “Academe is threatened by the twin
dangers of fossilization and scholasticism (of three types: tedium, high
tech, and radical chic). The agenda for the next decade, at least as I see
it, ought to be the opening up of the disciplines, the ventilating of
professional communities that have come to share too much and that have
become too self-referential
"Lab Experiments Are a Major Source of Knowledge in the Social Sciences,"
by Armin Falk and James J. Heckman, IZA Discussion Paper No. 4540, October
2009 ---
http://ftp.iza.org/dp4540.pdf
Laboratory experiments are a widely used
methodology for advancing causal knowledge in the physical and life
sciences. With the exception of psychology, the adoption of laboratory
experiments has been much slower in the social sciences, although during
the last two decades, the use of lab experiments has accelerated.
Nonetheless, there remains considerable resistance among social
scientists who argue that lab experiments lack “realism” and “generalizability”.
In this article we discuss the advantages and limitations of laboratory
social science experiments by comparing them to research based on
nonexperimental data and to field experiments. We argue that many recent
objections against lab experiments are misguided and that even more lab
experiments should be conducted.
Jensen Comment
It disappointed me that Falk and Heckman did not really discuss the issue of
replication and verifiability while claiming that "lab experiments are a
major source of knowledge in the social sciences." The might've given more
examples where studies were independently replicated, and there are such
studies --- especially lab experiments in psychology.
They do mention in passing that lab experiments might support or run
counter to empirical studies, but here again it would've helped to provide
some examples. I did a bit of searching and found one example that they
might've used for such purposes ---
http://www.jsecjournal.com/JSEC_Mesoudi_1-2.pdf
I suspect there are hundreds of similar examples.
The trade-offs between lab experiments versus field studies are discussed
in the following paper:
"Internal and External Validity in Economics Research: Tradeoffs between
Experiments, Field Experiments, Natural Experiments and Field Data," by
Brian E. Roe and David R. Just, 2009 Proceedings Issue, American Journal
of Agricultural Economics ---
http://aede.osu.edu/people/roe.30/Roe_Just_AJAE09.pdf
Abstract: In the realm of empirical research,
investigators are first and foremost concerned with the validity of
their results, but validity is a multi-dimensional ideal. In this
article we discuss two key dimensions of validity – internal and
external validity – and underscore the natural tension that arises in
choosing a research approach to maximize both types of validity. We
propose that the most common approaches to empirical research – the use
of naturally-occurring field/market data and the use of laboratory
experiments – fall on the ends of a spectrum of research approaches, and
that the interior of this spectrum includes intermediary approaches such
as field experiments and natural experiments. Furthermore, we argue that
choosing between lab experiments and field data usually requires a
tradeoff between the pursuit of internal and external validity.
Movements toward the interior of the spectrum can often ease the tension
between internal and external validity but are also accompanied by other
important limitations, such as less control over subject matter or topic
areas and a reduced ability for others to replicate research. Finally,
we highlight recent attempts to modify and mix research approaches in a
way that eases the natural conflict between internal and external
validity and discuss if employing multiple methods leads to economies of
scope in research costs.
Lab experiments, but not field studies, are quite popular in some of the
leading accounting research journals and are most commonly conducted on
student volunteers. The problem is the behavioral lab experiments findings
are apparently not important enough to verify and replicate, although the
hypotheses may have been generated from anecdotal observations in the real
world or even, on occasion, by related empirical studies.
I've always contended that more experiments might be replicated if
journal editors encouraged replications by adopting policies of sending
replication submissions out for review with at least a chance of publication
for studies that corroborate findings as well as negate findings. The fact
that behavioral experiments published in TAR, JAR, and JAE are virtually
never replicated sends out signals that the findings are either too obvious
or too unimportant or too superficial to be of interest in and of
themselves.
Unlike some leading social science journals, the leading accounting
journals tend not to publish case and field research studies even if these
sometimes indirectly support the lab experimental outcomes.
Experimental Economics: Rethinking the Rules by Nicholas
Bardsley and others (Princeton University Press; 2009, 375 pages; $55).
Discusses the use of experimental methods in economic research and examines
controversies over the growing field.
In the first 40 years of
TAR, an accounting “scholar” was first and foremost an expert on accounting.
After 1960, following the Gordon and Howell Report, the perception of what
it took to be a “scholar” changed to quantitative modeling. It became
advantageous for an “accounting” researcher to have a degree in mathematics,
management science, mathematical economics, psychometrics, or econometrics.
Being a mere accountant no longer was sufficient credentials to be deemed a
scholarly researcher. Many doctoral programs stripped much of the accounting
content out of the curriculum and sent students to mathematics and social
science departments for courses. Scholarship on accounting standards became
too much of a time diversion for faculty who were “leading scholars.”
Particularly relevant in this regard is Dennis Beresford’s address to the
AAA membership at the 2005 Annual AAA Meetings in San Francisco:
In my eight years in teaching
I’ve concluded that way too many of us don’t stay relatively up to
date on professional issues. Most of us have some experience as an auditor,
corporate accountant, or in some similar type of work. That’s great, but
things change quickly these days.
Beresford [2005]
Jane Mutchler made a
similar appeal for accounting professors to become more involved in the
accounting profession when she was President of the AAA [Mutchler, 2004, p.
3].
In the last 40 years, TAR’s
publication preferences shifted toward problems amenable to scientific
research, with esoteric models requiring accountics skills in place of
accounting expertise. When Professor Beresford attempted to publish his
remarks, an Accounting Horizons referee’s report to him contained the
following revealing reply about “leading scholars” in accounting research:
1. The paper provides specific
recommendations for things that accounting academics should be doing to make
the accounting profession better. However (unless the author believes that
academics' time is a free good) this would presumably take academics' time
away from what they are currently doing. While following the author's advice
might make the accounting profession better, what is being made worse? In
other words, suppose I stop reading current academic research and start
reading news about current developments in accounting standards. Who is made
better off and who is made worse off by this reallocation of my time?
Presumably my students are marginally better off, because I can tell them
some new stuff in class about current accounting standards, and this might
possibly have some limited benefit on their careers. But haven't I made my
colleagues in my department worse off if they depend on me for research
advice, and haven't I made my university worse off if its academic
reputation suffers because I'm no longer considered a leading scholar?
Why does making the accounting profession better take precedence over
everything else an academic does with their time? As quoted in Jensen [2006a]
The above quotation
illustrates the consequences of editorial policies of TAR and several other
leading accounting research journals. To be considered a “leading scholar”
in accountancy, one’s research must employ mathematically-based
economic/behavioral theory and quantitative modeling. Most TAR articles
published in the past two decades support this contention. But according to
AAA President Judy Rayburn and other recent AAA presidents, this scientific
focus may not be in the best interests of accountancy academicians or the
accountancy profession.
In terms of citations, TAR
fails on two accounts. Citation rates are low in practitioner journals
because the scientific paradigm is too narrow, thereby discouraging
researchers from focusing on problems of great interest to practitioners
that seemingly just do not fit the scientific paradigm due to lack of
quality data, too many missing variables, and suspected non-stationarities.
TAR editors are loath to open TAR up to non-scientific methods so that
really interesting accounting problems are neglected in TAR. Those
non-scientific methods include case method studies, traditional historical
method investigations, and normative deductions.
In the other account, TAR
citation rates are low in academic journals outside accounting because the
methods and techniques being used (like CAPM and options pricing models)
were discovered elsewhere and accounting researchers are not sought out for
discoveries of scientific methods and models. The intersection of models and
topics that do appear in TAR seemingly are borrowed models and uninteresting
topics outside the academic discipline of accounting.
We close with a quotation
from Scott McLemee demonstrating that what happened among accountancy
academics over the past four decades is not unlike what happened in other
academic disciplines that developed “internal dynamics of esoteric
disciplines,” communicating among themselves in loops detached from their
underlying professions. McLemee’s [2006] article stems from Bender [1993].
“Knowledge and competence
increasingly developed out of the internal dynamics of esoteric disciplines
rather than within the context of shared perceptions of public needs,”
writes Bender. “This is not to say that professionalized disciplines or the
modern service professions that imitated them became socially irresponsible.
But their contributions to society began to flow from their own
self-definitions rather than from a reciprocal engagement with general
public discourse.”
Now, there is a definite note of sadness in Bender’s narrative – as there
always tends to be in accounts
of theshift from Gemeinschaftto
Gesellschaft.Yet it is also clear
that the transformation from civic to disciplinary professionalism was
necessary.
“The new disciplines offered relatively precise subject matter and
procedures,” Bender concedes, “at a time when both were greatly confused.
The new professionalism also promised guarantees of competence —
certification — in an era when criteria of intellectual authority were vague
and professional performance was unreliable.”
But in the epilogue to Intellect and Public Life, Bender
suggests that the process eventually went too far. “The risk now is
precisely the opposite,” he writes. “Academe is threatened by the twin
dangers of fossilization and scholasticism (of three types: tedium, high
tech, and radical chic). The agenda for the next decade, at least as I see
it, ought to be the opening up of the disciplines, the ventilating of
professional communities that have come to share too much and that have
become too self-referential.”
For the good of the AAA membership and the profession of accountancy in
general, one hopes that the changes in publication and editorial policies at
TAR proposed by President Rayburn [2005, p. 4] will result in the “opening
up” of topics and research methods produced by “leading scholars.”
The Two Faces of Accountics Scientists Accountics scientists have almost a knee jerk, broken record reaction
when confronted with case method/small sample research as evidenced by
SHAHID ANSARI's review of the following book ---Click Here
ROBERT S. KAPLAN and DAVID P. NORTON
, The Execution Premium: Linking
Strategyto Operations for Competitive Advantage
Boston,
MA: Harvard Business Press, 2008,ISBN 13: 978-1-4221-2116-0, pp. xiii, 320.
If you are an academician who believes in
empirical data and rigorous statistical analysis, you will find very
little of it in this book. Most of the data in this book comes from
Harvard Business School teaching cases or from the consulting practice
of Kaplan and Norton. From an empirical perspective, the flaws in the
data are obvious. The sample is nonscientific; it comes mostly from
opportunistic interventions. It is a bit paradoxical that a book which
is selling a rational-scientific methodology for strategy development
and execution uses cases as opposed to a matched or paired sample
methodology to show that the group with tight linkage between strategy
execution and operational improvement has better results than one that
does not. Even the data for firms that have performed well with a
balanced scorecard and other mechanisms for sound strategy execution
must be taken with a grain of salt.
Bob Jensen has a knee jerk, broken record reaction to accountics
scientists who praise their own "empirical data and rigorous statistical
analysis." My reaction to them is to show me the validation/replication of
their "empirical data and rigorous statistical analysis." that is
replete with missing variables and assumptions of stationarity and
equilibrium conditions that are often dubious at best. Most of their work is
so uninteresting that even they don't bother to validate/replicate each
others' research ---
http://faculty.trinity.edu/rjensen/TheoryTAR.htm
This citation was forwarded by Don Ramsey
"Why business ignores the business schools," by Michael Skapinker,
Financial Times, January 7, 2008
Chief executives, on the other hand, pay little
attention to what business schools do or say. As long ago as 1993, Donald
Hambrick, then president of the US-based Academy of Management, described
the business academics' summer conference as "an incestuous closed loop", at
which professors "come to talk with each other". Not much has changed. In
the current edition of The Academy of Management Journal.
. . .
They have chosen an auspicious occasion on which to
beat themselves up: this year is The Academy of Management Journal's 50th
anniversary. A scroll through the most recent issues demonstrates why
managers may be giving the Journal a miss. "A multi-level investigation of
antecedents and consequences of team member boundary spanning behaviour" is
the title of one article.
Why do business academics write like this? The
academics themselves offer several reasons. First, to win tenure in a US
university, you need to publish in prestigious peer-reviewed journals.
Accessibility is not the key to academic advancement.
Similar pressures apply elsewhere. In France and
Australia, academics receive bonuses for placing articles in the top
academic publications. The UK's Research Assessment Exercise, which
evaluates university research and ties funding to the outcome, encourages
similarly arcane work.
But even without these incentives, many business
school faculty prefer to adorn their work with scholarly tables, statistics
and jargon because it makes them feel like real academics. Within the
university world, business schools suffer from a long-standing inferiority
complex.
The professors offer several remedies. Academic
business journals should accept fact-based articles, without demanding that
they propound a new theory. Professor Hambrick says that academics in other
fields "don't feel the need to sprinkle mentions of theory on every page,
like so much aromatic incense or holy water".
Others talk of the need for academics to spend more
time talking to managers about the kind of research they would find useful.
As well-meaning as these suggestions are, I suspect
the business school academics are missing something. Law, medical and
engineering schools are subject to the same academic pressures as business
schools - to publish in prestigious peer-reviewed journals and to buttress
their work with the expected academic vocabulary.
The schism between academic research and the
business world:
The outside world has little interest in research of the business school
professors
If our research findings were important, there would be more demand for
replication of findings
The
business-school world has been besieged by criticism in the
past few months, with prominent professors and writers
taking bold swipes at management education. Authors such as
management expert Gary Hamel and
Harvard Business School Professor
Rakesh Khurana have published books this fall expressing
skepticism about the direction in which business schools are
headed and the purported value of an MBA degree. The
December/January issue of the Academy of Management
Journal includes a
special section in which 10 scholars question the value of
business-school research.
B-school
deans may soon be able to counter that criticism, following
the launch of an ambitious study that seeks to examine the
overall impact of business schools on society. A new Impact
of Business Schools task force convened by the
Association to Advance Collegiate Schools of Business (AACSB)—the
main organization of business schools—will mull over this
question next year, conducting research that will look at
management education through a variety of lenses, from
examining the link between business schools and economic
growth in the U.S. and other countries, to how management
ideas stemming from business-school research have affected
business practices. Most of the research will be new, though
it will build upon the work of past AACSB studies,
organizers said.
The
committee is being chaired by Robert Sullivan of the
University of California at San Diego's
Rady School of Management, and
includes a number of prominent business-school deans
including Robert Dolan of the University of Michigan's
Stephen M. Ross School of Business,
Linda Livingstone of Pepperdine University's
Graziado School of Business & Management, and
AACSB Chair Judy Olian, who is also the dean of UCLA's
Anderson School of Management.
Representatives from Google (GOOG)
and the Educational Testing Service will also participate.
The committee, which was formed this summer, expects to have
the report ready by January, 2009.
BusinessWeek.com reporter
Alison Damast recently spoke with Olian about the committee
and the potential impact of its findings on the
business-school community.
There has been a rising tide of
criticism against business schools recently, some of it from
within the B-school world. For example, Professor Rakesh
Khurana implied in his book
From Higher Aims to Hired Hands
(BusinessWeek.com, 11/5/07) that
management education needs to reinvent itself. Did this have
any effect on the AACSB's decision to create the Impact of
Business Schools committee?
I think that
is probably somewhere in the background, but I certainly
don't view that as in any way the primary driver or
particularly relevant to what we are thinking about here.
What we are looking at is a variety of ways of commenting on
what the impact of business schools is. The fact is, it
hasn't been documented and as a field we haven't really
asked those questions and we need to. I don't think a study
like this has ever been done before.
As a doctoral student at Yale University's
psychology department, George E. Newman became increasingly interested
in applying theories he studied to people's business decisions.
He began exploring, for instance, why people
prefer buying original pieces of artwork over perfect duplicates and why
they're willing to pay a lot for celebrity possessions.
"What we found is that a lot of those decisions
have to do, importantly, with psychological essentialism," he said.
"People believe the objects contain some essence of their previous
owners or manufacturers."
Wanting to further pursue such application of
his psychology training, Mr. Newman accepted a postdoctoral appointment
at Yale's School of Management, and last year became an assistant
professor there.
The career path he has followed, as a social
scientist moving to a top-tier business school, is becoming relatively
common, particularly for Ph.D.'s in psychology, economics, and
sociology. As those institutions have sought to bolster and broaden
their research, they've been looking to hire faculty with strong
scholarship in disciplines outside of business. The prospect of teaching
and researching at a business school can be alluring to scholars, too.
And a rough academic job market in the social sciences has also helped
push people with Ph.D.'s in that direction.
Focus on
Research
Adam D. Galinsky, professor of ethics and
decision in management at the Kellogg School of Management at
Northwestern University, was trained as a social psychologist. Mr.
Galinsky, who was hired by Kellogg more than a decade ago, says he was
among the first wave of social scientists to join the faculties of
top-tier business schools. The push to hire more psychologists and
sociologists, he says, was motivated by the institutions' desire to
improve the research they produced.
"There was a sense that the quality of research
in business schools was inadequate," he says. "The idea was to hire
strong discipline-based people and bring them into the business schools
with their strong foundation of research skills."
That trend may have started to slow recently,
Mr. Galinsky says, in part because of the improved training that
business schools can now offer because they have hired social
scientists. As a result, business-school graduates are more competitive
when they apply for faculty positions at business-schools that trained
psychologists and other social scientists are also seeking.
Many social scientists are attracted to
business schools because they provide an opportunity to approach fields
of study from more applied and interdisciplinary perspectives.
Victoria L. Brescoll, who completed her Ph.D.
and held a postdoctoral appointment at Yale's psychology department, is
an assistant professor of organizational behavior at Yale's School of
Management. She says that moving from a psychology department to a
business school was something she had always thought of doing, because
her research on how people are perceived at work is at the intersection
of various disciplines, including social psychology, women studies,
communications, and organizational studies.
"The distinctions between disciplines can be
somewhat artificial," she says. "Part of why I like being in the
business school is that I can do that kind of interdisciplinary work."
Ms. Brescoll says she enjoys the challenge of
considering an economic or business perspective to her work.
"You have to rethink what high-quality evidence
is because you have to think about it from the perspective of someone
from a totally different discipline," she says. "Things you might have
taken for granted, you just can't."
Job-Market
Pressures
For some Ph.D. candidates, the tight academic
job market can be an incentive to explore faculty positions at a
business school.
After completing his doctoral degree in social
psychology at Princeton University in 1999, Mr. Galinsky says he applied
to 50 psychology departments and three business schools. He barely
received any responses from the psychology departments but heard back
from two of the business schools. He accepted a postdoctoral appointment
at Kellogg. "It was a path that was chosen for me," he says.
"For a lot of people interested in social
psychology, there are just not a lot of jobs in that field in general,"
says Mr. Newman, the Yale professor who studies decision-making.
Moving from psychology to business is "not an
expected path at this point, but it is a common path," says Elanor F.
Williams, who completed her Ph.D. in social psychology at Cornell
University in 2008 and then accepted a postdoctoral appointment at the
University of Florida's Warrington College of Business. Her research
focuses on how people think in a social or realized context.
Though she applied to some psychology
departments, Ms. Williams says she focused her job search heavily on
postdoctoral positions at business schools because of the transition
they can offer. In her case, her postdoctoral appointment at Florida
even paid for her to participate in an eight-week program to train
nonbusiness Ph.D.'s to teach in business schools. The Post-Doctoral
Bridge to Business Program was started in 2007 by the Association to
Advance Collegiate Schools of Business, an accrediting agency, as
business schools faced a shortage of qualified professors to teach
growing numbers of students.
My good friend Jason Xiao
[xiao@Cardiff.ac.uk] pointed out that the Academy of Management
Review (AMR) is a theory journal and the Academy of Management Journal
(AMJ) is the empirical-article Academy of Management.
He’s correct, and I would like to now point out a more technical
distinction. The Dialogue section of the AMR invites reader comments
challenging validity of assumptions in theory and, where applicable, the
assumptions of an analytics paper. The AMJ takes a slightly different tack
for challenging validity in what is called an “Editors’ Forum,” examples of
which are listed in the index at
http://journals.aomonline.org/amj/amj_index_2007.pdf
One index had some academic vs. practice Editors' Forum articles that
especially caught my eye as it might be extrapolated to the schism between
academic accounting research versus practitioner needs for applied research:
Bartunek, Jean M. Editors’ forum (AMJ turns 50! Looking back and
looking ahead)—Academic-practitioner collaboration need not require
joint or relevant research: Toward a relational
Cohen, Debra J. Editors’ forum (Research-practice gap in human
resource management)—The very separate worlds of academic and
practitioner publications in human resource management: Reasons for the
divide and concrete solutions for bridging the gap. 50(5): 1013–10
Guest, David E. Editors’ forum (Research-practice gap in human
resource management)—Don’t shoot the messenger: A wake-up call for
academics. 50(5): 1020–1026.
Hambrick, Donald C. Editors’ forum (AMJ turns 50! Looking back and
looking ahead)—The field of management’s devotion to theory: Too much of
a good thing? 50(6): 1346–1352.
Latham, Gary P. Editors’ forum (Research-practice gap in human
resource management)—A speculative perspective on the transfer of
behavioral science findings to the workplace: “The times they are a-changin’.”
50(5): 1027–1032.
Lawler, Edward E, III. Editors’ forum (Research-practice gap in human
resource management)—Why HR practices are not evidence-based. 50(5):
1033–1036.
Markides, Costas. Editors’ forum (Research with relevance to
practice)—In search of ambidextrous professors. 50(4): 762–768.
McGahan, Anita M. Editors’ forum (Research with relevance to
practice)—Academic research that matters to managers: On zebras, dogs,
lemmings,
Rousseau, Denise M. Editors’ forum (Research-practice gap in human
resource management)—A sticky, leveraging, and scalable strategy for
high-quality connections between organizational practice and science.
50(5): 1037–1042.
Rynes, Sara L. Editors’ forum (Research with relevance to
practice)—Editor’s foreword—Carrying Sumantra Ghoshal’s torch: Creating
more positive, relevant, and ecologically valid research. 50(4):
745–747.
Rynes, Sara L. Editors’ forum (Research-practice gap in human
resource management)—Editor’s afterword— Let’s create a tipping point:
What academics and practitioners can do, alone and together. 50(5):
1046–1054.
Rynes, Sara L., Tamara L. Giluk, and Kenneth G. Brown. Editors’ forum
(Research-practice gap in human resource management)—The very separate
worlds of academic and practitioner periodicals in human resource
management: Implications
It happened to Archimedes in the bath. To Descartes
it took place in bed while watching flies on his ceiling. And to Newton it
occurred in an orchard, when he saw an apple fall. Each had a moment of
insight. To Archimedes came a way to calculate density and volume; to
Descartes, the idea of coordinate geometry; and to Newton, the law of
universal gravity.
Five light-bulb moments of understanding that
revolutionized science.
In our fables of science and discovery, the crucial
role of insight is a cherished theme. To these epiphanies, we owe the
concept of alternating electrical current, the discovery of penicillin, and
on a less lofty note, the invention of Post-its, ice-cream cones, and
Velcro. The burst of mental clarity can be so powerful that, as legend would
have it, Archimedes jumped out of his tub and ran naked through the streets,
shouting to his startled neighbors: "Eureka! I've got it."
In today's innovation economy, engineers,
economists and policy makers are eager to foster creative thinking among
knowledge workers. Until recently, these sorts of revelations were too
elusive for serious scientific study. Scholars suspect the story of
Archimedes isn't even entirely true. Lately, though, researchers have been
able to document the brain's behavior during Eureka moments by recording
brain-wave patterns and imaging the neural circuits that become active as
volunteers struggle to solve anagrams, riddles and other brain teasers.
Following the brain as it rises to a mental
challenge, scientists are seeking their own insights into these light-bulb
flashes of understanding, but they are as hard to define clinically as they
are to study in a lab.
To be sure, we've all had our "Aha" moments. They
materialize without warning, often through an unconscious shift in mental
perspective that can abruptly alter how we perceive a problem. "An 'aha'
moment is any sudden comprehension that allows you to see something in a
different light," says psychologist John Kounios at Drexel University in
Philadelphia. "It could be the solution to a problem; it could be getting a
joke; or suddenly recognizing a face. It could be realizing that a friend of
yours is not really a friend."
These sudden insights, they found, are the
culmination of an intense and complex series of brain states that require
more neural resources than methodical reasoning. People who solve problems
through insight generate different patterns of brain waves than those who
solve problems analytically. "Your brain is really working quite hard before
this moment of insight," says psychologist Mark Wheeler at the University of
Pittsburgh. "There is a lot going on behind the scenes."
In fact, our brain may be most actively engaged
when our mind is wandering and we've actually lost track of our thoughts, a
new brain-scanning study suggests. "Solving a problem with insight is
fundamentally different from solving a problem analytically," Dr. Kounios
says. "There really are different brain mechanisms involved."
By most measures, we spend about a third of our
time daydreaming, yet our brain is unusually active during these seemingly
idle moments. Left to its own devices, our brain activates several areas
associated with complex problem solving, which researchers had previously
assumed were dormant during daydreams. Moreover, it appears to be the only
time these areas work in unison.
"People assumed that when your mind wandered it was
empty," says cognitive neuroscientist Kalina Christoff at the University of
British Columbia in Vancouver, who reported the findings last month in the
Proceedings of the National Academy of Sciences. As measured by brain
activity, however, "mind wandering is a much more active state than we ever
imagined, much more active than during reasoning with a complex problem."
She suspects that the flypaper of an unfocused mind
may trap new ideas and unexpected associations more effectively than
methodical reasoning. That may create the mental framework for new ideas.
"You can see regions of these networks becoming active just prior to people
arriving at an insight," she says.
In a series of experiments over the past five
years, Dr. Kounios and his collaborator Mark Jung-Beeman at Northwestern
University used brain scanners and EEG sensors to study insights taking form
below the surface of self-awareness. They recorded the neural activity of
volunteers wrestling with word puzzles and scanned their brains as they
sought solutions.
Some volunteers found answers by methodically
working through the possibilities. Some were stumped. For others, even
though the solution seemed to come out of nowhere, they had no doubt it was
correct.
In those cases, the EEG recordings revealed a
distinctive flash of gamma waves emanating from the brain's right
hemisphere, which is involved in handling associations and assembling
elements of a problem. The brain broadcast that signal one-third of a second
before a volunteer experienced their conscious moment of insight -- an
eternity at the speed of thought.
The scientists may have recorded the first
snapshots of a Eureka moment. "It almost certainly reflects the popping into
awareness of a solution," says Dr. Kounios.
In addition, they found that tell-tale burst of
gamma waves was almost always preceded by a change in alpha brain-wave
intensity in the visual cortex, which controls what we see. They took it as
evidence that the brain was dampening the neurons there similar to the way
we consciously close our eyes to concentrate.
"You want to quiet the noise in your head to
solidify that fragile germ of an idea," says Dr. Jung-Beeman at
Northwestern.
At the University of London's Goldsmith College,
psychologist Joydeep Bhattacharya also has been probing for insight moments
by peppering people with verbal puzzles.
Continued in article
Jensen Comment
I'm having a hard time finding a worthy "aha" moment in accountancy. It
certainly would not be Pacioli's double entry contribution since double entry
accounting is thought to have been used for over 1,000 years before Pacioli.
There have been aha moments in the invention of derivative contracts, but none
of them to my knowledge are attributable to accountants. There have been some
seminal accounting ideas such as ABC costing, but I think a team of people at
Deere is credited for ABC Costing.
-----Original
Message-----
From: Dale Flesher University of Mississippi
[mailto:actonya@HOTMAIL.COM]
Sent: Friday, January 25, 2002 1:35 PM
To:
AECM@LISTSERV.LOYOLA.EDU
Subject: Re: The Only Invention of Academic Accountants
Contrary to a
recent statement in this forum, Dollar-Value Lifo (DVL) was not developed by
a professor. The father of DVL was Herbert T. McAnly, who retired in 1964 as
a partner at Ernst & Ernst after 44 years with the firm. Throughout his
career, McAnly was known as "Mr. LIFO."
Although he did not
develop LIFO, which had been around for decades in the form of the
base-stock method, he did develop DVL after the Internal Revenue began
accepting LIFO from all types of companies. The Treasury would probably
never have agreed to allow all companies to use LIFO (in 1939) had they been
able to prognosticate McAnly's idea. He first described the concept in an
address delivered at the Accounting Clinic and the Central States Accounting
Conference in Chicago in May 1941. His concept was finally accepted by the
IRS following the Hutzler Brothers Co. case in 1947 (8 TC 14 (1947)). He
later worked with the Treasury Department trying to get more practical
regulations relating to LIFO.
Dale L. Flesher
Professor of Accountancy University of Mississippi
Some Ideas for Applied
Research of Interest to Practitioners
“Research should be problem driven rather than
methodologically driven," said Lisa Garcia Bedolla, a member of the task force
who teaches at the University of California at Berkeley. Scott Jascik ---
http://www.insidehighered.com/news/2009/09/04/polisci
Although I will not dwell on details here,
practitioners are generally interested in clever discoveries of how to make
computer software, XBRL, Google Wave, cloud computing, computer gadgets, cloud computing, pattern recognition,
data visualization, and many other technology innovations relative to the
practice of accountancy. For example, I've attempted (thus far unsuccessfully)
to discover useful ways of visualizing multi-dimensional accounting variables
(including Chernoff faces) ---
http://faculty.trinity.edu/rjensen/352wpvisual/000datavisualization.htm
Alas, I'm a failure as an applied researcher thus far in life. My leading journal publications, like
other leading accounting research publications, have mostly been irrelevant "accountics" contributions ---
http://faculty.trinity.edu/rjensen/resume.htm#Published
In addition to
Bob, four AECMers have responded so far to my 10 September invitation to
share your suggestions of the most important research questions in financial
accounting. I’ve copied and pasted below. I hope the format comes through
ok in your e-mail reader as there are some indented explanatory items under
some of the questions. Will keep the light on for you in case you think of
some others.
The county-by-country
differences/similarities in reporting under IFRS. In other words, does a
company in country A apply IFRS differently from a company in country B?
*Do investors in country A interpret IFRS disclosures from country A any
differently than investors in country B.
*Does the existence of American GAAP truly cause executives in various
companies to non-comply? Would better disclosure result if there were few or no
standards?
*Does AACSB accreditation improve the
state of business education in the U.S.? [Not exactly financial reporting, but
we’re not picky here on AECM. –Ed]
*Do adequate disclosure thresholds
vary between historical cost and other accounting systems?
*What is the
extent that fair value information on statements is relevant to investors?
Accounting reflects the economics of the firm. Over time the economy has shifted
to more service-oriented than goods-oriented. The economic change makes the
revenue issue difficult because firms sell goods and services in packages.
*How is revenue
measured and is the disclosure relevant to investors (especially in the context
of fair value balance sheet information)? This question has a normative and an
empirical aspect as follows:
Normative
In ideal normative
terms, revenue should be measured to "best" represent the economic activity of
the firm. With regards to fair value, should revenue be the "change" of fair
value of the goods or services given or consideration received over the time
period in question. Contrast this approach with the current GAAP which makes a
statement of revenue as 1) the completion of the contract and 2) the receipt of
cash or assurance thereof. Thus, the characterization/disclosure of fair value
information is an issue because the accounting source data has become "fair
value" replacing "historical cost".
Empirical
In empirical
terms, the question is: What do investors think of financial accounting
information ... or in practical terms: What is the market statistical
significance of revenue information? The policy implications can be phrased as:
Given statistical information of alternative revenue information disclosures ...
make an inference about: What is the most highly significant choice of revenue
(formulation and disclosure)?
How can we develop
CONVINCING evidence regarding the relative usefulness of each accounting
alternative for each type of decision in each of a variety of broadly defined
circumstances?
Accounting
standards and the resulting accepted methods have been based on what amounts to
carefully developed theory as to what measures and related information would
result in decision makers making the "best" decision, where "best" means the
highest possible level of goal attainment is actually achieved as a result of
the decision.
The medical profession operated this way until about 800 years ago, but then
began to develop evidence regarding the results actually obtained from different
treatments.
Although business decision-making is certainly less tangible (and perhaps more
complex)than medicine, psychology and psychiatry have shown that it is possible
to develop scientific evidence regarding the relative usefulness of various
treatments in specified circumstances.
It won't be easy, particularly because of the enormous number of alternative
situations (at the time of the decision and in the interval until the result of
the decision is known)but we should get started ASAP. If we don't, all
accounting standards and methods will continue to be regarded (rightly) as mere
theories unsupported by convincing evidence.
Fair value presents our profession with an important issue which I believe is
suitable for this approach.
[Also Bob has
some ideas at the link he stated in his message below.]
Ed Scribner
New Mexico State University
Las Cruces, NM, USA
From:
AECM, Accounting Education using Computers and Multimedia [mailto:AECM@LISTSERV.LOYOLA.EDU]
On Behalf Of Jensen, Robert Sent: Thursday, September 10, 2009 3:14 PM To: AECM@LISTSERV.LOYOLA.EDU Subject: Re: Econometric methods (accountics?)
Hi Ed,
What a super
idea. I suspect that you have in mind those research items where
creative solutions will be praised by educators and/or practitioners.
In the past
20 years we’ve had the American Accounting Association Innovation in
Accounting Research Award that’s largely been ignored by both accounting
teachers and practitioners. Off the top of your head can you name more
than two of the winners (and their innovations) in the last two decades?
With a rare exception or two, this award has gone to accountics research
papers that are largely ignored by accounting teachers and
practitioners.
But I hope
all subscribers to the AECM will now give thought to your suggestion.
One approach for openers is to read the conclusion sections of
publications in both academic journals and practioner journals in search
of suggestions for future research.
And there are
some really, really important research problems such as how governmental
accounting tends to now be done with smoke and mirrors.
Robert E.
(Bob) Jensen
Trinity
University Accounting Professor (Emeritus)
190 Sunset Hill Road
Sugar Hill,
NH 03586
Tel. 603-823-8482
www.trinity.edu/rjensen
From:
AECM, Accounting Education using Computers and Multimedia [mailto:AECM@LISTSERV.LOYOLA.EDU]
On Behalf Of Ed Scribner Sent: Thursday, September 10, 2009 2:38 PM To: AECM@LISTSERV.LOYOLA.EDU Subject: Re: Econometric methods (accountics?)
Pat Walters
wrote:
I don't see the problem raised by Ron as one
related to the methodology used for the research. Rather my observation
is a lack of experience about the issues that cause us to want/need some
research in the first place. . . . ++++++++++++++++
I’d be interested
in what AECMers believe are
the most important research questions in financial accounting today. If all
would like to reply directly (escribne@nmsu.edu)
in
roughly the succinct form offered below, I’d be happy to copy and paste and
remove identifying info and send the resulting compilation to AECM.
If this turns out
to be interesting, we could do it for systems, auditing, managerial, etc.
(Bob might even decide to …er…REPLICATE this on CPAS-L to see what the
practitioners think. Hang on to your hats. If there’s ever a Nobel Prize
in Accounting, AECM will receive it as a group.)
Proposed format:
I believe the
most important research questions in financial accounting today are (in no
particular order, one item alone is fine):
1.
2.
Etc.
Succinctness will
be appreciated, and this may take a while anyway, since I’ll be on the road
the next ten days (son getting married in Rome, so I’ll be doing as the
Romans do, which doesn’t, for most Romans, include posting to AECM).
Ed Scribner
New Mexico State University
Las Cruces, USA
AACSB chair Judy Olian (dean, UCLA school of biz)
is quoted as saying that 39% of Fortune 500 CEOs are graduates of a
business school.
I am surprised that this is such a low number. Why
shouldn't this number be very much higher? Given that corporations are run
by professional managers, why wouldn't the college degree that prepares
professional managers show up with greater frequency in the profile of the
top professional managers?
I don't know how it is possible for this group of
deans to design a research study to show the relevance of business school
education. Well, I don't know how it would be possible for anyone to design
it. Isn't relevance a judgment call?
David Albrecht
January 2, 2008 reply from Bob Jensen
Hi David,
CEOs rise up from many walks of life, especially engineering, economics,
law, and the specialties of an industry such as chemistry, medicine,
agriculture, etc. CFOs and CAOs are another matter entirely.
As far as research impacts are determined, subjective judgment is
certainly a huge factor but there are other indicators. Can executives
recall a single article published in The Accounting Review or other leading
academic accounting journal upon which academic reputations are built? Can
executives name one author who received the AAA Seminal Contributions Award
or any other academic award of major academic associations?
One indicator in accounting is practitioner membership in the American
Accounting Association. The AAA started out as primarily an association for
accounting practitioners and teachers of accounting. For four decades
practitioners were heavily involved in the AAA and the longest-running
editor of The Accounting Review was a practitioner (Kohler) ---
http://snipurl.com/aohkohler
All this changed with what Jean Heck and I call the "perfect storm" of
the 1960s. Since then, practitioner membership steadily declined in the AAA
and readership of academic accounting research journals plummeted to
virtually zero. Practitioners still send us their money and their
recruiters, but leading academic researchers like Joel Demski warn against
accounting researchers catching a "vocational virus" and cringe at aiming
our research talent toward practical problems of the profession for which we
seemingly have no comparative advantage due to our rather useless accountics
skills.
The schism is probably greatest in accounting and the smallest in finance
where there practitioners have relied more on research findings and fads in
economics and finance journals.
Some universities are more focused on industry than others. Harvard
certainly has tried very hard in this regard, but Harvard's case method
research just cannot pass the hurdles of the journal referees of our leading
accounting research journals.
And even accounting academics are bored with the (yawn) articles
appearing in our academic research journals. Ron Dye is probably one of our
most esoteric accountics researchers (his degrees are in mathematics and
economics even though he's an "accounting professor"). Ron stated the
following at
http://faculty.trinity.edu/rjensen/Theory01.htm#AcademicsVersusProfession
Begin Quote from Ron Dye***************
About the question: by and large, I think it is
a mistake for someone interested in pursuing an academic career in
accounting not to get a phd in accounting. If you look at the "success"
stories, there aren't many: most of the people who make a post-phd
transition fail. I think that happens for a couple reasons. 1. I think
some of the people that transfer late do it for the money, and aren't
really all that interested in accounting. While the $ are nice, it is
impossible to think about $ when you are trying to come up with an idea,
and anyway, you're unlikely to come up with an idea unless you're really
interested in the subject. 2. I think, almost independent of the field,
unless you get involved in the field at an early age, for some reason it
becomes very hard to develop good intuition for the area - which is a
second reason good problems are often not generated by "crossovers."
The bigger thing - not related to the question
you raise - but maybe you could add to the discussion is that there are,
as far as I can tell, not a lot of new ideas being put forth by anyone
in accounting nowadays (with the possible exception of John Dickhaut's
neuro stuff). In most fields, the youngsters are supposed to come up
with the new problems, techniques, etc., but I see a lot more mimicry
than innovation among newly minted phds now.
Anyway, for what it's worth....
Ron
End Quote from Ron Dye****************
_________________
Perhaps the AACSB can make some progress toward bridging the schism. But
I leave you with a forthcoming quote in the January 6 edition of Tidbits:
Question "How many professors does it take to change a light bulb?"
Answer "Whadaya mean, "change"?" Bob Zemsky, Chronicle of Higher
Education's Chronicle Review, December 2007
The Two Faces of Accountics Scientists Accountics scientists have almost a knee jerk, broken-record reaction
when confronted with case method/small sample research as evidenced by
SHAHID ANSARI's review of the following book ---Click Here
ROBERT S. KAPLAN and DAVID P. NORTON
, The Execution Premium: Linking
Strategyto Operations for Competitive Advantage
Boston,
MA: Harvard Business Press, 2008,ISBN 13: 978-1-4221-2116-0, pp. xiii, 320.
If you are an academician who believes in
empirical data and rigorous statistical analysis, you will find very
little of it in this book. Most of the data in this book comes from
Harvard Business School teaching cases or from the consulting practice
of Kaplan and Norton. From an empirical perspective, the flaws in the
data are obvious. The sample is nonscientific; it comes mostly from
opportunistic interventions. It is a bit paradoxical that a book which
is selling a rational-scientific methodology for strategy development
and execution uses cases as opposed to a matched or paired sample
methodology to show that the group with tight linkage between strategy
execution and operational improvement has better results than one that
does not. Even the data for firms that have performed well with a
balanced scorecard and other mechanisms for sound strategy execution
must be taken with a grain of salt.
Bob Jensen has a knee jerk, broken record reaction to accountics
scientists who praise their own "empirical data and rigorous statistical
analysis." My reaction to them is to show me the validation/replication of
their "empirical data and rigorous statistical analysis." that is
replete with missing variables and assumptions of stationarity and
equilibrium conditions that are often dubious at best. Most of their work is
so uninteresting that even they don't bother to validate/replicate each
others' research ---
http://faculty.trinity.edu/rjensen/TheoryTAR.htm
Question
What are some "aha" moments in the history of accounting that are attributed to
one person's original/seminal idea?
It happened to Archimedes in the bath. To Descartes
it took place in bed while watching flies on his ceiling. And to Newton it
occurred in an orchard, when he saw an apple fall. Each had a moment of
insight. To Archimedes came a way to calculate density and volume; to
Descartes, the idea of coordinate geometry; and to Newton, the law of
universal gravity.
Five light-bulb moments of understanding that
revolutionized science.
In our fables of science and discovery, the crucial
role of insight is a cherished theme. To these epiphanies, we owe the
concept of alternating electrical current, the discovery of penicillin, and
on a less lofty note, the invention of Post-its, ice-cream cones, and
Velcro. The burst of mental clarity can be so powerful that, as legend would
have it, Archimedes jumped out of his tub and ran naked through the streets,
shouting to his startled neighbors: "Eureka! I've got it."
In today's innovation economy, engineers,
economists and policy makers are eager to foster creative thinking among
knowledge workers. Until recently, these sorts of revelations were too
elusive for serious scientific study. Scholars suspect the story of
Archimedes isn't even entirely true. Lately, though, researchers have been
able to document the brain's behavior during Eureka moments by recording
brain-wave patterns and imaging the neural circuits that become active as
volunteers struggle to solve anagrams, riddles and other brain teasers.
Following the brain as it rises to a mental
challenge, scientists are seeking their own insights into these light-bulb
flashes of understanding, but they are as hard to define clinically as they
are to study in a lab.
To be sure, we've all had our "Aha" moments. They
materialize without warning, often through an unconscious shift in mental
perspective that can abruptly alter how we perceive a problem. "An 'aha'
moment is any sudden comprehension that allows you to see something in a
different light," says psychologist John Kounios at Drexel University in
Philadelphia. "It could be the solution to a problem; it could be getting a
joke; or suddenly recognizing a face. It could be realizing that a friend of
yours is not really a friend."
These sudden insights, they found, are the
culmination of an intense and complex series of brain states that require
more neural resources than methodical reasoning. People who solve problems
through insight generate different patterns of brain waves than those who
solve problems analytically. "Your brain is really working quite hard before
this moment of insight," says psychologist Mark Wheeler at the University of
Pittsburgh. "There is a lot going on behind the scenes."
In fact, our brain may be most actively engaged
when our mind is wandering and we've actually lost track of our thoughts, a
new brain-scanning study suggests. "Solving a problem with insight is
fundamentally different from solving a problem analytically," Dr. Kounios
says. "There really are different brain mechanisms involved."
By most measures, we spend about a third of our
time daydreaming, yet our brain is unusually active during these seemingly
idle moments. Left to its own devices, our brain activates several areas
associated with complex problem solving, which researchers had previously
assumed were dormant during daydreams. Moreover, it appears to be the only
time these areas work in unison.
"People assumed that when your mind wandered it was
empty," says cognitive neuroscientist Kalina Christoff at the University of
British Columbia in Vancouver, who reported the findings last month in the
Proceedings of the National Academy of Sciences. As measured by brain
activity, however, "mind wandering is a much more active state than we ever
imagined, much more active than during reasoning with a complex problem."
She suspects that the flypaper of an unfocused mind
may trap new ideas and unexpected associations more effectively than
methodical reasoning. That may create the mental framework for new ideas.
"You can see regions of these networks becoming active just prior to people
arriving at an insight," she says.
In a series of experiments over the past five
years, Dr. Kounios and his collaborator Mark Jung-Beeman at Northwestern
University used brain scanners and EEG sensors to study insights taking form
below the surface of self-awareness. They recorded the neural activity of
volunteers wrestling with word puzzles and scanned their brains as they
sought solutions.
Some volunteers found answers by methodically
working through the possibilities. Some were stumped. For others, even
though the solution seemed to come out of nowhere, they had no doubt it was
correct.
In those cases, the EEG recordings revealed a
distinctive flash of gamma waves emanating from the brain's right
hemisphere, which is involved in handling associations and assembling
elements of a problem. The brain broadcast that signal one-third of a second
before a volunteer experienced their conscious moment of insight -- an
eternity at the speed of thought.
The scientists may have recorded the first
snapshots of a Eureka moment. "It almost certainly reflects the popping into
awareness of a solution," says Dr. Kounios.
In addition, they found that tell-tale burst of
gamma waves was almost always preceded by a change in alpha brain-wave
intensity in the visual cortex, which controls what we see. They took it as
evidence that the brain was dampening the neurons there similar to the way
we consciously close our eyes to concentrate.
"You want to quiet the noise in your head to
solidify that fragile germ of an idea," says Dr. Jung-Beeman at
Northwestern.
At the University of London's Goldsmith College,
psychologist Joydeep Bhattacharya also has been probing for insight moments
by peppering people with verbal puzzles.
Continued in article
Jensen Comment
I'm having a hard time finding a worthy "aha" moment in accountancy. It
certainly would not be Pacioli's double entry contribution since double entry
accounting is thought to have been used for over 1,000 years before Pacioli.
There have been aha moments in the invention of derivative contracts, but none
of them to my knowledge are attributable to accountants. There have been some
seminal accounting ideas such as ABC costing, but I think a team of people at
Deere is credited for ABC Costing.
-----Original
Message-----
From: Dale Flesher University of Mississippi
[mailto:actonya@HOTMAIL.COM]
Sent: Friday, January 25, 2002 1:35 PM
To:
AECM@LISTSERV.LOYOLA.EDU
Subject: Re: The Only Invention of Academic Accountants
Contrary to a
recent statement in this forum, Dollar-Value Lifo (DVL) was not developed by
a professor. The father of DVL was Herbert T. McAnly, who retired in 1964 as
a partner at Ernst & Ernst after 44 years with the firm. Throughout his
career, McAnly was known as "Mr. LIFO."
Although he did not
develop LIFO, which had been around for decades in the form of the
base-stock method, he did develop DVL after the Internal Revenue began
accepting LIFO from all types of companies. The Treasury would probably
never have agreed to allow all companies to use LIFO (in 1939) had they been
able to prognosticate McAnly's idea. He first described the concept in an
address delivered at the Accounting Clinic and the Central States Accounting
Conference in Chicago in May 1941. His concept was finally accepted by the
IRS following the Hutzler Brothers Co. case in 1947 (8 TC 14 (1947)). He
later worked with the Treasury Department trying to get more practical
regulations relating to LIFO.
Dale L. Flesher
Professor of Accountancy University of Mississippi
It is very difficult to find academic research in accounting that benefits
practice professionals
Here's an exception from Professors Chuck Mulford and Gene Comiskey
from Georgia Tech
"Cash Flow: a Better Way to Know Your Bank?A study of commercial
banks comes up with ways accounting for operating cash flow could be improved,"
by Sarah Johnson, CFO.com, July 9, 2009 ---
http://www.cfo.com/article.cfm/13981499/c_2984368/?f=archives
If banks more consistently accounted for their
operating cash flow, companies could gain a better grasp of their commercial
banks' financial health, two professors suggest in a report to be released
later this week.
The results would be astoundingly different than
what financial institutions' statements of cash flows tell us today. In the
course of an attempt to make the firms' cash-flow reports more comparable -
which entailed several adjustments to how banks classified their
investments, accounted for non-cash transfers of their loans, and recorded
cash flow from acquisitions last year - the researchers saw huge swings,
both downward (Bank of America) and upward (KeyCorp).
As it stands now, banks can't be reliably compared
to each other by their recorded cash flow from operations, the researchers
contend. Their observations stem from their study of the cash-flow reports
of 15 of the largest independent and publicly traded U.S. commercial banks
in terms of total assets as of December 31, 2008. "Right now, operating cash
flow for a bank is basically meaningless," says Charles Mulford, director of
the Georgia Tech Financial Analysis Lab, who co-wrote the study with fellow
accounting professor Eugene Comiskey.
In BofA's case, the bank reported operating cash
flow for 2008 of $4 billion. But under the researchers' method, the firm
would have had an operating cash flow of negative $6.9 billion. Other
financial institutions that saw a decline under the researchers'
calculations: J.P. Morgan Chase and Wells Fargo.
Some firms went the other way. These included
Citigroup, Fifth Third Bancorp, PNC Financial, and SunTrust Banks. KeyCorp,
which had reported $220 million in negative operating cash flow last year,
could have had a positive $3 billion result if it hadn't moved some loans
out of the held-for-sale classification to the held-for-investment category.
To be sure, the banks that would have had better
results may have been more concerned with the end product of other financial
metrics and made changes to its investment portfolio for the benefit of its
earnings results, rather than worrying about its operating cash flow,
according to Mulford. After all, he noted, operating cash flow a figure
largely ignored by analysts when it comes to banks.
Moreover, the researchers aren't accusing the banks
of doing anything wrong, since current accounting rules allow them to freely
make non-cash transfers between investment classifications, a move which can
have varying effects on how loans and securities are accounted for in
cash-flow statements. Most likely, Mulford says, the firms that make these
reclassifications are doing so for the good of their overall investment
portfolio, which in turn could help their earnings in the near term.
Banks' cash-flow reports differ among each other in
other ways as well. They vary in how they designate their various cash flows
as being from operating, investing, or financing activities. Perhaps, the
researchers imply, those concerned with banks' financial stability should
demand that more attention is paid to the cash-flow statement to get the
banks to be more consistent - and to give their investors incentive to give
their cash reports as much credence as they would those of non-financial
firms.
"For companies in general, cash flow is their
lifeblood," Mulford says. "Are they creating cash or consuming it? If
they're consuming it, then they have to find it somewhere, and may have to
rely on the capital markets, which aren't at a very friendly time right
now."
However, with banks, the cash-flow metric is
overlooked, Mulford contends. The researchers don't offer a solution or take
a stance, but rather ask that their research be used by standard-setters and
analysts to push for change. "Obviously something is wrong with [the
structure of] cash-flow statements when nobody uses it for a particular
group," Mulford says, calling his report an "open invitation" to the
Financial Accounting Standards Board.
"We wrote the study in the interest of building
dialogue and possibly improving upon the usefulness of cash flow for
commercial banks," Mulford says.
The researchers question the usefulness of the
current characterization of increases and decreases in deposits as financing
cash flow. Instead, they believe customer-driven deposits should be
accounted for under operating cash flow since "the very health of a bank's
operations depend on its deposit base and its ability to attract a growing
stream of deposits." The researchers admit their report's final calculations
are not fully accurate, partly because they didn't have enough information
to distinguish between brokered and consumer-driven deposits.
Stressing that they're mainly trying to stir up
public discussion about the problems in the financial reporting of banks'
operating cash flow, the researchers acknowledge that reports' conclusions
are far from perfect. After all, the researchers' adjusted numbers give
troubled Citigroup a relatively rosy picture of $159.4 billion in adjusted
operating cash flow - compared, for example, to a negative $94.3 billion for
J.P. Morgan.
From The Wall Street Journal Accounting Weekly Review on July 10, 2009
SUMMARY: Analysts
are looking for strong earnings results from tech sector companies to
support expectations that have led to stock market gains in this sector this
year in stark contrast to losses for industrial companies. Analysts hold the
same expectations for the entire year also for tech, telecom, and consumer
discretionary company stocks. Tech stocks such as Intel Corp. and Cisco
Systems are considered to be leading indicators of economic improvement
because "they often get orders early in an economic recovery...as companies
try to anticipate an upswing in demand."
CLASSROOM APPLICATION: This
article can be used in any financial accounting class from introductory
level and up to introduce analysts' use of accounting information and its
qualitative characteristics. Questions are oriented towards introducing the
usefulness of accounting information for predictive and (feedback)
confirmatory values.
QUESTIONS:
1. (Introductory)
Why are technology stocks performing better this year than industrial and
other companies, even when their earnings are expected to be lower in the
second quarter of 2009 than in the second quarter of 2008?
2. (Introductory)
Who are the analysts producing forecasts of earnings discussed in this
article?
3. (Introductory)
Explain the information given in the chart "Lowering Expectations". What is
being compared in the two bars placed next to one another? What are
consensus forecasts?
4. (Advanced)
Define the qualitative characteristics of predictive value and feedback
value of accounting information. In what authoritative standard are these
characteristics defined?
5. (Advanced)
How does analysts' use of accounting information demonstrate the predictive
value of accounting information?
6. (Advanced)
How does analysts' examination of accounting information for the second
quarter of 2009 demonstrate the feedback value of accounting information?
Reviewed By: Judy Beckman, University of Rhode Island
Technology companies, which have weathered the
financial storm better than most others, are under the spotlight as the
second-quarter earnings season begins this week.
Makers of semiconductor chips, computers and
software have blazed a path for the broader market this year as investors
bet that they would be among the first beneficiaries of any economic
recovery. While the Dow Jones Industrial Average remains down 5.7% for the
year, the technology-heavy Nasdaq Composite Index has jumped 14%.
When it comes to earnings, Wall Street analysts may
be more optimistic about technology than about any other industry, though
that may seem faint praise. Earnings for companies in Standard & Poor's
500-stock index are estimated to be down 36% on average from the second
quarter of 2008, continuing a record profit slump.
Investors will watch second-quarter earnings
generally with some anxiety. A three-month rally in stocks stalled recently
as hopes for a quick and robust economic recovery have been frustrated by
spotty data, including Thursday's uglier-than-expected jobs report. The news
sent the Dow down 1.9% for the week, capping three straight weeks of
declines. Even the Nasdaq declined 2.3%.
A weaker-than-expected earnings season would remove
one of the underpinnings of the fragile market. Strong earnings would
restore confidence that a recovery is afoot, at least for profits.
Analysts hope tech will offer that justification,
particularly after the sector's recent performance. They have raised profit
forecasts for tech, while lowering expectations for most other industries.
Tech earnings are expected to be down 24%, but that is an improvement over
the 26% decline analysts expected when the quarter began.
"My confidence in tech earnings power is a lot
higher than my confidence in the earnings power of many industrial
companies," says Vitaliy Katsenelson, head of research at Investment
Management Associates. He sees a reversal of the last stock market recovery,
when industrial stocks surged and tech stocks, recovering from their bubble,
struggled. "Industrial stocks today are where tech stocks were in 2001."
Analysts have also raised estimates for the
telecommunications sector, which has acted like tech, and for
consumer-discretionary stocks, but that is only because the bankruptcy
filing of General Motors Corp. removed the troubled auto maker and its
sure-to-be-dismal results from the index.
Taking a longer view, the story is the same:
Earnings expectations for the full year have improved for tech, telecom and
consumer discretionary but worsened for the rest.
The divergence between technology and much of the
rest of the market is important, because companies such as Intel Corp. and
Cisco Systems Inc. are considered good barometers of the business cycle.
They often get orders early in an economic recovery, as companies try to
anticipate an upswing in demand.
And tech has been led by what is typically the most
sensitive to demand: semiconductors. The Philadelphia Semiconductor Index,
composed of key names such as Intel and Advanced Micro Devices Inc., is up
24.3% this year.
"That's good news, because semis are at the front
end of the manufacturing process for tech," says Jason DeSena Trennert,
chief investment strategist at Strategas Research Partners. "That generally
should be a leading indicator for the rest of sector, and the economy."
In a rare meeting of the minds, both bulls and
bears are favoring technology stocks. Relative optimists like J.P. Morgan
strategists call it their favorite sector, while relative pessimists such as
David Rosenberg, chief economist and strategist at Toronto wealth-management
firm Gluskin Sheff, recently wrote that he "can't really quibble" with the
fundamentals of tech's success.
Universal love for a sector is often a "sell"
signal, contrarians are happy to remind investors.
They argue that the market has already digested
this good news, suggesting there may be little upside left, particularly if
the economic recovery is less than robust. Others say there are several
justifications for buying tech, even in a downbeat economy. While a jobs
recovery would threaten the profits of a range of industries, from retailers
to home builders and financials, it might actually bolster tech companies.
"In a weak economy, the last thing businesses want
to do is hire people," says Sung Won Sohn, economist at California State
University-Channel Islands. "Instead, they choose to raise productivity by
employing tech."
Continued in article
From The Wall Street Journal Accounting Weekly Review on July 10, 2009
TOPICS: Accounting
Information Systems, Managerial Accounting, Supply Chains
SUMMARY: "Boeing
Co. is in negotiations to purchase operations from one of its main suppliers
as part of an effort to gain more control over the supply chain of its
troubled 787 Dreamliner program....It will buy a facility from Vought
Aircraft Industries that makes sections of the 787 fuselage...." Boeing had
planned to have components of the Dreamliner manufactured by suppliers all
over the world, but the company "...quickly discovered that keeping track of
the different suppliers...was more difficult than it had anticipated....The
plane is now two years behind schedule."
CLASSROOM APPLICATION: The
article is good for introducing the concept of a supply chain and supply
chain management.
QUESTIONS:
1. (Introductory)
Define the terms supply chain, supply chain management system, and value
chain.
2. (Introductory)
How did the Boeing Corporation initially plan to rely on its supply chain
when initiating production of the 787 Dreamliner?
3. (Advanced)
What specific supply chain issues did Boeing face with this production plan?
How is a supply chain management system supposed to avoid these problems? Of
the problems initially listed, which are unlikely to be avoided because of a
good supply chain management system?
4. (Advanced)
Do you think that Boeing's acquisition of Vought Aircraft Industries
converts the fuselage manufacturing activities from a supply chain to a
value chain activity? Support your answer.
Reviewed By: Judy Beckman, University of Rhode Island
"The "Bright Star" of B-School Research: Finance While other
academic fields lie almost fallow — drawing criticism for lack of relevance —
examples abound of finance research that makes a difference," by Roy Harris
CFO.com, March 27, 2008 ---
http://cfo.com/article.cfm/10927537/c_10923636
Our
Tuesday article, "Business School for
Dummies?" looked at the drive at
accrediting group ACCSB to move research in the
direction of providing more useful lessons for the
business world.
Even as
business schools draw fire for producing too little
research of real relevance to Corporate America, the
area of finance may be the single most notable exception
— an area in which theory after theory is used to solve
daily business problems.
"Finance is the bright
star," says professor Gabriel Hawawini, one member of the AACSB "Impact of
Research" task force, which strongly suggested in its recent report pressing
for academic studies to do more to fill the needs presented by American
business. "If you ask what contributions have been made, you would put
finance at the top of the list for models, principles, and theories that are
in use today," adds the Hawawini, currently a visiting professor of finance
at the University of Pennsylvania's Wharton School.
It’s common for many at research universities
to say that just because they value scholarly production doesn’t mean
they don’t care about teaching. But a new study of political science
departments at doctoral institutions -- published in the journal PS --
suggests that there may be a tradeoff.
The study examined 122 departments at
universities that grant doctorates in political science to see which
institutions offer a course for doctoral students on how to become good
teachers. It turns out that only a minority of departments (41) do so --
even though the American Political Science Association and others have
urged graduate programs to recognize that the odds favor their students
finding jobs at institutions that place at least as much value on
teaching as on research. Of the 41 programs with courses, 28 are
required and the rest are optional.
The analysis then tried to determine which
programs were most likely to offer these courses. The size of the
department and the size of the universities -- both of which could be
thought to measure the resources available for courses -- were found not
to be factors.
But there was an inverse relationship between
research productivity in departments and the odds of offering such a
course. The relationship, while significant, had notable exceptions in
the survey among public but not among private institutions. Some of the
public institutions with strong research records -- such as Ohio State
University, the University of California at Berkeley and the University
of Wisconsin at Madison -- do have such courses. But as a general rule,
highly ranked private university departments do not.
Over all, public institutions were seven times
more likely than private institutions to offer such courses, the study
found, citing as a possible explanation “the public service component of
state institutions or the fact that public institutions are consistently
faced with state-mandated programs to enhance teaching generally.”
The study notes that there are innovations that
go beyond just having a single course on teaching techniques. For
example, Baylor University, in its relatively young doctoral program in
political science, has placed an emphasis on the idea that it is
training future college teachers with a “teaching apprentice” program.
In this program, grad students are assigned to work with senior
professors teaching an undergraduate course -- not by becoming teaching
assistants, but by analyzing the course. The grad students prepare an
annotated syllabus -- different from the syllabus used -- to explore
various teaching issues.
During the fourth year of the program, the grad
students are “instructors of record” for a course, but then in their
fifth year they shift to a focus on finishing dissertations. The study
suggests that this approach provides in-depth exposure to teaching
issues.
The paper on these issues was written by a professor (John
Ishiyama) and two doctoral students (Tom Miles and Christine Balarezo)
at the University of North Texas.
Question
What research methodology flaws are shared by studies in political science and
accounting science?
"Methodological Confusion: How indictments of
The Israel Lobby (by John J. Mearsheimer, Stephen M. Walt, ISBN-13:
9780374177720) expose political science's flaws" by Daniel W. Drezner, Chronicle
of Higher Education's Chronicle Review, February 22, 2008, Page B5 ---
http://chronicle.com/weekly/v54/i24/24b00501.htm
Does the public understand how political science
works? Or are political scientists the ones who need re-educating? Those
questions have been running through my mind in light of the drubbing that
John J. Mearsheimer and Stephen M. Walt received in the American news media
for their 2007 book, The Israel Lobby and U.S. Foreign Policy
(Farrar, Straus and Giroux, 2007). Pick your periodical — The Economist,
Foreign Affairs, The Nation, National Review, The New Republic, The New York
Times Book Review, The Washington Post Book World — and you'll find a
reviewer trashing the book.
From a political-science perspective, what's
interesting about those reviews is that they are largely grounded in
methodological critiques — which rarely break into the public sphere.
What's disturbing is that the methodologies used in The Israel Lobby and
U.S. Foreign Policy are hardly unique to Mearsheimer and Walt. Are the
indictments of their book overblown, or do they expose the methodological
flaws of the discipline in general?
The most persistent public criticism of Mearsheimer
and Walt has been their failure to empirically buttress their argument with
interviews. Writing in the Times Book Review, Leslie H. Gelb,
president emeritus of the Council on Foreign Relations, criticized their
"writing on this sensitive topic without doing extensive interviews with the
lobbyists and the lobbied." David Brooks, a columnist for The New York
Times, recently seconded that notion: "If you try to write about
politics without interviewing policy makers, you'll wind up spewing all
sorts of nonsense."
That kind of critique has a long pedigree. For
decades public officials and commentators have decried the failure of social
scientists to engage more deeply with the objects of their studies.
Secretary of State Dean Acheson once objected to being treated as a
"dependent variable." The New Republic ran a cover story in 1999 with the
subhead, "When Did Political Science Forget About Politics?"
To the general reader, such critiques must sound
damning. International-relations scholars know full well, however, that
innumerable peer-reviewed articles and university-press books utilize the
same kind of empirical sources that appear in The Israel Lobby. Most
case studies in international relations rely on news-conference transcripts,
official documents, newspaper reportage, think-tank analyses, other
scholarly works, etc. It is not that political scientists never interview
policy makers — they do (and Mearsheimer and Walt aver that they have as
well). However, with a few splendid exceptions, interviews are not the bread
and butter of most international-relations scholarship. (This kind of
fieldwork is much more common in comparative politics.)
Indeed, the claim that political scientists can't
write about policy without talking to policy makers borders on the absurd.
The first rule about policy makers is that they always have agendas — even
in interviews with social scientists. That does not mean that those with
power lie. It does mean that they may not be completely candid in outlining
motives and constraints. One would expect that to be particularly true about
such "a sensitive topic."
Further, most empirical work in political science
is concerned with actions, not words. How much aid has the United States
disbursed to Israel? How did members of Congress vote on the issue? Without
talking to members of Congress, thousands of Congressional scholars study
how the legislative branch acts, by analyzing verifiable actions or words —
votes, speeches, committee hearings, and testimony. Statistical approaches
allow political scientists to test hypotheses through regression analysis.
By Brooks's criteria, any political analysis of, say, 19th-century policy
decisions would be pointless, since all the relevant players are dead.
Other methodological critiques are more difficult
to dismiss. Walter Russell Mead's dissection of The Israel Lobby in Foreign
Affairs does not pull any punches. Mead, a senior fellow at the Council on
Foreign Relations, wrote that Mearsheimer and Walt "claim the clarity and
authority of rigorous logic, but their methods are loose and rhetorical.
This singularly unhappy marriage — between the pretensions of serious
political analysis and the standards of the casual op-ed — both undercuts
the case they wish to make and gives much of the book a disagreeably
disingenuous tone."
Mead enumerates several methodological sins, in
particular the imprecise manner in which the "Israel Lobby" is defined in
the book. For their part, the book's authors acknowledge that the term is
"somewhat misleading," conceding that "the boundaries of the Israel Lobby
cannot be identified precisely." It is certainly true that many of the
central concepts in international-relations theory — like "power" or
"regime" — have disputed definitions. But most political scientists deal
with nebulous concepts by explicitly offering their own definition to guide
their research. Even if others disagree, at least the definition is
transparent. In The Israel Lobby, however, Mearsheimer and Walt essentially
rely on a Potter Stewart definition of the lobby: They know it when they see
it. That makes it exceedingly difficult for other political scientists to
test or falsify their hypotheses.
Many of the reviews of the book highlight two flaws
that, disturbingly, are more pervasive in academic political science. The
first is the failure to compare the case in question to other cases. For
example, Mearsheimer and Walt Go to great lengths to outline the
"extraordinary material aid and diplomatic support" the United States
provides to Israel. What they do not do, however, is systematically compare
Israel to similarly situated countries to determine if the U.S.-Israeli
relationship really is unique. An alternative, strategic explanation would
posit that Israel falls into a small set of countries: longstanding allies
bordering one or multiple enduring rivals. The category of states that meet
that criteria throughout the time period analyzed by Mearsheimer and Walt is
relatively small: Pakistan, South Korea, Taiwan, and Turkey. Compared to
that smaller set of countries, the U.S. relationship with Israel does not
look anomalous. The United States has demonstrated a willingness to expend
blood, treasure, or diplomatic capital to ensure the security of all of
those countries — despite the wide variance in the strength of each's
"lobby."
Continued in article
Daniel W. Drezner is an associate professor of international politics
at the Fletcher School at Tufts University.
Jensen Comment
When I read the above review entitled "Methodological Confusion" I kept
thinking of the thousands of empirical and analytical studies by accounting
faculty and students that have similar methodology confusions. How many
mathematical/empirical database studies relating accounting events (e.g., a new
standard) with capital market behavior also conduct formal interviews with
investors, analysts, fund managers, etc. Do analytical researchers conduct
formal interviews with real-world decision makers before building their
mathematical models? The majority of behavioral accounting studies conducted by
professors use students as surrogates for real-world decision makers. This
methodology is notoriously flawed and could be helped if the researchers had
also interviewed real-world players.
And Drezner overlooked another common flaw shared by both political science
and
accountics research. If the findings are as important as claimed by
authors, why aren't other researchers frantically trying to replicate the
results? The lack
of replication in accounting science (accountics research) is scandalous
---
http://faculty.trinity.edu/rjensen/Theory01.htm#Replication
Formal and well-crafted interviews with important players (investors, standard
setters, CEOs, etc.) constitute possible ways of replicating empirical and
analytical findings.
The closest things we have to in-depth contact with real world players in
accounting research is research conducted by the standard setters themselves
such as the FASB, the IASB, the GASB, etc. Sometimes these are interviews,
although more often then not they are comment letters. But accountics
researchers wave off such research as anecdotal and seldom even quote the public
archives of such interviews and comments. Surveys are frequently published but
these tend to be relegated to less prestigious academic research journals and
practitioner journals.
Most importantly of all in accountics is that the leading accounting research
journals for tenure, promotion, and performance evaluation in academe are
devoted to accountics paper. Normative methods, case studies, and interviews are
rarely used in studies published in such journals. The following is a quotation
from “An Analysis of the Evolution of Research Contributions by The Accounting
Review (TAR): 1926-2005,” by Jean L. Heck and Robert E. Jensen, Accounting
Historians Journal, Volume 34, No. 2, December 2007, Page 121.
Leading accounting
professors lamented TAR’s preference for rigor over relevancy [Zeff,
1978; Lee, 1997; and Williams, 1985 and 2003]. Sundem [1987] provides
revealing information about the changed perceptions of authors, almost
entirely from academe, who submitted manuscripts for review between June
1982 and May 1986. Among the 1,148 submissions,
only 39 used archival
(history) methods; 34 of those submissions were rejected.
Another 34
submissions used survey methods; 33 of those were rejected.
And 100 submissions
used traditional normative (deductive) methods with 85 of those being
rejected. Except for
a small set of 28 manuscripts classified as using “other” methods
(mainly descriptive empirical according to Sundem), the remaining larger
subset of submitted manuscripts used methods that Sundem [1987, p. 199]
classified these as follows:
292 General Empirical
172 Behavioral
135 Analytical modeling
119 Capital Market
97 Economic modeling
40 Statistical modeling
29 Simulation
It is clear that by
1982, accounting researchers realized that having mathematical or
statistical analysis in TAR submissions made accountics virtually a
necessary, albeit not sufficient, condition for acceptance for
publication. It became increasingly difficult for a single editor to
have expertise in all of the above methods. In the late 1960s, editorial
decisions on publication shifted from the TAR editor alone to the TAR
editor in conjunction with specialized referees and eventually associate
editors [Flesher, 1991, p. 167]. Fleming et al. [2000, p. 45] wrote the
following:
The big change was in
research methods. Modeling and empirical methods became prominent during
1966-1985, with analytical modeling and general empirical methods
leading the way. Although used to a surprising extent, deductive-type
methods declined in popularity, especially in the second half of the
1966-1985 period.
I think the emphasis highlighted in red above demonstrates
that "Methodological Confusion" reigns supreme in accounting science as well as
political science.
A couple of years ago, P. Kothari, one of the
Editors of JAE and a full professor at MIT, visited the U. of Maryland to
present a paper. In my private discussion with him, I asked him to identify
what he considered to the settled findings associated with the last 30
years of capital markets research in accounting. I pointed out that
somewhere over half of all accounting research since Ball and Brown fit into
this category and I was curious as to what the effort had added to Ball and
Brown. That is, what conclusions have been drawn that could be considered
settled ground so that researchers could move on to other topics. His
response, and I quote, was "I understand your point, Jim." He could not
identify one issue that researchers had been able to "put to bed" after all
that effort.
P. Kothari's response is to be expected. I have had
similar responses from at least two ex-editors of TAR; how appropriate a TLA!
But who wants to bell the cats (or call off the naked emperors' bluff)?
Accounting academia knows which side of the bread is buttered.
That you needed to flaunt Kothari's resume to
legitimise his vacuous response shows the pathetic state of accounting
academia.
If accounting academia is not to be reduced to the
laughing stock of accounting practice, we better start listening to the
problems that practice faces. How else can we understand what we profess to
"research"? We accounting academics have been circling our wagons too long
as a ploy to keep our wages arbitrarily high.
In as much as we are a profession, any academic on
such a committee reduces the whole exercise to a farce.
Bob Jensen wrote:
The troubles with multiple regression and discriminant analysis models
are those nagging assumptions of linearity, predictor variable
independence, homoscedasticity, and independence of error terms. If we
move up to non-linear models, the assumption of robustness is a giant
leap in faith. And superimposed on all of this is the assumption of
stationarity needed to have any confidence in extrapolations from past
experience.
In the end, if gaming is allowed in the future as
it has been allowed by bankers and their auditors for decades, putting
accountics into the standards is not the answer.
Sophisticated accountics is just perfume sprayed on
the manure pile.
Amy Dunbar comment/questions: Oh my, what a
metaphor. ;-)
I continue to struggle with the dismissal of
econometric analysis (accountics?) as an approach to address accounting
issues. Many disciplines use econometric analysis in research, despite the
limitations you point out. What research methods do you think are
appropriate for studying accounting issues? In my opinion, research requires
a disciplined approach that can be replicated, which you argue is crucial.
Can one replicate research using the research methods that you favor? Or
perhaps I am misunderstanding your points.
For example, consider the FIN 48 tax disclosures.
My coauthors and I have collected data from the tax footnotes of300
companies to determine how firms are handling the FIN 48 21d requirement of
forecasting the expected tax reserve change over the next 12 months. We want
to know how accurate forecasts are and if the forecast errors result because
of the inherent difficulty of providing the forecast or if firms do not want
to disclose because they do not want to provide a roadmap for taxing
authorities. We use econometric methods to test our hypotheses. How would
you address this issue? By the way, the Illinois tax conference in October
has a panel session on FIN 48 disclosures, including the forecast
requirement, which suggests others are grappling with the informativeness of
these disclosures.
I ordered the book that Paul Williams suggested:
The Flight from Reality in the Human Sciences. I hope I will have a better
understanding of your position after I read it.
Amy Dunbar
UConn
September 8, 2009 reply from Bob Jensen
Hi Amy,
If you really want to understand the problem you’re
apparently wanting to study, read about how Warren Buffett changed the whole
outlook of a great econometrics/mathematics researcher (Janet Tavkoli). I’ve
mentioned this fantastic book before ---Dear Mr. Buffett. What opened her eyes is how Warren Buffet
built his vast, vast fortune exploiting the errors of the sophisticated
mathematical model builders when valuing derivatives (especially options)
where he became the writer of enormous option contracts (hundreds of
millions of dollars per contract). Warren Buffet dared to go where
mathematical models could not or would not venture when the real world
became too complicated to model. Warren reads financial statements better
than most anybody else in the world and has a fantastic ability to retain
and process what he’s studied. It’s impossible to model his mind.
I finally grasped what
Warren was saying. Warren has such a wide body of knowledge that he does not
need to rely on “systems.” . . . Warren’s vast knowledge of corporations and
their finances helps him identify derivatives opportunities, too. He only
participates in derivatives markets when Wall Street gets it wrong and
prices derivatives (with mathematical models) incorrectly. Warren tells
everyone that he only does certain derivatives transactions when they are
mispriced.
Wall Street derivatives
traders construct trading models with no clear idea of what they are doing.
I know investment bank modelers with advanced math and science degrees who
have never read the financial statements of the corporate credits they
model. This is true of some credit derivatives traders, too. Janet Tavakoli, Dear Mr. Buffett, Page 19
The part of my message
that you quoted was in the context of a bad debt estimation message. I don’t
think multivariate models in general work well in the context of bad debt
estimation because of the restrictive assumptions of the models (except in
some industries where bad debt losses are dominated by one or two really
good predictor variables). There is an exception in the case of the Altman,
Beaver, and Ohlson bankruptcy prediction models, but predicting bankruptcy
is in a different ball park than predicting defaults among 10 million rather
small accounts receivable.
As to multivariate models
as applied in TAR, JAR, and JAE I’ve no objection since the 1970s after
referees became much better at challenging model assumptions (in the 1960s
refereeing of econometrics models in accounting literature was often a
joke). "FANTASYLAND ACCOUNTING RESEARCH: Let's Make Pretend..." by Robert E.
Jensen, The Accounting Review,
Vol. 54, January 1979, 189-196.
The problem, as I see it,
is that there’s nothing wrong with our econometrics tool bag when applied to
problems where the tools fit the problem. The econometrics models (except
for nonlinear models) are relatively robust in most papers that do get
published these days.
An Example of
Challenges of Multivariate Model Assumptions
"Is accruals quality a priced risk factor?" by John E.
Corea, Wayne R. Guaya, and Rodrigo Verdib, Journal of Accounting and
Economics ,Volume 46, Issue 1, September 2008, Pages 2-22
Abstract
In a recent and influential empirical paper, Francis, LaFond, Olsson, and
Schipper (FLOS) [2005. The market pricing of accruals quality. Journal of
Accounting and Economics 39, 295–327] conclude that accruals quality (AQ) is
a priced risk factor. We explain that FLOS’ regressions examining a
contemporaneous relation between excess returns and factor returns do not
test the hypothesis that AQ is a priced risk factor. We conduct appropriate
asset-pricing tests for determining whether a potential risk factor explains
expected returns, and find no evidence that AQ is a priced risk factor.
We need to see the above disputes become the rule
rather than the exception!
Francis, LaFond, Olsson, and Schipper vigorously disagree with criticisms of
their work such that there are some interesting disputes that on occasion
arise in accountics research. For the most part, however, published papers
like this are rarely replicated such that errors and frauds go unchallenged
in most of the thousands of accountics papers that have been published in
the past four decades ---
http://faculty.trinity.edu/rjensen/theory01.htm#Replication
The Corea, Guaya, and Verdib replication is a very,
very, very rare exception. I only wish there were more such disputes over
underlying modeling assumptions --- they should be extended to data quality
as well.
Now let me ask about your
FIN 48 tax disclosure study. Was there any independent replication to verify
that you did not make any significant data collection or modeling analysis
errors (you would be the last person in the world that I would suspect of
research fraud)? Do we accept your harvest as totally edible without a
single taste test by independent replicators?
http://faculty.trinity.edu/rjensen/theory01.htm#Replication
The Bigger Problems
Accountics models seldom
focus on the big problems of the profession, because the econometrics and
mathematical analysis tools just are not suited to our systemic accountancy
problems (such as the vegetable nutrition problem) ---
http://faculty.trinity.edu/rjensen/FraudConclusion.htm#BadNews
The editorial problem in TAR, JAR, and JAE is that they
commenced in the 1980s to ignore problems that could not be attacked with
accountics mathematics and statistical tool bags. This leaves out most
problems faced in the accounting profession since practitioners and standard
setters seldom (almost never) have copies of TAR, JAR, JAE, and even AH on
the table when they are dealing with client issues or standards issues. AH
evolved from its original charge to where articles in AH versus TAR are
virtually interchangeable. I repeat from a message yesterday:
Not everything that can be counted, counts.
And not everything that counts can be counted. Albert Einstein
For a long time, elite accounting
researchers could find no “empirical evidence” of widespread earnings
management. All they had to do was look up from the computers where their
heads were buried. Bob Jensen ---
http://faculty.trinity.edu/rjensen/395wpTAR/Web/TAR395wp.htm
“Research should be problem driven rather
than methodologically driven," said Lisa Garcia Bedolla, a member of the
task force who teaches at the University of California at Berkeley. Scott Jascik ---
http://www.insidehighered.com/news/2009/09/04/polisci
"I understand your point,
Jim." He could not identify one issue that (accountics)
researchers had been able to "put to bed" after all that effort. P. Kothari, one of the Editors of JAE and a full professor at
MIT, as quoted by Jim Peters below.
Do we forecast? You bet. Do we have
confidence in our forecasts? Never! Confidence about a non-linear chaotic
system can only come in degrees, and even those degrees of confidence are
guesses. Not all hope is lost. There are times when it seems our ability to
predict is better than others. Thus we need to take advantage of it if we
see it. Trading ranges, pivot points, support and resistance, and the like
can help, and do help the trader. Michael Covel,
Trading Black Swans, September 2009 ---
http://www.michaelcovel.com/pdfs/swan.pdf
Most importantly of all in accountics is that the leading accounting
research journals for tenure, promotion, and performance evaluation in
academe are devoted to accountics paper. Normative methods, case studies,
and interviews are rarely used in studies published in such journals. The
following is a quotation from “An Analysis of the Evolution of Research
Contributions by The Accounting Review (TAR): 1926-2005,” by Jean L. Heck
and Robert E. Jensen, Accounting Historians Journal, Volume 34, No.
2, December 2007, Page 121.
Leading accounting professors lamented
TAR’s preference for rigor over relevancy [Zeff, 1978; Lee, 1997; and
Williams, 1985 and 2003]. Sundem [1987] provides revealing information about
the changed perceptions of authors, almost entirely from academe, who
submitted manuscripts for review between June 1982 and May 1986. Among the
1,148 submissions, only 39 used
archival (history) methods; 34 of those submissions were rejected.
Another 34
submissions used survey methods; 33 of those were rejected.And 100 submissions used traditional normative
(deductive) methods with 85 of those being rejected.
Except for a small set of 28 manuscripts classified as using “other” methods
(mainly descriptive empirical according to Sundem), the remaining larger
subset of submitted manuscripts used methods that Sundem [1987, p. 199]
classified these as follows:
292 General Empirical
172 Behavioral
135 Analytical modeling
119 Capital Market
97 Economic modeling
40 Statistical
modeling
29 Simulation
It is clear that by 1982, accounting researchers realized
that having mathematical or statistical analysis in TAR submissions made
accountics virtually a necessary, albeit not sufficient, condition for
acceptance for publication. It became increasingly difficult for a single
editor to have expertise in all of the above methods. In the late 1960s,
editorial decisions on publication shifted from the TAR editor alone to the
TAR editor in conjunction with specialized referees and eventually associate
editors [Flesher, 1991, p. 167]. Fleming et al. [2000, p. 45] wrote the
following:
The big change was in research
methods. Modeling and empirical methods became prominent during 1966-1985,
with analytical modeling and general empirical methods leading the way.
Although used to a surprising extent, deductive-type methods declined in
popularity, especially in the second half of the 1966-1985 period.
I think the emphasis highlighted in red
above demonstrates that "Methodological Confusion" reigns supreme in
accounting science as well as political science.
A couple of years
ago, P. Kothari, one of the Editors of JAE and a full professor at MIT,
visited the U. of Maryland to present a paper. In my private discussion with
him, I asked him to identify what he considered to the settled findings
associated with the last 30 years of capital markets research in accounting.
I pointed out that somewhere over half of all accounting research since Ball
and Brown fit into this category and I was curious as to what the effort had
added to Ball and Brown. That is, what conclusions have been drawn that
could be considered settled ground so that researchers could move on to
other topics. His response, and I quote, was "I understand your point, Jim."
He could not identify one issue that researchers had been able to "put to
bed" after all that effort.
P. Kothari's response
is to be expected. I have had similar responses from at least two ex-editors
of TAR; how appropriate a TLA! But who wants to bell the cats (or call off
the naked emperors' bluff)? Accounting academia knows which side of the
bread is buttered.
That you needed to
flaunt Kothari's resume to legitimise his vacuous response shows the
pathetic state of accounting academia.
If accounting
academia is not to be reduced to the laughing stock of accounting practice,
we better start listening to the problems that practice faces. How else can
we understand what we profess to "research"? We accounting academics have
been circling our wagons too long as a ploy to keep our wages arbitrarily
high.
In as much as we are
a profession, any academic on such a committee reduces the whole exercise to
a farce.
Jagdish
September 10, 2009 reply from Bob Jensen
Hi again Amy,
Accountics is the mathematical science of values.
Charles Sprague [1887] as quoted by McMillan [1998, p. 1][NH1]
The history of the accountics takeover of leading academic accounting
research journals around the world as well as the takeover of accountancy
doctoral programs in the U.S. and other nations can be found at http://faculty.trinity.edu/rjensen/395wpTAR/Web/TAR395wp.htm
The more I read in the book Dear Mr. Buffet by Janet
Tavakoli, the more I see a parallel between investment bankers and
accountics researchers.
After almost 20 years working for Wall
Street firms in New York and London, I made my living running a
Chicago-based consulting business. My clients consider my expertise in
product they consume. I had written books on credit derivatives and
complex structured finance products, and financial institutions, hedge
funds, and sophisticated investors came to identify and solve potential
problems. Janet Tavokoli, Dear
Mr. Buffett (Wiley, 2009, Page 5)
Jensen Comment
Before she wrote Dear Mr. Buffett, her technical book on
Structural Finance & Collateralized Debt Obligations (Wiley) sat on
my desk for constant reference. Janet also runs her own highly
successful hedge fund. She won't disclose how big it is, but certain
clues make me think it is over $100 million with very wealthy clients.
Her professional life changed when she commenced to correspond with what
was the richest man in the world in 2008 (before he gave much of
his wealth to the Gates Charitable Foundation). He's also one of the
nicest and most transparent and most humble men in the world.
Warren Buffett ---
http://en.wikipedia.org/wiki/Warren_Buffett
Warren Buffett disproved theory of
efficient markets that states that prices reflect all known information.
His shareholder letters, readily available (free)
through Berkshire Hathaway's Web site, told
investors everything they needed to know about mortgage loan fraud,
mospriced credit derivatives, and overpriced securitizations, yet this
information hid in plain "site." Janet Tavokoli, Dear
Mr. Buffett (Wiley, 2009, Page 7)
Jensen Comment
Berkshire Hathaway ---
http://en.wikipedia.org/wiki/Berkshire_Hathaway
Jensen Comment
This of course does not mean that on occasion Warren is not fallible.
Sometimes he does not heed his own advice, and rare occasions he loses
billions. But a billion or two to Warren Buffett is pocket change.
I finally grasped what
Warren was saying. Warren has such a wide body of knowledge that he does not
need to rely on “systems.” . . . Warren’s vast knowledge of corporations and
their finances helps him identify derivatives opportunities, too. He only
participates in derivatives markets when Wall Street gets it wrong and
prices derivatives (with mathematical models) incorrectly. Warren tells
everyone that he only does certain derivatives transactions when they are
mispriced. Janet Tavokoli,
Dear Mr. Buffett (Wiley, 2009, Page 19)
Why
investment bankers are like many accoutics professors
Wall Street derivatives traders construct trading models with no clear idea
of what they are doing. I know investment bank modelers
with advanced math and science degrees
who have never read the financial statements of the corporate credits they
model. This is true of some credit derivatives traders, too. Janet Tavokoli, Dear Mr. Buffett (Wiley, 2009, Page 19) Jensen Comment
Especially note the above quotation when I refer to Reviewer A below.
Warren is aided by the fact that most
investment banks use sophisticated Monte Carlo models that misprice the
transactions. Some of the models rely on (credit) rating agency inputs,
and the rating agencies do a poor job of rating junk debt. Janet Tavokoli, Dear
Mr. Buffett (Wiley, 2009, Page 21)
Investment banks could put on the
same trades if they did fundamental analysis of the underlying
companies, but they are too busy
playing with correlation models.
Janet Tavokoli, Dear
Mr. Buffett (Wiley, 2009, Page 24)
Warren has another advantage: Wall
Street underestimates him. I mentioned that Warren Buffett and I have
similar views on credit derivatives . . . My former colleague, a Wall
Street structured products "correlation" trader, wrinkled his nose and
sniffed: "That old guy? He hates derivatives." Janet Tavokoli, Dear
Mr. Buffett (Wiley, 2009, Page 24)
Warren Buffett writes billions of dollars worth of put options When Warren sells a put buyer the right to make
him pay a specific price agreed today for the stock index (no matter
what the value 20 years from now), Warren receives a premium. Berkshire
Hathaway gets to invest that money for 20 years. Warren thinks the
buyer, the investment bank, is paying him too much . . . Furthermore,
Berkshire Hataway invests the premiums that will in all likelihood cover
anything he might need to pay out anything at all, since the stock index
is likely to be higher than today's value. Janet Tavokoli, Dear
Mr. Buffett (Wiley, 2009, Page 24)
My Four Telltale Quotations about accoutics professors
Although there are no longer any investment banks in the United States since
early 2009, how were investment bankers much like accountics researchers?
There is of course very little similarity now since investment bankers are
standing in unemployment lines and investment banks are out of business ---
http://faculty.trinity.edu/rjensen/2008Bailout.htm#InvestmentBanking
Accountics professors are still happily in business dancing behind tenure
walls and biased journal editors who still cannot see beyond accountics
research methodology.
I provide three quotations below that, I think, pretty well tell the
story of why many, certainly not all, accountics professors are pretty much
like investment bankers that were superior at mathematics and model building
and lousy at accounting and finance fundamentals. You, Amy, will probably
recall each of these quotations although they may not have sunk in like they
should've sunk in.
Quotation 1
Denny Beresford gave a 2005 luncheon speech at the annual meetings of the
American Accounting Association. Having been both a former executive partner
with E&Y and, for ten years, Chairman of the FASB before becoming an
accounting professor at the University of Georgia, Denny has lived all sides
of accounting --- practice, standard setting, and academe. In his speech
Denny very politely suggested that accountics professors should take and
interest in and learn a bit more about, gasp, accounting.
After he gave his speech, Denny submitted his speech for publication to
Accounting Horizons. Referee A flatly rejected the Denny's submission
for the following reasons:
The paper provides specific recommendations for
things that accounting academics should be doing to make the accounting
profession better. However (unless the author believes that academics'
time is a free good) this would presumably take academics' time away
from what they are currently doing. While following the author's advice
might make the accounting profession better, what is being made worse?
In other words, suppose I stop reading current academic research and
start reading news about current developments in accounting standards.
Who is made better off and who is made worse off by this reallocation of
my time? Presumably my students are marginally better off, because I can
tell them some new stuff in class about current accounting standards,
and this might possibly have some limited benefit on their careers. But
haven't I made my colleagues in my department worse off if they depend
on me for research advice, and haven't I made my university worse off if
its academic reputation suffers because I'm no longer considered a
leading scholar? Why does making the accounting profession better take
precedence over everything else an academic does with their time?
Referee A's rejection letter,
Accounting Horizons, 2005
What riled me the most was the arrogance of Referee A. I read into it
that, whereas mathematicians and econometricians are true "scholars," other
accounting professors are little better than teachers of bookkeeping and
fairy tales. This is the same arrogant attitude held by previous investment
bankers trying to take advantage of Warren Buffet as their counterparties in
derivatives or other financial transactions.
Investment bankers and many accountics professors put on superior airs
because of their backgrounds in mathematics and science. To hell with
knowledge of fundamentals in accounting and finance apart from mathematical
models. To hell with reading and analyzing financial statements in great
depth. Accountics scholars, at least some of them who referee many
submissions to journals, don't waste their time on such mundane things.
Quotation 2
My second quotation laments that accounting education programs now often
have to pay the highest starting salaries for some graduates of accounting
doctoral programs who know very little accounting. Before she moved to
Wyoming, Linda Kidwell wrote a revealing message to the AECM listserv.
I cannot
find the exact quotation in my archives, but some years ago Linda Kidwell
complained that her university had recently hired a newly-minted graduate
from an accounting doctoral program who did not know any accounting. When
assigned to teach accounting courses, this new "accounting" professor was a
disaster since she knew nothing about the subjects she was assigned to
teach.
Quotation 3
In the year following his assignment as President of the American Accounting
Association Joel Demski asserted that research focused on the accounting
profession will become a "vocational virus" leading us away from the joys of
mathematics and the social sciences and the pureness of the scientific
academy:
Statistically there are a few youngsters who came to academia for the joy of
learning, who are yet relatively untainted by the
vocational virus.
I urge you to nurture your taste for learning, to follow your joy. That is
the path of scholarship, and it is the only one with any possibility of
turning us back toward the academy. Joel
Demski,
"Is Accounting an Academic Discipline? American Accounting Association
Plenary Session" August 9, 2006 ---
http://bear.cba.ufl.edu/demski/Is_Accounting_an_Academic_Discipline.pdf
Accounting professors are no longer "leading scholars" if they succumb to a
vocational virus and focus on accounting rather than mathematics,
econometrics, and/or psychometrics ---
http://faculty.trinity.edu/rjensen/395wpTAR/Web/TAR.htm
Quotation 4
One of the very leading accountics professors is employed by the graduate
school at Northwestern University. Ron Dye's academic background is in
mathematics rather than accounting, and he's written some of the most
esoteric accountics research papers ever published in leading accounting
research journals.
Richard Sansing
from Dartmouth, on the AECM, occasionally stresses the importance of a
background in mathematics for students seeking fame and fortune as
accounting professors. Although I agree with Richard because of the
dominance of accountics in the accounting academy over the past four
decades, I don't think Richard anticipated the response he got from Ron Dye
when he (Richard Sansing) asked Ron Dye to comment about accountics research
and about the possible desirability of getting a doctorate in mathematics,
econometrics, psychometrics, statistics, etc. before becoming an accounting
assistant professor.
About the question: by and large, I think it is
a mistake for someone interested in pursuing an academic career in
accounting not to get a phd in accounting. If you look at the
"success" stories, there aren't many: most of the people who make a
post-phd transition fail. I think that happens for a couple reasons.
1. I think some of the people that transfer
late do it for the money, and aren't really all that interested in
accounting. While the $ are nice, it is impossible to think about $
when you are trying to come up with an idea, and anyway, you're
unlikely to come up with an idea unless you're really interested in
the subject.
2. I think, almost independent of the
field, unless you get involved in the field at an early age, for
some reason it becomes very hard to develop good intuition for the
area - which is a second reason good problems are often not
generated by "crossovers."
The bigger thing - not related to the question
you raise - but maybe you could add to the discussion is that there are,
as far as I can tell, not a lot of new ideas being put forth by
anyone in accounting nowadays (with the possible exception of John
Dickhaut's neuro stuff). In most fields, the youngsters are supposed to
come up with the new problems, techniques, etc., but I see a lot more
mimicry than innovation among newly minted phds now.
Anyway, for what it's worth.... Ron Dye, Northwestern
University
I think Ron Dye is being extremely
blunt and extremely honest. What really strikes me is that four decades of
accountics research as pretty much evolved into sterile research where "not
a lot of new ideas are being put forth" by accountics professors.
What the big problem is with
accountics research is that it is too restrictive as to what problems are
taken on by accountics researchers, what papers are written for submission
to the leading academic accounting research journals, and the high level of
mathematics required for admission/progression in an accountancy doctoral
program.
What a boring time it is in accountics
research where virtually nothing comes out that is deemed worth replicating
and verifying.
Accountics researchers, however,
should thank the heavens that they did not become, like those "correlation
investment bankers," counterparties in derivatives with Warren Buffet.
It's far better to be among the highest paid professors in a university
while dancing behind the protective walls of tenure.
I will probably send out a lot more
tidbits from my hero Janet Tavaloli (she became more of a hero after she
delved into the mind of Warren Buffett).
Having been very busy at my "day job" the last few
days, I've missed much of this thread, but I'd like to comment on something
Ron Dye said in the excerpt below about "new ideas." I apologize if my
thoughts are not fully developed, so I'll label them observations or
questions.
How many new PhDs actually have any experience in
accounting or of thinking about accounting issues outside of their
undergraduate degree program?
Although I'm generally on the side of the non-accountics
folks in the debate about relevant research, I also believe it's difficult
for someone to come up with new and interesting questions about which to do
even accountics research if that person hasn't spent time thinking about the
issues of financial reporting (or management decisions-making, etc).
I don't see the problem raised by Ron as one
related to the methodology used for the research. Rather my observation is a
lack of experience about the issues that cause us to want/need some research
in the first place.
Thoughts?
Pat
September 10, 2009 reply from Bob Jensen
Hi Pat,
Gary Sundem,
while editor of TAR and while AAA President, made a major point of saying
that the accounting profession should not look to empirical research for
"new theories."
The following is a quote from the 1993
President’s Message of Gary Sundem, President’s Message. Accounting
Education News 21 (3). 3.
Although empirical
scientific method has made many positive contributions to accounting
research, it is not the method that is likely to generate new theories,
though it will be useful in testing them. For example, Einstein’s theories
were not developed empirically, but they relied on understanding the
empirical evidence and they were tested empirically. Both the development
and testing of theories should be recognized as acceptable accounting
research.
If we ever had an accounting Einstein in the past four
decades, that accounting Einstein probably could’ve never published in TAR,
JAR, JAE, CAR, or even AH (in later years). Hence, we do not look to these
“leading” research journals of the accounting academy for the development of
new theories that perhaps cannot be immediately tested.
When I was
Program Director for an AAA annual meeting in NYC, I arranged for Joel
Demski to be on a plenary session (actually a debate with Bob Kaplan). Among
other things I asked Joel to identify at least one seminal and creative idea
from the academy of accountics researchers that impacted on the practitioner
world. In his speech, Joel suggested Dollar-Value Lifo. Later I inspired
accounting historian Dale Flesher investigate the origins of Dollar-Value
Lifo.
-----Original
Message-----
From: Dale Flesher University of Mississippi
[mailto:actonya@HOTMAIL.COM]
Sent: Friday, January 25, 2002 1:35 PM
To:
AECM@LISTSERV.LOYOLA.EDU
Subject: Re: The Only Invention of Academic Accountants
Contrary to a recent
statement in this forum, Dollar-Value Lifo (DVL) was not developed by a
professor. The father of DVL was Herbert T. McAnly, who retired in 1964 as a
partner at Ernst & Ernst after 44 years with the firm. Throughout his
career, McAnly was known as "Mr. LIFO."
Although he did not
develop LIFO, which had been around for decades in the form of the
base-stock method, he did develop DVL after the Internal Revenue began
accepting LIFO from all types of companies. The Treasury would probably
never have agreed to allow all companies to use LIFO (in 1939) had they been
able to prognosticate McAnly's idea. He first described the concept in an
address delivered at the Accounting Clinic and the Central States Accounting
Conference in Chicago in May 1941. His concept was finally accepted by the
IRS following the Hutzler Brothers Co. case in 1947 (8 TC 14 (1947)). He
later worked with the Treasury Department trying to get more practical
regulations relating to LIFO.
Dale L. Flesher
Professor of Accountancy University of Mississippi
I repeat a
few quotations below:
For a long time, elite accounting
researchers could find no “empirical evidence” of widespread earnings
management. All they had to do was look up from the computers where their
heads were buried. Bob Jensen ---
http://faculty.trinity.edu/rjensen/395wpTAR/Web/TAR395wp.htm
If we ever had an accounting Einstein
in the past four decades, that accounting Einstein probably could’ve never
published in TAR, JAR, JAE, CAR, or even AH (in later years). Hence, we do
not look to these “leading” research journals of the accounting academy for
the development of new theories that perhaps cannot be immediately tested.
Bob Jensen
“Research should be problem driven rather
than methodologically driven," said Lisa Garcia Bedolla, a member of the
task force who teaches at the University of California at Berkeley. Scott Jascik ---
http://www.insidehighered.com/news/2009/09/04/polisci
"I understand your point,
Jim." He could not identify one issue that (accountics)
researchers had been able to "put to bed" after all that effort. P. Kothari, one of the Editors of JAE and a full professor at
MIT, as quoted by Jim Peters in an AECM message.
Amy,
Why don't you ask the protagonists what they are doing and why?
Anthropolotgists and sociologists do it all the time. At the AAA meeting in
NYC I used an analogy that Sylvia Earle provided at an Emerging Issues Forum
here at NC State a number of years ago. She is an oceanographer who holds
all the records for time and depth spent under water by a woman. She
described her discipline before and after the invention of SCUBA and other
forms (bathosphere) of deep diving technology. Before the ability to immerse
in the ocean environment she likened her research to being in a balloon over
NYC throwing a basket through the clouds and dragging it along the streets.
From the bits and pieces (much of which was simply
the detritus of life in the city) you had to infer what life was actually
like in a place you couldn't see. What underwater breathing technology did
for her field was absolutely revolutionary because, as she said, you could
actually be in the life of the sea. Obviously what we thought was the case
from the bits of stuff retrieved turned out to be woefully inadequate for
developing a rich understanding of oceanic life.
Accountics research is still little more than
throwing a basket over the side. It is observing at a distance the detritus
(bits of accounting data that float to the surface in the form of public
archives) and inferring what must be happening. This is further limited by
the invariable assumption that whatever is happening must be economic!
Little wonder we have made so little progress.
Ackerloff and Shiller (Animal Spirits) provide an
interesting, two dimensional matrix for understanding human behavior (they
are still economists, but at least Shiller's wife is a social psychologist
who has had a very positive influence on his thinking): One dimension is
Motives -- economic and non-economic (people are likely more non-economic
than economic) and Responses -- rational and irrational. Of the four boxes,
accountics research has confined itself to just one: motives must be
economic and responses must be rational. Seventy five percent of the terrain
of human social behavior is completely ignored.
Added to Bob's shortcomings to accountics research
I would add one more. Sue Ravenscroft and I have a working paper trying to
sort out the inadequacies of "decsion usefulness" as both a policy criterion
and a research objective. One problem with accounting research is that the
accountics approach privileges exclusively algorithmic knowledge -- behavior
that can be modeled (so Wayne Gretzky's famous observation, "I skate to
where the puck is going to be" is beyond understanding). Much of this
research utilizes accounting data as a principal source of measurement. The
problem is that though accountants produce numbers, they don't produce
Quantities, which is essential for performing mathematical operations.
Brian West discusses this extensively in his
Notable Contribution Award winner Professionalism and Accounting Rules. To
perform even the simplest arithmetic operation of addition the numbers you
add must represent quantities of a like type. I can add a coffee cup to a
Volkswagon and claim I have two, but two of what?
Accounting numbers are what Gillies describes as
operational numbers, i.e., numbers obtained by performing operations,
analogous to grading an exam. As West points out financial statements today
consist of numbers developed by performing operations that require cost,
unamortized cost, lower-of-cost or market (with floor and ceiling rules),
exit market values, present values, and, now, "fair" value. When you add all
of these up what do you have? Good question. You have a number, but you most
certainly do not have a quantity. So when an accountics researcher develops
a 20 variable regression model where the dependent variable and at least
half of the independent variables are the operational numbers produced by
accountants (numbers, not quantities), what could the results possibly MEAN.
It is a false precision of the most egregious
kind (GIGO?). In your study you will use operational numbers and assert this
is what my measures mean, but you have no way of knowing if this describes
the actual context in which the decisions were actually made (you are
looking at the stuff from the basket). What it means to you isn't
necessarily what it meant to the actual people who made these decisions.
My issue with so much accountics research is that
it means what the researcher chooses to have it mean; the researcher assigns
the meaning, but to understand what is going on with human beings it is
important to know what their behavior means to them.
And in accountics research this remains a mystery.
A couple of other books (once you finish Shapiro"s) are by Bent Flyvbjerg:
Rationality and Power and Making Social Science Matter. In the latter he
discusses the work of Dreyfus and Dreyfus on what they call "a-rational"
behavior (what Gretzsky is doing when he skates to where the puck is going
to be). See also Gerd Gigerenzer, Gut Feelings: The Intelligence of the
Unconscious..
Statistical methods are not inherently faulty. But they can be, and far too
frequently are, misused. So, to turn your metaphor on its head, much accountics
econometrics work is more like spraying manure in a perfumed room, or more like
a skunk spraying in a perfumed room.
Statistical methods are used for classifying, associating, predicting,
inferring (causally as well as associatively), organising, and learning. It is
important to always keep in mind in which context you are using statistics.
1.
In the accountics stuff I am familiar with, determining association is the
avowed objective, but the language subtly takes a predictive turn in
discussions. The reason usually is the positivist dogma having to do with
absence of causation in a naive positivist's lexicon.
I have been stunned by well known accounticians professing that we do not study
causes because there are no statistical methods for causal inference. And to the
last person, these folks have not heard of modern statistical tools for the
study of causation in statistics.
Ignorance is bliss in this wonderland. Social scientists, however, have used
them for a long time. Theological commitments are dangerous for ANY "science".
2.
Classification is the first step in learning. It is only VERY recently that
accounting folks have started talking about the use of classification by use of
clustering, support vector machines, neural nets, etc., but most of these
discussions take place in non-mainstream contexts.
3.
Many of the techniques in 2 are nowadays considered part of the field of machine
learning, a hybrid between statistics and computing. I am sure one of these
days, when they have become stale elsewhere,They’ll be used in accounting.
Mainstream accountics academics are far too conservative to accept any
statistical method unless they have been certified stale.
4.
Often, in conversations, accountics folks revert to counterfactual
statements.That is natural in the sciences. Underlying such statements are
usually causal inferences. It is in this context that I had made observation 1
above. Building a better mousetrap is a legitimate objective of sciences, and
therefore predictive models are essential component of any science. Accountics'
theological commitment to positivist dogma makes them schizophrenic in that they
cannot admit causality without jeopardising their philosophical suppositions and
yet cannot ignore it if they are to maintain their credibility as scientists.
As to some work in these areas of statistics, any list I prepare would include
the following books.
As David Bartholomae observes, “We make a huge
mistake if we don’t try to articulate more publicly what it is we value in
intellectual work. We do this routinely for our students — so it should not be
difficult to find the language we need to speak to parents and legislators.” If
we do not try to find that public language but argue instead that we are not
accountable to those parents and legislators, we will only confirm what our
cynical detractors say about us, that our real aim is to keep the secrets of our
intellectual club to ourselves. By asking us to spell out those secrets and
measuring our success in opening them to all, outcomes assessment helps make
democratic education a reality. Gerald Graff, "Assessment Changes
Everything," Inside Higher Ed, February 21, 2008 ---
http://www.insidehighered.com/views/2008/02/21/graff
Gerald Graff is professor of English at the University of Illinois at Chicago
and president of the Modern Language Association. This essay is adapted from a
paper he delivered in December at the MLA annual meeting, a version of which
appears on the MLA’s Web site and is reproduced here with the association’s
permission. Among Graff’s books are Professing Literature, Beyond the
Culture Wars and Clueless in Academe: How School Obscures the Life of the Mind.
The consensus report, which was approved by the
group’s international board of directors, asserts that it is vital when
accrediting institutions to assess the “impact” of faculty members’ research on
actual practices in the business world.
Ask anyone with an M.B.A.: Business school provides
an ideal environment to network, learn management principles and gain access
to jobs. Professors there use a mix of scholarly expertise and business
experience to teach theory and practice, while students prepare for the life
of industry: A simple formula that serves the school, the students and the
corporations that recruit them.
Yet like
any other academic enterprise, business schools expect their
faculty to produce peer-reviewed research. The relevance,
purpose and merit of that research has been debated almost
since the institutions started appearing, and now a new
report promises to add to the discussion — and possibly stir
more debate. The Association to Advance Collegiate Schools
of Business on Thursday released the final report of its
Impact of Research Task Force, the
result of feedback from almost 1,000 deans, directors and
professors to a preliminary draft circulated in August.
The consensus
report, which was approved by the group’s international
board of directors, asserts that it is vital when
accrediting institutions to assess the “impact” of faculty
members’ research on actual practices in the business world.
But it does not settle on concrete metrics for impact,
leaving that discussion to a future implementation task
force, and emphasizes that a “one size fits all” approach
will not work in measuring the value of scholars’ work.
The report
does offer suggestions for potential measures of impact. For
a researcher studying how to improve manufacturing
practices, impact could be measured by counting the number
of firms adopting the new approach. For a professor who
writes a book about finance for a popular audience, one
measure could be the number of copies sold or the quality of
reviews in newspapers and magazines.
“In the
past, there was a tendency I think to look at the
[traditional academic] model as kind of the desired
situation for all business schools, and what we’re saying
here in this report is that there is not a one-size-fits-all
model in this business; you should have impact and
expectations dependent on the mission of the business school
and the university,” said Richard Cosier, the dean of the
Krannert School of Management at Purdue University and vice
chair and chair-elect of AACSB’s board. “It’s a pretty
radical position, if you know this business we’re in.”
That
position worried some respondents to the initial draft, who
feared an undue emphasis on immediate, visible impact of
research on business practices — essentially, clear
utilitarian value — over basic research. The final report
takes pains to alleviate those concerns, reassuring deans
and scholars that it wasn’t minimizing the contributions of
theoretical work or requiring that all professors at a
particular school demonstrate “impact” for the institution
to be accredited.
“Many
readers, for instance, inferred that the Task Force believes
that ALL intellectual contributions must be relevant to and
impact practice to be valued. The position of the Task Force
is that intellectual contributions in the form of basic
theoretical research can and have been extremely valuable
even if not intended to directly impact practice,” the
report states.
“It also is
important to clarify that the recommendations would not
require every faculty member to demonstrate impact from
research in order to be academically qualified for AACSB
accreditation review. While Recommendation #1 suggests that
AACSB examine a school’s portfolio of intellectual
contributions based on impact measures, it does not specify
minimum requirements for the maintenance of individual
academic qualification. In fact, the Task Force reminds us
that to demonstrate faculty currency, the current standards
allow for a breadth of other scholarly activities, many of
which may not result in intellectual contributions.”
Cosier, who
was on the task force that produced the report, noted that
business schools with different missions might require
differing definitions of impact. For example, a traditional
Ph.D.-granting institution would focus on peer-reviewed
research in academic journals that explores theoretical
questions and management concepts. An undergraduate
institution more geared toward classroom teaching, on the
other hand, might be better served by a definition of impact
that evaluated research on pedagogical concerns and learning
methods, he suggested.
A further
concern, he added, is that there simply aren’t enough
Ph.D.-trained junior faculty coming down the pipeline, let
alone resources to support them, to justify a single
research-oriented model across the board. “Theoretically,
I’d say there’s probably not a limit” to the amount of
academic business research that could be produced, “but
practically there is a limit,” Cosier said.
But
some critics have worried that the
report could encourage a focus on the immediate impact of
research at the expense of theoretical work that could
potentially have an unexpected payoff in the future.
Historically, as the report notes, business scholarship was
viewed as inferior to that in other fields, but it has
gained esteem among colleagues over the past 50 or so years.
In that context, the AACSB has pursued a concerted effort to
define and promote the role of research in business schools.
The report’s concrete recommendations also include an awards
program for “high-impact” research and the promotion of
links between faculty members and managers who put some of
their research to use in practice.
The
recommendations still have a ways to go before they become
policy, however. An implementation task force is planned to
look at how to turn the report into a set of workable
policies, with some especially worried about how the
“impact” measures would be codified. The idea, Cosier said,
was to pilot some of the ideas in limited contexts before
rolling them out on a wider basis.
Jensen Comment
It will almost be a joke to watch leading accountics researchers trying of show
how their esoteric findings have impacted the practice world when the professors
themselves cannot to point to any independent replications of their own work ---
http://faculty.trinity.edu/rjensen/Theory01.htm#Replication
Is the practice world so naive as to rely upon findings of scientific research
that has not been replicated?
I’d surprised to see much reaction from
“accountics” researchers as they are pretty secure, especially since the
report takes pains not to antagonize them. Anyway, in the words of Corporal
Klinger of the 4077th MASH Unit, “It takes a lot of manure to produce one
perfect rose.”
> On one hand there is
no respect for accounting research in B-schools. On the other
> hand, publishing
accounting research in peer-reviewed pubs is a requirement for AQ
> status in B-schools.
>
> More and more I am
attracted to Ernest Boyer's description of multiple forms of
> scholarships and
multiple outlets of scholarship.
Re: this conversation.
Ian Shapiro, professor of
Political Science at Yale, has recently published a book "The Flight
from Reality in the Human Sciences" (Princeton U. Press, 2005) that
assures that the problem is not confined to accounting (though it is
more ludicrous a place for a discipline that is actually a practice).
All of the social sciences have succumbed to rational decision theory
and methodological purity to the point that academe now largely deals
with understanding human behavior only within a mathematically tractible
unreality made real in the academy essentially because of its
mathematical tractibility. Jagdish recent post is insightful (and
inciteful to the winners of this game in our academy). The problem the
US academy has defined for itself is not solvable. Optimal information
systems? Information useful for decision making (without any
consideration of the intervening "motives" (potentially infinite in
number) that convert assessments into actions)?
As Bob has so frequently
reminded us replication is the lifeblood of science, yet we never
replicate. But we couldn't replicate if we wanted to because
replication is not the point. Anyone with a passing familiarity with
laboratory sciences knows that a fundamental ethic of those sciences is
the laboratory journal. The purpose of the journal is to provide the
precise recipe of the experiments so that other scientists can
replicate. All research in accounting (that is published in the "top"
journals, at least) is "laboratory research." But do capital market or
principal/agent researchers maintain a log that decribes in minute
detail the innumerable decisions that they made along the way in
assembling and manipulating their data (as chemists and biologists are
bound to do by virtue of the research ethics of their disciplines) ?
No way. From any published article, it is nearly impossible to actually
replicate one of their experiments because the article is never
sufficient documentation. But, of course, that isn't the point.
Producing politically correct academic reputations is what our
enterprise is about. Ideology trumps science every time. We don't want
to know the "truth." Sadly, this suits the profession just fine. (It's
this dream world that permits such nonsensical statements like trading
off relevance for reliability -- how can I know how relevant a datum is
unless I know something about its reliability? Isn't the whole idea of
science to increase the relevance of data by increasing their
reliability?)
Reviving Journalism Schools and Business Schools For as long as doomsayers have predicted the decline of
civic-minded reportage as we know it, reformers have sought to draft a rewrite
of the institutions that train many undergraduate and graduate students pursuing
a career in journalism. Criticisms of journalism schools have ranged from
questioning whether the institutions are necessary in the first place (since
many journalists, and most senior ones, don’t have journalism degrees) to
debating the merits of teaching practical skills versus theory and whether
curriculums should emphasize broad knowledge or specialization in individual
fields . . . The sessions were part of an effort to evaluate the function of
journalism schools in an age of new media and the public’s declining faith in
the fourth estate: the Carnegie-Knight
Initiative on the Future of Journalism Education,
which in 2005 enlisted top institutions in the country to bolster their
curriculums with interdisciplinary studies and expose students to different
areas of knowledge, including politics, economics, philosophy and the sciences.
The initiative, funded by the Carnegie Corporation of New York and the John S.
and James L. Knight Foundation, also works with journalism schools to incubate
selected students working on national reporting projects.
Andy Guess, "Reviving the J-School," Inside Higher Ed, January 10, 2008
---
http://www.insidehighered.com/news/2008/01/10/jschools
There are an
increasing number of scholarly videos on this topic at BigThink: YouTube for Scholars (where
intellectuals may post their lectures on societal issues) ---
http://www.bigthink.com/
Some
of you may benefit by analyzing similarities and differences between the above
tidbit on J-Schools versus the AACSB effort to examine needs for change in
B-Schools.
SUMMARY: Professor
Charles Zech, director of the Center for the study of Church
Management and a professor of economics at Villanova
University, discusses their new MBA program. The article
mentions internal controls needed in church management
practices.
CLASSROOM
APPLICATION: Familiarity with specific types of MBA
programs, general educational issues, and the issues of
internal control evident in recent church and clergy
scandals can be discussed in an introductory accounting,
accounting information systems, or auditing class.
QUESTIONS:
1.) You may have seen advertisements for MBA programs
targeted to golf course or ski resort management. In
general, why are different industries targeted in management
education?
2.) Why did Villanova University decide to offer an MBA in
church management? In what ways will Villanova target the
MBA program?
3.) Not all universities may be able to offer this targeted
MBA. Why not?
4.) What is transparency in financial reporting? How do
examples given in the article indicate insufficient
transparency in church management and reporting practices?
5.) What internal control weaknesses are identified in the
article? List each weakness and describe a solution for the
weakness.
6.) How do properly functioning internal controls support
sufficient transparency in financial reporting?
7.) What is the concept of stewardship? How is it discussed
in the objectives of financial reporting in both U.S. and
international conceptual frameworks of accounting?
8.) How do the comments in the article make it clear that
focusing on stewardship better fits church management than
does focusing on other objectives and qualitative
characteristics identified in the conceptual framework of
accounting?
Reviewed By: Judy Beckman, University of Rhode Island
The reputations of many Roman Catholic Perishes
have been tarnished in recent years, both by the priest sex-abuse scandals
and a growing number of embezzlement cases. That has prompted a burgeoning
movement to improve the management and leadership skills of church officials
through new programs being offered primarily at Catholic universities.
M.B.A. Track columnist Ron Alsop talked recently with Charles Zech, director
of the Center for the Study of Church Management and a professor of
economics at Villanova University's School of Business in Villanova, Pa.,
about the launch of its master's degree in church management in May and the
need for more sophisticated and more transparent business practices in
Perishes and religious organizations.
WSJ: Why did Villanova decide to create a
master's degree in church management?
Dr. Zech: We find that business managers at both
the Perish and diocesan level often have social work, theology or education
backgrounds and lack management skills. While pastors aren't expected to
know all the nitty-gritty of running a small business, they at least need
enough training in administration to supervise their business managers.
Before starting the degree, we ran some seminars in 2006 and 2007 as a trial
balloon to see if folks were interested enough to pay for management
education. The seminars proved to be quite popular, drawing people from all
over the country, including high-level officials from both Catholic dioceses
and religious orders.
How have the sexual-abuse scandals and
embezzlement cases put a spotlight on poor management and governance
practices?
The Catholic Church has some real managerial
problems that were brought to light by the clergy abuse scandals. It became
quite obvious that the church isn't very transparent and accountable in its
finances. Settlements had been made off the books with abuse victims and
priests had been sent off quietly for counseling, to the surprise of many
Perishioners. Then came a string of embezzlement cases. Our center on church
management surveyed chief financial officers of U.S. Catholic dioceses in
2005 and found that 85% had experienced embezzlements in the previous five
years. One of our recommendations was that Perishes be audited once a year
by an independent auditor. There clearly are serious questions about
internal financial controls at the Perish level, and we are now doing
research on Perish advisory councils and asking questions about such things
as who handles the Sunday collection and who has check-writing authority.
Does the same person count the collection, deposit the money and then
reconcile the checkbook? Obviously, you're just asking for problems if it's
the same person; you can imagine the temptations.
Beyond the need for better financial controls,
what other management issues should get more attention from church leaders?
Performance management is definitely an important
but neglected area. That's partly because it's a very touchy issue. Who is
going to appraise the performance of a priest or a church worker who is also
a member of the Perish? There's great reluctance on the part of the clergy
to be appraiser or appraisee. You have to view the Perish as a family
business and understand that it's like evaluating members of your family.
How will Villanova's church management degree be
different from what other universities have started offering?
Some schools combine standard business classes with
courses from theology and other departments. But if you're taking a regular
M.B.A. finance class, you're learning about Wall Street and other things
that aren't really relevant. What we're doing is creating courses
specifically for this degree program, so there are both business and
faith-based elements in every class. For example, the law course will deal
with civil law relative to church law so students understand the possible
conflicts. The accounting course will cover internal financial-control
issues for churches. And the human-resource management class will include
discussion of volunteers, a big part of the labor force for Perishes.
Have you encountered any resistance from church
officials?
Yes, some people say a church is not a business.
But I point out that we still have to be good stewards of our resources --
our financial and human capital -- to carry out God's work on Earth. When
you use management terms with bishops, they often get turned off. But when
you use the word stewardship, it has more impact because it's in the Bible.
Jesus talked about the importance of our being good stewards who take care
of our talents and other gifts.
Is the degree restricted to Catholic clergy and
lay managers?
The courses will have a Catholic focus because as a
Catholic university, our mission is to try to meet the needs of our
community. But the degree is certainly not restricted to Catholics. Every
church has similar managerial problems. In fact, we're eager for other
Christian denominations to become part of the program and provide some
valuable contributions to class discussions. A typical course, however,
would not apply to other religions because of the different way Christian
churches are organized compared with synagogues and other religious
institutions.
Why is the degree being offered primarily
online, with only a one-week residency on campus?
Since we view the market for church-management
education as national and even global, a distance-learning degree will
attract clergy and church workers from any part of the world who can't take
off for two years to come to Villanova. In fact, we already have heard from
a priest in Ireland and a Presbyterian minister in Cameroon interested in
enrolling in the program.
The church management degree costs $23,400. How
can clergy and church workers afford it?
We expect the vast majority of students to be
supported by a diocese or other religious or social service organizations.
We will chop 25% off the price for anyone who can get their organization to
pay a third of the tuition. That cuts a student's out-of-pocket costs by
about half. We're trying to send the message to religious leaders that this
is important and that they should invest in management training.
"theory Fetish: Too Much of a Good Thing? Management journals
demand contributions to theory. But slavish devotion to theory inhibits other
valuable research," by Donald C. Hambrick, Business Week, January 13,
2008 ---
Click Here
Recently I was at a brown-bag seminar where a pair
of faculty colleagues in our business school's department of management
sought advice about a preliminary research idea. We all quickly agreed that
their research question was fascinating and would be of great interest to
both academics and practicing managers. The only problem: The presenters had
no theory.
No theory! Everyone knows that the top scholarly
journals in management require without exception that manuscripts make
contributions to theory. And so we spent the entire session that day going
through our collective mental catalogues of theories. Theories that I'd
never heard of were proposed. Things got a little frenzied: "Good God, there
must be a theory that we can latch onto," someone said.
Losing the Trees for the Forest
Because these researchers are savvy about academic
publishing, their project likely will appear some day in a leading journal.
But the straightforward beauty of the original research idea will probably
be largely lost. In its place will be what we too often see in our journals
and what undoubtedly puts non-scholars off: a contorted, misshapen,
inelegant product, in which an inherently interesting phenomenon has been
subjugated to an ill-fitting theoretical framework.
Many nice things can be said about theory. Theories
help us organize our thoughts, generate coherent explanations, and improve
our predictions. But they are not ends in themselves, and in academic
management we have allowed obsession with theory to compromise the larger
goal of understanding. Most important, perhaps, it prevents the reporting of
rich detail about interesting phenomena for which no theory yet exists but
which, once reported, might stimulate the search for an explanation.
Happily, our sister disciplines in business
education—accounting, finance, and marketing—are not afflicted to the extent
that those of us in management are. But the breadth and variety of the
subjects that fall under the category of management exceed those of the
other business school academic departments; a number of MBA-granting
institutions, in fact, call themselves schools of management. If management
scholars fail to connect with real-life managers or management scholarship
is shrugged off by managers as irrelevant—both of which happen with
regularity—the credibility of all business academe suffers.
Management's idolization of theory began after two
blue-ribbon reports of the late 1950s, from the Carnegie and Ford
foundations, levied withering attacks on business schools for their lack of
academic sophistication. As a result, in the 1960s and 1970s schools adopted
a new commitment to drawing from basic academic disciplines (e.g., economics
and psychology), and to analytic rigor, science, and—above all—theory. Since
then, however, other fields have relaxed their single-mindedness about
theory, while management scholars have not.
Trapped in Inertia?
To confirm this, I recently analyzed the 120
articles published in 2005 by three leading scholarly management
journals—the Academy of Management Journal, the Administrative Science
Quarterly, and Organization Science. Every one contained some variation of
the word "theory." In contrast, only 78% of the 178 articles published in
2005 in the Journal of Marketing, the Journal of Finance, and Accounting
Review contained those words. Moreover, they appeared 18 times, on average,
in each management article, but only eight times, on average, in each
non-management article. Finally, about two-thirds of the articles in the
management journals had section headings that trumpeted "theory," compared
with one in five headings in the non-management journals.
I must admit to uncertainty about the reason for
this continuing fetish; perhaps we in management academe are simply trapped
in our own inertia. But at what a cost! To illustrate, let me take a
hypothetical case from another field that has nothing to do with management
or business.
Question
Given the dire shortages of doctoral students in accountancy, should the
requirement for doctoral degrees be eliminated in higher education?
Perhaps I'm old and tired, but I always think that the chances of finding
out what really is going on are so absurdly remote that the only thing to do
is to say hang the sense of it and just keep yourself occupied. Douglas Adams
There are two explanations one can give for this
state of affairs here. The first is due to the great English economist Maurice
Dobb according to whom theory of value was replaced in the United States by
theory of price. May be, the consequence for us today is that we know the price
of everything but perhaps the value of nothing. Economics divorced from politics
and philosophy is vacuous. In accounting, we have inherited the vacuousness by
ignoring those two enduring areas of inquiry. Professor Jagdish Gangolly, SUNY
Albany
The second is the comment that Joan Robinson made
about American Keynsians: that their theories were so flimsy that they had to
put math into them. In accounting academia, the shortest path to respectability
seems to be to use math (and statistics), whether meaningful or not. Professor Jagdish Gangolly, SUNY
Albany
There are two
sides to nearly every profession (as opposed to a narrow trade). The first one
is the clinical side, and the second one is the research side. But this is not
to say that the twain do not meet.
I advocate
requiring that most (maybe not all) clinical instructors be grounded solidly in
research. Requiring a PhD is a traditional way to get groundings in research.
Probably more importantly is that doctoral studies are ways to motivate
clinically-minded students to attempt to do research on clinical issues and make
important contributions to the practicing profession.
I define
“research” as a contribution to new knowledge. Among other things a good
doctoral program should make scholars more appreciative of good research and
critical of bad/superficial research that does not contribute to much of
anything that is relevant, including research that should get
Senator William Proxmire's
Golden Fleece Awards. Like urban cowboys, our academic accounting
researchers are all hat (mathematical/statistical models) with no cows.
The problem with
accountancy doctoral programs is that they’ve become narrowly bounded by
accountics (especially econometrics and psychometrics) that in the past three
decades have made little progress toward helping the clinical side of our
profession of accountancy. This makes our doctoral programs very much unlike
those in economics, finance, medicine, science, and engineering where many
clinical advances in their disciplines have emerged from studies in doctoral
programs.
The problem with
higher education in accountancy is not that we require doctoral degrees
in our major colleges and universities. The problem is that our doctoral
programs shut out research methodologies that are perhaps better suited for
making research discoveries that really help the clinical side of our
profession. Accountics models just do not deal well with missing variables and
nonstationarities that must be allowed for on the clinical side of accountancy.
Humanities researchers face many of these same issues and have evolved a much
broader arsenal of research methodologies that are
verboten in accounting
doctoral programs --- (See below).
The related
problem is that our leading scholars running those doctoral programs have taken
a supercilious view of the clinical side of our profession. Or maybe it’s just
that these leaders do not want to take the time and trouble to learn the
clinical side of the profession. Once again I repeat the oft-quoted referee of
an Accounting Horizons rejection of Denny Beresford’s 2005 submission
*************
1. The paper provides specific recommendations for things that accounting
academics should be doing to make the accounting profession better. However
(unless the author believes that academics' time is a free good) this would
presumably take academics' time away from what they are currently doing. While
following the author's advice might make the accounting profession better, what
is being made worse? In other words, suppose I stop reading current academic
research and start reading news about current developments in accounting
standards. Who is made better off and who is made worse off by this reallocation
of my time? Presumably my students are marginally better off, because I can tell
them some new stuff in class about current accounting standards, and this might
possibly have some limited benefit on their careers. But haven't I made my
colleagues in my department worse off if they depend on me for research advice,
and haven't I made my university worse off if its academic reputation suffers
because I'm no longer considered a leading scholar? Why does making the
accounting profession better take precedence over everything else an academic
does with their time?
**************
Joel Demski
steers us away from the clinical side of the accountancy profession by saying we
should avoid that pesky “vocational virus.” (See below).
The (Random House) dictionary defines "academic" as
"pertaining to areas of study that are not primarily vocational or applied , as
the humanities or pure mathematics." Clearly, the short answer to the question
is no, accounting is not an academic discipline. Joel Demski, "Is Accounting an Academic Discipline?" Accounting
Horizons, June 2007, pp. 153-157
Statistically there are a few youngsters who came to
academia for the joy of learning, who are yet relatively untainted by the vocational virus.
I urge you to nurture your taste for learning, to follow your joy. That is the
path of scholarship, and it is the only one with any possibility of turning us
back toward the academy. Joel Demski, "Is Accounting an Academic Discipline? American
Accounting Association Plenary Session" August 9, 2006 ---
http://faculty.trinity.edu/rjensen//theory/00overview/theory01.htm
Too many
accountancy doctoral programs have immunized themselves against the “vocational
virus.” The problem lies not in requiring doctoral degrees in our leading
colleges and universities. The problem is that we’ve been neglecting the
clinical needs of our profession. Perhaps the real underlying reason is that our
clinical problems are so immense that academic accountants quake in fear of
having to make contributions to the clinical side of accountancy as opposed to
the clinical side of finance, economics, and psychology.
Our problems with doctoral programs in accountancy are shared with other
disciplines, notably education and nursing schools.
Bob Jensen's threads on controversies in higher education are at
http://faculty.trinity.edu/rjensen/HigherEdControversies.htm
Linking Research and Teaching in History For
academic historians the link between research and teaching is regarded as an
integral part of the provision of a high-quality history education: vital to
teachers and students and to the ongoing health of the discipline.
These resources have been compiled as part of a
Higher Education Academy project on linking teaching and research in the
disciplines. The project's aim is to provide case-studies of existing
practice alongside a review essay considering the nature of the
research-teaching relationship in each discipline. Whilst the resources are
intended in the first instance for new members of academic staff, they will
be of interest to anyone who wishes to reflect on the research-teaching
nexus in History and the ways in which academic historians have translated
this in the context of their teaching.
Our Subject Centre is very keen to build upon this
collection of case-studies. We would welcome further contributions so that
we can create a resource for our community that reflects the importance of
this topic and the wealth of experience that historians have in linking
their research and teaching at both undergraduate and postgraduate levels.
Jensen Comment
The above site may be of interest to the accounting academy for a number of
reasons:
Accountancy doctoral programs over the past three decades have virtually
dropped all research methodologies other than social science methodologies (Click
Here). The above case studies lend insight to how research methodologies
from the humanities could give greater breadth to accounting doctoral
studies. This could serve at least two purposes. First, it might attract
more accountants into doctoral programs, especially those that have little
aptitude for and interest in studying four years of accountics (advanced
mathematics, econometrics, statistics, and psychometrics). Second, Second it
might allow doctoral programs to expose doctoral
students to instructors, mentors, and advisors who have specialties in
something other than accountics.
There is presently an expectations/readership gap between academic
research papers in leading accounting research journals and the profession
of accountancy and students studying to enter that profession. Perhaps some
of the case studies in the site mentioned above can be extended to show the
links between academic accounting research and practice. In a limited way,
the AICPA has already undertaken such an effort.
The Journal of Accountancy (AICPA) has
begun a new series of articles to review accounting research papers and
explain them to practitioners. The April issue has an article on "Mining
Auditing Research."
It summarizes about a dozen research articles,
mostly from The Accounting Review, but also including articles from JAR,
CAR, AOS, and the European Accounting Review.
This may be useful in bringing research
findings into classes
Ron
I cannot find where Cynthia Bolt-Lee followed through
with this intention beyond the relatively short summaries in her April 14,
2007 article.
The Higher Education Academy site mentioned above may inspire students
and faculty to have a greater appreciation how important history is to
knowledge and future research in virtually all disciplines of study.
Technology is perhaps helping history more than most disciplines. A problem
with history is that there's so much of it in our libraries, information
databases, and knowledge bases. Another problem is that history is so
compartmentalized by dates, cultures, topic areas, etc. Technology enables
researchers/scholars to more efficiently mine these stored bases of
information and knowledge. Efforts by Google and Microsoft to digitize
millions of collegiate and public library works will help bring history
together. See
http://books.google.com/advanced_book_search
Also note the "Reflective Log Case Study" at
http://www.hca.heacademy.ac.uk/resources/case_Studies/snas/drummond.doc
Question
Is accounting an "academic" discipline?
The (Random House) dictionary defines "academic" as
"pertaining to areas of study that are not primarily vocational or applied , as
the humanities or pure mathematics." Clearly, the short answer to the question
is no, accounting is not an academic discipline. Joel Demski, "Is Accounting an Academic Discipline?" Accounting Horizons,
June 2007, pp. 153-157
Statistically there are a few youngsters who came to
academia for the joy of learning, who are yet relatively untainted by the
vocational virus. I
urge you to nurture your taste for learning, to follow your joy. That is the
path of scholarship, and it is the only one with any possibility of turning us
back toward the academy. Joel Demski, "Is Accounting an Academic Discipline?
American Accounting Association Plenary Session" August 9, 2006 ---
http://faculty.trinity.edu/rjensen//theory/00overview/theory01.htm
Jensen Comment
Joel's lament is a bit confusing since for the past four decades, virtually all
doctoral programs have replaced accounting professional content with
mathematics, statistics, econometrics, psychometrics, and sociometrics content
to a fault and to a point where very few accountants are interested in applying
for accountancy doctoral programs ---
http://faculty.trinity.edu/rjensen//theory/00overview/theory01.htm#DoctoralPrograms
The decline in doctoral program graduates (to less than 100 per year in the
United States) combined with the scientific requirements for publication in
leading academic accounting research journals resulted in the academy serving
the accountancy profession less and less over the past few decades:
It would help if Joel would be more explicit about what types of basic
"academic" research studies qualify as "accounting research" and why there is
virtually none of it being produced according to his paper and his address to
the AAA membership in August 2006. In particular, I would like to know what
types of academic "accounting" publications set academic accounting apart from
mathematical economics and mathematics disciplines such that these basic
research contributions can still be called "accounting" research that is not
applied (in the sense of his definition of "academic" research as not being
applied).
Following Joel's paper is a paper by the same title "is Accounting an
Academic Discipline?" by John C. Fellingham, Accounting Horizons, June
2007, pp. 159-163. John features the following quotation from Henry Rand
Hatfield in 1924:
I am sure that all of us who teach accounting in
the university suffer from the implied contempt of our colleagues, who look
upon accounting as an intruder, a Saul among the prophets, a paria whose
very presence detracts somewhat from the sanctity of the academic halls. Henry Rand Hatfield, "An Historical Defense of Bookkeeping,"
Journal of Accountancy, 1924.
I consider this quotation to be inappropriate in 2007. Professor Hatfield was
referring to the teaching of bookkeeping which is no longer the mundane
vocational subject matter of college accounting in the past fifty or more years.
I consider most of what we now teach in college accountancy to be very
appropriate in service to the accountancy profession. You can read more about
accounting education in Hatfield's time in the following historic papers:
Allen, C. E. (1927), "The growth of accounting instruction since 1900," The
Accounting Review (June): 150-166 ---
http://maaw.info/TheAccountingReview.htm Click on the "Non USF User Link"
Atkins, P. M. (1928), "University instruction in industrial cost
accounting," The Accounting Review," (December): 345-363 ---
http://maaw.info/TheAccountingReview.htm Click on the "Non USF User
Link"
Atkins, P. M. (1929), "University instruction in
industrial cost accounting," The Accounting Review (March):
23-32 ---
http://maaw.info/TheAccountingReview.htm Click on the "Non USF User
Link"
I guess what I'm really trying to say is that accountancy is a profession
like law is a profession, medicine is a profession, architecture is a
profession, engineering is a profession, pharmacy is a profession, etc. Why does
the academy need to apologize for teaching to the profession of accountancy when
in fact the academy is very proud to serve those other highly esteemed
professions. I do not see schools of law and schools of medicine apologizing to
the world for nobly serving those professions.
Both Demski and Fellingham made emotional appeals for academic accounting
researchers to make noteworthy contributions to the "true academic disciplines"
as quoted by Fellingham on Page 163. Not only should this be a goal, but in a
sense they are arguing that this should be a primary goal far above the goal of
serving the accountancy profession. I fail to note similar appeals being made by
professors of law and medicine and engineering. These professions do distinguish
between clinical versus research publications and teaching, but in general they
do not further glorify their research if it cannot conceivably have some
relevance to their professions. Indeed, even the most basic chemical and
physiological research in medicine still takes place with an eye toward eventual
relevance to human health.
I might also note that both law and medicine also publish some academic
research that is not based upon esoteric mathematics and statistics. For
example, historical and philosophical research methodologies are still allowed
in their most prestigious academic law and science journals, which currently is
not the case for leading academic accounting research journals.
By way of example, since Joel Demski took charge of the accounting doctoral
program at the University of Florida, every applicant to that doctoral program
cannot even matriculate into the program before pre-requisites of advanced
mathematics are satisfied.
Students are required to demonstrate math
competency prior to matriculating the doctoral program. Each student's
background will be evaluated individually, and guidance provided on ways a
student can ready themselves prior to beginning the doctoral course work.
There are opportunities to complete preparatory course work at the
University of Florida prior to matriculating our doctoral program.
University of Florida Accounting Concentration
---
http://www.cba.ufl.edu/fsoa/docs/phd_AccConcentration.pdf
Why does every candidate have to qualify in advanced mathematics rather than
allowing substitutes such as advanced philosophy or advanced legal studies?
I might also add that science and medicine academic journals also still place
monumental priorities on replications of research findings. Leading academic
accounting research journals will not even publish replications and mostly as a
result it is very difficult to find replications of most of the top academic
accounting research papers published by so-called leading accounting researchers
---
http://faculty.trinity.edu/rjensen//theory/00overview/theory01.htm#Replication
More of my rants on this can be found in the following links:
Question
Are college students good surrogates for real life studies?
The majority of behavioral experiments in accounting have used students as
experimental subjects.
Many of the numbers that make news about how we
feel, think and behave are derived from studying a narrow population:
college students. It's cheap for social scientists to tap into the on-campus
research pool -- everyone from psychology majors who must participate in
studies for course credit to students who respond to posters promising a few
bucks if they sign up.
Consider just three studies that have received
press in the past month. In one, muscular men were twice as likely as their
less well-built brethren to have had more than three sex partners -- at
least according to 99 UCLA undergraduates. Another, an examination of six
separate studies that tape-recorded college students' conversations, found
that women, despite being stereotyped as relatively chatty, spoke just 3%
more words each day than men. And in the third, 40 undergraduates at
Washington University in St. Louis were 6% more likely to complete verbal
jokes and 14% more likely to complete visual jests than 41 older study
participants.
College students are "essentially free," says Brian
Nosek, a psychology professor at the University of Virginia. "We walk out of
our office, and there they are." The epitome of a convenience sample, they
have become the basis for what some critics call the "science of the
sophomore."
But psychologists may be getting what they pay for.
College students aren't representative by age, wealth, income, educational
level or geographic location. "What if you studied 7-year-old kids and made
inferences about geriatrics?" asks Robert Peterson, a marketing professor at
the University of Texas, Austin. "Everyone would say you can't do that. But
you can use these college students."
Prof. Peterson scoured the literature for examples
of studies that examined the same psychological relationships in students
and nonstudents. In almost half of the 63 relationships he examined, there
were major discrepancies between students and nonstudents: The two groups
either produced contradictory results, or one showed an effect at least
twice as great as the other.
In a follow-up study, not yet published, Prof.
Peterson demonstrated that even college students are far from homogeneous.
With help from faculty at 58 schools in 31 states, he surveyed undergraduate
business students across the country and found that they vary widely from
school to school. That means a professor studying the relationship between
students' attitudes toward capitalism and business ethics at one school
could reach a sharply different conclusion than a professor at another
school.
"People have always been aware of this issue,"
Prof. Peterson says, but many have chosen to ignore it. A 1986 paper by
David Sears, a UCLA psychology professor, documented the increased use of
college students for research in the prior quarter century and explored the
potential biases that might introduce. In the meantime, the use of college
students has, if anything, risen, researchers say.
Authors of the recent studies on sex, chattiness
and humor acknowledge the limitations of their research pool. But they argue
that college students do just fine for purposes of studying basic cognitive
processes. Others agree. "If you think all people have the same attitudes as
introductory psychology students, that's really problematic," says Tony
Bogaert, a psychology professor at Brock University in St. Catharines,
Ontario. "But if you're looking at cognitive processes, intro psych students
probably work OK."
After all, every study is hampered by possible
differences between those who volunteer to participate and those who don't,
whether they're college students or a broader group.
In any case, the fault often lies not with the
researchers, who are careful not to overstate the impact of their findings,
but with the news articles suggesting the numbers apply to all humanity.
"Even if you only focus on college students, the results are still
generalizable to millions of Americans," says David Frederick, a UCLA
psychology graduate student and lead author of the study on muscularity and
sex partners.
Prof. Nosek, a critic of the science of the
sophomore, responds that college students are still developing their
personalities and behavior. "There is no other time outside my life as an
undergraduate where I thought it would be a good idea to wear all my clothes
inside out," he says, or to "stay up for as many hours in a row as I could
just to see what happens."
To widen the pool of people answering questions
about, say, all-nighters, Prof. Nosek has submitted a proposal to the
National Institutes of Health to fund the creation of an international,
online research panel. That would build on studies his laboratory has
already administered online at ProjectImplicit.net.
Online research has its own problems, but at least
it taps into the hundreds of millions of people who are online globally,
rather than just the hundreds of people enrolled in Psych 101.
"The scientific reward structure does not benefit
someone who puts in the enormous effort" to create a representative research
sample, Prof. Nosek says. "The way to change researchers' data habits is to
make it easier to collect data in a more generalizable way."
Question
When should professors add practitioners to their courses?
In a class about United Nations regulations on the
laws of war, the discussion turned inevitably to Star Trek.
When the U.N. authorizes sanctions against a
particular nation, said Ilan Berman, the professor, the institution acts
much like the Borg — in the show’s universe, a mechanized force of cyborg
mercenaries bent on assimilating all of mankind. The analogy was lost on
most of the class, but Berman drove the point home for those who didn’t
regularly tune in to syndicated science fiction programs in the early 1990s:
Each member nation must act as part of the collective.
The lecture, peppered as it was with the occasional
pop culture reference, covered a lot of ground, from the U.S. national
security strategy to the justifications for nations’ use of force. The
students in the class — five were present on a Monday night in July for the
elective — come from a range of backgrounds, several of them working
full-time, but all in the program with an eye toward defense policy, whether
in the government, consulting or think tanks.
In Washington, those are hardly unorthodox goals.
Programs in defense or security studies churn out students every year in the
nation’s capital, from well-known and respected institutions such as Johns
Hopkins University’s School of Advanced International Studies and Georgetown
University’s School of Foreign Service, and also outside the Beltway at
places like Harvard (Kennedy) and Princeton (Wilson). The students in
Berman’s class, tucked in a conference room on the seventh floor of a
corporate office building in Fairfax, Va., are part of a relatively new
experiment: What if a state school in Springfield, Mo., operated a satellite
campus alongside the established players in defense studies?
So far, enrollments have been growing each year
since the unit opened shop in 2005 within commuting distance from the city,
sandwiched between a rapidly developing apartment complex and an office
park. The Department of Defense and Strategic Studies, a part of Missouri
State University, caters to students who want to break into Beltway defense
circles with a public university price tag and the advantages of a more
practical approach. In doing so, it offers a two-year M.S. degree that
requires both coursework and internships.
Having access to actual practitioners in the
classroom means, in this case, connections to defense and foreign policy
officials in the government. As with others like it, the program has had a
long revolving-doors tradition, starting from its original incarnation in
the early 1970s at the University of Southern California, where it was
founded by a former defense official who served on the SALT I delegation,
William R. Van Cleave, and partially funded by the free-market Earhart
Foundation. But unlike at similar departments elsewhere, Missouri State’s
full-time faculty of three and its nine affiliated lecturers tend to come
mainly from positions in Republican administrations and conservative-leaning
institutions.
Continued in article
Jensen Comment
Some years back Professor Sharon Lightner (UC at San Diego) put together a
really interesting online course for students, practitioners, and accounting
standard setters in six different countries where the classes met synchronously.
"An Innovative Online International Accounting Course on Six Campuses Around the
World" ---
http://faculty.trinity.edu/rjensen/255light.htm
Question
Does faculty research improve student learning in the classrooms where
researchers teach?
Put another way, is research more important than scholarship that does not
contribute to new knowledge?
Major Issue
If the answer leans toward scholarship over research, it could monumentally
change criteria for tenure in many colleges and universities.
AACSB
International: the Association to Advance Collegiate Schools of Business, has
released for comment
a reportcalling for the accreditation process for
business schools to evaluate whether faculty research improves the learning
process. The report expresses the concern that accreditors have noted the volume
of research, but not whether it is making business schools better from an
educational standpoint. Inside Higher Ed, August 6, 2007 ---
http://www.insidehighered.com/news/2007/08/06/qt
FL (August 3,
2007) ― A report released today evaluates the nature and purposes of
business school research and recommends steps to increase its value to
students, practicing managers and society. The report, issued by the Impact
of Research task force of AACSB International, is released as a draft to
solicit comments and feedback from business schools, their faculties and
others. The report includes recommendations that could profoundly change the
way business schools organize, measure, and communicate about research.
AACSB
International, the Association to Advance Collegiate Schools of Business,
estimates that each year accredited business schools spend more than $320
million to support faculty research and another half a billion dollars
supports research-based doctoral education.
“Research is
now reflected in nearly everything business schools do, so we must find
better ways to demonstrate the impact of our contributions to advancing
management theory, practice and education” says task force chair Joseph A.
Alutto, of The Ohio State University. “But quality business schools are not
and should not be the same; that’s why the report also proposes
accreditation changes to strengthen the alignment of research expectations
to individual school missions.”
The task force
argues that a business school cannot separate itself from management
practice and still serve its function, but it cannot be so focused on
practice that it fails to develop rigorous, independent insights that
increase our understanding of organizations and management. Accordingly, the
task force recommends building stronger interactions between academic
researchers and practicing managers on questions of relevance and developing
new channels that make quality academic research more accessible to
practice.
According to
AACSB President and CEO John J. Fernandes, recommendations in this report
have the potential to foster a new generation of academic research. “In the
end,” he says, “it is a commitment to scholarship that enables business
schools to best serve the future needs of business and society through
quality management education.”
The Impact of
Research task force report draft for comments is available for download on
the AACSB website:
www.aacsb.edu/research. The website
also provides additional resources related to the issue and the opportunity
to submit comments on the draft report. The AACSB Committee on Issues in
Management Education and Board of Directors
will use the feedback to determine the next steps for implementation.
The AACSB International Impact of Research Task Force
Chairs:
Joseph A. Alutto, interim president, and
John W. Berry, Senior Chair in Business, Max M. FisherCollege of Business,
The Ohio State University
K. C. Chan, The Hong Kong University of Science and
Technology
Richard A. Cosier, Purdue University
Thomas G. Cummings, University of Southern California
Ken Fenoglio, AT&T
Gabriel Hawawini, INSEAD and the University of Pennsylvania
Cynthia H. Milligan, University of Nebraska-Lincoln
Myron Roomkin, Case Western Reserve University
Anthony J. Rucci, The Ohio State University
Now that the 2007 Annual Meetings
are ended and it is public information that finance professor Erik Lie
(University of Iowa) won the AICPA/AAA Notable Contributions to Accounting
Literature Award, I feel compelled to make my letter to Kate written on May 17
public. This year I served on the Part 2 selection committee that chose Erik Lie
from the list of candidates submitted to us by the Part 1 Screening Committee.
Professor Lie's contribution was truly notable and deserving of this award for
2007.
But I have serious reservations
about the Part 1 Screening Committee's choices over the past two decades. I
think it's been a rigged game in which the Part 2 Selection Committee has no
choice but to choose an esoteric "accountics" article published in an academic
research journal.
My letter to Kate is entirely
consistent with the long tidbit below received from Paul Williams on August 10,
2007 after the AAA 2007 Annual Meetings in Chicago. Kate was chair of our 2007
Selection Committee but not the 2007 Screening Committee.
An important
aspect of this debate is the timing of the fall off of practitioner interest in
academic accounting research. Both public and managerial accountants at one time
followed very closely theory and practice research of academic accountants
much like lawyers take an interest in law school research, physicians take an
interest in medical research, engineers take an interest in engineering school
research, etc. We had it made until the 1960s. Then accounting practitioner
interest in our research virtually zeroed out in the ensuing decades. We no
longer serve our profession, although we try and try to make a contribution to
the economics and finance professions. Joel Demski in a plenary speech in
Washington DC called serving the accounting profession a “vocational virus” to
avoid so that doing research can be “more fun.” As Judy Rayburn pointed out when
she was President Elect of the AAA, the citation records indicate that there is
little interest by anybody, including finance and economics professor, in our
leading accountics research.
I think the
telltale turning point was when accountics professors took over the refereeing
of articles in the leading accounting research journals in the 1960s and 1970s.
Before then practitioners took a keen interest in both our top journals like
The Accounting Review and our sessions/debates at AAA annual meetings.
Between 1925 and 1965 practitioners published articles in TAR and had more
members in the AAA than did colleges. In fact the longest running editor
(Kohler) of TAR was a practitioner ---
http://fisher.osu.edu/departments/accounting-and-mis/the-accounting-hall-of-fame/membership-in-hall/eric-louis-kohler/
Now practitioner
participation in the AAA is virtually zero except for PR partners and PR staff
employees of large firms. How long has it been since a practitioner
published/cited a paper inTAR or Accounting Horizons?
It’s very
revealing to compare the titles and authors of papers published in TAR between
1925 and 1965 versus those published 1966-2008.
Zeff and Granof claim that leading published research was just more
interesting before the 1960s.
The FASB now
sees little interest in even keeping an academic on the Board. I’m sure
Katherine and Tom did their best, but we did not give them enough good material
to bring to the Board.
An Analysis of the
Contributions of The Accounting Review Across 80 Years: 1926-2005 ---
http://faculty.trinity.edu/rjensen/395wpTAR/Web/TAR395wp.htm
Co-authored with Jean Heck and forthcoming in the December 2007 edition of the
Accounting Historians Journal.
David Dennis organized a
discussion panel to address the state of academic research in accounting. I
could not be at the AAA meetings this year. But Paul Williams was on the panel
and sent out the following message to panel members.
Paul Williams (North Carolina
State University) Weighs in Once Again on the Sad State of Accounting Research
in the Academy. Paul gave me permission to post his email message to the panel
members.
It is a source of constant
frustration that there exists reams of "empirical evidence" that the US
academy is as we trouble makers say it is. For folks who claim to worship
empirical evidence there is a great reluctance to consider it. Jacci
Rodgers and I have another paper that you didn't include that was published
in The Accounting Historians Journal that dealt with authors during the same
period of time as our editors' paper.
We did a comparison of elite
school graduates appearances as authors in TAR (The Accounting
Review) with their proportion in the population of North American PhDs
(a procedure that was biased in that it overstates the proportion of elite
graduates who were in the effective population of people of publishing
age). In Table 3 of that paper we report the proportion of appearance by
elite grads and their proportion of the total North American PhD population
at the beginnning of each TAR editor's term starting with
Trumball, the first editor to have a published
editorial board, the first number is proportion of appearances and the
second is proportion of PhDs:
Editor
Trumball: 63.6/63.5
Griffin:
71.3/59.6
Hendrickson: 75/53.7
Keller:
61.1/50.3
Decoster:
63/45.2
Zeff:
51.9/43.1
Sundem:
47.1/38
Kinney:
50.6/34.7
Abdel-khalik: 56.6/33
Through Zeff and Sundems' editorships we start to see
the effects of the emergence of the many new doctoral programs that were
created during the 1970s. The dilution of elite school dominance proceeded
apace through time as the elite became a smaller proportion of the total
population. I had a paper accepted in TAR by both Zeff and Sundem: both
experiences were good. Both Zeff and Sundem were open-minded and quite
helpful during the process; the reviews were constructive.
But this expected demographically induced trend
dramatically reversed itself after Sundem's editorship. Since that time the
elite appearances among authors has hovered, Avogadro's number-like around
the mid-60 percent mark -- the proportion that prevailed when Trumball was
editor. All of a sudden the virtues of scholarship that Zeff and Sundem
were able to recognize in the work of people not trained at elite schools as
conventional economists disappeared. The ideologues took over by default
because of TAR's fear of losing so much reputational ground to JAR and JAE.
TAR became a JAR and JAE clone. It hasn't changed since.
So why doesn't Bill McCarthy get enough good systems
papers? Perhaps it's because we haven't been terribly interested, for nearly
25 years, in training in U.S. PhD programs people who could do quality
systems, or sociological, or historical, or legal, or anthropological work
in accounting. As Jagdish Gangolly noted on the AECM, finance types
reproduce like mosquitoes, but it is a struggle for anyone interested in
some "causal delta" other than neoclassical economics to find a place to
study.
Today, with the exception of a couple of places, you
have to go outside the United States. Why submit a paper to TAR when the
editorial process is not one to be trusted? Those of us who have been in
the AAA a long time have heard these promises of "inclusiveness" before.
They were hot air then, they're hot air now unless the TAR editorial process
is willing to take a laxative and publish some papers that may not be the
best (there are an awful lot of "main-stream" papers published that aren't
very good, either).
TAR has to signal it isn't telling us another fib and
that involves more than just passively sitting around waiting for papers to
come. Trust has been lost and you won't get it back by chastising the
mistrustful. Wouldn't it be refreshing to see someone from the editorial
board show up at conferences like IPA, APIRA, CPA, . . . etc. to press the
flesh and find out what the rest of the world thinks?
It is perhaps not a coincidence that the only two
papers ever published in TAR informed by critical literature (papers by Chua
and Hines) were ushered through the review process by Sundem. Nothing of
that kind has ever appeared in TAR since.
Even JAR published a paper by Peter Miller!
David: kudos on your item 8. As the U.S. has become
the O.E.C.D. country with the most skewed distribution of income and wealth
and as our great experiment in democracy appears more and more each day to
be less and less robust (see Prem Sikka's work on the extensiveness of
accounting corruption), we get a scholarly community primarily fixated on
individual career enhancement through the engineering of a linear model with
an R-squared of seldom double digits explaining yet some other absurdity
about why Nozickian justice is the sine qua non of human existence.
I have seen literally thousands of those models
over the years and no two have ever born any resemblance to each other.
What kind of "models" are really only unique
representations of themselves? Thank you for organizing the panel and
allowing me to participate.
Paul
Paul Williams
paul_williams@ncsu.edu
(919)515-4436
The Financial Accounting Standards Board recently approached Bloomfield
about studying how to create financial accounting standards that will assist
investors as much as possible, he quickly turned to the virtual world for
answers.
Abstract:
Since the 1970s, the decision-usefulness has taken center stage and our
attention has been concentrated on valuation of assets and liabilities
instead of income measurement. The concept of income, once considered
the gravitational center of accounting has lost its primacy and become a
byproduct of the balance sheet derived from the measurement of assets
and liabilities.
However, we have not been equipped with robust
conceptual foundation supporting theoretically reasoned accounting
measurement. It is not only theoretically but also practically important
to renew our seemingly waned interest in the concept of income because
ongoing reforms of accounting standards cannot be successfully
implemented without a sound understanding of the concept of income.
"Theory Meets Practice Online: Researchers and academics are looking to
online worlds such as Second Life to shed new light on old economic questions,"
by Francesca Di Meglio, Business Week, July 24, 2007 ---
Click Here
In fact, many economics researchers, including
Bloomfield, professor of accounting at Cornell's Johnson Graduate School of
Management, are using the virtual environment to test ideas involving
staples of economics such as game theory, the effects of regulation, and
issues involving money. Since 1989, Bloomfield has been running experiments
in the lab in which he creates small game economies to study narrow issues.
But when the Financial Accounting Standards Board recently approached
Bloomfield about studying how to create financial accounting standards that
will assist investors as much as possible, he quickly turned to the virtual
world for answers.
"It would be very difficult to look at the complex
issues that FASB is trying to address with eight people in a laboratory
playing a very simple economic game," he says. "I started looking for how I
could create a more realistic economy with more players dealing with a high
degree of complexity. It didn't take me long to realize that people in
virtual worlds are already doing just that."
. . .
At
Indiana University, researcher Edward Castronova has posed
the idea of creating multiple virtual economies to study the
effects of different regulatory policies. At Indiana,
Castronova is director of the Synthethic Worlds Initiative,
a research center to study virtual worlds. "The opportunity
is to conduct controlled research experiments at the level
of all society, something social scientists have never been
able to do before," the center's Web site notes (see
BusinessWeek.com, 5/1/06,
"Virtual World, Virtual Economies").
A
virtual stock market is certainly not the only online entity
that opens itself up to research. Marketers are already
using the virtual world to test campaigns, packaging, and
consumer satisfaction. Pepsi (PEP)
famously tracks use of its products in
There.com. Architects seek reaction to design. Starwood
Hotels (HOT)
test-marketed its new loft designs in Second Life
(see BusinessWeek.com, 8/23/06,
"Starwood Hotels Explore Second Life First").
The Journal of Accountancy (AICPA) has begun
a new series of articles to review accounting research papers and explain
them to practitioners. The April issue has an article on "Mining Auditing
Research."
It summarizes about a dozen research articles,
mostly from The Accounting Review, but also including articles from JAR,
CAR, AOS, and the European Accounting Review.
Nearly two years ago I sent out an "Appeal" for accounting
educators, researchers, and practitioners to actively support what I call The
Accounting Review (TAR) Diversity Initiative as initiated by last year's
American Accounting Association President Judy Rayburn ---
http://faculty.trinity.edu/rjensen/395wpTAR/Web/TAR.htm
In it I noted that a bright ray of hope for changing narrow
focus of The Accounting Review (TAR) was the appointment of Bill McCarthy
as Associate Editor for purposes of introducing Accounting Information Systems
research into TAR.
This thread and other AECM posts regarding
information technology research in accounting casts a grim picture for
people who wish to do computer science related work aimed at the major
accounting academic journals. This has been an "us vs. them" problem for
most of my 30 years in AIS research.
While it is indeed true that JAR, JAE, and the
other private accounting journals remain in the Stone Age as far as
accounting technology issues are concerned, there have been significant
steps taken by TAR to open up the main AAA journal to this kind of work. Dan
Dhaliwal appointed me as an editor with the express purpose of having a
person knowledgeable in information systems and computer science research
methods available to the AIS research community for manuscript review and
decision-making.
Surprisingly, as I have outlined at both the
sectional and national AAA meetings, the problem has not been as much with
"them" as it has been with "us," at least in the last 15 months or so. Quite
simply, the number of AIS submissions to TAR has been alarmingly low. In
Washington last August, I set a target of 12-18 for the AIS community for
this academic year, a number I thought was modest and achievable. However,
it does not look like we will come close to that at our present rate.
*
As I mentioned in Washington, the submission
procedure is this:
*
Do the work and make sure it is rigorous according
to accounting, IS, and/or computer science standards,
*
Submit the paper and note or show that it deals
with an important accounting issue issue by using AIS, MIS or CS methods,
and
*
Ask that the paper be assigned to me as the editor
most familiar with IS and CS methods.
If you make a convincing case on these points and
if the senior editor thinks it is high quality, then I get it, I assign the
referees, and I get to make the consolidated judgment.
Paraphrasing the famous Canadian hockey player
Wayne Gretzky, the AIS research and the accounting practice communities will
miss on 100% of the good ideas that never get submitted to TAR. If we want
change the face of accounting research, the time for action is now. Do the
work and submit "that" paper. Additionally, send your name off to me as a
possible referee, outlining your particular expertise in either methods or
specific technologies.
What we may be paying as the price for dragging
doctoral education in accounting back to the Stone Age about 40 years ago,
is the phenomenon you describe. People have become so disenchanted with TAR
that they have found other more comfortable venues for pursuing their work.
In spite of public declarations about the new openness, we have heard this
before only to have it turn out to be disengenuous PR. I think your appeal
here might encourage people to trust you once and submit a paper, BUT it
better produce some postitive experiences.
Another issue is "rigor." Everything must be
RIGOROUS, but most GOOD IDEAS aren't "rigorous". They are typically fraught
with error, but they open new vistas and ways of thinking about things. The
history of science is filled with tales of earth changing ideas that were
not offered in a RIGOROUS way (we know Mendel fudged his data on sweet peas,
so did Milliken and Keynes General Theory... was notoriously cobbled
together). We have become so fixated on method and our public appearance as
rigorous scientists that all accounting scholarship in the U.S. at least
follows the same template. Our idea of rigor is, frankly, naïve, based more
on appearance than substance. Robert Heilbroner once remarked that
"Mathematics brought great rigor to economics.
Unfortunately it also brought mortis." Bill, you
now have some power (?). Take some chances. What is the point of an academic
discourse confined only to statistical model building where, simultaneously,
replication is emphatically discouraged? Empirical rigor means doing it over
and over by independent investigators with rigorous controls. We may not
even be doing what we currently do "rigorously."
Methodological hangups, fetish about quantitative
rigour, phobia about normative research, all have afflicted most disciplines
at one time or the other. We in accounting seem to have them all at the same
time.
I remembering sitting on a doctoral committee with
folks from psychology, and was frightened to discover my own prejudices
after hearing a well known (Skinnerian) psychologist fellow committee member
asked me to be a bit more understanding of methodologies used by others.
I have found the accounting crowd reward conformity
with received wisdom from the self-anointed sages.
Much of my work has been normative, and therefore
considered "unsuitable" for publications in better known accounting journals
(statement made by editor of one of the top rated accounting journal). I
feel driven out of the field years ago into Operations Research, Information
Systems, Computing & Information Sciences.
In none of those fields have the journal editors/
referees used any litmus tests. On the other hand, the referees at an AAA
section journal, (about 20 years ago) was bold enough to state that my paper
was an insult to the excellent work done by others in the field (the paper
was later published in a respected journal in IS with few changes; it was
the last paper I submitted to any establishment accounting journals).
Bill's message gives me hope in a way I never
imagined. As a test balloon, I will submit TAR one of our papers that I had
targeted for a CSI journal.
We need a balance between rigour, relevance, and
methodological purity. Above all, we need tolerance for work that differs
from our own perspective on each of these. We also need a diversity of
approaches to the issues in the papers.
Jagdish
Academics Versus the Profession
The real world is only a special case, and not a very interesting one at
that.
--Attributed to C. E. Ferguson and forwarded by Ed Scribner
Imagination is not to be
divorced from facts: it is a way of illuminating the facts. It works by
eliciting the general principles which apply to the facts, as they exist,
and then by an intellectual survey of alternative possibilities which are
consistent with these principles. It enables men (sic) to construct an
intellectual vision of a new world, and it preserves the zest of life by the
suggestion of satisfying purposes.
Alfred North Whitehead in an address to the AACSB in 1927 and quoted in the
paper by Bennis and O'Toole cited below.
During the past several decades,
many leading B schools have quietly adopted an inappropriate --- and ultimately
self-defeating --- model of academic excellence. Instead of measuring
themselves in terms of the competence of their graduates, or by how well their
faculties understand important drivers of business performance, they measure
themselves almost solely by the rigor of their scientific research. They have
adopted a model of science that uses abstract financial and economic analysis,
statistical regressions, and laboratory psychology. Some of the research
produced is excellent, but because so little of it is grounded in actual
business practices. the focus of graduate business education has become
increasingly circumscribed --- and less and less relevant to practitioners ...We
are not advocating a return to the days when business schools were glorified
trade schools. In every business, decision making requires amassing and
analyzing objective facts, so B schools must continue to teach quantitative
skills. The challenge is to restore balance to the curriculum and the
faculty: We need rigor and relevance. The dirty little secret at
most of today's best business schools is that they chiefly serve the faculty's
research interests and career goals, with too little regard for the needs of
other stakehollders. Warren G. Bennis and James O'Toole, "How Business Schools Lost Their
Way," Harvard Business Review, May 2005.
The article be downloaded for a fee of $6.00 ($3.70 to educators) ---
http://harvardbusinessonline.hbsp.harvard.edu/b02/en/hbr/hbr_home.jhtml
"David Ginsberg, chief data scientist at SAP,
said communication skills are critically important in the field, and that a key
player on his big-data team is a “guy who can translate Ph.D. to English. Those
are the hardest people to find.” James Willhite (see below)
Might we also say the same thing about accountics scientists slaving over their
enormous purchased "big data" databases?
Wanted: Ph.D.-level statistician with the
technical skill to use data-visualization software and a deep
understanding of the _____ industry.
Fill in the blank with almost any business:
consumer products, entertainment, health care, semiconductors or fast
food. The list reflects the growing range of companies trying to mine
mountains of data in hopes of improving product design, supply chains,
customer service or other operations.
. . .
At the most basic level, big data is the art
and science of collecting and combing through vast amounts of
information for insights that aren’t apparent on a smaller scale.
Financial executives who want to harness big data face a critical
hurdle: Finding people who can glean it, understand it, and translate it
into plain English.
The field is so new that the U.S. Bureau of
Labor Statistics doesn’t yet have a classification for data scientists,
according to BLS economist Sara Royster. That makes it tough to estimate
the unemployment rate or salaries for job seekers in the field.
But executives and recruiters, who compete for
talent in the nascent specialty, point to hiring strategies that can get
a big-data operation off the ground. They say they look for specific
industry experience, poach from data-rich rivals, rely on interview
questions that screen out weaker candidates and recommend starting with
small projects.
David Ginsberg, chief data scientist at
business-software maker SAP AG , said communication skills are
critically important in the field, and that a key player on his big-data
team is a “guy who can translate Ph.D. to English. Those are the hardest
people to find.”
Along with the ability to explain their
findings, data scientists need to have a proven record of being able to
pluck useful information from data that often lack an obvious structure
and may even come from a dubious source. This expertise doesn’t always
cut across industry lines. A scientist with a keen knowledge of the
entertainment industry, for example, won’t necessarily be able to
transfer his skills to the fast-food market.
Some candidates can make the leap. Wolters
Kluwers NV, a Netherlands-based information-services provider, has had
some success in filling big-data jobs by recruiting from other,
data-rich industries, such as financial services. “We have found
tremendous success with going to alternative sources and looking at
different businesses and saying, ‘What can you bring into our business?’
” said Kevin Entricken, the company’s chief financial officer.
The trick, some experts say, is finding a
candidate steeped in higher mathematics with hands-on familiarity with a
particular business. “When you have all those Ph.D.s in a room, magic
doesn’t necessarily happen because they may not have the business
capability,” said Andy Rusnak, a senior executive for the Americas in
Ernst & Young’s advisory practice.
Companies can hamstring themselves in big-data
projects by thinking too long term, Mr. Rusnak said. They should focus
instead on what they can discover in an eight- to 10-week period, he
said, and think less about business transformation.
Dunkin’ Brands Group Inc. aims to wring all the
value it can out of its data, by using it to entice customers to visit
its stores more often and try new doughnuts and drinks. Last week, it
went national with a loyalty program that will allow it to harvest data
on customer habits.
The program allows the company to target
individuals who opt into the program with specific offers aimed at
making them more frequent customers. “If you’ve only been coming in the
morning, perhaps we’d give you an offer for the afternoon,” said Dunkin’
Chief Information Officer Jack Clare.
Netflix’s Mr. Amatriain said, “I like to face
candidates with real practical problems.” He said he will say to an
applicant, “You have this data that comes from our users. How can you
use it to solve this particular problem? How would you turn it into an
algorithm that would recommend movies?” He said that the question is
deliberately open-ended, forcing candidates to prove that they can
understand not only the math, but what he calls “the big picture
approach to using big data to gain insights.”
Business professors are great at writing
jargon-filled, hard-to-digest research papers. But every once and a while,
they knock it out of the park with the general public. A small pool of
research achieved such blockbuster status in 2012 by becoming the most read,
most downloaded, or most written-about pieces authored by professors at top
business schools. Tax evasion, finding a job, and the benefits of teaching
employees Spanish are some of the topics that got non-students reading.
At
Harvard Business School, an
excerpt
from Clayton Christensen’s book How Will You
Measure Your Life? was the year’s most read preview of forthcoming
research. The passage uses the downfall of Blockbuster and the rise of
Netflix (NFLX)
as an analogy for how we may end up paying a high cost for small decisions.
Continued in article
MIT, like Harvard, places enormous value on having both feet planted in
the real world
The professions of architecture, engineering, law, and medicine are heavily
dependent upon the researchers in universities who focus on needs for research
on the problems of practitioners working in the real world.
If accountics scientists want to change their ways and focus more on problems
of the accounting practitioners working in the real world, one small step that
can be taken is to study the presentations scheduled for a forthcoming MIT Sloan
School Conference.
Learning best practice from the best practitioners
MIT Sloan invites more than 400 of the world’s
finest leaders to campus every year. The most anticipated of these visits
are the talks given as part of the Dean’s Innovative Leader Series, which
features the most dynamic movers and shakers of our day.
At a school that places enormous value on having
both feet planted in the real world, the Dean’s Innovative Leader Series is
a powerful learning tool. Students have the
rare privilege of engaging in frank and meaningful discussions with the
leaders who are shaping the present and future marketplace.
"The Impact of Academic Accounting Research on Professional Practice:
An Analysis by the AAA Research Impact Task Force," by Stephen R.
Moehrle, Kirsten L. Anderson, Frances L. Ayres, Cynthia E. Bolt-Lee, Roger
S. Debreceny, Michael T. Dugan, Chris E. Hogan, Michael W. Maher, and
Elizabeth Plummer, Accounting Horizons, December 2009, pp. 411- 456.
SYNOPSIS:
The accounting academy has been long recognized as the premier developer
of entry-level talent for the accounting profession and the major
provider of executive education via master’s-level curricula and
customized executive education courses. However, the impact that the
academy’s collective ideas have had on the efficiency and effectiveness
of practice has been less recognized. In this paper, we summarize key
contributions of academic accounting research to practice in financial
accounting, auditing, tax, regulation, managerial accounting, and
information systems. Our goal is to increase awareness of the effects of
academic accounting research. We believe that if this impact is more
fully recognized, the practitioner community will be even more willing
to invest in academe and help universities address the escalating costs
of training and retaining doctoral-trained research faculty.
Furthermore, we believe that this knowledge will attract talented
scholars into the profession. To this end, we encourage our colleagues
to refer liberally to research successes such as those cited in this
paper in their classes, in their textbooks, and in their presentations
to nonacademic audiences.
Jensen Comment
This paper received the AAA's 2010 Accounting Horizon's best paper
award. However, I don't find a whole lot of recognition of work in
practitioner journals. My general impression is one of disappointment. Some
of my comments are as follows:
Unsubstantiated Claims About the Importance of Accountics Event
Studies on Practitioners
The many citations of accounting event studies are more like a listing of
"should-have-been important to practitioners" rather than demonstrations
that these citations were "actually of great importance to practitioners."
For example, most practitioners for over 100 years have known that earnings
numbers and derived ratios like P/E ratios impact investment portfolio
decisions and acquisition-merger decisions. The findings of accountics
researchers in these areas simply proved the obvious to practitioners if
they took the time and trouble to understand the complicated mathematics of
these event studies. My guess is that most practitioners did not delve
deeply into these academic studies and perhaps do not pay any attention to
complicated studies that prove the obvious in their eyes. In any case, the
authors of the above studies did not contact practitioners to test out
assumed importance of accountics research in these events studies. In other
words, this AAA Task Force did not really show, at least to me, that these
events studies had a great impact on practice beyond what might've been used
by standard setters to justify positions that they probably would've taken
with or without the accountics research findings.
Mention is made about how the FASB and government agencies included
accounting professors in some deliberations. This is well and good but the
study does not do a whole lot to document if and how these collaborations
found accountics research of great practical value.
Practitioner Journal Citations of Accountics Research
The AAA Task Force study above did not examine practitioner journal
citations of accountics research journals like TAR, JAR, and JAE. The
mentions of practitioner journals refer mostly to accounting professors who
published in practitioner journals such as when Kenney and Felix published a
descriptive piece in the 1980 Journal of Accountancy or Altman/McGough
and Hicks published 1974 pieces in the Journal of Accountancy. Some
mentions of practitioner journal citations have to go way back in time such
as the mention of the Mautz and Sharaf. piece in the 1961 Journal of
Accountancy.
Accountics professors did have some impact of auditing practice,
especially in the areas of statistical sampling. The types of sampling used
such as stratified sampling were not invented by accounting academics, but
auditing professors did make some very practical suggestions on how to use
these models in both audit sampling and bad debt estimation.
Communication with Users
There is a very brief and disappointing section in the AAA Task Force
report. This section does not report any Task Force direct communications
with practitioners. Rather it cites two behavioral studies using real-world
subjects (rather than students) and vague mention studies related to SAS No.
58.
Unsubstantiated Claims About the Importance of Mathematical Models on
Management Accounting Practice
To the extent that mathematical models may or may not have had a significant
impact on managerial accounting is not traced back to accounting literature
per se. For example, accounting researchers did not make noteworthy advances
of linear programming shadow pricing or inventory decision models
originating in the literature of operations research and management science.
Accounting researcher advances in these applications are hardly noteworthy
in the literature of operations research and management science or in
accounting practitioner journal citations.
No mention is made by the AAA Task Force of how the AICPA funded the
mathematical information economics study Cost
Determination: A Conceptual Approach, and then the AICPA refused
to publish and distanced itself from this study that was eventually picked
up by the Iowa State University Press
in1976. I've seen no evidence that this research had an impact on practice
even though it is widely cited in the accountics literature. The AICPA
apparently did not think it would be of interest to practitioners.
The same can be said of regression models used in forecasting. Business
firms do make extensive applications of regression and time series models in
forecasting, but this usage can be traced back to the economics, finance,
and statistics professors who developed these forecasting models. Impacts of
accounting professors on forecasting are not very noteworthy in terms of
accounting practice.
Non-Accountics Research
The most valid claims of impact of accounting academic research on practice
were not accountics research studies. For example, the balanced score card
research of Kaplan and colleagues is probably the best cited example of
accounting professor research impacting practice, but Bob Kaplan himself is
a long-time critic of resistance to publishing his research in TAR, JAR, and
JAE.
There are many areas where AIS professors interact closely with
practitioners who make use of their AIS professor software and systems
contributions, especially in the areas of internal control and systems
security. But most of this research is of the non-accountics and even
non-mathematical sort.
One disappointment for me in the AIS area is the academic research on
XBRL. It seems that most of the noteworthy creative advances in XBRL theory
and practice have come from practitioners rather than academics.
Impact of Academic Accountants on Tax Practice
Probably the best section of the AAA Task Force report cites links between
academic tax research and tax practice. Much of this was not accountics
research, but credit must be given its due when the studies having an impact
were accountics studies.
Although many sections of the AAA Task force report disappointed me, the
tax sections were not at all disappointing. I only wish the other sections
were of the same quality.
For me the AAA Task Force report is a disappointment except where noted
above. If we had conducted field research over the past three years that
focused on the A,B,C,D, or F grades practitioners would've given to academic
accounting research, my guess is that most practitioners would not even know
enough about most of this research to even assign a grade. Some of them may
have learned about some of this research when they were still taking courses
in college, but their interest in this research, in my opinion, headed south
immediately after they received their diplomas (unless they returned to
college for further academic studies).
One exception might be limited exposure to academic accounting research
given by professors who also teach CEP courses such as CEP courses in audit
sampling, tax, audit scorecard, ABC costing, and AIS. I did extensive
CEP teaching on the complicated topics of FAS 133 on accounting for
derivative financial instruments and hedging activities. However, most of my
academic research citations were in the areas of finance and economics since
there never has been much noteworthy research on FAS 133 in the accountics
literature.
Is there much demand for CEP courses on econometric modeling and capital
markets research?
Most practitioners who are really into valuation of business firms are
critical of the lack of relevance of Residual Income models and Free Cash
Flow models worshipped ad nauseum in the academic accounting research
literature.
An Excellent Presentation on the Flaws of Finance, Particularly the
Flaws of Financial Theorists
A recent topic on the AECM listserv concerns the limitations of
accounting standard setters and researchers when it comes to understanding
investors. One point that was not raised in the thread to date is that a lot
can be learned about investors from the top financial analysts of the world
--- their writings and their conferences.
The difference between physics versus finance models is that
physicists know the limitations of their models.
Another difference is that components (e.g., atoms) of a physics
model are not trying to game the system.
The more complicated the model in finance the more the analyst is
trying to substitute theory for experience.
There's a lot wrong with Value at Risk (VaR) models that regulators
ignored.
The assumption of market efficiency among regulators (such as Alan
Greenspan) was a huge mistake that led to excessively low interest rates
and bad behavior by banks and credit rating agencies.
Auditors succumbed to self-serving biases of favoring their clients
over public investors.
Banks were making huge gambles on other peoples' money.
Investors themselves ignored risk such as poisoned CDO risks when
they should've known better. I love his analogy of black swans on a
turkey farm.
Why don't we see surprises coming (five
excellent reasons given here)?
The only group of people who view the world realistically are the
clinically depressed.
Model builders should stop substituting
elegance for reality.
All financial theorists should be forced to
interact with practitioners.
Practitioners need to abandon the myth of optimality before the
fact.
Jensen Note
This also applies to abandoning the myth that we can set optimal
accounting standards.
In the long term fundamentals matter.
Don't get too bogged down in details at the expense of the big
picture.
Max Plank said science advances one funeral at a time.
The speaker then entertains questions from the audience (some are
very good).
James Montier is a very good speaker from England!
Mr. Montier is a member of GMO’s asset
allocation team. Prior to joining GMO in 2009, he was co-head of Global
Strategy at Société Générale. Mr. Montier is the author of several books
including Behavioural Investing: A Practitioner’s Guide to Applying
Behavioural Finance; Value Investing: Tools and Techniques for
Intelligent Investment; and The Little Book of Behavioural Investing.
Mr. Montier is a visiting fellow at the University of Durham and a
fellow of the Royal Society of Arts. He holds a B.A. in Economics from
Portsmouth University and an M.Sc. in Economics from Warwick University
http://www.gmo.com/america/about/people/_departments/assetallocation.htm
There's a lot of useful information in this talk for accountics
scientists.
Tribute to Bob Anthony from Jake Birnberg and Bob Jensen and Others
Bob Anthony is probably best known as an extremely successful accounting
textbook author ---
http://www.amazon.com/Robert-N.-Anthony/e/B001IGJT5W
But there were many other career highlights of the great professor and my
personal friend.
By any measure, Robert Newton Anthony
(1916–2006) was a giant among 20th century academic accountants. After
obtaining a Bachelor’s degree from Colby College, he matriculated to the
Harvard Business School (HBS), where he earned his M.B.A. and D.B.A.
degrees. Bob spent his entire academic career at HBS, retiring in 1983.
He is best known as a prolific writer of articles, textbooks, and
research reports. He was inducted as a member of the Accounting Hall of
Fame (1986), was a recipient of the American Accounting Association’s
(AAA) Outstanding Accounting Educator Award (1989), and then was the
second recipient of the AAA Management Accounting Section’s Lifetime
Contribution to Management Accounting Award (2003), as well as serving
as President of the American Accounting Association (1973–1974). In
addition, he was elected a Fellow of the Academy of Management (1970).
These honors indicate that he was, indeed, a significant contributor to
the development of his chosen field of management accounting for over 50
years, and highly respected by his peers. They do not indicate why. My
intention is to answer that question.
Bob Anthony was the ideal person to be a leader
in the post-World War II movement that changed cost accounting into
management accounting. He possessed broad interests and not only was an
academic, but also was interested in solving problems found in the real
world. He was equally comfortable working as an academic and as a
manager. He served as Under Secretary (Comptroller) in the Department of
Defense for his old friend and fellow Harvard Business School graduate,
Robert S. McNamara, from 1965 to 1968. While at the Department, Anthony
earned the Defense Department Award for Public Service for developing a
system of cost management and control for the Department (Harvard
University Gazette 2006)...
Continued in article
Jensen Comment
The takeover of the academic accounting research by accountics scientists
was fought off in the 1920s but commenced again in earnest in the 1960s as
documented by Heck and Jensen along a timeline at
http://faculty.trinity.edu/rjensen/395wpTAR/Web/TAR395wp.htm
"We
fervently hope that the research pendulum will soon swing back from the
narrow lines of inquiry that dominate today's leading journals to a
rediscovery of the richness of what accounting research can be. For that to
occur, deans and the current generation of academic accountants must
give it a push."
"Research on Accounting Should Learn From the Past,"
by Michael H. Granof and Stephen A. Zeff , Chronicle of Higher
Education, March 21, 2008
http://www.trinity.edu/rjensen/TheoryTAR.htm#Appendix01
Although it's common among various recent Presidents of the American
Accounting Association (e.g.,
Judy Rayburn and
Greg Waymire) and AAA Presidential Address Scholars, e.g., Tony Hopwood
("Whither Accounting Research?" The
Accounting Review 82(5), 2007, pp.1365-1374
)and Bob Kaplan (Accounting Scholarship that Advances
Professional Knowledge and Practice," The Accounting Review, March
2011, Volume 86, Issue 2) , perhaps the earliest and most scathing
lament accountics scientist takeover of AACSB doctoral programs and the top
tier academic accounting research journals came from former AAA President
Bob Anthony in his1989 AAA membership as that years Outstanding
Educator Award recipient. This was an oral address, and I don't think there
is any record of Bob's scathing lament in front of the AAA membership. Nor
is there a record to my knowledge of the subsequent lament on the same
matters by AAA's 1990 President Al Arens year later.
In some ways I was a guinea pig for Bob Anthony. In the late 1960s and
into the 1990s, Bob lacked the mathematical background to understand the
exploding interest by accounting researchers in accountics, particularly
mathematical programming, management science, decision science, and
operations research in the years that Herb Simon were achieving worldwide
fame at Carnegie-Mellon University that in some ways was leaving venerable
old Harvard in the dust. Bob Anthony followed my career as an accounting PhD
graduate from Stanford who had been teaching mathematical programming at
Michigan State University and the University of Maine. Bill Kinney and Bob
May and other accounting doctoral candidates at MSU in the late 1960s
probably recall my mathematical programming doctoral seminars.
Bob Anthony invited me to make accountics science presentations at the
Harvard Business School and at an alumni-day programs that he organized for
his Colby College alma mater following my seven TAR publications 1967-1979
---
http://maaw.info/TheAccountingReview2.htm
I remember that he was particularly skeptical of my praise of shadow
pricing in linear programming, which was also at the core of a doctoral
thesis by Joel Demski in those days. I was always careful to point out the
limitations of mathematical programming when solutions spaces were not
convex. But Bob Anthony had a deeper suspicion, which he had trouble
articulating in those days, that accounting information played a vital role
in systems that were too complex and too non-stationary to model in the real
world, especially model to a point where we could declare solutions
"optimal" for the real and ever-changing world of complicated human beings
and their organizations. Anthony Hopwood built upon this same theme when he
founded a successful journal called Accounting, Organizations, and
Society (AOS).
It's not that Bob Anthony opposed our accountics science research. What
he opposed is accountics science (read that positivism) takeover of
the doctoral programs and academic research journals. What he felt down deep
that accountics science was just too easy. We could build our analytical
models and devise "optimal" solutions without having to set foot from the
campus into a real world. We could build ever-increasingly sophisticated
data analysis models using the CRSP and Compustat database without having to
sweat buckets collecting financial data first-hand in the real world. We
could conduct accounting behavioral research models pretending that student
subjects were adequate surrogates making pretend that they were real-world
managers and accountants.
I suspect that Bob Anthony followed Bob Kaplan's career with great
interest. In those early years, Bob Kaplan was an accountics faculty member
and eventually Dean at Carnie-Mellon in the years that Professor and Dean
Kaplan was heavy into mathematics and decision science. Then Bob Kaplan
became more interested in the real world and eventually traveled between
Harvard and Carnegie as a joint accounting professor. I suspect Bob Anthony
influenced Bob Kaplan into taking up more and more case-method research and
the eventual decision of Kaplan to become a full-time accounting professor
at Harvard (the case method school in those days) in place of
Carnegie-Mellon (the quantitative-methods school in those days). Of course
in recent years the difference between the Harvard versus Carnegie schools
is not demarked so clearly as it was in the 1970s.
In any case Bob Anthony and I corresponded intermittently throughout most
of my career. He was particularly pleased when I became more and more
skeptical of the accountics science takeover of accounting doctoral programs
and top-tier academic accounting research journals. Once again, however, I
stress that it was not so much that we were disappointed in accountics
science that was becoming increasingly sophisticated and respectable. Rather
Bob Anthony, Bob Kaplan, and Bob Jensen along with Bob Sterling, Paul
Williams, Anthony Hopwood, and others became increasingly disturbed about
the takeover by Zimmerman and Watts and their positivism disciples. In those
same years Demski and Feltham were rewriting the quantitative information
economics standards of what constitutes scholarly research in accounting.
The following
appeared on Boston.com:
Headline: Robert Anthony; reshaped Pentagon budget process
Date: December 20,
2006
"At the behest of
Robert S. McNamara, his longtime friend, Robert N.Anthony set aside
scholarly pursuits at Harvard Business School in the mid-1960s to
take a key role reshaping the budget process for the Defense
Department."
Thank you! Bob
has been a longtime great friend. His obituary is at
http://www.hbs.edu/news/120506_anthonyobit.html
What is really amazing is the wide range of long-time service to at
very high levels, including serving on the FASB as well as being
Defense Department's Assistant Secretary (Comptroller) during the
Viet Nam War. He also received the Defense Department's Medal for
Distinguished Public Service. The FASB requested that Bob focus on
accounting for nonprofit organizations. He also served as President
of the American Accounting Association.
I
don't know if you were present when Bob Anthony gave his 1989
Outstanding Educator Award Address to the American Accounting
Association. It was one of the harshest indictments I've ever heard
concerning the sad state of academic research in serving the
accounting profession. Bob never held back on his punches.
Bob Jensen
December 20, 2006 reply from Denny Beresford
[DBeresfo@TERRY.UGA.EDU]
(Denny was Chairman of the FASB when Bob was a special consultant to the
FASB)
Bob,
Yesterday's New York Times also included an
obituary for Bob Anthony . . . Bob wasn't the easiest person to get
along with, but I considered him to be one of the very brightest
people I ever associated with. He was a wonderful writer and I
always enjoyed the letters and other things he sent me at the FASB
and later - even when I disagreed completely with his ideas. His
work with the government made him one of the most generally
influential accountants of the 20th century, I believe.
Denny
His accounting concepts ranged from the
global to the provincial. In a 1970 letter to The New York Times, he
proposed that the United States create a tax surcharge to cover damages
to the Soviet Union in the event of an accidental American nuclear
strike. The tax burden would be “the smallest consequence of maintaining
a nuclear arsenal,” he wrote. “An all-out nuclear exchange would
probably mean the end of civilization.” In the late 1980s, Professor
Anthony moved to Waterville Valley, N.H., where for 10 years he was the
town’s elected auditor. “I got 24 votes last year; that’s all there
were,” he once said.
<http://www.nytimes.com/pages/business/index.html>
Added Jensen Comment
I often suspected that Bob Anthony's 1980s move to New Hampshire (that
created an extremely long commute to Cambridge, Taxachusetts) was motivated
in large part by the huge financial successes of his book royalties. I would
not blame him for this move since there's nothing criminal or immoral about
taking advantage of tax law opportunities. Then again he may simply wanted
to be closer to our mountains and forests ---
http://faculty.trinity.edu/rjensen/Pictures.htm
Jensen Comment
Note that this site includes a long listing of research in accounting,
finance, and economics, much of it based on positivism and financial
markets.
Rankings of Accountics Science Researchers
It's only slightly misleading to call the Pickerd (2011) et al. accountics
science researcher rankings (see below). There are a small percentage of
non-accountics research articles included in the thousands of articles in
the 11 journals in this study's database, but these these were apparently
insignificant since Table 2 of the study is limited to three accountics
science research methods. In Table 2 only three
research methods are recognized in the study --- Analytical, Archival, and
Experimental. Accounting Information Systems (AIS) does not fit
neatly into the realm of accountics science. The authors mention that there
are "Other" occasional non-accountics and non-AIS articles published in the
11 journals of the database, but these are totally ignored as "research
methods" in Table 2 of the study.
The top-ranked academic accounting researchers listed in the tables of
this study are all noted for their mathematics and statistical writings.
The articles in the rankings database were published over two recent
decades in 11 leading academic accounting research journals.
The "Top Six" Journals
The Accounting Review (TAR),
Journal of Accounting Research (JAR),
Journal of Accounting and Economics (JAE),
Contemporary Accounting Research (CAR),
Review of Accounting Studies (RAST),
Accounting, Organizations and Society (AOS).
Other Journals in the
Rankings Database Auditing: A Journal of Practice & Theory (Auditing),
Journal of the American Taxation Association (JATA),
Journal of Management Accounting Research (JMAR),
Journal of Information Systems (JIS),
Behavioral Research in Accounting (BRIA).
Probably the most telling bias of the study is the
bias against normative, case method, and field study accountancy research.
In fact only three methods are recognized as "research methods" in Table 2
--- Analytical, Archival, and Experimental. For example, the best known and
most widely published accounting case method researcher is arguably Robert
Kaplan of Harvard University. Kaplan is not even listed among the hundreds
of accountics scientists ranked in Table 1 (Topical Areas) of this this
study although he was, before 1990, a very noted accountics researcher who
shifted more into case and field research. Nor is the famous accounting case
researcher Robin Cooper mentioned in the study. For years both Kaplan and
Cooper have complained about how the top accountics science journals like
TAR discourage non-accountics science submissions
"Accounting Scholarship that Advances Professional Knowledge and Practice,"
The Accounting Review, March 2011, Volume 86, Issue 2,
Also see
http://www.trinity.edu/rjensen/TheoryTAR.htm
What is not clear is what the Pickerd (2011) et al. authors did
with non-accountics articles in Table 1 (Topics) versus Table 2 (Methods).
These articles were obviously not included in Table
2 (Methods) . But were their non-accountics study authors included in Table
1 (Topics)? My guess is that they were included in Table 1. Other
than for AIS, I could be wrong on this with respect to Table 1. In any case,
the number of non-accountics articles available for the database is
extremely small relative to the thousands of accountics science articles in
the database. Except in the area of AIS in Table 1, this is an accountics
scientist set of rankings.
ABSTRACT: This paper ranks individual accounting researchers based on their research productivity in the most recent six, 12, and 20 years. We extend
prior individual faculty rankings by providing separate individual faculty research rankings for each topical area commonly published in accounting journals
(accounting information systems [AIS], audit, financial, managerial, and tax). In addition, we provide individual faculty research rankings for each research
methodology commonly used by accounting researchers (analytical, archival, and experimental). These findings will be of interest to potential doctoral students
and current faculty, as well as accounting department, business school, and university administrators as they make decisions based on individual faculty members’ research productivity.
When reading the rankings the following coding is used in the cells:
Table 1 presents the top 100-ranked accounting
researchers by topical area based on publication counts in the selected
accounting journals. In the tables, the first number reported is the
ranking that does not take into account coauthorship; the second
reported number (after the *) is the ranking if authors receive only
partial credit for coauthored work. The table shows the author rank
based on article counts over the entire sample period of the study (20
years), as well as ranks based on the number of articles published in
selected journals over the past 12-year and six-year windows. Even
though specialization is common in accounting research, it is
interesting to note that some professors publish widely in a variety of
topical areas.
In other words, Jane Doe (3*32) means that Jane ranks 3 in terms of
authorship of articles in a category but has a lower rank of 32 if the
rankings are adjusted for joint authorship partial credit.
It should also be noted that authors are listed on the basis of the
20-year window.
One of the most noteworthy findings in this study, in my viewpoint, is
the tendency for most (certainly not all) leading academic researchers to
publish research more frequently in the earliest years of their careers
(especially before earning tenure) relative to later years in their careers.
Here are the top two winners in each category:
Table 1, Panel A: AIS
Author
6-Year (2004–2009) 12-Year (1998–2009) 20-Year (1990–2009)
Hunton, James E., Bentley University 1
*1 1 *1
1 *1
Murthy, Uday S., University of South Florida 10
*35 8 *4
2 *3
Table 1, Panel B: Audit
Author
6-Year (2004–2009) 12-Year (1998–2009) 20-Year (1990–2009)
Raghunandan, K., Florida International U. 1
*4 1 *2
1 *3
Wright, Arnold M., Northeastern University 7
*9 5 *5
1 *2
Table 1, Panel C: Financial
Author
6-Year (2004–2009) 12-Year (1998–2009) 20-Year (1990–2009)
Barth, Mary E., Stanford University 60
*159 2 *8
1 *2
Francis, Jennifer, Duke University 6
*26 3 *13
2 *5
What is interesting is to note how poorly some of these universities do
in the Pickerd (2011) rankings of their individual faculty members. Some
like Stanford and Duke do quite well in the Pickerd rankings, but many other
highly ranked accountics science programs in the above the list do much
worse than I would've expected. This suggests that some programs are ranked
high on the basis of numbers of accountics scientists more than the
publishing frequency of any one resident scientist. For example, the
individual faculty members at Chicago, the University of Illinois, Wharton
(Pennsylvania), and Harvard don't tend to rank highly in the Pickerd
rankings.
Ignoring the Accountics Science Controversies
Pickerd (2011) et al. make no mention of the limitations and heated
controversies concerning accountics science and the fact that one of the
journals (AOS) among the 11 in the database (as well as AOS's founder and
long-time editor) is largely devoted to criticism of accountics science.
"Whither Accounting Research?" by Anthony G. Hopwood The
Accounting Review 82(5), 2007, pp.1365-1374
Organizations like the American Accounting
Association also have a role to play, not least with respect to their
presence in the field of scholarly publication. For the American
Accounting Association, I would say that now is the time for it to adopt
a leadership role in the publication of accounting research. Not only
should every effort be made to encourage The Accounting Review to
embrace the new, the innovative, what accounting research might be in
the process of becoming, and new interdisciplinary perspectives, but
this should also be done in a way that provides both a catalyst and a
model for other journals of influence. For they need encouragement, too.
While the Association has done much to embrace the need for a diversity
of gender and race, so far it has done relatively little to invest in
intellectual diversity, even though this is not only of value in its own
terms, but also an important generator of innovation and intellectual
progress. I, at least, would see this as appropriate for a learned
society in the modern era. The American Accounting Association should
set itself the objective of becoming an exemplar of intellectual
openness and thereby innovation.
"The Absence of Dissent," by Joni J.
Young, Accounting and the Public Interest 9 (1), 2009 ---
Click Here
At the forthcoming American
Accounting Association (AAA) annual meetings in Washington DC this year on
August 7, two new distinguished scholars will be inducted into the
Accounting Hall of Fame.
I don't know if you've seen the
news yet, but Bob Kaplan and Bob Sterling will be this year's inductees to
the Accounting Hall of Fame.
Denny
June
23, 2006 reply from Bob Jensen
Hi
Denny,
Thanks for the update. Both Bob and Bob are more than worthy of this honor.
Both accountancy professors have very distinguished teaching and research
accomplishments. Although I do not want to detract from those most
noteworthy accomplishments, I cannot resist this opportunity to point out
that both Bob Sterling and Bob Kaplan are failed critics of the hijacking
of the leading academic accounting research journals by the Accountics/Positivist
Establishment. However, both of these scholars took vastly different
approaches in their efforts to maintain diversity of research methods and
topics in the leading research journals.
The
Accountics/Positivist Establishment virtually ignored both Sterling and
Kaplan!
The
following quotations appear in the following two documents:
An "Appeal" for accounting
educators, researchers, and practitioners to actively support what I call The Accounting Review (TAR)
Diversity Initiative as initiated by American Accounting Association
President Judy Rayburn ---
http://faculty.trinity.edu/rjensen/395wpTAR/Web/TAR.htm
Accountics is the mathematical science of (accounting)
values. Charles Sprague
(1887) as quoted by McMillan (2003, 1)
As far as the laws of mathematics refer to reality, they are not
certain; and as far as they are certain, they do not refer to
reality.
Albert Einstein
PG. #390
NONAKA
The chapter argues that building theory of knowledge
creation needs to an epistemological and ontological discussion,
instead of just relying on a positivist approach, which has been
the implicit paradigm of social science.
The positivist rationality has become identified with analytical
thinking that focuses on generating and testing hypotheses
through formal logic. While providing a clear guideline for
theory building and empirical examinations, it poses problems
for the investigation of complex and dynamic social phenomena,
such as knowledge creation. In positivist-based research,
knowledge is still often treated as an exogenous variable or
distraction against linear economic rationale. The relative lack
of alternative conceptualization has meant that management
science has slowly been detached from the surrounding societal
reality. The understanding of social systems cannot be based
entirely on natural scientific facts. Ikujiro Nonaka as
quoted at Great Minds in
Management: The Process of Theory Development ---
http://faculty.trinity.edu/rjensen//theory/00overview/GreatMinds.htm
Blast from the Past on the Rochester School of Accounting
"The methodology of positive accounting," by C
Christensen, The Accounting Review (January 1983): 1-22. (JSTOR
link).
Abstract
Michael Jensen, Watts, and Zimmerman (referred to hereafter, following
Jensen (1976), as "the Rochester School of Accounting,") have charged that
most accounting theories are "unscientific" because they are normative. They
advocate the development of "positive" theories to explain actual accounting
practice. The program of the Rochester School raises a number of
methodological issues that are addressed in this article. First it is argued
that the Rochester School's criticism of traditional accounting theory is
off the mark because of the failure to distinguish between two different
levels of phenomena.
Second it is artued that the concept of "positive"
theory is based on the misconception (derived from nineteenth entruiry
positivism) that empirical science is conceived solely with the actual, with
"what is." Empirical theories, it is shown, are negative in their import;
they state what is taken to be empirically possible.
Third, it is shown that "negative" theories of the
sort described in this article are exactly what is needed in the
predictive, explanatory, and normative reasoning. Finally, it is argued that
the standards advocated by the Rochester School for the appraisal of their
own theories are so weak that those fail to satisfy Popper's (1959) proposal
for demarking science from metaphysics.
July 28, 2011 reply from Dan Stone
The mystery to me is why, given that positivist
science is known to stand on a house of cards, that it is embraced as
"real" science to the exclusion of other, equally valid (or invalid)
paradigms in TAR, JAR, JAE. Me thinks that somehow, to the accountant
turned professor mind, positivist science looks real whereas the
alternatives are somehow soft and fuzzy.
And so, I suppose I am offering a
theory-of-mind of the accountant-turned professor and of why the
accountant-turned-professor buys the utter nonsense that only positivist
science is real science. For the record, the top journals in other
business disciplines do NOT have this wack-job belief that only
positivist science is real and valid.
Dan Stone
Jensen Comment
Also note the spate of negativism from other philosophy scholars (e.g., Bob
Sterling, Paul Williams, Tony Tinker, Anthony Hopwood, and others) about
positivism that commenced to dominate research articles accepted by leading
academic accounting research journals and doctoral programs. Accountics research
rooted in the Rochester School of Accounting is now deemed a failure by me and
others even though it persists in our leading R1 accounting research
universities.
Note especially the conclusion (on Page 20) of Christensen's article that
asserts that the Rochester School of Accounting should follow the advice of Sir
Isaac Newton.
Jensen Comment
Note that this site includes a long listing of research in accounting,
finance, and economics, much of it based on positivism and financial
markets.
Bob
Sterling is rooted in economics and philosophy. He, like Tony Tinker,
Barbara Marino, and Paul Williams, relied upon his roots in philosophy to
attack the positivists from the standpoint of misinterpretation of the
writings of Karl Popper ---
http://en.wikipedia.org/wiki/Karl_Popper
Sterling wrote the following in "Positive Accounting: An
Assessment," Abacus, Volume
26, Issue 2, September 1990:
*********Begin Quote
Positive accounting theory, using the book of the same name by Watts and
Zimmerman (1986) as the primary source of information about that theory, is
subjected to scrutiny. The two pillars — (a) value-free study of (b)
accounting practices — upon which the legitimacy of that theory are said to
rest (and the absence of which is said to make other theories illegitimate)
are found to be insubstantial. The claim that authorities — economic and
scientific — support the type of theory espoused is found to be mistaken.
The accomplishments — actual and potential — of positive theory are found to
have been nil, and are projected to continue to be nil. Based on these
findings, the recommendation is to classify positive accounting theory as a
'cottage industry' at the periphery of accounting thought and reject its
attempt to take centre stage by radically redefining the fundamental
question of accounting.
*********End Quote
I
might add that the above critique would've had zero chance of being
published in The Accounting Review
(TAR) or other leading U.S. accounting research journals. Professor Sterling
always wrote with interesting and simple analogies. He stated that if
anthropology research was limited to positivism, then the only research
would be the study of anthropologists rather than anthropology.
In
some ways, Bob Kaplan is the more interesting critic of the hijacking of
academic accounting research by the Accountics/Positivist Establishment.
This is because Professor Kaplan built his early reputation, while full time
at Carnegie-Mellon University, as an accountics expert in mathematical model
building. Later, after he took on joint appointments at Carnegie and the
Harvard Business School, he became more involved in case method research.
Now he's best noted as a case method researcher since moving full time to
Harvard.
In
1986 Steve Zeff was President of the AAA. I had the honor of being appointed
by Steve as Program Director for the 1986 AAA annual meetings in Times
Square in NYC. I persuaded Bob Kaplan and Joel Demski to share a plenary
session in debate of the hijacking of the leading academic accounting
research journals by the Accountics/Positivist Establishment (although since
the early 1900s the term "accountics" was no longer used in accounting in
favor of the term "analytics").
Bob
Kaplan's 1986 presentation lamented the fact that researchers using the case
method could no longer get their research published in TAR or other leading
accounting research journals. He also lamented that innovations generally
had their seminal roots in discoveries of practitioners rather than
researchers publishing in the leading academic accounting research journals.
Whereas practitioners once took a keen interest in academic accounting
research, this interest waned to almost nothing.
Joel
Demski's presentation defended mathematical model building and analysis as
the cornerstone of accounting as a a pure "academic discipline." I would not
describe Joel as an evangelist of positivism relative to the extremes of
Watts and Zimmerman. Joel typically has had less to say about positivism
than he has about mathematical model building and economic information
theory applied to accountancy. In this regard I would describe Joel as an
ardent defender of accountics. Joel admitted in 1986 that it was very
difficult to pinpoint discoveries in academe that were noteworthy in the
practicing profession. However, he claimed that this was not a leading
purpose of academic accounting research.
Joel Demski
steers us away from the clinical side of the accountancy profession by
saying we should avoid that pesky “vocational virus.” (See below).
The (Random House) dictionary defines "academic"
as "pertaining to areas of study that are not primarily vocational or
applied , as the humanities or pure mathematics." Clearly, the short answer
to the question is no, accounting is not an academic discipline. Joel Demski, "Is Accounting an Academic Discipline?" Accounting
Horizons, June 2007, pp. 153-157
Statistically there are a few youngsters who
came to academia for the joy of learning, who are yet relatively untainted
by the vocational virus.
I urge you to nurture your taste for learning, to follow your joy. That is
the path of scholarship, and it is the only one with any possibility of
turning us back toward the academy. Joel Demski, "Is Accounting an Academic Discipline? American
Accounting Association Plenary Session" August 9, 2006 ---
http://faculty.trinity.edu/rjensen//theory/00overview/theory01.htm
Too many
accountancy doctoral programs have immunized themselves against the
“vocational virus.” The problem lies not in requiring doctoral degrees in
our leading colleges and universities. The problem is that we’ve been
neglecting the clinical needs of our profession. Perhaps the real underlying
reason is that our clinical problems are so immense that academic
accountants quake in fear of having to make contributions to the clinical
side of accountancy as opposed to the clinical side of finance, economics,
and psychology.
Our problems with doctoral programs in accountancy are shared with other
disciplines, notably education and nursing schools.
Bob Jensen's threads on controversies in higher education are at
http://faculty.trinity.edu/rjensen/HigherEdControversies.htm
Ohio
State University became one of the leading accountics/positivsim research
centers. Under the noteworthy leadership of Tom Burns, OSU became one of the
first major universities to drop traditional accounting courses from its
doctoral programs in favor of sending students outside the College of
Business to take graduate courses in mathematics, statistics, econometrics,
psychometrics, and sociometrics. In this context, it is a pleasure that
leaders at OSU, in conjunction with the outside Accounting Hall of Fame
nominating committee members, sees fit this year to honor two ardent critics
of the Accountics/Positivist Establishment.
Hopefully some of you will
heed my current "Appeal" for accounting educators, researchers, and
practitioners to actively support what I call The Accounting Review (TAR)
Diversity Initiative as initiated by American Accounting Association
President Judy Rayburn ---
http://faculty.trinity.edu/rjensen/395wpTAR/Web/TAR.htm
Why doesn't anybody ask the obvious question
that, since the Federal government now owns 80% of AIG, the taxation of AIG
is in a sense an intra-company transfer payment?
Setting AIG in the IRS's sights is not quite
the same as aiming at General Electric's tax shelters.
I don't think Watts and Zimmerman ever
envisioned such government ownership complications of positive accounting
theory. Shooting at AIG with the right hand is a little like shooting off
80% of the left hand.
From The Wall Street Journal Accounting Weekly Review on March 27, 2009
SUMMARY: Watts
and Zimmerman, in making arguments know under the general
heading as "positive accounting theory," express the notion
that large sized companies tend to choose certain accounting
policies and practices because they become noticed by
government regulators. Such seems to be the problem for AIG
who may not have chosen conservatively in structuring deals
with foreign entities to generate foreign tax credit
benefits. The article describes an example of structuring an
offshore AIG subsidiary, which obtains financing from a
foreign bank and generates interest income by loaning the
funds to another AIG subsidiary. AIG then can deduct the
interest payments to reduce U.S. taxes. However, the foreign
bank receives ownership in the first subsidiary as
collateral for the loan and "overseas tax authorities treat
the offshore AIG subsidiary as being owned by the foreign
bank..." resulting in the interest payments from AIG being
"treated as intracompany dividends...and exempt from foreign
tax."
CLASSROOM
APPLICATION: The business purpose test for structured
transactions is the basis for challenging the AIG offshore
entities developed by the unit that paid the bonuses
generating taxpayer and lawmaker outrage. The article also
refers to disclosure of challenges to tax positions required
under FASB Interpretation No. 48.
QUESTIONS:
1. (Introductory) Summarize one example transaction
in which AIG structured an entity to generate a foreign tax
credit.
2. (Introductory) What business benefit helped to
generate profits from the foreign subsidiaries established
by AIG?
3. (Advanced) Why may the IRS challenge these
structured transactions? In your answer, comment on the
business purpose for establishing these entities and explain
the importance of that notion of business purpose.
4. (Advanced) "In a securities filing, AIG said it
expects the IRS to challenge tax benefits from several other
transactions." Why must such a disclosure be made in a
securities filing?
Reviewed By: Judy Beckman, University of Rhode Island
Some of the same banks that got
government-funded payouts to settle contracts with American
International Group Inc. also turned to the insurer for help cutting
their income taxes in the U.S. and Europe, according to court records
and people familiar with the business.
The Internal Revenue Service is challenging
some of the tax deals structured by AIG Financial Products Corp., the
same unit of the New York company that has caused political ire over
$165 million in employee bonuses.
The company paid $61 million last year in
disputed taxes stemming from the deals but sued the U.S. government last
month in federal court in New York, seeking a refund, according to
filings in the case.
Banks that worked with AIG on tax deals include
Crédit Agricole SA of France, Bank of Ireland and Bank of America Corp.,
according to AIG's lawsuit. The banks declined to comment.
In general, AIG's tax deals permitted U.S.
companies and foreign banks to effectively claim credit in their home
country for a single tax payment, partly through the use of an offshore
AIG subsidiary. In its lawsuit against the government, the insurer said
it was told by the IRS that AIG hadn't shown that the transactions "had
sufficient economic substance and business purpose" to justify tax
benefits. The IRS declined to comment.
The tax-structuring operation started by AIG in
the 1990s was even bigger than AIG's credit-default-swaps business,
according to a person familiar with the matter.
An AIG spokesman declined to discuss the
tax-cutting transactions in detail but asserted that the tax benefits
were proper and justified. AIG wants to "ensure that it is not required
to pay more than its fair share of taxes," a company spokeswoman said.
More AIG Workers to Return $50 Million of
BonusesWealth: Bus Tours of the Rich and InfamousSoros: Credit Default
Swaps Need Stricter RegulationDefenders of these arrangements say that
taking advantage of differences between tax laws in the U.S. and
overseas is simply smart business, arguing that the deals weren't
explicitly prohibited by IRS regulations at the time.
New versions of these foreign-tax-credit deals
effectively stopped in 2007 after the IRS proposed regulations to end
them. The agency has formed a special team of agents and attorneys to
examine such transactions. AIG wound down its tax unit last year
following the proposed regulations.
Cross-border tax transactions are drawing
increased scrutiny from U.S. and European tax officials, who are seeking
to limit deals that help firms to play one nation's tax laws against
another. This month, U.K. tax authorities said they were reviewing
documents that show how Barclays PLC structured offshore deals for
clients.
Last week, IRS Commissioner Douglas Shulman
told the Senate Finance Committee that the agency is "aggressively
pursuing" so-called "foreign tax-credit generators." Those are the sort
of deals that the IRS is challenging at AIG, court records in two cases
show.
Mr. Shulman didn't identify specific companies,
though such a transaction "really perverts the foreign tax credit," he
said.
The foreign-tax-credit transactions took
numerous forms. In one version, an offshore AIG subsidiary would borrow
money from an overseas bank and also earn investment income overseas.
The AIG unit would pay foreign taxes on that investment income and earn
a foreign tax credit in the U.S., according to court records involving
companies using these deals that have been challenged by the IRS and
people who have worked on such deals.
Another AIG unit would then pay interest to the
foreign bank, deducting those payments from its U.S. taxes. Meanwhile,
the foreign bank was exempt from tax on that interest because overseas
tax authorities treated the bank as simultaneously owning the AIG
subsidiary. That effectively gave the foreign bank credit for taxes paid
by the AIG subsidiary.
Because the foreign bank got a tax exemption
overseas, it could charge lower interest costs on the cash loaned to
AIG, according to people familiar with the transactions.
AIG helped set up a complex transaction for
France's Crédit Agricole in the late 1990s that generated roughly $17.8
million in tax savings for AIG and unspecified tax savings for Crédit
Agricole, according to court filings by AIG in its suit against the IRS.
The bank declined to comment.
Last year, Crédit Agricole's Calyon
investment-banking unit got $3.3 billion in payouts as part of the U.S.
government's rescue of AIG.
"If people are going to get taxpayer money,
then there definitely should be a measure of corporate social
responsibility, to put it bluntly," said Reuven S. Avi-Yonah, a former
corporate tax attorney who is director of the international tax program
at the University of Michigan's law school.
Continued in article
Question
What is the new concept of phronesis in the context of accounting research?
SYNOPSIS:
We describe case study research
and explain its value for developing theory and informing practice.
While recognizing the complementary nature of many research methods, we
stress the benefits of case studies for understanding situations of
uncertainty, instability, uniqueness, and value conflict. We introduce
the concept of phronesis—the analysis of what actions are practical and
rational in a specific context— and indicate the value of case studies
for developing, and reflecting on, professional knowledge. Examples of
case study research in managerial accounting, auditing, and financial
accounting illustrate the strengths of case studies for theory
development and their potential for generating new knowledge. We
conclude by disputing common misconceptions about case study research
and suggesting how barriers to case study research may be overcome,
which we believe is an important step in making accounting research more
relevant.
Jensen Comment
In 1986 Steve Zeff was President of the AAA. I had the honor of
being appointed by Steve as Program Director for the 1986 AAA annual
meetings in Times Square in NYC. I persuaded Bob Kaplan and Joel
Demski to share a plenary session in debate of the hijacking of the
leading academic accounting research journals by the Accountics/Positivist
Establishment (although since the early 1900s the term "accountics"
was no longer used in accounting in favor of the term "analytics").
Bob Kaplan's 1986 presentation
lamented the fact that researchers using the case method could no
longer get their research published in TAR or other leading
accounting research journals. He also lamented that innovations
generally had their seminal roots in discoveries of practitioners
rather than researchers publishing in the leading academic
accounting research journals. Whereas practitioners once took a keen
interest in academic accounting research, this interest waned to
almost nothing.
Joel Demski's presentation defended
mathematical model building and analysis as the cornerstone of
accounting as a a pure "academic discipline." I would not describe
Joel as an evangelist of positivism relative to the extremes of
Watts and Zimmerman. Joel typically has had less to say about
positivism than he has about mathematical model building and
economic information theory applied to accountancy. In this regard I
would describe Joel as an ardent defender of accountics. Joel
admitted in 1986 that it was very difficult to pinpoint discoveries
in academe that were noteworthy in the practicing profession.
However, he claimed that this was not a leading purpose of academic
accounting research.
Joel
Demski steers us away from the clinical side of the accountancy
profession by saying we should avoid that pesky “vocational virus.”
(See below).
The (Random House) dictionary defines
"academic" as "pertaining to areas of study that are not primarily
vocational or applied , as the humanities or pure mathematics."
Clearly, the short answer to the question is no, accounting is not
an academic discipline. Joel Demski, "Is Accounting an Academic Discipline?"
Accounting Horizons, June 2007, pp. 153-157
Faculty interest in a
professor’s “academic” research may be greater for a number of
reasons. Academic research fits into a methodology that other
professors like to hear about and critique. Since academic
accounting and finance journals are methodology driven, there is
potential benefit from being inspired to conduct a follow up study
using the same or similar methods. In contrast, practitioners are
more apt to look at relevant (big) problems for which there are no
research methods accepted by the top journals.
Accounting Research Farmers Are More Interested in Their Tractors
Than in Their Harvests
For a long time I’ve argued
that top accounting research journals are just not interested in the
relevance of their findings (except in the areas of tax and AIS). If
the journals were primarily interested in the findings themselves,
they would abandon their policies about not publishing replications
of published research findings. If accounting researchers were more
interested in relevance, they would conduct more replication
studies. In countless instances in our top accounting research
journals, the findings themselves just aren’t interesting enough to
replicate. This is something that I attacked at
http://faculty.trinity.edu/rjensen/book02q4.htm#Replication
At one point back in the
1980s there was a chance for accounting programs that were becoming
“Schools of Accountancy” to become more like law schools and to have
their elite professors become more closely aligned with the legal
profession. Law schools and top law journals are less concerned
about science than they are about case methodology driven by the
practice of law. But the elite professors of accounting who already
had vested interest in scientific methodology (e.g., positivism) and
analytical modeling beat down case methodology. I once heard Bob
Kaplan say to an audience that no elite accounting research journal
would publish his case research. Science methodologies work great in
the natural sciences. They are problematic in the psychology and
sociology. They are even more problematic in the professions of
accounting, law, journalism/communications, and political “science.”
We often criticize
practitioners for ignoring academic research Maybe they are just
being smart. I chuckle when I see our heroes in the mathematical
theories of economics and finance winning prizes for knocking down
theories that were granted earlier prizes (including Nobel prices).
The Beta model was the basis for thousands of academic studies, and
now the Beta model is a fallen icon. Fama got prizes for showing
that capital markets were efficient and then more prizes for showing
they were not so “efficient.” In the meantime, investment bankers,
stock traders, and mutual funds were just ripping off investors. For
a long time, elite accounting researchers could find no “empirical
evidence” of widespread earnings management. All they had to do was
look up from the computers where their heads were buried.
Few, if any, of the elite
“academic” researchers were investigating the dire corruption of the
markets themselves that rendered many of the published empirical
findings useless.
Academic researchers
worship at the feet of Penman and do not even recognize the name of
Frank Partnoy or Jim Copeland.
Bob Jensen
Apparently Cooper and Morgan in 2008 are trying to
infect us with the pesky vocational virus as well as lending value to
research with sample sizes of one that Zimmerman and other positivists
would not accept as legitimate accounting research from Kaplan or
anybody else.
The case study approach does
not prescribe what theories should inform the study or which methods
should be used for gathering and analyzing data. Based on the
problem and research questions being addressed, a variety of methods
may be used, including analysis of archival materials, observation,
interviews, and quantitative techniques. Case studies focus on
bounded and particular organizations, events, or phenomena, and
scrutinize the activities and experiences of those involved, as well
as the context in which these activities and experiences occur
Stake
2000.
The case study research
approach is useful where the researcher is investigating:
• complex and dynamic
phenomena where many variables
including
variables that are not quantifiable
are involved;
• actual practices,
including the details of significant activities that may be
ordinary, unusual, or infrequent
e.g.,
changes in accounting regulation; and
• phenomena in which the
context is crucial because the context affects the phenomena
being studied
and
where the phenomena may also interact with and influence its
context.
(Yin, 1989)
notes
that case studies are suited to answer “how” and “why” questions.
Furthermore, well-done case study research answers how and why so
compellingly and vividly that readers understand and remember the
findings the study reveals. Practitioners find “how” questions to be
particularly important—for example, case studies are valuable in
describing the details of how new accounting and auditing
innovations are actually done. Providing details helps convert
private knowledge
for example, the detailed
procedures and calculations that are otherwise hidden in the reports
or minds of innovators
into publicly available
knowledge. Unlike the “action research” some espouse
(Kaplan
,1998), a theory-oriented case study requires explicitness in theory underlying the case analysis, and in the contribution to
theory development or testing.
Case studies also address “why” questions, illustrating why
something was done or came to be, or when and why something works. (Schön,
1983),
50
argues that case studies are
valuable to the “entire process of reflection-in-action, which is
central to the ‘art’ by which practitioners sometimes deal well with
situations of uncertainty, instability, uniqueness and value
conflict.” Such case research considers the values, interests, and
operations of power involved—who gained, who lost, and why. While
researchers may disagree about what should be done, a good case will
stimulate reflection and learning about the actions of all involved,
including the researcher. Action or constructivist researchers often
use cases to describe examples of an accounting intervention, but
they too often neglect theoretical lessons to be learned
(Jönsson
and Lukka, 2007).
Although any research approach can focus on how or why, non-case
approaches typically emphasize different questions. Statistical
analyses using large data sets1
have a
comparative advantage in answering “how much” questions, such as the
average size of CEO compensation or the average difference in
compensation for companies with, for example, high versus low ROA.
Experiments may be particularly helpful in answering “what”
questions such as what type of response individuals might have to a
proposed accounting measure or disclosure. Case studies, archival
research, and experiments are complementary research approaches. To
illustrate the complementary nature of different approaches,
consider that as part of an accounting firm’s efforts to improve its
audits, it may:
• statistically analyze data on the
properties of specific accounts;
• conduct pilot studies
experiments
before deploying new audit procedures; and
• study the best-practice
cases of audits, considering how the client, audit staff,
regulators, and partners might vary in their assessments of what
is best.
The quality of the accounting
firm’s overall analysis and decisions is improved by using all
approaches to acquiring and assessing knowledge. Whether used on
their own or in conjunction with other research approaches, case
studies can contribute insights to practitioners and researchers.
Jensen Comment
Note that this site includes a long listing of research in accounting,
finance, and economics, much of it based on positivism and financial
markets.
I examined the Vision being promoted, since November 8, 2006, by CEOs of the
largest accounting firms ---
http://www.globalpublicpolicysymposium.com/CEO_Vision.pdf
It struck me as yet another example of how small the role of academe is in shaping
the future of the profession of accountancy. I wonder if the professions of
medicine and law would chart the future of their own professions with so little
regard for schools of medicine and law. Large firms in accounting actively seek
to hire our students and have great public relations with professors. However,
when it comes to something as substantive as this it's very difficult to find
where leaders of the profession charted this change in course by building upon
academic accounting research. There are probably indirect links, but it would be
surprising if the writers of this proposed huge change in policy were influenced
heavily by published academic research. An exception might be the thrust toward XBRL, but the so-called leading academic accounting journals have paid scant
attention to XBRL,
On one hand we could blame the leaders of the profession for avoiding
academe in the generation of new vision for the future. On the other hand we
could blame the accounting researchers and their top journals for addressing
what they can study with scientific models rather than what the profession
wants to be studied. My threads on this issue are at
http://faculty.trinity.edu/rjensen//theory/00overview/theory01.htm#AcademicsVersusProfession
As part of the Global Public Policy Symposium
in Paris, held on November 8 and attended by key players concerned with
ensuring the quality and reliability of financial reporting worldwide,
the Chief Executive Officers (CEOs) of PricewaterhouseCoopers (PwC)
International, Grant Thornton International, Deloitte, KPMG
International and Ernst & Young, published a joint statement of their
vision of what the future might hold for financial reporting and the
accounting profession.
Entitled “Global Capital Markets and the Global
Economy: A Vision from the CEOs of the International Audit Networks,”
the document envisions investors having access to real time company
financial information through XBRL, financial statements that go beyond
reporting past performance to projecting future performance based on
information about business intangibles that are not currently measured,
and a recommendation that companies choose to supplement regular audits
with periodic forensic audits. The report may be viewed at
www.globalpublicpolicysymposium.com/
“This essay is about one type of information
and its importance to all actors in the global economy; information
about the performance of management and companies that make and deliver
goods and services, and compete for capital,” the symposium paper says.
In a letter to the Wall Street Journal
published on November 8, the day their paper was released, the CEOs
wrote that when the basics of current accounting procedures were
written, the world’s investors were more a “private club than a global
network. Auditors used fountain pens, capital stayed pooled in a few
financial centers, and information moved by runner.” The world has
changed since then.
In the short term, the letter says, it will be
necessary to proceed as rapidly as possible with convergence in
international accounting standards, and with overcoming national
differences in oversight of auditors and in enforcement.
In the longer term, auditors themselves must
evaluate the usefulness to investors of information provided in the
current financial statement and footnote format and consider the
inclusion of more nonfinancial information.
But, the CEOs say in the Journal letter, “All
of these steps should include an emphasis on allowing auditors greater
room to exercise judgment. Accountants and auditors are trained
professionals who have the ability to apply the spirit of broad
principles in deciding how to account for and report financial and other
information. . . . Such [future] measures should also include an honest
assessment of the “expectations gap,” relating to material fraud and the
ability of auditors to uncover it at a reasonable cost.”
The paper looks forward to a world “where users
increasingly will want to customize the information they receive” in
which “the process for recording and classifying business information
will be as important, if not more important, than the static formats in
which today’s financial information is reported. Our jobs as auditors,
must therefore change to increasing focus on those business processes.”
An “important enabler” of future reporting will
be the Global XBRL Initiative, the paper says. XBRL users will be able
to view company data in any language, any currency and under different
accounting systems and get immediate answers to queries. “In fact the
new world is already here for the approximately 40,000 companies that
already use XBRL to input their data. . . . China, Spain, the
Netherlands and the United Kingdom have required companies to use XBRL.”
The paper acknowledges that investors, analysts
and others will still want standardized reports to be issued by public
companies on a regular basis. But the CEOs say that investors have told
them they want more relevant information to be included. “The large
discrepancies between the “book” and “market” values of many, if not
most, public companies similarly provide strong evidence of the limited
usefulness of statements of assets and liabilities that are based on
historical costs. A range of intangibles, such as employee creativity
and loyalty and relationships with suppliers and customers, can drive a
company’s performance, yet the value of these intangibles is not
consistently reported."
In short, the CEO’s vision states “the same
forces that are reshaping economies at all levels are driving the need
to transform what kind of information various stakeholders want from
companies, in what form, and at what frequency. In a world of “mass
customization,” standard financial statements have less and less meaning
and relevance. The future of auditing in such an environment lies in the
need to verify that the process by which company-specific information is
collected, sorted and reported is reliable and the information presented
is relevant for decision making.”
Investors and regulatory bodies may expect
auditors to go further than is reasonable to detect fraud and the paper
recommends that all companies be subjected to a regular forensic audit,
or be subjected to forensic audits on a random basis.
Another option would be introducing more choice
regarding the intensity of audits for fraud. For example, since forensic
audits are conducted primarily for the benefit of investors, one
possibility would be to let shareholders decide on the intensity of the
fraud detection effort
they want auditors to perform. Shareholders could be assisted in making
this decision by disclosure in the proxy materials of the costs of the
different levels of audits, as well as the historical experience of the
company with fraud.
The CEO paper calls for both liability reform
and scope of service reform.
Considering the “Brave New World” of auditing
envisioned in the document and the scope of the questions it raises,
“Global Capital Markets and the Global Economy” has received little
attention in the financial press, Motley Fool reports. But, while
approving the idea of more timely information flows for the investor,
Fool says, “enough companies have trouble meeting their reporting
obligations as it is. I would prefer to both maintain those reports and
supplement them with additional data.”
That financial reporting will evolve and change
is inevitable, the International Herald Tribune says, but whether large
accounting firms will lead the dialogue is another matter that may be
influenced by their “life-threatening litigation risks.”
Redesigning an MBA Curriculum Toward the Action: Why Aren't
Accountants Headed on the Same Paths?
"Wall Street Warms To Finance Degree With Focus on Math," by Ronald
Alsop, The Wall Street Journal, November 14, 2006; Page B7 ---
Click Here
Just a few years ago, the University of
California, Berkeley, found its master's degree in financial engineering
a hard sell. Wall Street had cut back sharply on hiring, and many
recruiters were still fixated on M.B.A. graduates.
"The doors were shut on us at the
human-resource level on Wall Street," recalls Linda Kreitzman, executive
director of the financial engineering program at Berkeley's Haas School
of Business. "I had to go directly to managing directors to get our
students placed after we started the program in 2001."
Now, in a turnabout, it's often the banks and
hedge funds that are calling on Dr. Kreitzman and offering her graduates
six-figure compensation packages. "They have come to realize they really
need students with strong skills in financial economics, math and
computer modeling for more complex products like mortgage- and
asset-backed securities and credit and equity derivatives," she says.
This fall, all 58 financial engineering students seeking internships
found spots at such companies as Citigroup, Lehman Brothers and Merrill
Lynch. Their projects will include credit portfolio valuation,
artificial-intelligence trading models and structured fixed-income
products.
While the master's in business administration
certainly remains in high demand, companies are increasingly interested
in other graduate-level credentials, including Ph.D.s and master's
degrees in specific business fields. Deutsche Bank, for example, has
hired Ph.D. and master-of-finance graduates in Europe for some time and
is now recruiting more in the U.S. as well.
"We are continually looking for strong
quantitative skills," says Kristina Peters, global head of graduate
recruiting. With a master's degree in finance, "there tends to be more
applied finance knowledge such as derivatives pricing."
Continued in article
Jensen Comment
The big question is where will auditing firms find accountants that can
handle the exotic contracts written by the financial engineers?
English professors reflect their graduate
school training long after they "graduate" as newly minted Ph.D.s. The
rub comes in if you happen to have been more deeply trained in literary
theory than you were in literature, and you were taught to believe that
theoreticians were much more interesting than novelists or poets.
The result is that many English professors of a
certain age find it easier to get excited about multiculturalism than
about great writers because they have read very few primary works of
consequence. Asking these folk about literature reminds me of the
Israeli army recruit who was asked if he could swim, "No," he replied,
then quickly added "But I know theory of it." English departments
are likely to suffer through this joke for at least the next twenty more
years, as professors who got tenure because they were savvy about
Derrida and Foucault hang around to shape an English department
curriculum that is longer on deserts than it is on meat-and-potatoes.
That's why advanced seminars in
multiculturalism, Madonna, or "The Sopranos" are just a heart beat away
from making it into the college catalogue. Those who remember an Irish
poet named Yeats might remember what he said about things falling apart
and the center not holding. That is what is occurring across the land as
English department have a hard time resisting whatever fashionable
bandwagon squeaks its way down the road.
The well known mathematician GH Hardy once
observed that he would be disappointed if any one found mathematics
useful (I think he was referring to "Pure" mathematics), and that
mathematics is to be enjoyed to appreciate its intrinsic beauty.
Nevertheless, even "Pure" Mathematics Mathgematics is found useful by
many. One pertinent example I can give is of non-Euclidean Geometry
which has had a profound impact on data visualisation (See, for example,
http://iv.slis.indiana.edu/sw/hyptree.html ).
While mathematical propositions are
tautological and hence not "verifiable" in a positivist sense, the
underlying axiom system can be examined to see if it corresponds to
reality. That is how, for example, things work in Physics where
replication is an essential and valued activity. In accounting research
(especially of the financial accounting kind), replication is not well
regarded, and unlike in Physics there is no "competition" to reach the
top of the greasy pole or to prove each other wrong. The result is the
mutual admiration society that we have reduced ourselves to, with a few
citing each other and the rest of the world ignoring us all.
In human science such as ours is, research
should be relevant and useful. We have an obligation to be evaluated by
the society (all the stakeholders including the professional practice)
at large about this. In this, in my opinion, we in academics have failed
miserably.
Jagdish
February 4, 2006 reply from Bob Jensen
Hi Jagdish,
You have pointed to the heart of the mess in modern day academic
accounting research. The pure mathematics term "mathgematics"
reminds me of the historic term "accountics."
After an intense turn-of-the-century debate over whether academic
accounting research should become the
"mathematical science of values," leading accounting researchers
rejected this "accountics" idea. Both the term and the movement died out
for the next 60 years.
In the 1960s the concept was born again without the revival of the
word "accountics." You aptly and concisely described how accountics has
taken over our top-tier journals that, in turn, have turned our doctoral
programs into virtually a singular very narrow research skills
curriculum.
I was greatly encouraged by Judy Rayburn's Presidential Address on
August 10, 2005 and the publishing of her remarks in Accounting
Education News, Fall 2005, pp. 1-4.
Accounting research is different from other business disciplines
in the area of citations: Top-tier accounting journals in total
have fewer citations than top-tier journals in finance, management,
and marketing. Our journals are not widely cited outside our
discipline. Our top-tier journals as a group project too narrow a
view of the breadth and diversity of (what should count as)
accounting research.
Rayburn (2005b, Page 4)
I might add that Judy's points are mostly echoing Andy Bailey's 1994
Presidential Address in which he claimed the AAA journals were at a
"crisis point." The AAA Publications Committees, TAR editors, and TAR
referees ignored Andy's appeals to broaden the scope of topics and
research methods that allowed in TAR. And after a long conversation with
the current editor of TAR on February 2, 2006, I fear that Judy's
appeals are also falling on deaf ears. TAR is not going to change in the
near future with the exception of adding some AIS papers that Bill
McCarthy, as the new AIS Associate Editor, allows to pass through the
gates. TAR will expand to five issues per hear in 2006 and six issues
per year after that. But accountics constraints will still dominate TAR
in years to come.
Mathgematics was an innocent typo on my part.
Your response worried me that there might really be such a term, and so
I googled it and went through each of those pages. And on each of those
pages the problem was a similar typo. While I would love to put my stamp
on lexicography, I need to improve my keyboarding skills first. (My Mac
keyboard is driving me up the wall.)
Hardy used the term pure mathematics (he wrote
a book with the same title that we used as text) in the same sense that
Immanuel Kant used it in the "Critique of Pure Reason" -- uncontaminated
by facts.
People were always uncomfortable with Euclid's
fifth postulate which says that given a straight line and a point not on
the line, it is possible to construct a straight line through the point
that is parallel to the given line (there are other equivalent ways to
state the postulate). For example, if you stand in the middle of
railroad tracks in Kansas and look into the horizon along the tracks, it
would appear to you that the two parallel tracks meet there, which would
"invalidate" the postulate.
Mathematicians before Lobachevsky were trying
to prove that the fifth postulate could be proved as a theorem from the
first four (which we all know from grade school). Lobachevsky thought
out of the box and showed that Euclidean Geometry was a special case of
general non-Euclidean Geometries. Lobachevsky was not alone in this
discovery. Gauss (German) and Bolyai (Hungarian) mathematicians
independently developed the area.
By the way, the tracks seem to meet at the
horizon in Kanbsas because earth is spherical. The non-Euclidean
Geometry I referred to in the earlier message was spherical Geometry
which is the staple of data visualisation in diverse fields as taxonomy,
genetics, forestry,...; We can even use it in Accounting, for example,
in visualising XBRL taxonomies.
Jagdish
So what is the history of accountics?
TAR Between 1926 and 1955: Ignoring Accountics
Accountics is the
mathematical science of values.
Charles Sprague (1887) as quoted by McMillan (2003, 1)
Accounting professor Charles
Sprague coined the word "accountics" in 1887. The word is not
used today in accounting and has some alternative meanings outside our
discipline. However, in the early 19th Century, accountics
was the centerpiece of some forward thrusting unpublished lectures by
Charles Sprague at Columbia University. McMillan (2003, 11) stated the
following:
These claims were not a pragmatic strategy to legitimize the
development of sophisticated bookkeeping theories. Rather, this
development of a science was seen as revealing long-hidden realities
within the economic environment and the double-entry bookkeeping system
itself. The science of accounts, through systematic mathematical
analysis, could discover hidden thrust of the reality of economic
value. The term, “accountics,” captured the imagination of the members
of the IA, connoting advances in bookkeeping that all these men were
experiencing.
By 1900 there was a
journal called Accountics according to Forrester (2003). Both
the journal and the term accountics had short lives, but belief that
mathematical analysis and empirical research can “discover hidden thrust
in the reality of economic value” underlies much of what has been
published in TAR over the past three decades. Hence we propose reviving
the term “accountics” in the context of research methods and
quantitative analysis tools that have become popular in TAR and other
leading accounting research journals.
The
American Association of University Instructors of Accounting, which in
December 1935 became the American Accounting Association, commenced
unofficially in 1915, (Zeff 1966, 5). It was proposed in October 1919
that the Association publish a Quarterly Journal of Accountics.
But this proposed accountics
journal never got off the ground while leaders in the Association argued
heatedly and fruitlessly about whether accountancy was a science. A
quarterly journal called The Accounting Review was subsequently
born in 1925 with its first issue being published in March of 1926. Its
accountics-like attributes did not commence in earnest until the 1960s.
Practitioner involvement, in a
large measure, was the reason for changing the name of the Association
by removing the words “University Instructors.” Practitioners interested
in accounting education participated actively in AAA meetings. TAR
articles in the first several decades were devoted heavily to education
issues and accounting issues in particular industries and trade groups.
Research methodologies were mainly normative (without mathematics),
case, and archival (history) methods. Anecdotal evidence and
hypothetical illustrations ruled the day. The longest serving editor of
TAR was a practitioner who determined what was published in TAR between
1929 and 1943. In those years the AAA leadership actually mandated that
TAR focus on development of accounting principles and to orient the
papers to both practitioners and educators, Chatfield (1975, Page 4).
Following World War II,
practitioners outnumbered educators in the AAA, (Chatfield 1975, 4).
Leading partners from accounting firms took pride in publishing papers
and books intended to inspire scholarship among professors and students.
Some practitioners, particularly those with scholarly publications, were
admitted over the years into the Accounting Hall of Fame formed by The
Ohio State University. Accounting educators were generally long on
practical experience and short on academic credentials such as doctoral
degrees prior to the 1960s.
A major
catalyst for change was the Ford Foundation that poured millions of
dollars into first the study of collegiate business schools and second
the funding of doctoral programs and students in business studies.
Gordon and Howell (1959) reported that business faculty in colleges
lacked research skills and academic esteem among their humanities and
science colleagues. The Ford Foundation thereafter funded doctoral
programs and top quality graduate students to pursue doctoral degrees in
business and accountancy. This Foundation even funded publication of
selected doctoral dissertations to give business discipline doctoral
studies more visibility. Great pressures were also brought to bear on
academic associations like the AAA to increase the academic standards
for publications in journals like TAR.
Competitors to TAR were launched in the early 1960s, including the
Journal of Accounting Research (1963), Abacus (1965) and
The International Journal of Accounting Education and Research
(1965). Clinging to its traditional normative roots and trade-article
style would have made TAR appear to be a journal for academic luddites.
Actually, many of the new mathematical approaches to theory development
were fundamentally normative, but they were couched in the formidable
language and rigors of mathematics. Publication of papers in traditional
normative theory, history, and systems slowly ground to almost zero in
the new age of accountics.
These
new spearheads in accountics were not without problems. It’s humorous
and sad to go back and discover how naïve and misleading some of TAR’s
bold and high risk thrusts were into quantitative methods. Statistical
models were employed without regard to underlying assumptions of
independence, temporal stationarity, multicollinearity,
homoscedasticity, missing variables, and departures from the normal
distribution. Mathematical applications were proposed for real-world
systems that failed to meet continuity and non-convexity assumptions
inherent in such models as linear programming and calculus
optimizations. Proposed applications of finite mathematics and discrete
(integer) programming failed because the fastest computers in the world
then, and now, could not solve most realistic integer programming
problems in less than 100 years.
After
financial databases provided a BETA covariance of each security in a
portfolio with the market portfolio, a flood of capital market events
studies were published by TAR and other leading accounting journals. In
the early years, accounting researchers did not challenge CAPM’s
assumptions and limitations, limitations that, in retrospect cast doubt
upon many of the findings based upon any single index of market risk, (Fama
and French 1992).
Leading
accounting professors have lamented as TAR’s preference for rigor over
relevancy, (Zeff 1978; Lee 1997; and Williams 1999). Sundem (1987)
provides revealing information about the changed perceptions of authors,
almost entirely from academe, who submitted manuscripts for review
between June 1982 and May 1986. Among the 1,148 submissions, only 39
used archival (history) methods and 34 of those submissions were
rejected. Also 34 used survey methods and 33 of those were rejected.
And 100 used traditional normative (deductive) methods with 85 of those
being rejected. Except for a small set of 28 manuscripts classified as
using “other” methods (mainly descriptive empirical according to Sundem),
the remaining larger subset submitted manuscripts used methods that
Sundem classified as follows for leading 1982-1986 submissions:
292
General Empirical
119
Capital Market
172
Behavioral
135
Analytical modeling
97
Economic modeling
40
Statistical modeling
29
Simulation
What’s clear is that by
1982 accounting researchers got the message that having mathematical or
statistical analysis in TAR publications made accountics virtually a
necessary, albeit not sufficient, condition for acceptance for
publication. It became increasingly difficult for a single editor to
have expertise in all the above methods. In the late 1960s editorial
decisions on publication shifted from the TAR editor alone to the TAR
editor in conjunction with specialized referees and eventually associate
editors, (Flesher 1991, 167). Fleming et al. (2000) wrote the following:
The big change was in research methods. Modeling and empirical
methods became prominent during 1966-1985, with analytical modeling and
general empirical methods leading the way. Although used to a
surprising extent, deductive-type methods declined in popularity,
especially in the second half of the 1966-1985 period.
Fleming
et al. (2000, Page 48) report that education articles in TAR declined
from 21% in 1966 to 8% before Issues in Accounting Education
began to publish education articles. Garcha, Harwood, and Hermanson
(1983) reported on the readership of TAR before any new specialty
journals commenced in the AAA. They reported that among their AAA
membership respondents, only 41.7% would subscribe if TAR was unbundled
in terms of dollar savings from AAA membership dues. TAR apparently was
not meeting the membership’s market test. Based heavily upon the written
comments of respondents, the authors’ conclusions were, in part, as
follows:
The findings of the survey reveal that opinions vary regarding
TAR and that emotions run high. At one extreme some respondents seem to
believe that TAR is performing its intended function very well. Those
sharing this view may believe that its mission is to provide a
high-quality outlet for those at the cutting-edge of accounting
research. The pay-off for this approach may be recognition by peers,
achieving tenure and promotion, and gaining mobility should one care to
move. This group may also believe that trying to affect current
practice is futile anyway, so why even try?
At the other extreme are those who believe that TAR is not
serving its intended purpose. This group may believe TAR should serve
the readership interests of the audiences identified by the Moonitz
Committee. Many in the intended audience cannot write for, cannot read,
or are not interested in reading the Main Articles which have been
published during approximately the last decade. As a result there is
the suggestion that this group believes that a change in editorial
policy is needed.
After a
study by
Abdel-khalik(1976) that revealed complaints about difficulties of
following the increased quantitative methods jargon in TAR, editors did
introduce abstracts in front of the articles to summarize major findings
with less jargon, (Flesher 1991, 169). But the
problem was simultaneously exacerbated when TAR stopped publishing
commentaries and rebuttals that sometimes aid understanding of
complicated research. Science journals are much better about encouraging
commentaries and rebuttals.
Scientific Method in Accounting Has
Not Been a Method for Generating New Theories
The following is a quote from the 1993
President’s Message of Gary Sundem,
President’s Message. Accounting Education News 21
(3). 3.
Although empirical scientific method has made many positive
contributions to accounting research, it is not the
method that is likely to generate new theories, though
it will be useful in testing them. For example,
Einstein’s theories were not developed empirically, but
they relied on understanding the empirical evidence and
they were tested empirically. Both the development and
testing of theories should be recognized as acceptable
accounting research.
Question
What is the trend in the number of doctoral degrees awarded
in accountancy in the United States?
Answer
It all depends on who you ask and whether or not the alma
maters are AACSB accredited universities
(note that the AACSB accredits bachelors and masters degree
programs but not doctoral programs per se).
The data suggest that there are a lot of ABD doctoral
students who never complete the final hurdle of writing a
dissertation, although this is only my speculation based
upon the higher number of graduates that I would expect from
the size of the enrollments.
On January 27, 2006, Jean Heck at
Villanova sent me the following message:
This data is only for AACSB accredited schools, so the
numbers you had for Accounting in the slide are a little
bigger. I got these numbers straight from the AACSB data
director.
Accounting & Finance Historical Data 2000 - 2004
Accounting
Full Time Enrollment
Part Time Enrollment
Degrees Conferred
2000
552
36
122
2001
585
80
102
2002
578
13
97
2003
694
12
103
2004
631
16
86
Finance
2000
738
59
159
2001
771
109
129
2002
807
49
125
2003
939
40
136
2004
859
48
109
********************
Jensen Comment Hasselback, J.R. (2006), Accounting Faculty Directory
2006-2007 (Prentice-Hall, Just Prior to Page 1) reports the
following doctoral graduates in accounting:
1998–99 122 - 18%
1999–00 095 - 22%
2000–01 108 +14%
2001–02 099 - 08%
2002–03 069 - 30%
In Slide 23 of her Presidential
Address at the American Accounting Association Annual Meetings in
San Francisco on August 10, Judy Rayburn presented the following
data regarding doctoral graduates in accounting ---
http://aaahq.org/AM2005/menu.htm
145 Accounting Ph.D.s were awarded in 2002-2003, an increase
over 2001-2002 estimates.
TABLE 3B
Accounting Ph.D’s Awarded 1998–99 Through 2002–03
Number of Graduates Rate of Growth
1998–99 185 – 3%
1999–00 195 + 5%
2000–01 115 – 41%
2001–02 110 – 4%
2002–03 145 + 32%
Data from the U.S. Department of Education
You can download an Excel spreadsheet of Doctor's degrees conferred
by degree-granting institutions, by discipline division: Selected
years, 1970-71 to 2002-03 ---
http://nces.ed.gov/programs/digest/d04/tables/dt04_252.asp
Part of that spreadsheet is shown below:
Table 252. Doctor's degrees
conferred by degree-granting institutions, by discipline
division:
Selected years, 1970-71 to 2002-03
_
_
_
_
_
_
Discipline division
1998-99
1999-00
2000-01
2001-02
2002-03
_
_
_
_
_
Agriculture and natural
resources .................
1,231
1,168
1,127
1,148
1,229
Architecture and related
services .......................
123
129
153
183
152
Area, ethnic, cultural, and
gender studies ...................................
187
205
216
212
186
Biological and biomedical
sciences .......................................
5,024
5,180
4,953
4,823
5,003
Business
...........................................................
1,201
1,194
1,180
1,156
1,251
Communication, journalism, and
related programs
..............................................
Public administration and
social services ........................
532
537
574
571
596
Security and protective
services ....................................
48
52
44
49
72
Social sciences and history
........................................
3,855
4,095
3,930
3,902
3,850
Theology and religious
vocations ....................
1,440
1,630
1,461
1,350
1,321
Transportation and materials
moving .....................
0
0
0
0
0
Visual and performing arts
...............................
1,130
1,127
1,167
1,114
1,293
Not classified by field of
study ...................
6
71
63
0
0
Question
Why is supply of doctoral faculty, and possibly all business faculty, not a
sustainable process?
Jensen Answer
See Below
Question
Why do accounting doctoral students have to be more like science students
than medical students and law students?
Jensen Answer With the explosion of demand for accounting faculty, production of only
about 100 doctoral graduates from AACSB schools is no longer a sustainable
process. Perhaps the time has come to have a Scholarship Track and a Research Track
in accounting doctoral studies. One of the real barriers to entry has been the
narrow quantitative method and science method curriculum now required in
virtually all doctoral programs in accountancy. Many accounting professionals
who contemplate returning to college for doctoral degrees are not interested
and/or not talented in our present narrow Ph.D. curriculum.
In my opinion this will work only if our most prestigious universities take
the lead in lending prestige to Scholarship Track doctoral students in
accounting. Case Western is one university that has already taken a small step
in this direction. Now lets open this alternative to younger students who have
perhaps only had a few years experience in accounting practice,
In the January 30, 2006 edition of New Bookmarks I presented tables of
the numbers of doctoral graduates in all disciplines with particular stress on
those in accounting, finance, and business in general. As baby boomers from the
World War II era commence to retire, the AACSB International predicts a crisis
shortage of new faculty to take their place and to meet the growth in popularity
of business programs in universities. In August
2002, the AACSB International Management Education Task Force (METF) issued a
landmark report, “Management Education at Risk.” The 2002 report on this is
available at
http://www.aacsb.edu/publications/dfc/default.asp
In particular, note the section on Rethinking Doctoral Education quoted below.
Rethinking Doctoral Education
Several issues in doctoral education are in need of
rethinking in light of doctoral faculty shortages. They include vertical
orientation, strategies for sourcing doctoral faculty, the relevance of
curricula, rewards and promotion, accreditation standards, and leveraging
technology.
Vertical Orientation
Doctoral education is built on vertical orientation
to disciplines, requiring prospective applicants to choose their field at
the point of entry. Many doctoral programs train students in narrowly
defined research agendas, giving them little, if any, exposure to research
problems and methodologies outside their discipline. In parallel, most
hiring adheres to traditional departmental tracks, with few instances of
cross-departmental appointments because they are inherently challenging to
the structure of most business schools. Among the schools that are
exceptions is IMD, in Switzerland, which eliminated departmental and rank
distinctions.
Meanwhile, advancement in business knowledge and
thinking requires research frameworks that can span functional and industry
boundaries. And businesses continue to call for more cross-functional
education in undergraduate and MBA programs. There is inevitable and
healthy tension between training and theory in vertical disciplines, on the
one hand, and the evolving issues of the marketplace that tend to defy such
neat categorization, on the other.
There is little question that schools need to add
to their doctoral curricula research training that encompasses questions and
methodologies across vertical boundaries. Unless some shifts are
instituted, the training ground for researchers in business will become less
relevant to the knowledge advances the marketplace needs and demands, and to
the teaching and learning needs within business schools.
Strategies for Sourcing Doctoral Faculty
To preserve the inimitable scholarship role of
business academics, faculty resources need to be better leveraged. Business
schools must address pervasive doctoral shortages creatively by reaching
beyond traditional sources for doctoral faculty. Though not without
challenges, the following are among possible alternative sources of doctoral
faculty:
Ph.D. graduates of research disciplines
outside business schools (for example, psychology, sociology,
anthropology, physics, biotechnology), who bring alternative
perspectives on business education and research.
Executive or professional doctoral
graduates from programs outside the advanced theoretical research
category, such as the Executive Doctor of Management program at Case
Western Reserve University.
Ph.D. graduates from other fields who have
accumulated years of business experience and can serve as doctorally
qualified clinical professors.
New models of qualification to the doctorate,
practiced by some European schools, that award doctoral degrees based
solely on published research.
Along with tapping new sources for doctoral
faculty, such strategies may have the added benefit of increasing the
"practice" flavor of curricula.
A concurrent approach to support continued, vibrant
scholarship of business research faculty is a productivity-enhancement
strategy, rather than a focus on faculty supply. The reason for suggesting
that approaches to enhance productivity are needed is that reduced teaching
loads alone do not ensure increased faculty research contributions.
Possible such approaches include faculty development in best research
practices; greater flexibility in faculty employment relationships, to
facilitate researcher collaboration and mobility across institutions; a
multilevel faculty model that fine-tunes faculty assignments to fit their
competencies; and differentiated performance accountability and rewards
around these assignments.
The quest for sustained research productivity also
hinges on our definition of research. EQUIS, the business school
accreditation program offered by the European Foundation for Management
Development, has proposed an expanded definition of research to include
research, development, and innovation (RDI). RDI includes activities
related to the origination, dissemination, and application of knowledge to
practical management.
I have always been one to distinguish scholarship from research. One can be a
scholar by mastering some important subset of what is already known. A
researcher must attempt to contribute new knowledge to this subset. Every
academic discipline has an obligation to conduct research in an effort to keep
the knowledge base dynamic and alive. However, this does not necessarily mean
that every tenured professor must have been a researcher at some point along the
way as long as the criteria for tenure include highly significant scholarship.
This tends not to be the model we work with in colleges and universities in
modern times. But given the extreme shortages in accounting doctoral students,
perhaps the time has come to attract more scholars into our discipline. It will
require a huge rethinking of curriculum and thesis requirements, and I do think
there should be a thesis requirement that demonstrates advanced scholarship. I
also think that the curriculum should cover a variety of disciplines without
aspirations to produce Super CPAs to teach accounting. Possibly universities
will even generate some doctoral theses other than the present ones that
everybody hopes, including the authors, that nobody will read.
Medical schools have used these two tracks for years. Some medical professors
are highly skilled clinically and teach medicine without necessarily devoting
80% of their time in research labs. Other medical professors spend more than 80%
of their time in research labs. In law, the distinction is less obvious, but I
think when push comes to shove there are many law professors who have mastered
case law without contributing significantly to what the legal profession would
call new knowledge. Other law professors are noted for their contributions to
new theory.
Along these lines follows an obligation to teach “professionalization” in
an effort to attract doctoral students
Donald E. Hall finishes his series with proposals to change the dissertation
process and a call to teach “professionalization.”
"Collegiality and Graduate School Training," by Donald E. Hall, Inside
Higher Ed, January 24, 2006 ---
http://www.insidehighered.com/workplace/2006/01/24/hall
This emphasis on conversational skills
and commitments allows us then to fine tune also our
definition of what “professionalization” actually means.
Certainly in the venues above — the classroom and in
research mentorship — we work to make our students more
aware of the norms and best practices of academic
professional life. But the graduate programs that are most
concerned with meeting their students’ needs attend also to
that professionalization process by offering seminars,
roundtables, workshops, and other activities to students
intent on or just thinking about pursuing an academic
career. In all of these it is important to note that
aspiring academics are not only entering the conversation
represented by their research fields, but also the
conversation of a dynamic and multi-faceted profession.
This does mean encouraging literal
conversations among graduate students and recent graduates
who have taken a wide variety of positions — from high
profile academic, to teaching centered, to those in the
publishing industry and a wide variety of non-academic
fields. I started this essay by noting that when I was a
graduate student I had never heard from or about individuals
who had taken jobs like the one I eventually took. Certainly
I could have sought out those individuals on my own (though
I didn’t know them personally, since they were not part of
my cohort group), but it is also true that those individuals
were not generally recognized as ones to emulate.
One hopes, given the terrible
prospects that most new Ph.D.’s face today as they enter the
academic job market, that such snobbishness has waned.
However, I still would not go so far as to say that we
should tell students that “any job” is better than “no job”
or that they should simply “take what they can get.” Some
individuals would be terribly mismatched with certain
positions — weak teachers who live for research should not
take positions at teaching universities unless they are
willing to re-prioritize and devote their energies to
improving their pedagogies. Similarly, I have known superb
teachers with poor research habits and skills who have taken
wholly inappropriate positions at prestigious universities
and then lost those jobs for low research productivity
during third year or tenure reviews (unfortunately, they
sometimes got their jobs in the first place because they
were able to — and were counseled to — market themselves
within certain highly sought-after identity political fields
but with no recognition of their own individual needs or
abilities). A discussion of who will be happy and will
succeed where must be part of any broad conversation on the
academic profession, whether that conversation takes place
in seminars, workshops, or with groups of students about to
“go on the market.”
Indeed, it is vital to invite
students into conversation on these matters as often and as
early as possible. At the beginning of every meeting of
every graduate class I teach, I ask if there are any
questions on the minds of the students regarding their
program, general professional issues or processes, or the
often unexplained norms of academic life. Even if students
are sometimes too shy to ask what they really want to know
in class, their recognition of my willingness to address
such issues means they often show up during office hours to
ask what they consider an embarrassing question (“how much
do assistant professors typically make?” or “what do you say
in a cover letter when you send out an article for
consideration?”). We have to let students know that we are
willing to share information with them in an honest and
practical manner. We should be “open texts” for them to read
and learn from in their own processes of professional
interpretation and skill-building.
I believe it would be useful to
build some of the expectations above into the desired
outcomes of our graduate programs. In fact, I haven’t heard
of any programs that articulate specific goals for
professionalization processes, but I think we should be
asking what specifically we wish the end product to be of
those seminars, workshops, and other conversations about
academic life. I would offer that an overarching goal might
be to help our students become more supple and skilled
participants in the wide variety of conversations that
comprise an academic career. By necessity, acquiring this
conversational skill means learning the value of being both
multi-voiced and open to the perspectives of others.
This bears some explanation. By
multi-voiced I am not implying that students should learn to
be Machiavellian or duplicitous. Rather, I mean that all of
us who are thriving in our careers have learned to speak
within a wide variety of contexts and to choose our language
carefully depending upon the venue. I would never speak in
class as I do in some of my more theoretically dense
writings. I would never speak to administrators from other
departments as I do to those in my home department who use
the same terms and points of reference. And finally I would
never speak to the public exactly as I would to a scholarly
audience at a conference. Being multi-voiced in this way
means being aware of your conversation partners’ needs and
placing their need to understand above your own desire to
express yourself in intellectually self-serving ways.
And this is, in fact, an important
component of being open to the perspectives of others. Yet
that openness also means allowing one’s own beliefs, values,
and opinions to be challenged and transformed by contact
with those of conversation partners. This does not mean
being unwilling to defend one’s beliefs (whether on matters
of social justice or minute points of interpretation), but
it does mean being able to position oneself at least
partially outside of oneself in the process of
conversational exchange. It certainly means working to
understand how the general public perceives the academy (and
the debate over tenure, for example). It means trying to see
the world through the eyes of a different generation of
professors who may not use the same methodologies or
theoretical touchstones in their work. It means seeing one’s
own sacredly held positions as ones that exist in a
landscape of positions, many of which are also sacredly
held.
At Bowling Green, much institutional emphasis is
being placed on having undergraduates conduct or participate in research. Of
course, I'm pretty sure the program is slanted toward the hard sciences. An
economics professor here is active in this area. She suggests that I get
involved.
I'd love to get involved, there are significant
rewards being tossed about.
On what would my undergraduates do research?
Please help me.
David Albrecht
December 12, 2005 reply from Bob Jensen
Hi David,
At the college of business level, you might suggest that your college
become involved in the highly popular National Conferences on Undergraduate
Research (NCUR). This affords students the opportunity to travel a bit and
make presentations with other students at the excellent NCUR conferences. It
also is an opportunity to promote your college and its faculty. Your social
and physical science colleges may already be involved with NCUR ---
http://www.ncur.org/
As far as research goes, I think it would be great to have students write
responses to FASB, GASB, and IASB exposure drafts and other invitations to
comment. Undergraduate research is not as esoteric as PhD research and
leaves some room for normative methodology.
Along these lines I had an opportunity to view two absolutely absurd
referee reports sent to a professor, not me, with respect to a submission.
His submission suggested, among other things, that some accounting faculty
should spend more time responding to standard setters' invitations to
comment on matters that need more applied research. For lack of a better
term, I will call this applied research in accounting.
The reports of both referees were highly critical of professors trying to
publish applied research in any AAA journals (including Accounting Horizons
which they assert is read mostly by academics rather than practitioners).
Perhaps they might make an allowance for Issues in Accounting Education, but
no mention is made for IAE in these referee reports.
I think the following quotation (listed as the Number 1 criticism) from
one of the referee reports pretty much sums up the sad state of academic
accounting research today.
I quote:
*************
1. The paper provides specific recommendations for things that
accounting academics should be doing to make the accounting profession
better. However (unless the author believes that academics' time is a
free good) this would presumably take academics' time away from what
they are currently doing. While following the author's advice might make
the accounting profession better, what is being made worse? In other
words, suppose I stop reading current academic research and start
reading news about current developments in accounting standards. Who is
made better off and who is made worse off by this reallocation of my
time? Presumably my students are marginally better off, because I can
tell them some new stuff in class about current accounting standards,
and this might possibly have some limited benefit on their careers. But
haven't I made my colleagues in my department worse off if they depend
on me for research advice, and haven't I made my university worse off if
its academic reputation suffers because I'm no longer considered a
leading scholar? Why does making the accounting profession better take
precedence over everything else an academic does with their time?
**************
Both referees imply that studying accounting standards will take our
researchers away from what's really important in accounting academe, namely
publishing empirical and analytical research on problems that lend
themselves to esoteric statistics and mathematics. The irony is that most of
the esoteric research published research along those lines is more or less
focused on trivial hypotheses of little interest in and of themselves.
Certainly our academic friends in economics and finance are not subscribing
to our accounting research journals. We, of course, subscribe to their
esoteric journals.
Once again I make my case that that academic research hypotheses
published in top accounting research journals cannot be of much interest
since all top accounting research journals in academe have a policy against
publication of replication studies. What value can the findings have of the
replication studies are of no interest? See
http://faculty.trinity.edu/rjensen//theory/00overview/theory01.htm#Replication
The bottom line is that real scientists, economists, medical researchers,
and legal researchers would laugh the above two arrogant AAA journal
referees off the face of the planet. I'm certainly glad that medical
researchers focus on professional practice problems and insist on
replication. I'm certainly glad that biology researchers focus on microbes
that are helping or hindering life on earth. I'm certainly glad that legal
research is almost entirely focused on real world case law. No respectable
academic discipline, other than accounting, divorces itself from the
practice of its own profession. I think this is the main reason academic
accounting research is held is such low esteem both by practitioners and by
other academic disciplines. We've become a sick joke.
What the two idiots, who are typical arrogant referees for AAA journals,
are doing, David, is leaving a whole lot of room for Bowling Green's
undergraduates to conduct research on the important problems of the academic
profession while they themselves go off and play in the sandbox of research
that their own top journals conclude is not worth replicating. I suggest to
you David that there is ample room for your undergraduates do applied
research that may benefit the profession. Just do not expect the arrogant
"philosophers" who guard the gates of our academic accounting research
journals to allow any of this research pass into the gates of heaven.
I think the two referee reports mentioned above are exactly what the
current AAA President (Judy Rayburn) and the Past President (Jane Mutchler)
are trying in vain to overcome by changing the refereeing policy of the
AAA's leading journals. I'm certain the prejudices of our arrogant ivory
tower academics are so ingrained that these two women are fighting losing
battles.
I suggest that you, David, conduct a lab experiment in your undergraduate
classes. Bring a scale to each class and have the students weigh the last
four issues of The Accounting Review. Then have students weigh the last four
issues of Accounting Horizons. You must first tear out only the research
articles themselves since both journals do publish some items that are not
research submissions to the journals. Please publish this comparative study
on the AECM. I think the results will speak for themselves about the sad
state of applied research in accounting academe.
Imagine the how academe might be shaken up if an AAA Doctoral Consortium
were entirely devoted one year to taking up current issues facing the FASB,
GASB, and IASB. The very foundations of academe might crumble if we let
outsiders into the tightly controlled esoteric program of the Doctoral
Consortium and corrupt the research biases of our new doctoral graduates in
accountancy.
Send your undergraduate researchers marching forward David. The
accounting world will be a better place. The profession is getting very
little help from unreplicated research articles that pass through the gates diligently
guarded by arrogant and narcisstic AAA journal referees.
On Monday 12 December 2005, David Fordham wrote
on AECM:
...
No matter how good it is, no matter what
its form, systems research will not be published in accounting
journals given the current editorship and review staff
...
David and other AECM system researchers:
This has been generally true in the past and
there are certainly still a host of accounting journals that
underestimate the importance of accounting information systems (AIS)
research. Additionally, it is still true that almost all accounting
academics remain clueless about the different kinds of methodologies
that AIS, MIS, and computer science researchers generally use. Thus,
accounting systems people (like Dave and I plus many AECM members) are
forced to live in an academic world that understands neither “the what”
nor “the how” of AIS research and teaching.
However, the American Accounting Association
(in general) and The Accounting Review (in particular) are taking steps
to narrow this gap in understanding. Dan Dhaliwal, the senior editor of
The Accounting Review (TAR) has appointed me – a known maverick in
accounting circles and a long-time champion of AIS research and teaching
-- as an editor for TAR.
That was the good news; now the bad (sort of)
news. Since the announcement in August of a systems champion at the
Review, we have seen no changes because systems people are not
submitting manuscripts. I know that gearing up takes a while, but in the
interim, I think we need to speak less of our underprivileged past
status and concentrate more on how we are going to attack the myriad of
problems that accounting faces today with systems-informed thinking and
systems-informed methods. If you fervently believe that the practice of
accounting benefits little from what TAR, JAR, JAE, et al. produce, and
you also believe that accounting practice could benefit tremendously
from improvements researched and suggested by good AIS people and
computer scientists, you need to get busy.
I am going to give a speech on this at the AAA
Information Systems Section mid-year meeting on January 7th, 2006, but
in the interim, I hope people can use their inter-term break time to get
the flow to TAR increased. Let’s get going!!
Bill McCarthy
Michigan State
Dennis
Beresford, former Chairman of the Financial Accounting Standards Board and
current Ernst & Young Professor of Accounting at the University of Georgia,
had much to recommend on how academic accountants could improve. His
luncheon speech on August 10, 2005 at the AAA Annual Meetings in San
Francisco is provided at
http://faculty.trinity.edu/rjensen//theory/00overview/BeresfordAAAspeech2005.htm
I snipped the above URL to
http://snipurl.com/Beresford2005
My apologies
for some formatting that was lost when I converted Denny's DOC file into a
HTM file.
December 12, 2005 reply from David Albrecht
What is applied research?
I've never been able to figure this one out.
David Albrecht
December 13, 2005 reply from Bob Jensen
Hi David,
First let me point out that for over three
decades, Denny Beresford has been appealing for more applied research
among accounting educators. Two days ago I requested and received his
permission to post his luncheon speech at the annual 2005 AAA meetings
in San Francisco. His somewhat emotional appeal is at
http://snipurl.com/Beresford2005
Among the many definitions the one I like is
that basic research is "the systematic, intensive study directed toward
the practical application of knowledge and problem solving."
www.unlv.edu/depts/cas/glossary.htm
The key word in this definition is "practical
application." In the context of the accountancy profession I think of
this is as discovery of practical applications that can be put into
place by practicing accountants and their firms. Included here are
practical applications for standard setters such as the FASB, GASB, and
IASB.
By way of example, I would include virtually all
of the applied research papers published by Ira Kawaller on the
practical applications of derivative financial instruments and
accounting for derivative financial instruments ---
http://www.kawaller.com/articles.shtml
By way of a particular example, I like Ira's
applied research on when to use dollar-offset versus regression tests of
hedge effectiveness. Hedge effectiveness testing is required for hedge
accounting per Paragraph 62 in FAS 133. The FASB does not prescribe how
such testing should be done in practice. It only says such testing is
required. Ira makes some practical suggestions at
http://www.kawaller.com/pdf/AFP_Regression.pdf
I contend that most ABC costing research is of
an applied nature since most published papers and the seminal
discoveries of ABC by the John Deere Company back in the 1940s are
intended for practical application.
Lines between basic research and applied
research in accounting are really confusing because it is common to
associate quantitative methods and/or historical methodology with basic
research. Basic research should not be confused with tools and methods
of research. Basic research quite simply is a research discovery, new
knowledge, that has no perceived application in practice or at best has
some hope for possible discovery of practical applications in future
applied research.
I suspect that the discovery of the structure of
DNA by Watson and Crick is conceived as basic research. Applied
researchers later on found ways to put this to use in practice such as
the practice of using DNA evidence in criminal cases.
I suspect that portfolio theory in the 1959
doctoral dissertation of Harry Markowitz at Princeton would be
considered basic research that later led to the CAPM model and Options
Pricing Model applied in practice. The discovery by Markowitz was
totally impractical until simplified index models were later discovered
when trying to apply Markowitz theory to actual portfolio choices.
The best examples of basic versus applied
research discoveries probably come from the discipline of mathematics.
Theoretical mathematicians like to prove things with no thought as to
possible relevance to anything in the real world.
It is much more difficult to find truly basic
research discoveries in accountancy. We should be grateful that we do
not have to select Nobel Prize Winners in accountancy. The Ball and
Brown study got the first Seminal Contribution Award from the AAA. But
this is an application of capital market research discovered previously
by researchers in finance and economics. Capital markets studies have
mostly applied models developed in finance, econometrics, and
statistics.
What I am saying is that it is possible to apply
theory and test hypotheses without intending to have the discoveries be
put directly into practice in a profession. For example an events study
such as the discovery by George Foster that the publication of a Barrons'
paper by Abe Briloff was highly correlated with a plunge in share prices
of McDonalds Corporation tells us something about an association between
Briloff's accounting publication and capital market events. But
correlation is not causation. Foster's study could not really tell us
if the accounting issue (dirty pooling) or the mere fact that Briloff
said something negative about McDonalds in Barrons actually caused the
plunge in share prices.
The bottom line here is that the basic versus
applied research distinction in mathematics and science does not carry
over well into accounting. I prefer to make the distinction more along
the lines of research not having versus having a direct impact on
practicing accountants. For example, Ira's paper on hedge effectiveness
techniques had immediate and direct impact on having firms use
dollar-offset testing for retrospective data and regression for
prospective data. Companies actually follow Ira's recommendations when
implementing FAS 133 rules.
So what makes Ira's study different from those
of Ball and Brown, Beaver, and Foster? I guess the distinction lies in
the "take home" for practicing accountants and standard setters. Most
capital markets research discoveries do not provide the CPA on the
street with something to immediately place into practice or take out of
practice. The Ira Kawaller studies linked above provide CFOs with
strategies for hedging and CAOs/CPAs with strategies for implementing
FAS 133.
Now the question is: What is Denny
Beresford asking us to provide to the standard setters? I think what
he's asking for is more along the lines of Ira Kawaller's
practical-application contributions. If Ira's studies had been done
before FAS 133 was issued, the standard itself in Paragraph 62 might
have suggested or even required specific types of hedge effectiveness
testing. Instead Paragraph 62 of FAS 133 offered no suggestions for how
to test for effectiveness. This has led to thousands of variations,
often inconsistent, of hedge effectiveness testing in practice.
Both while he was Chairman of the FASB and
after he became a professor of accounting at Georgia, Denny Beresford
has consistently been appealing for the academy to conduct research that
will have more direct benefit in the writing of accounting standards.
This of course entails a considerable effort in learning the issues
faced by standard setters on particular complicated issues like the
thousands of different types of derivative financial instruments
actually used in practice. Most academic accountants shun learning
about such contracts and instead turn to tried and true regression
models of data found in existing databases like those provided by
Compustat and Audit Analytics. My conclusion is that this so-called
basic research is actually easier than making creative contributions to
practicing accountants, i.e. providing them with discoveries that they
did not make themselves in practice. This is so tough that it is why
the academy tends to avoid Denny's appeal.
I repeat and lament the sad state of the
accountancy academy as reflected in the following quotation from a
referee that closed the gate on publishing a paper of a very close
friend of mine:
I quote:
*************
1. The paper provides
specific recommendations for things that accounting academics should
be doing to make the accounting profession better. However (unless
the author believes that academics' time is a free good) this would
presumably take academics' time away from what they are currently
doing. While following the author's advice might make the accounting
profession better, what is being made worse? In other words, suppose
I stop reading current academic research and start reading news
about current developments in accounting standards. Who is made
better off and who is made worse off by this reallocation of my
time? Presumably my students are marginally better off, because I
can tell them some new stuff in class about current accounting
standards, and this might possibly have some limited benefit on
their careers. But haven't I made my colleagues in my department
worse off if they depend on me for research advice, and haven't I
made my university worse off if its academic reputation suffers
because I'm no longer considered a leading scholar? Why does making
the accounting profession better take precedence over everything
else an academic does with their time?
**************
My bottom line conclusion is that the referee
acting superior above is really scared to death that he or she cannot be
creative enough to make a practical suggestion to the FASB that the FASB
itself has not already discovered.
Steve Zeff
has been saying this since his stint as editor of The Accounting
Review (TAR); nobody has listened. Zeff famously wrote at least two
editorials published in TAR over 30 years ago that lamented the
colonization of the accounting academy by the intellectually unwashed.
He and Bill Cooper wrote a comment on Kinney's tutorial on how to do
accounting research and it was rudely rejected by TAR. It gained a new
life only when Tony Tinker published it as part of an issue of
Critical Perspectives in Accounting devoted to the problem of dogma
in accounting research.
It has only been
since less subdued voices have been raised (outright rudeness has been
the hallmark of those who transformed accounting into the empirical
sub-discipline of a sub-discipline for which empirical work is
irrelevant) that any movement has occurred. Judy Rayburn's diversity
initiative and her invitation for Anthony Hopwood to give the
Presidential address at the D.C. AAA meeting came only after many years
of persistent unsubdued pointing out of things that were uncomfortable
for the comfortable to confront.
This type of review is all
too common and is symptomatic of what the accounting academy has become.
I recall a panel discussion that was organized for an AAA annual meeting
(I believe it was the last time we held it in Washington) to air an
issue that Bill Cooper was animated about at that time -- data sharing
and the bigger problem of research impropriety. One of the panelists was
a scientist from John Hopkins who had just started a research ethics
journal. As part of this program editors of many leading accounting
journals were invited to give their perspectives on the problem of
replication and potential research malfeasance. Of course none thought
there was any problem.
One editor (still an
editor of one of the most prominent journals) responding to the
scientist's contention that the scholarly enterprise is to ultimately
seek knowledge, concurred, but added, (paraphrased, but pretty close)
"An alternative hypothesis is that the academic enterprise is a game
constructed to identify the cleverest people so we know who to give the
money to."
His smirk revealed a great
deal about what he believed to be the silly idea that scholarship was
about knowledge. The reviewer's reply above is evidence that the
hypothesis about an academic game is more believable than one in which
the academic enterprise in accounting has understanding anything as its
objective. And the profession is certainly culpable. It created
professorships and awarded them to the winners of this game. It funded
the JAR conferences. It dropped out of the AAA. This may be because the
profession has never had any great respect for scholarship, at least not
in my lifetime. Medical scholarship is not about creating profit
opportunities for doctors; neither is legal scholarship about creating
profit opportunities for lawyers. Perhaps this is why we now have, as
Ray Chambers opined in his Abacus article in 1999 (just before he passed
away) that we had created vast tomes of incoherent rules "...as if for a
profession of morons."
“Knowledge and competence
increasingly developed out of the internal dynamics of
esoteric disciplines rather than within the context of
shared perceptions of public needs,” writes Bender.
“This is not to say that professionalized disciplines or
the modern service professions that imitated them became
socially irresponsible. But their contributions to
society began to flow from their own self-definitions
rather than from a reciprocal engagement with general
public discourse.”
Now, there is a definite note of sadness in Bender’s
narrative – as there always tends to be in accounts of
the shift from Gemeinschaft to Gesellschaft.
Yet it is also clear that the
transformation from civic to disciplinary
professionalism was necessary.
“The new disciplines offered
relatively precise subject matter and procedures,”
Bender concedes, “at a time when both were greatly
confused. The new professionalism also promised
guarantees of competence — certification — in an era
when criteria of intellectual authority were vague and
professional performance was unreliable.”
But in the epilogue to
Intellect and Public Life, Bender suggests that the
process eventually went too far. “The risk now is
precisely the opposite,” he writes. “Academe is
threatened by the twin dangers of fossilization and
scholasticism (of three types: tedium, high tech, and
radical chic). The agenda for the next decade, at least
as I see it, ought to be the opening up of the
disciplines, the ventilating of professional communities
that have come to share too much and that have become
too self-referential.”
The above quotation does not contain beginning and ending parts of
the article
I loved the Marx Brothers
Analogy in This One: It shows what happens when government runs a business
"Is This Any Way to Run a Railroad? You think you've got problems?
Amtrak's got an overpaid workforce. Its trains and tracks are falling
apart. Worse, the carrier's balance sheet is a flat-out mess," by John
Goff, CFO Magazine,
November 2005 ---
http://www.cfo.com/article.cfm/5077873/c_5101083?f=magazine_featured
As Marx Brothers movies go,
Go West isn't much. The aging comedy team was running out of ideas, and
it shows: the plot is predictable and the gags are stale. Yet
there is one memorable scene in the 1940 film.
In it, the boys — desperate to keep a steam-powered locomotive chugging
along — feed the entire train to itself, car by car, piece by piece,
caboose to tender.
Management at the National
Railroad Passenger Corp., better known as Amtrak, performed a similar
sacrifice in 2001. Four years into an effort to wean itself from federal
operating subsidies, the rail carrier was running on empty. Executives
had already started diverting funds earmarked for capital projects to
help plug operating holes. But even that wasn't enough, and soon,
Amtrak's management began cannibalizing the railroad. Recalls Cliff
Black, Amtrak's director of media relations: "We mortgaged everything."
Things got so bad that the
railroad took out a loan on New York's Pennsylvania Station to cover
three months of expenses. It was a move the U.S. Office of Management
and Budget called "a financial absurdity equivalent to a family taking
out a second mortgage on its home to pay its grocery bills." Eventually,
Amtrak conceded it couldn't break even, and Congress continued pumping
funds back into the rail operator.
The damage to the balance
sheet had been done, however. During the five-year plan, the carrier's
debt load nearly tripled, from $1.7 billion to $4.8 billion. Once dubbed
the "Glide Path to Profitability," Amtrak's intended march to
self-sufficiency is termed something else by current CFO David Smith. "I
call it the slippery slope to hell," he says.
Since taking the reins last
November, Smith has personally spent considerable time in purgatory —
stuck awaiting vital federal funding for the carrier while politicians
dither over the future of passenger rail service. "Amtrak's never had
full support from any Administration. And it has no ongoing real capital
budget," notes James Coston, chairman of Corridor Capital LLC, which
specializes in finance and development for intercity and commuter rail
systems. "So each year, they go up to Capitol Hill with a tin cup."
And that cup remains far
from full. Last February, for example, the White House announced it
intended to cut off Amtrak's billion-dollar-plus annual subsidy — which
covers about half the railroad's total budget — unless the carrier
agreed to a radical restructuring. Both the House and the Senate defied
the Administration, calling for subsidies ranging from $1.17 billion to
$1.45 billion for 2006 (the carrier generated $1.9 billion in revenues
last year against $2.9 billion in costs). But the details have yet to be
ironed out, and it's still unclear just how much money Amtrak will get.
Amid the revenue
uncertainty, Smith must somehow pay down Amtrak's borrowings, upgrade
its information technology and financial skills, and wring concessions
from entrenched unions. He is also charged with mapping out long-term
capital investments on the railroad's antiquated infrastructure — a tall
order when you don't actually know what funds will be available to
finance the repairs. And he must do all this under the scrutiny of an
Administration whose purported goal, says Amtrak president and CEO David
Gunn, is "to destroy Amtrak."
It is, in sum, a nearly
impossible to-do list. But judging from his efforts so far, Smith has
what it takes to defy long odds: steadiness, belief, and a certain
imperviousness to the Coliseum crowd. Some observers say his first year
on the job could be used as a case study for grace under fire. Says
Coston: "I can't imagine a tougher job than being CFO at Amtrak."
December 5, 2005 reply from Paul Williams
Bob, Come on! This kind of argument is unfair. You
sound like the folks at Rochester. Outcomes I like I attribute to market
forces and the private sector; outcomes I don't like are the fault of
government meddling. I defy anyone to draw a line that demarcates private
from public outcomes. The intertwining of government and economics is today
the same as it has always been. Abandoning the messy world of political
economy for the mathematically elegant imaginary world of mere economics
makes for a nice living for a lot of mathematicians. Since my paycheck is
drawn on the account of the State of North Carolina I am legally a
government employee. NC State's Centennial Campus is living testament to the
impossibility, in a meaningful scientific sense (as opposed to a rhetorical
sense), of the distinction between pubic and private. All that exists are
organizations within a context of constraints and incentives mutually
determined by economic, political, and social forces (if force is the right
metaphor).
From the KPMG Audit Report on September 30, 2004
--- http://www.amtrak.com/pdf/04financial.pdf The Company (Amtrak) has a
history of substantial operating losses and is highly dependent upon
substantial Federal government subsidies to sustain its operations. There
are currently no Federal government subsidies authorized or appropriated for
any period subsequent to the fiscal year ending September 30, 2005 (“fiscal
year 2005”). Without such subsidies, Amtrak will not be able to continue to
operate in its current form and significant operating changes, restructuring
or bankruptcy may occur. Such changes or restructuring would likely result
in asset impairments.
************************
I guess I have to agree Paul that the difference
between Amtrak and other businesses, like farmers, dependent upon government
subsidies is largely semantic (rhetorical). In a sense, Amtrak is less like
Fanny Mae since Amtrak's debt is not guaranteed by the Federal government.
It is also less like the U.S. Post Office since Amtrak did sell equity (that
has nearly been wiped out by huge deficits). Like the Post Office, Amtrak
does negotiate directly with the government for appropriations to a
particular business. But unlike the Post Office, I think Amtrak can set
prices without an act of Congress.
The lines are indeed fuzzy between government
enterprises, private enterprises directly subsidized, private enterprises
indirectly subsidized, and theoretical private firms that have no
government subsidies. There may not be any such private firms in modern
times since nearly every product or service is indirectly subsidized
somewhere along the supply chain.
One possible distinction between public and private
enterprises is whether the government is obligated to pay creditors off in
full if the enterprise fails. I gather that this is the case for NC state
universities, the U.S. Post Office, and Fannie Mae (even though Fanny Mae
also sells equity shares). Debt guarantees are not assured in the case of
Amtrak such that Amtrak is closer to being private in this context. In this
context, classifying public versus private enterprises becomes a sliding
scale as to what portion of the debt is guaranteed by the government.
Pension guarantees cloud this issue since these are a form of insurance that
enterprises must buy inGo to become partly covered.
I'm not certain where your argument bears much
fruit if we don't have some distinction between public and private. If
subsidies make every enterprise a government enterprise, wouldn't all
businesses become government enterprises? It would not be helpful to have no
definition of private enterprise since many equity owners and creditors can
still fail and do every day in firms where the government does not guarantee
repayment of all debt.
One problem of debt guarantees like we have in
Fanny Mae and the Post Office is that managers of those companies can be
tempted put their companies in extremely high levels of debt risk because
creditors are always willing to loan to the hilt if the government
guarantees repayment. Then cowboy managers
might be tempted to borrow great amounts to pay for highly inefficient
operating costs or make extremely high risk investments (as Fannie Mae did
with billions invested in losing manufactured housing mortgages).
When I started this thread I mistakenly thought
that Amtrak's debt was guaranteed by the government. What amazes me is how
Amtrak is still able to borrow money to finance losing operations. Creditors
(who are largely in Canada and France) must have faith that the U.S.
government will not allow Amtrak to fail in spite of Amtrak's bleak future
for ever earning a profit. Apparently the close association of Amtrak and
government make it not like Penn Central in the eyes of lenders.
PRECISELY one year ago, we lucky taxpayers
took over Fannie Mae and Freddie Mac, the mortgage finance giants that
contributed mightily to the wild and crazy home-loan-boom-turned-bust. In
that rescue operation, the Treasury agreed to pony up as much as $200
billion to keep Fannie in the black, coughing up cash whenever its
liabilities exceed its assets. According to the company’s most recent
quarterly financial statement, the Treasury will, by Sept. 30, have handed
over $45 billion to shore up the company’s net worth.
It is still unclear what the ultimate cost
of this bailout will be. But thanks to inquiries by Representative Alan
Grayson, a Florida Democrat, we do know of another, simply outrageous cost.
As a result of the Fannie takeover, taxpayers are paying millions of dollars
in legal defense bills for three top former executives, including Franklin
D. Raines, who left the company in late 2004 under accusations of accounting
improprieties. From Sept. 6, 2008, to July 21, these legal payments totaled
$6.3 million.
With all the turmoil of the financial
crisis, you may have forgotten about the book-cooking that went on at Fannie
Mae. Government inquiries found that between 1998 and 2004, senior
executives at Fannie manipulated its results to hit earnings targets and
generate $115 million in bonus compensation. Fannie had to restate its
financial results by $6.3 billion.
Almost two years later, in 2006, Fannie’s
regulator concluded an investigation of the accounting with a scathing
report. “The conduct of Mr. Raines, chief financial officer J. Timothy
Howard, and other members of the inner circle of senior executives at Fannie
Mae was inconsistent with the values of responsibility, accountability, and
integrity,” it said.
That year, the government sued Mr. Raines,
Mr. Howard and Leanne Spencer, Fannie’s former controller, seeking $100
million in fines and $115 million in restitution from bonuses the government
contended were not earned. Without admitting wrongdoing, Mr. Raines, Mr.
Howard and Ms. Spencer paid $31.4 million in 2008 to settle the litigation.
When these top executives left Fannie, the
company was obligated to cover the legal costs associated with shareholder
suits brought against them in the wake of the accounting scandal.
Now those costs are ours. Between Sept. 6,
2008, and July 21, we taxpayers spent $2.43 million to defend Mr. Raines,
$1.35 million for Mr. Howard, and $2.52 million to defend Ms. Spencer.
“I cannot see the justification of people
who led these organizations into insolvency getting a free ride,” Mr.
Grayson said. “It goes right to the heart of what people find most
disturbing in this situation — the absolute lack of justice.”
Lawyers for the three executives did not
returns calls seeking comment.
An additional $16.8 million was paid in
the period to cover legal expenses of workers at the Office of Federal
Housing Enterprise Oversight, Fannie’s former regulator. These costs are
associated with defending the regulator in litigation against former Fannie
executives.
This tally of taxpayer legal costs took
several months for Mr. Grayson to extract. On June 4, after Congressional
hearings on the current and future status of Fannie and Freddie, he
requested the information from the Federal Housing Finance Agency, now their
regulator. He got its response on Aug. 26.
A spokeswoman for the agency said it would
not comment for this article.
THE lawyers’ billable hours, meanwhile,
keep piling up. As the F.H.F.A. explained to Mr. Grayson, the $6.3 million
in costs generated by 10 months of legal defense work for Mr. Raines, Mr.
Howard and Ms. Spencer includes not a single deposition for any of them.
Instead, those bills covered 33 depositions of “other parties” relating to
the shareholder suits and requiring the presence of the three executives’
counsel.
One of Mr. Grayson’s questions about these
payments remains unanswered — whether placing Fannie Mae into receivership,
rather than conservatorship, would have negated the agreement to cover the
former executives’ legal costs. Choosing conservatorship allowed Fannie to
stabilize and meant that it was going to continue to operate, not wind down
immediately.
But, Mr. Grayson pointed out: “If these
companies had gone into receivership instead of conservatorship, the trustee
in bankruptcy or the receiver would have been free, legally, to reject these
contracts that called for indemnification. Raines, Howard and Spencer would
have had to pay their own fees.”
When asked about this, Fannie’s regulator,
the F.H.F.A., waffled. “Whether these costs could have been avoided would
depend on the facts and circumstances surrounding any receivership,” it
said. “It is possible that receiverships could have reduced the costs of the
litigation, but by no means certain.”
Mr. Grayson said he intended to find out
whether there are any legal options under the conservatorship to stop paying
for the defense of the Fannie Mae three. “When did Uncle Sam become Uncle
Sap?” he said. “In a situation where billions of losses have already
occurred, is it really asking too much that people pay their own legal
fees?”
While the $6.3 million paid to defend Mr.
Raines, Mr. Howard and Ms. Spencer is a pittance compared with other bills
coming due in the bailout binge, it is still disturbing for these costs to
be covered by those who had nothing to do with the problems and certainly
did not benefit from them. The money may be small, but the episode’s message
looms large: those who presided over this debacle aren’t being held
accountable.
“It is wrong in a very deep sense,” Mr.
Grayson said. “The essence of our society is that people who do good things
are rewarded and people who do bad things are punished.
Where is the punishment for Raines,
Howard and Spencer? There is none.”
Continued in article
I Saw Maxine Kissing Franklin Raines ---
http://www.youtube.com/watch?v=vbZnLxdCWkA
Before Franklin Raines resigned as CEO of Fannie Mae and paid over a million
dollar fine for accounting fraud to pad his bonus, he was the darling of the
liberal members of Congress. Frank Raines was creatively managing earnings to
the penny just enough to get his enormous bonus. The auditing firm of KPMG was
accordingly fired from its biggest corporate client in history ---
http://faculty.trinity.edu/rjensen/Theory01.htm#Manipulation
Mortgage Fraud Increasing Despite the attention paid to mortgage fraud committed
by borrowers and lenders since declines in the real estate values and the
subprime loan crisis triggered severe problems in the banking industry, the
number of Federal Bureau of Investigation’s (FBI) investigations of mortgage
fraud and associated financial crimes is increasing. “The FBI has experienced
and continues to experience an exponential rise in mortgage fraud
investigations,” John Pistole, Deputy Director, told the Senate Judiciary
Committee in April. AccountingWeb, August 18, 2009 ---
http://www.accountingweb.com/topic/mortgage-loan-fraud-increasing
Jensen Comment
I think mortgage fraud will continue to rise as long as remote third parties
like Fannie Mae, Freddie Mac, and FHA continue to buy up mortgages negotiated by
banks and mortgage companies basking in moral hazard. The biggest hazards are
fraudulent real estate appraisals and lies about income in mortgage
applications. We need to bring back George Bailey (James Stewart) in It's a
Wonderful Life ---
http://en.wikipedia.org/wiki/It%27s_a_Wonderful_Life
The banks that negotiate the mortgages should have to hang on to those
mortgages. Watch the video at
http://www.youtube.com/watch?v=MJJN9qwhkkE
When I was gone I received a message from the
authors of Corporate Finance by Vernimmen, Quiry, Le Fur, and Salvi.
The book, newsletter, and website are all very
interesting and useful.
The book is 48 chapters (about 1000 pages) full of
corporate finance. I have to agree with the authors "It is a book in which
theory and practice are constantly set off against each other...."
I really like it. Especially the emphasis not so
much on techniques ("which tend to shift and change over time."
VERY WELL DONE!
Moreover, the authors also put out a monthly
newsletter and have a web site that could stand alone as one of the best in
the business.
Jensen Comment:
Perhaps intermediate accounting textbooks will one day follow this lead of
contrasting theory and practice.
Accountics Takeover of Academic Accounting Research: What Went
Wrong? Blast from the Past (Accountics Science in Accounting Research) An Analysis of the Evolution of Research Contributions by The Accounting
Review, 1926-2005 . .
by Jean L. Heck and Robert E. Jensen
Accounting Historians Journal, 2007, Vol. 34, no. 2, pp. 109-142
http://faculty.trinity.edu/rjensen/395wpTAR/Web/TAR395wp.htm
Three Interesting (albeit
negative) Sites on Peer Review (I highly recommend them even though one is my
own)
Those who think that peer review is inherently fair and accurate are wrong.
Those who think that peer review necessarily suppresses their brilliant new
ideas are wrong. It is much more than those two simple opposing tendencies
---
http://rodneybrooks.com/peer-review/
The comments are especially interesting
Bob Jensen: 574
Shields Against Validity Challenges in Plato's Cave ---
http://faculty.trinity.edu/rjensen/TheoryTAR.htm
Prestigious accounting research journals claim they encourage replication.
They just don't encourage replication because
replication studies in academic accounting research are blocked by the peer
review process.
Jensen Comment
This is why I spend such a large part of every day reading blogs. Blog
modules are not formally refereed but in a way they are subjected to
widespread peer review among the entire population of readers of the blog as
long as the blogger publishes their replies to to his or her blog modules.
This is why I think blogs and
listservs are less suppressive of new ideas.
One of the stupid unmentioned
results of peer review in our most prestigious academic accounting research
journals is that they rarely publish articles without equations. Go figure!
This paper presents rankings of
accounting journals disaggregated by topical area (AIS, audit,
financial, managerial, tax, and other) and methodology (analytical,
archival, experimental, and other). We find that only for the financial
topical area and archival methodology does the traditional top-3
characterization of the best journals accurately describe what journals
publish the most-cited work. For all other topic areas and
methodologies, the top-3 characterization does not describe what
journals publish the most-cited work. For only analytical research does
the traditional top-6 journal characterization accurately describe what
journals publish the most-cited work. In AIS, the traditional top-3/-6
journals are even less representative, as only one traditional top-3
journal is listed among the six journals publishing the most-cited AIS
work, and only three of the traditional top-6 journals are in this list.
In addition to creating journal rankings using citations, we create
rankings using a unique measure of the attention given by stakeholders
outside of the academy. With this measure we find similar results; the
traditional top journals are not publishing the articles that receive
the most attention in some topical areas. The results call into question
whether individuals and institutions should rely solely on the
traditional top-3/-6 journal lists for evaluating research productivity
and impact.
The article itself has important citations on the limitations of
rankings based upon citations and the limitations of classifications of
multi-topic journals. I won't dwell on these.
The main limitations of the rankings is that with only a few
exceptions the articles published in all of these academic journals are not
validated by replication which in science would be considered absurd ---
http://faculty.trinity.edu/rjensen/TheoryTAR.htm
This is a set of prestigious academic accounting journals that
mostly cite articles by each other with no added consideration of their impact
on the accounting practitioners, business leaders, the financial press, or the
outside world (outside of accounting academics) world.
There's an enormous bias toward publishing articles with
equations as opposed to narratives.
There's virtually no recognition given to how
articles published in these journals changed the world apart from the world
of publishing in these journals. No attempt is made to detect the impact of any
article on the professional world.
Hermann Weyl born in Hamburg, Germany. He wrote,
"One may say that mathematics talks about the things which are of no concern to
men. Mathematics has the inhuman quality of starlight---brilliant, sharp, but
cold ... thus we are clearest where knowledge matters least: in mathematics,
especially number theory." ---
Each university has created a role
that will feature a senior academic leading on practical steps the
institution is taking to bolster research quality, such as better
training, open data practices and assessing the criteria used in
recruitment and promotion decisions
Jensen Comment
Leading academic accounting journals publish neither commentaries on their
articles nor replications of research. It's almost rare for academic
accounting research to be independently reproduced or otherwise
verified. It's not that accounting researchers are more accurate and honest
than scientists. It's more of a problem with lack of relevance of the
research in the profession of accountancy ---
http://faculty.trinity.edu/rjensen/TheoryTAR.htm
It's doubtful that the UK network mentioned above will
affect schools of business in general.
Creating Relevance of
Accounting Research (ROAR) Scores to Evaluate the Relevance of
Accounting Research to Practice
Keywords: Research Relevance,
Accounting
Rankings, Practice-Oriented Research, Journal Rankings
JEL Classification: M40, M41, M49, M00
Abstract
The relevance of
accounting
academic research to practice has been frequently discussed in the
accounting
academy; yet, very little data has been put forth in these
discussions. We create relevance of
accounting
research (ROAR) scores by having practitioners read and evaluate the
abstract of every article published in 12 leading
accounting
journals for the past three years. The ROAR scores allow for a more
evidence-based evaluation and discussion of how academic
accounting
research is relevant to practitioners. Through these scores, we
identify the articles, authors, journals, and
accounting
topic areas and methodologies that are producing practice-relevant
scholarship. By continuing to produce these scores in perpetuity, we
expect this data to help academics and practitioners better identify
and utilize practice-relevant scholarship.
V. CONCLUSIONS
This research provides empirical data
about the contribution accounting academics are making to practice.
Specifically, we had nearly 1,000 professionals read the abstract of
academic accounting articles and rate how relevant the articles are
to practice. We then present the data to rank journals,
universities, and individual scholars. Overall, we interpret the
results to suggest that some of the research that is currently
produced and published in 12 accounting journals is relevant to
practice, but at the same time, there is room to improve. Our hope
is that by producing these rankings, it will encourage journals,
institutions, and authors to produce and publish more relevant
research, thus helping to fulfill the Pathways charge “to build a
learned profession.”
We now take the liberty to provide
some normative comments about our research findings in relation to
the goal of producing a learned profession.
One of the key findings in this study
is that the traditional top 3 and top 6 journals are not producing
the most or the greatest average amount of practice relevant
research, especially for the distinct accounting topic areas.
Prior research shows that the collection of a small group of 3/6
journals is not representative of the breadth of accounting
scholarship (Merchant 2010; Summers and Wood 2017; Barrick, et al.
2019). Given the empirical research on this topic, we question why
institutions and individual scholars continue to have a myopic focus
on a small set of journals. The idea that these 3/6 journals publish
“the best” research is not empirically substantiated. While many
scholars argue that the focus is necessary for promotion and tenure
decisions, this seems like a poor excuse (see Kaplan 2019).
Benchmarking production in a larger set of journals would not be
hard, and indeed has been done (Glover, Prawitt, and Wood 2006;
Glover, Prawitt, Summers, and Wood 2019). Furthermore, as trained
scholars, we could read and opine on article quality without
outsourcing that decision to simple counts of publications in
“accepted” journals. We call on the 18 We recognize that only
looking at 12 journals also limits the scope unnecessarily. The
primary reason for the limitation in this paper is the challenge of
collecting data for a greater number of journals. Thus, we view 12
journals as a start, but not the ideal. academy to be much more open
to considering research in all venues and to push evaluation
committees to do the same.
A second important finding is that
contribution should be a much larger construct than is previously
considered in the academy. In our experience, reviewers, editors,
and authors narrowly define the contribution an article makes and
are too often unwilling to consider a broad view of contribution.
The current practice of contribution too often requires authors to
“look like everyone else” and rarely, if ever, allows for a
contribution that is focused exclusively on a practice audience. We
encourage the AACSB, AAA, and other stakeholders to make a more
concerted effort to increase the focus on practice-relevant
research. This may entail journals rewriting mission statements,
editors taking a more pro-active approach, and training of reviewers
to allow articles to be published that focus exclusively on
“practical contributions.” This paper has important limitations.
First, we only examine 12 journals. Ideally, we would like to
examine a much more expansive set of journals but access to
professionals makes this challenging at this time. Second, measuring
relevance is difficult. We do not believe this paper “solves” all of
the issues and we agree that we have not perfectly measured
relevance. However, we believe this represents a reasonable first
attempt in this regard and moves the literature forward. Third, the
ROAR scores are only as good as the professionals’ opinions. Again,
we limited the scores to 5 professionals hoping to get robust
opinions, but realize that some articles (and thus authors and
universities) are not likely rated “correctly.” Furthermore,
articles may make a contribution to practice in time and those
contributions may not be readily apparent by professionals at the
time of publication. Future research can improve upon what we have
done in this regard.
We are hopeful that shining a light
on the journals, institutions, and authors that are excelling at
producing research relevant to practice will encourage increased
emphasis in this area.
Jensen Question
Is accounting research stuck in a rut of repetitiveness and irrelevancy?
"Accounting
Craftspeople versus Accounting Seers: Exploring the Relevance and
Innovation Gaps in Academic Accounting Research," by William E.
McCarthy,Accounting
Horizons, December 2012, Vol. 26, No. 4, pp. 833-843 ---
http://aaajournals.org/doi/full/10.2308/acch-10313
Is accounting research stuck in a
rut of repetitiveness and irrelevancy? I(Professor
McCarthy)would
answer yes, and I would even predict that both its gap in relevancy
and its gap in innovation are going to continue to get worse if the
people and the attitudes that govern inquiry in the American academy
remain the same. From my
perspective in accounting information systems, mainstream accounting
research topics have changed very little in 30 years, except for the
fact that their scope now seems much more narrow and crowded. More
and more people seem to be studying the same topics in financial
reporting and managerial control in the same ways, over and over and
over. My suggestions to get out of this rut are simple. First, the
profession should allow itself to think a little bit normatively, so
we can actually target practice improvement as a real goal. And
second, we need to allow new scholars a wider berth in research
topics and methods, so we can actually give the kind of creativity
and innovation that occurs naturally with young people a chance to
blossom.
Since
the 2008 financial crisis, colleges and universities have faced
increased pressure to identify essential disciplines, and cut
the rest. In 2009, Washington State University announced it
would eliminate the department of theatre and dance, the
department of community and rural sociology, and the German
major – the same year that the University of Louisiana at
Lafayette ended its philosophy major. In 2012, Emory University
in Atlanta did away with the visual arts department and its
journalism programme. The cutbacks aren’t restricted to the
humanities: in 2011, the state of Texas announced it would
eliminate nearly half of its public undergraduate physics
programmes. Even when there’s no downsizing, faculty salaries
have been frozen and departmental budgets have shrunk.
But despite the funding crunch, it’s a
bull market for academic economists. According to a 2015
sociologicalstudyin
theJournal
of Economic Perspectives, the median salary of
economics teachers in 2012 increased to $103,000 – nearly
$30,000 more than sociologists. For the top 10 per cent of
economists, that figure jumps to $160,000, higher than the next
most lucrative academic discipline – engineering. These figures,
stress the study’s authors, do not include other sources of
income such as consulting fees for banks and hedge funds, which,
as many learned from the documentaryInside
Job(2010),
are often substantial. (Ben Bernanke, a former academic
economist and ex-chairman of the Federal Reserve, earns
$200,000-$400,000 for a single appearance.)
Unlike engineers and chemists, economists cannot point to
concrete objects – cell phones, plastic – to justify the high
valuation of their discipline. Nor, in the case of financial
economics and macroeconomics, can they point to the predictive
power of their theories. Hedge funds employ cutting-edge
economists who command princely fees, but routinely underperform
index funds. Eight years ago, Warren Buffet made a 10-year, $1
million bet that a portfolio of hedge funds would lose to the
S&P 500, and it looks like he’s going to collect. In 1998, a
fund that boasted two Nobel Laureates as advisors collapsed,
nearly causing a global financial crisis.
The failure of the field to predict the
2008 crisis has also been well-documented. In 2003, for example,
only five years before the Great Recession, the Nobel Laureate
Robert E Lucas Jrtoldthe
American Economic Association that ‘macroeconomics […] has
succeeded: its central problem of depression prevention has been
solved’. Short-term predictions fair little better – in April
2014, for instance,a
surveyof
67 economists yielded 100 per cent consensus: interest rates
would rise over the next six months. Instead, they fell. A lot.
Nonetheless,surveys
indicatethat
economists see their discipline as ‘the most scientific of the
social sciences’. What is the basis of this collective faith,
shared by universities, presidents and billionaires? Shouldn’t
successful and powerful people be the first to spot the
exaggerated worth of a discipline, and the least likely to pay
for it?
In
the hypothetical worlds of rational markets, where much of
economic theory is set, perhaps. But real-world history tells a
different story, of mathematical models masquerading as science
and a public eager to buy them, mistaking elegant equations for
empirical accuracy.
Jensen Comment
Academic accounting (accountics) scientists took economic astrology
a step further when their leading journals stopped encouraging and
publishing commentaries and replications of published articles ---
How Accountics Scientists Should Change:
"Frankly, Scarlett, after I get a hit for my resume inThe
Accounting ReviewI
just don't give a damn"
http://www.cs.trinity.edu/~rjensen/temp/AccounticsDamn.htm
Times are changing in social science research
(including economics) where misleading p-values are no longer the
Holy Grail. Change among accountics scientist will lag behind change
in social science research but some day leading academic accounting
research journals may publish articles without equations and/or
articles of interest to some accounting practitioner somewhere in
the world ---
See below
Three years ago, the American Statistical Association (ASA) expressed
hope that the world would move to a “post-p-value
era.”
The statement in which they made that recommendation has been cited more
than 1,700 times, and apparently, the organization has decided that
era’s time has come. (At least one journal had already banned p values by 2016.)
In an editorial
in a special issue
of The American Statistician out today, “Statistical Inference in the
21st Century: A World Beyond P<0.05,” the executive director of the ASA,
Ron Wasserstein, along with two co-authors, recommends that when it
comes to the term “statistically significant,” “don’t say it and don’t
use it.” (More than 800 researchers signed onto a piece published in Nature yesterday
calling for the same thing.) We asked Wasserstein’s co-author, Nicole Lazar of the University of Georgia,
to answer a few questions about the move.
So the ASA wants to say goodbye to “statistically significant.” Why, and
why now?
In the past few years there has been a growing recognition in the
scientific and statistical communities that the standard ways of
performing inference are not serving us well. This manifests itself in,
for instance, the perceived crisis in science (of reproducibility, of
credibility); increased publicity surrounding bad practices such as
p-hacking (manipulating the data until statistical significance can be
achieved); and perverse incentives especially in the academy that
encourage “sexy” headline-grabbing results that may not have much
substance in the long run. None of this is necessarily new, and indeed
there are conversations in the statistics (and other) literature going
back decades calling to abandon the language of statistical
significance. The tone now is different, perhaps because of the more
pervasive sense that what we’ve always done isn’t working, and so the
time seemed opportune to renew the call.
Much of the editorial is an impassioned plea to embrace uncertainty. Can
you explain?
The world is inherently an uncertain place. Our models of how it works
— whether formal or informal, explicit or implicit — are often only
crude approximations of reality. Likewise, our data about the world are
subject to both random and systematic errors, even when collected with
great care. So, our estimates are often highly uncertain; indeed, the
p-value itself is uncertain. The bright-line thinking that is emblematic
of declaring some results “statistically significant” (p<0.05) and
others “not statistically significant” (p>0.05) obscures that
uncertainty, and leads us to believe that our findings are on more solid
ground than they actually are. We think that the time has come to fully
acknowledge these facts and to adjust our statistical thinking
accordingly.
“In
statistics, Type I errors (false alarms) and Type II errors (misses)
are sometimes considered separately, with Type I errors being a
function of the alpha level and Type II errors being a function of
power. An advantage of signal detection theory is that it combines
Type I and Type II errors into a single analysis of discriminability…”
“…p
values were effective, though not perfect, at discriminating between
real and null effects.”
“Bayes
factor incurs no advantage over p values at detecting a real
effect versus a null effect … This is because Bayes factors are
redundant with p values for a given sample size.”
“When
power is high, researchers using p values to determine statistical
significance should use a lower criterion.”
“… a
change to be more conservative will decrease false alarm rates at
the expense of increasing miss rates. False alarm rates should not
be considered in isolation without also considering miss rates.
Rather, researchers should consider the relative importance for each
in deciding the criterion to adopt.”
“…given
that true null results can be theoretically interesting and
practically important, a conservative criterion can produce
critically misleading interpretations by labeling real effects as if
they were null effects.”
“Moving
forward, the recommendation is to acknowledge the relationship
between false alarms and misses, rather than implement standards
based solely on false alarm rates.”
Continued in article
Academic accounting researchers sheilded themselves from validity
challenges by refusing to publish commentaries and refusing to accept
replication studies for publication ---
http://faculty.trinity.edu/rjensen/TheoryTAR.htm
Scientific Method in Accounting Has Not Been a Method for Generating
New Theories The following is a quote from the 1993
President’s Message of Gary Sundem, President’s
Message. Accounting Education News 21 (3). 3.
Although empirical scientific
method has made many positive contributions to accounting research,
it is not the method that is likely to generate new theories, though
it will be useful in testing them. For example, Einstein’s theories
were not developed empirically, but they relied on understanding the
empirical evidence and they were tested empirically. Both the
development and testing of theories should be recognized as
acceptable accounting research.
Message from Bob Jensen to
Steve Kachelmeier in 2015
Hi Steve,
As usual, these AECM threads between you, me, and Paul Williams
resolve nothing to date. TAR still has zero articles without
equations unless such articles are forced upon editors like the
Kaplan article was forced upon you as Senior Editor. TAR still has
no commentaries about the papers it publishes and the authors make
no attempt to communicate and have dialog about their research on
the AECM or the AAA Commons.
I do hope that our AECM threads will continue and lead one day to
when the top academic research journals do more to both encourage
(1) validation (usually by speedy replication), (2) alternate
methodologies, (3) more innovative research, and (4) more
interactive commentaries.
I remind you that Professor Basu's essay is only one of four essays
bundled together in Accounting Horizons on the topic of how to make
accounting research, especially the so-called Accounting Sciience or
Accountics Science or Cargo Cult science, more innovative.
"Framing the Issue of Research Quality in a Context of
Research Diversity," by Christopher S. Chapman ---
"Accounting Craftspeople versus Accounting Seers: Exploring
the Relevance and Innovation Gaps in Academic Accounting
Research," by William E. McCarthy ---
"Is Accounting Research Stagnant?" by Donald V. Moser ---
Cargo Cult Science "How Can Accounting Researchers Become
More Innovative? by Sudipta Basu ---
I will try to keep drawing attention to these important essays and
spend the rest of my professional life trying to bring accounting
research closer to the accounting profession.
I also want to dispel the myth that accountics research is harder
than making research discoveries without equations. The hardest
research I can imagine (and where I failed) is to make a discovery
that has a noteworthy impact on the accounting profession. I always
look but never find such discoveries reported in TAR.
The easiest research is to purchase a database and beat it with an
econometric stick until something falls out of the clouds. I've
searched for years and find very little that has a noteworthy impact
on the accounting profession. Quite often there is a noteworthy
impact on other members of the Cargo Cult and doctoral students
seeking to beat the same data with their sticks. But try to find a
practitioner with an interest in these academic accounting
discoveries?
Our latest thread leads me to such questions as:
Is accounting research of inferior quality relative to other
disciplines like engineering and finance?
Are there serious innovation gaps in academic accounting
research?
Is accounting research stagnant?
How can accounting researchers be more innovative?
Is there an "absence of dissent" in academic accounting
research?
Is there an absence of diversity in our top academic
accounting research journals and doctoral programs?
Is there a serious disinterest (except among the Cargo Cult)
and lack of validation in findings reported in our academic
accounting research journals, especially TAR?
Is there a huge communications gap between academic
accounting researchers and those who toil teaching accounting
and practicing accounting?
One fall out of this thread is that I've been
privately asked to write a paper about such matters. I hope that
others will compete with me in thinking and writing about these
serious challenges to academic accounting research that never seem
to get resolved.
Thank you Steve for sometimes responding in my
threads on such issues in the AECM.
Respectfully,
Bob Jensen
Sadly Steve like all other
accountics scientists (with one sort of exception) no longer
contributes to the AECM
April 22, 2012 reply from Bob Jensen
Steve Kachelmeier wrote:
"I am very proud to have accepted and
published the Magilke, Mayhew, and Pike experiment, and I think it
is excellent research, blending both psychology and economic
insights to examine issues of clear importance to accounting and
auditing. In fact, the hypocrisy somewhat amazes me that, amidst all
the complaining about a perceived excess of financial
empirical-archival (or what you so fondly call "accountics"
studies), even those studies that are quite different in style also
provoke wrath."
I read the first
25 or so pages of the paper. As an actual audit committee
member, I feel comfortable in saying that the assumptions going
into the experiment design make no sense whatsoever. And using
students to "compete to be hired" as audit committee members is
preposterous.
I have served on
five audit committees of large public companies, all as
chairman. My compensation has included cash, stock options,
restricted stock, and unrestricted stock. The value of those
options has gone from zero to seven figures and back to zero and
there have been similar fluctuations in the value of the stock.
In no case did I ever sell a share or exercise an option prior
to leaving a board. And in every case my *only *objective as an
audit committee member was to do my best to insure that the
company followed GAAP to the best of its abilities and that the
auditors did the very best audit possible.
No system is
perfect and not all audit committee members are perfect
(certainly not me!). But I believe that the vast majority of
directors want to do the right thing. Audit committee members
take their responsibilities extremely seriously as evidenced by
the very large number of seminars, newsletters, etc. to keep us
up to date. It's too bad that accounting researchers can't find
ways to actually measure what is going on in practice rather
than revert to silly exercises like this paper. To have it
published in the leading accounting journal shows how out of
touch the academy truly is, I'm afraid.
Denny Beresford
Bob Jensen's Reply
Thanks Steve, but if if the Maglke, Mayhew, and Pike experiment was
such excellent research, why did no independent accountics science
researchers or practitioners find it worthy of being validated?
The least likely accountics science research
studies to be replicated are accountics behavioral experiments that
are usually quite similar to psychology experiments and commonly use
student surrogates for real life professionals? Why is that these
studies are so very, very rarely replicated by independent
researchers using either other student surrogates or real world
professionals?
Why are these accountics behavioral
experiments virtually never worthy of replication?
Years ago I was hired, along
with another accounting professor, by the FASB to evaluate research
proposals on investigating the impact of FAS 13. The FASB reported
to us that they were interested in capital markets studies and case
studies. The one thing they explicitly stated, however, was that
they were not interested in behavioral experiments. Wonder why?
The Bottom Line As with so many disciplines academic research ceased being
relevant to the outside world --- like Political Science
In a 2008
speech to the Association of American Universities, the former Texas A&M
University president and then-Secretary of Defense Robert M. Gates
declared that "we must again embrace eggheads and ideas." He went on to
recall the role of universities as "vital centers of new research"
during the Cold War. The late Thomas Schelling would have agreed. The
Harvard economist and Nobel laureate once described "a wholly
unprecedented ‘demand’ for the results of theoretical work. … Unlike any
other country … the United States had a government permeable not only by
academic ideas but by academic people."
Gates’s
efforts to bridge the gap between Beltway and ivory tower came at a time
when it was growing wider, and indeed, that gap has continued to grow in
the years since. According to a Teaching, Research & International
Policy Project survey,
a regular poll of international-relations scholars, very few believe
they should not contribute to policy making in some way. Yet a majority
also recognize that the state-of-the-art approaches of academic social
science are precisely those approaches that policy makers find least
helpful. A related poll of senior national-security decision-makers
confirmed that, for the most part, academic social science is not giving
them what they want.
The problem,
in a nutshell, is that scholars increasingly privilege rigor over
relevance. That has become strikingly apparent in the subfield of
international security (the part of political science that once most
successfully balanced those tensions), and has now fully permeated
political science as a whole. This skewed set of intellectual priorities
— and the field’s transition into a cult of the irrelevant — is the
unintended result of disciplinary professionalization.
The
decreasing relevance of political science flies in the face of a
widespread and longstanding optimism about the compatibility of rigorous
social science and policy relevance that goes back to the Progressive
Era and the very dawn of modern American social science. One of the most
important figures in the early development of political science, the
University of Chicago’s Charles Merriam, epitomized the ambivalence
among political scientists as to whether what they did was "social
science as activism or technique," as the American-studies scholar Mark
C. Smith put it. Later, the growing tension between rigor and relevance
would lead to what David M. Ricci termed
the "tragedy of political science": As the discipline sought to become
more scientific, in part to better address society’s ills, it became
less practically relevant.
When
political scientists seek rigor, they increasingly conflate it with the
use of particular methods such as statistics or formal modeling. The
sociologist Leslie A. White captured
that ethos as early as 1943:
We may thus
gauge the ‘scientific-ness’ of a study by observing the extent to which
it employs mathematics — the more mathematics the more scientific the
study. Physics is the most mature of the sciences, and it is also the
most mathematical. Sociology is the least mature of the sciences and
uses very little mathematics. To make sociology scientific, therefore,
we should make it mathematical.
Relevance, in
contrast, is gauged by whether scholarship contributes to the making of
policy decisions.
That
increasing tendency to embrace methods and models for their own sake
rather than because they can help us answer substantively important
questions is, I believe, a misstep for the field. This trend is in part
the result of the otherwise normal and productive workings of science,
but it is also reinforced by less legitimate motives, particularly
organizational self-interest and the particularities of our intellectual
culture.
While
the use of statistics and formal models is not by definition irrelevant,
their edging out of qualitative approaches has over time made the
discipline less relevant to policy makers. Many pressing policy
questions are not readily amenable to the preferred methodological tools
of political scientists. Qualitative case studies most often produce the
research that policy makers need, and yet the field is moving away from
them.
Continued in article
Jensen Comment
This sounds so, so familiar. The same type of practitioner irrelevancy
commenced in the 1960s when when academic accounting became "accountics
science" --- About the time when The Accounting
Review stopped publishing submissions that did not have equations and
practicing accountants dropped out of the American Accounting Association
and stopped subscribing to academic accounting research journals.
An Analysis of the Contributions of The Accounting
Review Across 80 Years: 1926-2005 --- http://faculty.trinity.edu/rjensen/395wpTAR/Web/TAR395wp.htm
Co-authored with Jean Heck and forthcoming in the December 2007 edition
of the Accounting Historians Journal.
Unlike engineering, academic accounting research is no
longer a focal point of practicing accountants. If we gave a prize for
academic research discovery that changed the lives of the practicing
profession who would practitioners choose to honor for the findings?
How
false-negatives in diagnostic testing lead to the release of infected
people, motivate extreme containment measures have been implemented, explain
why official figures are too low. The COVID-19 outbreak, explained with
Bayes’ Rule.
The war between frequentists
and Bayesians rages on, especially on the battle lines drawn in real-world
databases rather than hypothetical puzzles.
April 8, 2020 reply from David
Johnstone in Australia
The war is won Bob, medical testing (which has the
advantage that with experience the error probabilities of a test become
known) is naturally Bayesian, as is genetics.
Frequentist statistics - and poor behaviour by
researchers that exploits frequentist statistics - gave rise to the
replication crisis because it did not train people to assess weight of
evidence in a logical way - e.g. there are still many researchers who
believe that a low p-level with a higher sample size represents greater
evidence against the null hypothesis (the exact opposite of the Bayesian
argument in Lindley's paradox).
If I can be rude, I have watched your posts on this
now for a while and I sense your great ambivalence, you seem to want those
beautiful frequentist methods to have at least equal status. They are
beautiful in their maths, but they are built on flawed logic (making sure
that we separate the two; e.g. a p-level is a logical creation that can be
put into effect by correct and very clever math to yield a misleading
measure of evidence).
Your natural frequentist proclivities are I
perceive "trained in" and hard to give up on, that's the whole Kuhn
progression. Bayesian stats understands and can do anything that a
frequentist does, but can do a lot more and with a lot more appreciation for
meaning.
April 8, 2020 reply from Bob
Jensen
It's that word "subjective" that always turns me off
Thanks David
April 8, 2020 reply from
Jagdish Gangolly
Bob,
When you are trying to choose between the two, the
only good way to compare them is by examining the axioms underlying them.
Look at the axioms underlying the Bayesian statistics and compare them with
the axioms of traditional probability stated by Kolmogorov. There is no
contest. You see the clear difference, and there is no reason to look at
"subjective".
Regards,
Jagdish
April 8, 2020 reply from David
Johnstone in Australia
Dear
Bob and Jagdish,
Bayesians like "subjective" because it removes a straight jacket.
Frequentism is riddled with handcuffs and chastity belts. e.g. you draw a
random sample and reject the null, but you notice that the sample was
particularly biased looking (e.g. its composition does not resemble the
population at all, perhaps in some very worrying way). Too late, you can't
reject the sample, its "random" and that rejection would only be subjective.
April 8, 2020 reply from
Jagdish Gangolly
Dear
David,
I entirely agree with
what you said: Once you have the random sample taken, the game is in some
sense over. Of course for estimation you can do sequential plans and so on,
but for inference the game is over and you are back to square 1.
I think the greatest
objection the frequentists have regarding the Bayesians is in the choice of
a prior. That it is arbitrary, and so subjective. When I was an
undergraduate, that bothered me a bit. Almost all ny professors were
anti-Bayesians, and would not accept my argument that in science, as Newton
said, you stand on the shoulders of those who came before you and therefore
have pretty good hunches as to what the prior distribution might be, and in
many problems the process that generates the data tells you what the
distribution it is and you might even have a pretty good idea what the
parameters might be. For example, if it is a system reliability problem you
might know it is a Weibull distribution and the specification of the system
might tell you what the design parameters are. I essentially gave up until
I went to graduate school (established by MIT in Calcutta) where at least
some were Bayesians and offered advanced Bayesian courses.
The second argument was
that computations were too time consuming. That, of course was a valid
argument those days (mid 1960s) when in India we were working with IBM 1401s
and 1620s with something like 4-16kB memory and sometimes no disks. This
objection no longer is valid.
The punchline to the
story was that one of my anti-Bayesian professors (P.D. Ghangurde) came to
the US, worked with the great statistician/mathematician H.O. Hartley, wrote
a dissertation on optimization os sampling plans using mathematical
programming and Bayesian methods after becoming a Bayesian.
Regards,
Jagdish
April 9, 2020 reply from Bob
Jensen
Hi David and Jagdish,
I understand your love
for the analytics apart from the real world.
But if I took the trouble to find frequentist studies that have been
independently verified there are millions to choose from, especially in real
world science.
I've never seen Bayesian inference studies real world studies that have been
independently verified.
Do you have some
examples of Bayesian inference conclusion verifications?
I have the same trouble
with verification in specific asset appraisals, especially when it comes to
cost-benefit analysis to verify appraisals. Two appraisers may have
significantly different appraised valuations. So we can hire 100 appraisers
and then look at the means and variances of crowd sourcing distributions.
But then the buyer
who eventually purchases the asset may get it at an amount significantly
different from the mean or median value of the subjective estimates of 100
appraisers.
Of course verification
is less costly for some types of appraisals. It would be very costly to
verify appraisals of the Empire State Building. It's less costly to verify
the value of an Iowa Farmer's truckload of corn when he takes it to a local
ethanol plant. We can't use the commodity market price of corn in Chicago,
because that price is affected by both location of the corn and quality
standards set by the trading market. The farmer's corn obviously differs in
location and probably differs significantly in commodity market quality,
particularly in terms of moisture content. But the variance around
independent appraised values of a truck load of corn will have a much
smaller variance problem than the variance problem with appraised values of
the Empire State Building.
In the study I cited at the start of this thread, I think independent
verification would be quite costly to obtain, especially from 100 experts
---
How false-negatives in
diagnostic testing lead to the release of infected people, motivate
extreme containment measures have been implemented, explain why official
figures are too low. The COVID-19 outbreak, explained with Bayes’ Rule.
Do
either of you have some illustrations of real world conclusions from
Bayesian inference?
April 9, 2020 reply from David Johnstone in Australi9
David Johnstone <david.johnstone@sydney.edu.au>
Dear Bob, independent Bayesian verifications occur
routinely in DNA inferences. These are easy because priors are largely
agreed. In other cases, verifications require enough data to draw people
with different priors together. But remember, there's no hiding from the
same issue in frequentism. X and Y might get the same p-level but they
interpret it differently - because there is no objective way to interpret a
p-level (e.g. X "discounts" it for sample size, Y "discounts" it for its
funny looking random sample, Z takes a regimented binary interpretation
whereby 4.99% means something completely different to 5.01 % , etc.......)
Frequentism has the same issues as Bayesianism, they are just swept under
the carpet. The very famous and quite eclectic statistician Jack Good called
them SUTC statistics.
I will just add that people who think about these
things enough more and more become Bayesian, because its the only way that
makes sense. e.g. its the only. way that applies all the laws of probability
without any inconsistency to the task of assessing probabilities.
April 9, 2020
Maybe accountics scientists will one day jump on your bandwagon, but I
don't see evidence of it yet in accounting research journals. They remain
Frequentists.
It may be due to the lower number of experts who can agree agree on the
subjective priors.
But then it may also be that moving accountics scientists is like moving
bodies in a cemetery (a quote from Woodrow about getting academics to change
in general).
In the late 1800s, one of the most enduring fictional characters of all
time first appeared on the scene. No, I am not talking about Sherlock
Holmes or Oliver Twist, but a less well-known though arguably more
influential individual: Homo economicus.
Literally
meaning “economic man,” the origins of the term Homo economicus
are somewhat obscure—early references can be traced to the Oxford
economist C. S. Devas in 1883—but
his characteristics have become all too familiar. He is infinitely
rational, possessing both unlimited cognitive capacity and access to
information, but with the persona of the Marlboro Man: ruggedly
self-centered, relentlessly materialistic, and a complete lone ranger.
Homo economicus, created to personify the supposedly rational way
humans behave in markets, quickly came to dominate economic theory.
But then in the 1970s, the psychologists Daniel Kahneman and Amos
Tversky made a big discovery. The academics drew on psychological
evidence to show that the actions of human beings deviate from the
ironclad rationality of Homo economicus
in all sorts of ways: People make systematic errors of judgment, such as
being excessively attached to what they own, and yet are also more
generous and cooperative than they’re given credit for. These insights
led to the founding of a new field, behavioral economics, which became a
household name 10 years ago, after Cass Sunstein and Richard Thaler
published the best-selling book Nudge
and showed how this new understanding of human behavior could have major
policy consequences. Last year, Thaler won the Nobel Prize in Economics,
and promised to spend the $1.1 million in prize money “as irrationally
as possible.”
But despite
the fanfare, Homo economicus remains a stubbornly persistent part
of the economics curriculum. While it is fashionable for most economics
departments to have courses on behavioral economics, the core requirements in economics
at many colleges are usually limited to only two substantive courses—one
in microeconomics, which looks at how individuals optimize economic
decisions, and another in macroeconomics, which focuses on national or
regional markets as a whole. Not only is the study of behavioral
economics largely optional, but the standard textbooks used by many
college students make limited references to behavioral breakthroughs.
Hal Varian’s IntermediateMicroeconomics devotes only 16
of its 758 pages to behavioral economics, dismissing it as a blip in the
grand scheme of things, an “optical illusion” that would disappear “if
people took the time to consider choices carefully—applying the
measuring stick of dispassionate rationality.” The staple textbook on
macroeconomics, written by Gregory Mankiw, gives behavioral approaches
even shorter shrift by scarcely mentioning them at all.
Instead, the overwhelming majority of courses that students take in
economics are heavily focused on statistics and econometrics. In 2010,
the Institute for New Economic Thinking convened a task force
to study the undergraduate economics curriculum, following up on a
report from 1991. What changed in the
intervening years, it found, was “an increase in mathematical and
technical sophistication” that was “not sufficient to foster habits of
intellectual inquiry.” In other words,
Homo economicus is going strong in lecture halls and textbooks
across the country
…
our results suggest that the [instrumental variables] and, to a lesser
extent, [difference-in-difference] research bodies have substantially
more p-hacking and/or selective publication than those based on
[randomized controlled trials] and [regression-discontinuity]…
Three years ago, the American Statistical Association (ASA) expressed
hope that the world would move to a “post-p-value
era.”
The statement in which they made that recommendation has been cited more
than 1,700 times, and apparently, the organization has decided that
era’s time has come. (At least one journal had already banned p values by 2016.)
In an editorial
in a special issue
of The American Statistician out today, “Statistical Inference in the
21st Century: A World Beyond P<0.05,” the executive director of the ASA,
Ron Wasserstein, along with two co-authors, recommends that when it
comes to the term “statistically significant,” “don’t say it and don’t
use it.” (More than 800 researchers signed onto a piece published in Nature yesterday
calling for the same thing.) We asked Wasserstein’s co-author, Nicole Lazar of the University of Georgia,
to answer a few questions about the move.
So the ASA wants to say goodbye to “statistically significant.” Why, and
why now?
In the past few years there has been a growing recognition in the
scientific and statistical communities that the standard ways of
performing inference are not serving us well. This manifests itself in,
for instance, the perceived crisis in science (of reproducibility, of
credibility); increased publicity surrounding bad practices such as
p-hacking (manipulating the data until statistical significance can be
achieved); and perverse incentives especially in the academy that
encourage “sexy” headline-grabbing results that may not have much
substance in the long run. None of this is necessarily new, and indeed
there are conversations in the statistics (and other) literature going
back decades calling to abandon the language of statistical
significance. The tone now is different, perhaps because of the more
pervasive sense that what we’ve always done isn’t working, and so the
time seemed opportune to renew the call.
Much of the editorial is an impassioned plea to embrace uncertainty. Can
you explain?
The world is inherently an uncertain place. Our models of how it works
— whether formal or informal, explicit or implicit — are often only
crude approximations of reality. Likewise, our data about the world are
subject to both random and systematic errors, even when collected with
great care. So, our estimates are often highly uncertain; indeed, the
p-value itself is uncertain. The bright-line thinking that is emblematic
of declaring some results “statistically significant” (p<0.05) and
others “not statistically significant” (p>0.05) obscures that
uncertainty, and leads us to believe that our findings are on more solid
ground than they actually are. We think that the time has come to fully
acknowledge these facts and to adjust our statistical thinking
accordingly.
“In
statistics, Type I errors (false alarms) and Type II errors (misses)
are sometimes considered separately, with Type I errors being a
function of the alpha level and Type II errors being a function of
power. An advantage of signal detection theory is that it combines
Type I and Type II errors into a single analysis of discriminability…”
“…p
values were effective, though not perfect, at discriminating between
real and null effects.”
“Bayes
factor incurs no advantage over p values at detecting a real
effect versus a null effect … This is because Bayes factors are
redundant with p values for a given sample size.”
“When
power is high, researchers using p values to determine statistical
significance should use a lower criterion.”
“… a
change to be more conservative will decrease false alarm rates at
the expense of increasing miss rates. False alarm rates should not
be considered in isolation without also considering miss rates.
Rather, researchers should consider the relative importance for each
in deciding the criterion to adopt.”
“…given
that true null results can be theoretically interesting and
practically important, a conservative criterion can produce
critically misleading interpretations by labeling real effects as if
they were null effects.”
“Moving
forward, the recommendation is to acknowledge the relationship
between false alarms and misses, rather than implement standards
based solely on false alarm rates.”
Remember, poll aggregators must average several
polls to make a good prediction. Due to sparse state-level polling,
predictions were “stuck” on values from about two weeks prior to the
election, when support for Clinton had been higher. Note that this
sparse polling scenario indicates that polling methods are generally
sound, although more frequent polling of swing states would be helpful.
Continued in article
Jensen Comment This non-stationarity problem is somewhat similar
to the "methodological deficiencies" in accountics research discussed by
Dyckman and Zeff and the "temporal aggregation cointegration" problem
discussed by David Giles.
From Two Former Presidents of the AAA
"Some Methodological Deficiencies in Empirical Research Articles in
Accounting."by Thomas R. Dyckman and Stephen A. Zeff ,
Accounting Horizons: September 2014, Vol. 28, No. 3, pp. 695-712 ---
http://aaajournals.org/doi/full/10.2308/acch-50818 (not free)
This paper uses a sample of the regression and
behavioral papers published in The Accounting Review and the Journal of
Accounting Research from September 2012 through May 2013. We argue first
that the current research results reported in empirical regression
papers fail adequately to justify the time period adopted for the study.
Second, we maintain that the statistical analyses used in these papers
as well as in the behavioral papers have produced flawed results. We
further maintain that their tests of statistical significance are not
appropriate and, more importantly, that these studies do not�and
cannot�properly address the economic significance of the work. In other
words, significance tests are not tests of the economic meaningfulness
of the results. We suggest ways to avoid some but not all of these
problems. We also argue that replication studies, which have been
essentially abandoned by accounting researchers, can contribute to our
search for truth, but few will be forthcoming unless the academic reward
system is modified.
This Dyckman and Zeff paper is indirectly related to the following
technical econometrics research: "The Econometrics of Temporal Aggregation - IV - Cointegration,"
by David Giles, Econometrics Blog, September 13, 2014 ---
http://davegiles.blogspot.com/2014/09/the-econometrics-of-temporal.html
Why aren't our leading accounting research journals
providing warning labels on p-values common to virtually all published
empirical studies in accounting?
In science p-values have fallen from grace, and leading
scientists are recommending something tantamount to warning labels on tables
of p-values in virtually all statistical inference presentations ---
Scroll down below
But our editors of leading accounting
research journals seem to be totally oblivious to what scientists now
recommend regarding warning labels for p-values.
Is there any accounting
research journal policy statement that even acknowledges the need for
warning labels on p-values published in articles?
Is there any accounting
research article having a table of p-values with a warning label?
My Exhibit A today is the following recent
article published authors who are our discipline's leading accountics
science researchers. I read this article and, in particular, was interested
in finding warning labels for the p-values published in the article. I find
no such warning labels. Nothing is provided with respect to p-value warnings
that are becoming increasingly common in scientific papers.
The JOBS Act and Information Uncertainty in IPO Firms
Wayne R.
Landsman
The University of North Carolina at Chapel Hill
Daniel J.
Taylor
University of Pennsylvania
Supplemental
material can be accessed by clicking the link in Appendix A.
ABSTRACT:
This study
examines the effect of the Jumpstart Our Business Startups Act (JOBS Act) on
information uncertainty in IPO firms. The JOBS Act creates a new category of
issuer, the Emerging Growth Company (EGC), and exempts EGCs from several
disclosures required for non-EGCs. Our findings are consistent with
proprietary cost concerns motivating EGCs to eliminate some of the
previously mandatory disclosures, which increases information uncertainty in
the IPO market, attracts investors who rely more on private information, and
leads EGCs to provide additional post-IPO disclosures to mitigate the
increased information uncertainty. Our results also are consistent with
agency explanations, whereby EGCs exploit the JOBS Act provisions to avoid
compensation-related disclosures, which results in larger IPO underpricing
for such firms. Overall, we provide evidence on how reduced mandatory
disclosure affects the IPO market.
I track a lot of published
accounting research. But I've yet to find accounting research article that
provides warning labels about p-values presented in that paper?
Are any of you
aware of a published accounting research paper that has warning labels or
any discussion about how p-values can be misleading in the world of science
and accounting?
Are any of you
aware of where an accounting research journal policy statement even
acknowledges the fall from grace of p-values in scientific research?
It's not that
p-values should be avoided? What's important is that there are warnings
about how they can be misleading.
I'm serious here about finding any evidence
that editors of our accounting research journals do not still have their
heads in the sand regarding p-values. In a recent AECM message Dan Stone at
the University of Kentucky mentioned having a working paper on p-values but
he did not share that paper with us. I think it might be under review by one
of our accounting research journals.
I could have easily have missed where a
published study in accounting research provides warning labels on its
p-values. Please help me out by sending me references where accountics
researchers are keeping up with the times regarding p-values.
December 4, 2017 reply from Paul Williams
Bob,
The key statement in the abstract is "we find evidence consistent with
agency explanations" which is absolutely mandatory for any accountics
paper to be published in the American journals. The agenda behind
accountics research is fundamentally ideological. It serves the purpose
very well to ignore the problems with p-values because disclaimers
immediately cast doubt and doubt about basic premises underlying
accountics research is simply unacceptable. Accountics research is not
motivated by a desire to learn something, but by a desire to prove
something. We have "confirmed" agency explanations so many times over
the past 30 years that to continue to look for such explanations seems
pointless unless the purpose is to continuously reaffirm the faith so
that only the faithful become the elite.
December 4, 2017 reply from Jagdish
Gangolly
Bob,
As to p-values etc., the latest issue
of the journal Nature has an excellent discussion ("Five ways to fix
statistics"). Since I downloaded it directly from Nature I presume it is
legit to share it here. This should be required reading for anyone
interested in "archival" (Oh, how I hate that term) folks. If they
assimilate the views there, I am sure most who have published archival
stuff, with the exception of a very few, would hang their head in shame.
BLAKELEY B. MCSHANE & ANDREW GELMAN:
Abandon statistical significance
In many fields,
decisions about whether to publish an empirical finding, pursue a
line of research or enact a policy are considered only when results
are ‘statistically significant’, defined as having a P value
(or similar metric) that falls below some pre-specified threshold.
This approach is called null hypothesis significance testing (NHST).
It encourages researchers to investigate so many paths in their
analyses that whatever appears in papers is an unrepresentative
selection of the data.
Worse, NHST is
often taken to mean that any data can be used to decide between two
inverse claims: either ‘an effect’ that posits a relationship
between, say, a treatment and an outcome (typically the favoured
hypothesis) or ‘no effect’ (defined as the null hypothesis).
In practice,
this often amounts to uncertainty laundering. Any study, no matter
how poorly designed and conducted, can lead to statistical
significance and thus a declaration of truth or falsity. NHST was
supposed to protect researchers from over-interpreting noisy data.
Now it has the opposite effect.
This year has seen a debate about whether
tightening the threshold for statistical significance would improve
science. More than 150 researchers have weighed in4,5.
We think improvements will come not from tighter thresholds, but
from dropping them altogether. We have no desire to ban P values.
Instead, we wish them to be considered as just one piece of evidence
among many, along with prior knowledge, plausibility of mechanism,
study design and data quality, real-world costs and benefits, and
other factors. For more, see our article with David Gal at the
University of Illinois at Chicago, Christian Robert at the
University of Paris-Dauphine and Jennifer Tackett at Northwestern
University6.
For example, consider a claim, published in a
leading psychology journal in 2011, that a single exposure to the US
flag shifts support towards the Republican Party for up to eight
months7.
In our view, this finding has no backing from political-science
theory or polling data; the reported effect is implausibly large and
long-lasting; the sample sizes were small and nonrepresentative; and
the measurements (for example, those of voting and political
ideology) were noisy. Although the authors stand by their findings,
we argue that their P values provide very little information.
Statistical-significance thresholds are perhaps useful under certain
conditions: when effects are large and vary little under the
conditions being studied, and when variables can be measured
accurately. This may well describe the experiments for which NHST
and canonical statistical methods were developed, such as
agricultural trials in the 1920s and 1930s examining how various
fertilizers affected crop yields. Nowadays, however, in areas
ranging from policy analysis to biomedicine, changes tend to be
small, situation-dependent and difficult to measure. For example, in
nutrition studies, it can be a challenge to get accurate reporting
of dietary choices and health outcomes.
Open-science
practices can benefit science by making it more difficult for
researchers to make overly strong claims from noisy data, but cannot
by themselves compensate for poor experiments. Real advances will
require researchers to make predictions more capable of probing
their theories and invest in more precise measurements featuring, in
many cases, within-person comparisons.
A crucial step is to move beyond the alchemy of binary statements
about ‘an effect’ or ‘no effect’ with only a P value dividing
them. Instead, researchers must accept uncertainty and embrace
variation under different circumstances.
DAVID COLQUHOUN: State
false-positive risk, too
. . .
MICHÈLE B. NUIJTEN: Share analysis
plans and results
. . .
STEVEN N. GOODMAN: Change norms
from within
Jensen Comment
In science p-values have fallen from grace, and leading
scientists are recommending something tantamount to warning labels on tables
of p-values in virtually all statistical inference presentations ---
Scroll down below
Abstract
Misinterpretation and abuse of statistical tests, confidence intervals,
and statistical power have been decried for decades, yet remain rampant.
A key problem is that there are no interpretations of these concepts
that are at once simple, intuitive, correct, and foolproof. Instead,
correct use and interpretation of these statistics requires an attention
to detail which seems to tax the patience of working scientists. This
high cognitive demand has led to an epidemic of shortcut definitions and
interpretations that are simply wrong, sometimes disastrously so—and yet
these misinterpretations dominate much of the scientific literature. In
light of this problem, we provide definitions and a discussion of basic
statistics that are more general and critical than typically found in
traditional introductory expositions. Our goal is to provide a resource
for instructors, researchers, and consumers of statistics whose
knowledge of statistical theory and technique may be limited but who
wish to avoid and spot misinterpretations. We emphasize how violation of
often unstated analysis protocols (such as selecting analyses for
presentation based
on the
P values
they produce) can lead to small P values even if the declared test
hypothesis is correct, and can lead to large P values even if that
hypothesis is incorrect. We then provide an explanatory list of 25
misinterpretations of P values, confidence intervals, and power. We
conclude with guidelines for improving statistical interpretation and
reporting.
Jensen Comment
The sad thing is that journal editors of leading accounting research journals
seem to not care --- they're addicted to P-values
Why aren't our leading accounting research journals
providing warning labels on p-values common to virtually all published empirical
studies in accounting?
In science p-values have fallen from grace, and leading
scientists are recommending something tantamount to warning labels on tables of
p-values in virtually all statistical inference presentations ---
Scroll down below
But our editors of leading accounting research
journals seem to be totally oblivious to what scientists now recommend regarding
warning labels for p-values.
Is there any accounting
research journal policy statement that even acknowledges the need for warning
labels on p-values published in articles?
Is there any accounting
research article having a table of p-values with a warning label?
My Exhibit A today is the following recent
article published authors who are our discipline's leading accountics science
researchers. I read this article and, in particular, was interested in finding
warning labels for the p-values published in the article. I find no such warning
labels. Nothing is provided with respect to p-value warnings that are becoming
increasingly common in scientific papers.
Where are the P-value warnings?
The JOBS Act and Information Uncertainty in IPO Firms
Wayne R. Landsman
The University of North Carolina at Chapel Hill
Daniel J. Taylor
University of Pennsylvania
Supplemental
material can be accessed by clicking the link in Appendix A.
ABSTRACT:
This study
examines the effect of the Jumpstart Our Business Startups Act (JOBS Act) on
information uncertainty in IPO firms. The JOBS Act creates a new category of
issuer, the Emerging Growth Company (EGC), and exempts EGCs from several
disclosures required for non-EGCs. Our findings are consistent with proprietary
cost concerns motivating EGCs to eliminate some of the previously mandatory
disclosures, which increases information uncertainty in the IPO market, attracts
investors who rely more on private information, and leads EGCs to provide
additional post-IPO disclosures to mitigate the increased information
uncertainty. Our results also are consistent with agency explanations, whereby
EGCs exploit the JOBS Act provisions to avoid compensation-related disclosures,
which results in larger IPO underpricing for such firms. Overall, we provide
evidence on how reduced mandatory disclosure affects the IPO market.
The “New Statistics” and Nullifying the Null: Twelve
Actions for Improving Quantitative Accounting Research Quality and Integrity
By Dan N. Stone Accounting Horizons: March 2018, Vol. 32, No. 1, pp. 105-120.
https://doi.org/10.2308/acch-51949
An earlier draft of this manuscript received the “Best Theoretical Research
Award” at the 2016 21st Annual Ethics Research Symposium.
Leveraging accounting scholars' expertise in the integrity of
information and evidence, and in managers' self-interested discretion in
information collection and reporting, offers the possibility of accounting
scholars creating, promoting, and adapting methods to ensure that accounting
research is of exemplary integrity and quality. This manuscript uses the six
principles from the recent American Statistical Association (ASA) report on
p-values as an organizing framework, and considers some implications of
these principles for quantitative accounting research. It also proposes 12
actions, in three categories (community actions, redefining research
quality, and ranking academic accounting journals) for improving
quantitative accounting research quality and integrity. It concludes with a
clarion call to our
community
to create, adopt, and promote scholarship practices and policies that lead
in scholarly integrity.
. . .
Dyckman
(2016,
Abstract) observes: “Accounting as an empirical research discipline appears
to be the last of the research communities to face up to the inherent
problems of significance test use and abuse.”
The
recent American Statistical Association (ASA) statement on the appropriate
use of NHST and p-values (Wasserstein
and Lazar 2016)
offers a starting point for considering the limited potential for NHST and
p-values to contribute to quantitative accounting research. I initially
describe the six principles and, following this, link their continued use to
the future of accounting research. The ASA statement begins by observing
that the continued use of NHST and p-values, despite common knowledge of
their deep flaws, likely results from a cultural circularity: statisticians
teach NHST because that is what scholars and journal editors use. And
scholars and journal editors use NHST because that is what statisticians
teach. Sound familiar? I have been teaching the introductory Ph.D. class in
accountancy research for about 25 years. As a former AAA journal editor, I
am (mostly) guilty as charged. For 25 years I have reviewed NHST in my
introductory class (although, for the past ten years I have also discussed
its deep flaws and substantial limits). As a journal editor, I expected
authors to use NHST methods. However, for at least ten years, I have
recommended, at a minimum, the supplemental reporting procedures that I
discuss herein, often to resistant editors and authors.
Table 1
presents the six ASA principles. The first acknowledges the common use of
p-values and their embeddedness, typically, in NHST. Specifically, p-values
allow one to opine on the extent to which data adhere to a “null” hypothesis
of no difference (i.e., when applied to comparing two or more groups) or no
relationship (i.e., when applied to relations between two or more
variables). When the assumptions of the model hold, smaller p-values provide
less support for the no difference hypothesis, while larger p-values provide
greater support for the no difference hypothesis. The second principle
states what a p-value is not, by refuting two common misconceptions about
p-values, i.e., that a p-value tests whether a tested hypothesis is “true,”
and “the probability that the data were produced by random chance alone.”
. . .
When It
Is Not an “Empirical Question”—The Criticality of Triangulated Methods and
Diverse Scholars to Knowledge Production
Within
accounting research, the misuse of p-values as arbiters of truth is often
found in the regrettable bromide, “it's an empirical question,” used in
relation to a research question that is tested using only NHST and
p-values. Such a formulation, when operationalized in NHST and p-values, is
exactly the misuse identified in Principle No. 2 of the ASA. Specifically,
“it's an empirical question” implies that the NHST enterprise produces
truth—that the method resolves the uncertainty regarding a real-world
question; it does not, for reasons articulated in the ASA statement
(Principle No. 2 of the ASA, p. 131):
Researchers
often wish to turn a p-value into a statement about the truth of a null
hypothesis, or about the probability that random chance produced the
observed data. The p-value is neither. It is a statement about data in
relation to a specified hypothetical explanation, and is not a statement
about the explanation itself.
Stated differently,
NHST examines the extent to which the observed data are consistent with an
odd, often irrelevant (null) hypothesis. In a strict sense, the null
hypothesis can never be true, since differences always exist between two
groups, and there is always some relationship between two variables. Hence,
the relevant pragmatic question, which is unrecognized in NHST, is how
big the difference is between two groups, and how big the
relationship is between two variables. Pragmatically, p-values heavily
depend on sample sizes and statistical power, i.e., ceteris paribus,
p-values decrease as statistical power (and sample size) increases (Cohen
1992).3
Hence, with the “Big Data” (i.e., very large) samples that are increasingly
common in much archival accounting research, small p-values often obtain
since the statistical power of tests usually approaches 1.0. Nevertheless,
the relevant practical questions that matter in an applied discipline are
not answered by a p-value. And if the research method and reporting stops
with a p-value, the relevant practical question remains uninvestigated. As
Cohen (1990)
states, “the primary product of a research inquiry is one or more measures
of effect size, not p values” (see also Ellis 2010).
As with all
quantitative research methods, the NHST depends upon a set of
epistemological (about truth), ontological (about reality), and statistical
(about the data) assumptions (cf. Chua 1986).
In a few cases, a p-value is one potentially useful bit of evidence
that bears on a research question, but this exercise, in isolation, never
produces “truth” or provides much insight into a practical question. To
claim otherwise is to misunderstand the weak validity of single study,
mono-method, and mono-measure research (Shadish,
Cook, and Campbell 2002).
One implication of the failings of NHST—in isolation—to produce truth is the
necessity of “triangulated” methods to scientific scholarship (Jick
1979). The
form of method triangulation considered herein is the use of multiple
methods (e.g., an experiment and archival data or a survey and interviews)
in investigating a critical research question. This approach to method
triangulation helps ensure that the observed variation in a phenomenon
results from true variation in the phenomenon and related data, and not from
the idiosyncratic properties of a single measure or method (Campbell
and Fiske 1959).
For example, accounting scholars, in applying triangulation, might
investigate the use (and misuse) of discretion by corporate managers through
archival investigation, experiments, surveys, and interviews. Our confidence
in the results increases to the extent that multiple methods and results,
and differing investigators, produce similar conclusions.
But the trend in
accounting scholarship is the exact opposite; i.e., toward a single
research method, i.e., large-sample evidence using general linear models (GLMs)
and standardized financial and auditing databases (Tuttle
and Dillard 2007).
This trend contradicts a shared goal of producing a cumulative body of
scientific evidence that bears on critical accounting questions. Any single
method, i.e., a scientific “monoculture,” produces procrustean “truths”
about a phenomenon just as a “monoculture” ecological environment fails to
represent the scientific diversity of an environmental ecology because of
its, usually artificial, domination by a single species. A community of
scholars seeking to generate science must, necessarily, be a
methodologically diverse community not due to “political correctness” (i.e.,
diversity for its own sake), but because its ability to understand a complex
phenomenon, and generate accurate descriptions of it, requires diverse
methods and data (Weick
1983).
Following Weick (1983),
imagine a camera lens that has only one setting. Such a camera will capture,
with clarity, objects at exactly the distance setting of the lens. All other
objects will be out of focus. Similarly, a scientific community with only
one methodological tool, e.g., financial, archival research using
standardized datasets, will be constrained to studying only a fraction of
the richness of the ecology of accounting information. Capturing a richer
ecological space requires richer methods and questions.
. . .
Research on the tragic deaths of firefighters notes a curious paradox.
Firefighters who are near safety will often retain their tools and perish in
the growing flames, rather than drop their now-useless tools and flee to
safety (e.g., Weick 1996).
Why do firefighters hold onto their (useless) tools and die? Although the
reasons are varied and complex, one crucial factor is the experience of
vu jade, i.e., of experiencing that which one has never seen before,
that for which one is under trained, and that which calls for actions that
contradict deeply learned behavior. Partly, firefighters retain useless
tools and perish because, to drop one's long-held tools and run is to admit
defeat, to admit that familiar, long-used technologies are now useless, and
to admit a profound misjudgment of relevant risks.
Sound familiar? Scholarship, and accounting scholarship, is
now in a
vu jade world. We retain our familiar but now antiquated tools to the
demise of our credibility, relevance, and legitimacy. p-values and NHST are
now the metaphoric equivalent of the tools that firefighters, who facing
immediate death, kept, rather than admitting the tools' obsolescence in the
face of new, unfamiliar risks. In short, it is time to drop our familiar
tools and quickly learn their replacements, which are adapted to the
emerging “Big Data,” “big computing” world
The “New Statistics” and Nullifying the Null: Twelve
Actions for Improving Quantitative Accounting Research Quality and Integrity
By Dan N. Stone Accounting Horizons: March 2018, Vol. 32, No. 1, pp. 105-120.
https://doi.org/10.2308/acch-51949
An earlier draft of this manuscript received the “Best Theoretical Research
Award” at the 2016 21st Annual Ethics Research Symposium.
Leveraging accounting scholars' expertise in the integrity of
information and evidence, and in managers' self-interested discretion in
information collection and reporting, offers the possibility of accounting
scholars creating, promoting, and adapting methods to ensure that accounting
research is of exemplary integrity and quality. This manuscript uses the six
principles from the recent American Statistical Association (ASA) report on
p-values as an organizing framework, and considers some implications of
these principles for quantitative accounting research. It also proposes 12
actions, in three categories (community actions, redefining research
quality, and ranking academic accounting journals) for improving
quantitative accounting research quality and integrity. It concludes with a
clarion call to our
community
to create, adopt, and promote scholarship practices and policies that lead
in scholarly integrity.
. . .
Dyckman
(2016,
Abstract) observes: “Accounting as an empirical research discipline appears
to be the last of the research communities to face up to the inherent
problems of significance test use and abuse.”
The recent American
Statistical Association (ASA) statement on the appropriate use of NHST and
p-values (Wasserstein
and Lazar 2016)
offers a starting point for considering the limited potential for NHST and
p-values to contribute to quantitative accounting research. I initially
describe the six principles and, following this, link their continued use to
the future of accounting research. The ASA statement begins by observing
that the continued use of NHST and p-values, despite common knowledge of
their deep flaws, likely results from a cultural circularity: statisticians
teach NHST because that is what scholars and journal editors use. And
scholars and journal editors use NHST because that is what statisticians
teach. Sound familiar? I have been teaching the introductory Ph.D. class in
accountancy research for about 25 years. As a former AAA journal editor, I
am (mostly) guilty as charged. For 25 years I have reviewed NHST in my
introductory class (although, for the past ten years I have also discussed
its deep flaws and substantial limits). As a journal editor, I expected
authors to use NHST methods. However, for at least ten years, I have
recommended, at a minimum, the supplemental reporting procedures that I
discuss herein, often to resistant editors and authors.
Table 1
presents the six ASA principles. The first acknowledges the common use of
p-values and their embeddedness, typically, in NHST. Specifically, p-values
allow one to opine on the extent to which data adhere to a “null” hypothesis
of no difference (i.e., when applied to comparing two or more groups) or no
relationship (i.e., when applied to relations between two or more
variables). When the assumptions of the model hold, smaller p-values provide
less support for the no difference hypothesis, while larger p-values provide
greater support for the no difference hypothesis. The second principle
states what a p-value is not, by refuting two common misconceptions about
p-values, i.e., that a p-value tests whether a tested hypothesis is “true,”
and “the probability that the data were produced by random chance alone.”
. . .
When
It Is Not an “Empirical Question”—The Criticality of Triangulated Methods
and Diverse Scholars to Knowledge Production
Within
accounting research, the misuse of p-values as arbiters of truth is often
found in the regrettable bromide, “it's an empirical question,” used in
relation to a research question that is tested using only NHST and
p-values. Such a formulation, when operationalized in NHST and p-values, is
exactly the misuse identified in Principle No. 2 of the ASA. Specifically,
“it's an empirical question” implies that the NHST enterprise produces
truth—that the method resolves the uncertainty regarding a real-world
question; it does not, for reasons articulated in the ASA statement
(Principle No. 2 of the ASA, p. 131):
Researchers
often wish to turn a p-value into a statement about the truth of a null
hypothesis, or about the probability that random chance produced the
observed data. The p-value is neither. It is a statement about data in
relation to a specified hypothetical explanation, and is not a statement
about the explanation itself.
Stated differently,
NHST examines the extent to which the observed data are consistent with an
odd, often irrelevant (null) hypothesis. In a strict sense, the null
hypothesis can never be true, since differences always exist between two
groups, and there is always some relationship between two variables. Hence,
the relevant pragmatic question, which is unrecognized in NHST, is how
big the difference is between two groups, and how big the
relationship is between two variables. Pragmatically, p-values heavily
depend on sample sizes and statistical power, i.e., ceteris paribus,
p-values decrease as statistical power (and sample size) increases (Cohen
1992).3
Hence, with the “Big Data” (i.e., very large) samples that are increasingly
common in much archival accounting research, small p-values often obtain
since the statistical power of tests usually approaches 1.0. Nevertheless,
the relevant practical questions that matter in an applied discipline are
not answered by a p-value. And if the research method and reporting stops
with a p-value, the relevant practical question remains uninvestigated. As
Cohen (1990)
states, “the primary product of a research inquiry is one or more measures
of effect size, not p values” (see also Ellis 2010).
As with all
quantitative research methods, the NHST depends upon a set of
epistemological (about truth), ontological (about reality), and statistical
(about the data) assumptions (cf. Chua 1986).
In a few cases, a p-value is one potentially useful bit of evidence
that bears on a research question, but this exercise, in isolation, never
produces “truth” or provides much insight into a practical question. To
claim otherwise is to misunderstand the weak validity of single study,
mono-method, and mono-measure research (Shadish,
Cook, and Campbell 2002).
One implication of the failings of NHST—in isolation—to produce truth is the
necessity of “triangulated” methods to scientific scholarship (Jick
1979). The
form of method triangulation considered herein is the use of multiple
methods (e.g., an experiment and archival data or a survey and interviews)
in investigating a critical research question. This approach to method
triangulation helps ensure that the observed variation in a phenomenon
results from true variation in the phenomenon and related data, and not from
the idiosyncratic properties of a single measure or method (Campbell
and Fiske 1959).
For example, accounting scholars, in applying triangulation, might
investigate the use (and misuse) of discretion by corporate managers through
archival investigation, experiments, surveys, and interviews. Our confidence
in the results increases to the extent that multiple methods and results,
and differing investigators, produce similar conclusions.
But the trend in
accounting scholarship is the exact opposite; i.e., toward a single
research method, i.e., large-sample evidence using general linear models (GLMs)
and standardized financial and auditing databases (Tuttle
and Dillard 2007).
This trend contradicts a shared goal of producing a cumulative body of
scientific evidence that bears on critical accounting questions. Any single
method, i.e., a scientific “monoculture,” produces procrustean “truths”
about a phenomenon just as a “monoculture” ecological environment fails to
represent the scientific diversity of an environmental ecology because of
its, usually artificial, domination by a single species. A community of
scholars seeking to generate science must, necessarily, be a
methodologically diverse community not due to “political correctness” (i.e.,
diversity for its own sake), but because its ability to understand a complex
phenomenon, and generate accurate descriptions of it, requires diverse
methods and data (Weick
1983).
Following Weick (1983),
imagine a camera lens that has only one setting. Such a camera will capture,
with clarity, objects at exactly the distance setting of the lens. All other
objects will be out of focus. Similarly, a scientific community with only
one methodological tool, e.g., financial, archival research using
standardized datasets, will be constrained to studying only a fraction of
the richness of the ecology of accounting information. Capturing a richer
ecological space requires richer methods and questions.
. . .
Research on the tragic deaths of firefighters notes a curious paradox.
Firefighters who are near safety will often retain their tools and perish in
the growing flames, rather than drop their now-useless tools and flee to
safety (e.g., Weick 1996).
Why do firefighters hold onto their (useless) tools and die? Although the
reasons are varied and complex, one crucial factor is the experience of
vu
jade, i.e., of experiencing that which one has never seen before, that
for which one is under trained, and that which calls for actions that
contradict deeply learned behavior. Partly, firefighters retain useless
tools and perish because, to drop one's long-held tools and run is to admit
defeat, to admit that familiar, long-used technologies are now useless, and
to admit a profound misjudgment of relevant risks.
Sound familiar? Scholarship, and accounting scholarship, is
now in a
vu jade world. We retain
our familiar but now antiquated tools to the demise of our credibility,
relevance, and legitimacy. p-values and NHST are now the metaphoric
equivalent of the tools that firefighters, who facing immediate death, kept,
rather than admitting the tools' obsolescence in the face of new, unfamiliar
risks. In short, it is time to drop our familiar tools and quickly learn
their replacements, which are adapted to the emerging “Big Data,” “big
computing” world
We
commemorate the 50th anniversary of Ball and Brown [1968] by chronicling its
impact on capital market research in accounting. We trace the evolution of
various research paths that post-Ball and Brown [1968] researchers took as
they sought to build on the foundation laid by Ball and Brown [1968] to
create a body of research on the usefulness, timeliness, and other
properties of accounting numbers. We discuss how those paths often link back
to the groundwork laid and questions originally posed in Ball and Brown
[1968].
Keywords: Ball and Brown, earnings, earnings-return relation, earnings
usefulness, earnings timeliness, asymmetric timeliness, conservatism,
association study, event study, information content, value relevance,
positive economics, efficient markets hypothesis, market efficiency,
post-announcement drift
Accountants aren’t known for taking risks. So a
new experiment from Journal of Accounting Research stands out: an
upcoming
conference issue
will include only papers that were accepted
before the authors knew what their results would be. That’s very
different from the traditional academic publication process, in which
papers are published -- or not -- based largely on their results.
The new
approach, known as “registered reports,” has developed a following in
the sciences in light of the so-called
reproducibility crisis.
But JAR is the first accounting journal to try it.
At the same time, The Review of Financial Studies is breaking
similar ground in business.
“This is what good accountants do -- we make reports trusted and worthy
of that trust,” said Robert Bloomfield, Nicholas H. Noyes Professor of
Management at Cornell University and guest editor of JAR’s
registered reports-based issue.
Beyond registered reports, JAR will publish a paper -- led by
Bloomfield -- about the process. The article’s name, “No System Is
Perfect: Understanding How Registration-Based Editorial Processes Affect
Reproducibility and Investment in Research Quality,” gives away its
central finding: that registered reports have their virtues but aren’t a
panacea for research-quality issues.
“Registration is a different system that has its benefits, but one of
the costs,” Bloomfield said, “is that the quality of the research
article does improve with what we call follow-up investment -- or all
the stuff people do after they’ve seen their results.”
In the
life sciences and some social science fields, concerns about the
reproducibility of results have yielded calls for increased data
transparency. There are also calls to rethink the editorial practices
and academic incentives that might encourage questionable research
practices. QRPs, as such practices are known, include rounding up P
values to the arguably arbitrary “P<0.05” threshold suggesting
statistical significance and publishing results that don't support a
flashy hypothesis in the trash (the “file drawer effect").
Some of
those calls have yielded results. The American Journal of Political
Science, for example, has a Replication & Verification Policy
incorporating reproducibility and data sharing into the academic
publication process. Science established Transparency and
Openness Promotion guidelines
regarding data availability and more, to which hundreds of journals have
signed on. And the Center for Open Science continues to do important
work in this area. Some 91 journals use the registered
reports publishing format either as a regular submission option or as
part of a single special issue, according to
information
from the center. Other journals offer some features of the format.
Bloomfield said he’d been following such developments for years and
talked to pre-registration proponents in the sciences before launching
his project at JAR, where he is a member of the editorial
board. To begin, he put out a call for papers explaining
the registration-based editorial process, or REP. Rather than submitting
finished articles, authors submitted proposals to gather and analyze
data. Eight of the most well-designed proposals asking important
questions, out of 71 total, were accepted and guaranteed publication --
regardless of whether the results supported their hypotheses, and as
long as authors followed their plans.
Bloomfield and his co-authors also held a conference on the process and
surveyed authors who had published both registered papers and
traditional papers. They found that the registered-paper authors
significantly increased their up-front “investment” in planning, data
gathering and analysis, such as by proposing challenging experimental
settings and bigger data sets. Yet, as Bloomfield pointed out,
registration tended to reduce follow-up work on data once results were
known. That is, a lot of potentially valuable data that would have been
explored further in a traditional paper may have been left on the table
here.
In all, the editorial process shift makes individual results more
reproducible, the paper says, but leaves articles “less thorough and
refined.” Bloomfield and his co-authors suggest that pre-registration
could be improved by encouraging certain forms of follow-up investment
in papers without risking “overstatement” of significance.
Feedback from individual authors is instructive.
“The stakes of the proposal process motivated a greater degree of
front-end collaboration for the author team,” wrote one conference
participant whose registered paper was accepted by JAR. “The
public nature made us more comfortable presenting a widely-attended
proposal workshop. Finally, the proposal submission process provided
valuable referee feedback. Collectively, this created a very tight
theoretical design. In short, the challenges motivated idealized
behavior.”
Asked about how pre-registration compares to traditional publication,
the participant said, “A greater degree of struggle to concisely
communicate our final study.” Pilot testing everything but the main
theory would have been a good idea, in retrospect, the respondent
said, since “in our effort to follow the registered report process, I
now believe we were overly conservative.”
Bloomfield also asked respondents how researchers choose which measures
and analysis to report and highlight, and what effect it has on
traditional published research. Over, participants said this kind of
"discretion" was a good thing, in that it was exercised to make more
readable of coherent research.. But some suggested the pressure to
publish was at work.
“This is a huge problem,” said one respondent. “What does it give the
co-author team to provide no-results tests, for example, in the
publishing process?” Another said, “Only significant results tend to get
published. Potentially meaningful non-results may be overlooked.”
Similarly, one participant said, “I find it amazing how just about every
study in the top tier has like a 100 hypothesis support rate -- not
healthy.” Yet another said that “experiments are costly. I think people
use this discretion to get something publishable from all of the time
and effort that goes into an experiment.”
Bloomfield’s paper poses but doesn’t answer certain logistical questions
about what might happen if pre-registration spreads further. Should
editors be more willing to publish short papers that flesh out results
left on the table under REP, for example, it asks. What about
replications of papers whose reproducibility was potentially undermined
by traditional publishing? And how should authors be “credited” for
publishing under REP, such as when their carefully designed studies
don’t lead to positive results?
Over all, the paper says, editors could improve both the registered and
traditional editorial processes by identifying studies that are “better
suited to each process, allowing slightly more discretion under REP and
slightly less under [the traditional process], clarifying standards
under REP, and demanding more transparency" in traditional processes.
The Review of Financial Studies
has organized two upcoming issues to include registered reports on
certain themes: financial technology in 2018 and climate finance in
2019. Financial technology authors will present at Cornell next month.
Andrew Karolyi, associate dean for academic affairs at Cornell’s Samuel
Curtis Johnson Graduate School of Management and the journal’s executive
editor, has described the registration process as one that transfers
academic risk from the researcher to the journal.
Asked if he thought registration would gain a foothold in business,
Karolyi said via email that other journals in his field are following
RFS’s experiments.
“There is more work curating these initiatives, but I had a great
passion for it so I think less about the work than the outcome,” he
said. “I want to believe I and my editorial team did our homework and
that we designed the experiments well. Time will tell, of course.”
Continued in article
Jensen Comment
Academic (accountics) accounting research results are no longer of much
interest as evidenced by the lack of interest of the practicing profession
in the esoteric accounting research journals and the lack of interest of the
editors of those journals in encouraging either commentaries or replications
---
http://faculty.trinity.edu/rjensen/TheoryTAR.htm How Accountics "Scientists" Should
Change:
"Frankly, Scarlett, after I get a hit for my resume in The Accounting
Review I just don't give a damn"
http://www.cs.trinity.edu/~rjensen/temp/AccounticsDamn.htm
This new initiative in academic accounting research is
a a good thing, but as Woodrow Wilson said years ago"
"It's easier to move a cemetary than to change a university curriculum (or
accounting research journals) or simple (unrealistic) experiments using
students as surrogates of real-life decision makers."
Academic accounting researchers just don't like to leave
the campus to collect research data. They prefer to analyze data that
purchase and cannot control at collection points. They worship at the alters
of p-values generated by regression software.
The fall from grace of Accountics Science Sacred Cows --- P-Values
Beginning in the 1960s. academic accounting research commenced to rely mostly on
the general linear (regression) model applied to purchased databases like CRSP,
Compustat, AuditAnalitics, etc. Elite academic journals like TAR, JAR, and
JAE ceased accepting any submissions that did not have equations. Either the
equations were analytical based upon unrealistic economic assumptions or
empirical based upon dubious assumptions of efficient markets and the unreliable
Capital Asset Pricing Model (CAPM). Down deep researchers knew correlation was
not causation but results usually ignored this in the conclusions of the
GLM model applications. Errors in the purchased databases were overlooked by
journal editors and referees. The accounting profession virtually lost interest
in the tenure game being played by academic accounting (accountics) researchers
---
Keep scrolling down this module for details.
Question
Is accounting research stuck in a rut of repetitiveness and irrelevancy?
"Accounting
Craftspeople versus Accounting Seers: Exploring the Relevance and Innovation
Gaps in Academic Accounting Research," by William E. McCarthy,Accounting
Horizons, December 2012, Vol. 26, No. 4, pp. 833-843 ---
http://aaajournals.org/doi/full/10.2308/acch-10313
Is accounting research stuck in a rut of
repetitiveness and irrelevancy? I(Professor
McCarthy)would
answer yes, and I would even predict that both its gap in relevancy and its
gap in innovation are going to continue to get worse if the people and the
attitudes that govern inquiry in the American academy remain the same.
From my perspective in accounting information systems, mainstream accounting
research topics have changed very little in 30 years, except for the fact
that their scope now seems much more narrow and crowded. More and more
people seem to be studying the same topics in financial reporting and
managerial control in the same ways, over and over and over. My suggestions
to get out of this rut are simple. First, the profession should allow itself
to think a little bit normatively, so we can actually target practice
improvement as a real goal. And second, we need to allow new scholars a
wider berth in research topics and methods, so we can actually give the kind
of creativity and innovation that occurs naturally with young people a
chance to blossom.
Since the
2008 financial crisis, colleges and universities have faced increased
pressure to identify essential disciplines, and cut the rest. In 2009,
Washington State University announced it would eliminate the department
of theatre and dance, the department of community and rural sociology,
and the German major – the same year that the University of Louisiana at
Lafayette ended its philosophy major. In 2012, Emory University in
Atlanta did away with the visual arts department and its journalism programme. The cutbacks aren’t restricted to the humanities: in 2011,
the state of Texas announced it would eliminate nearly half of its
public undergraduate physics programmes. Even when there’s no
downsizing, faculty salaries have been frozen and departmental budgets
have shrunk.
But despite the funding crunch, it’s a bull market
for academic economists. According to a 2015 sociologicalstudyin
theJournal
of Economic Perspectives, the median salary of economics
teachers in 2012 increased to $103,000 – nearly $30,000 more than
sociologists. For the top 10 per cent of economists, that figure jumps
to $160,000, higher than the next most lucrative academic discipline –
engineering. These figures, stress the study’s authors, do not include
other sources of income such as consulting fees for banks and hedge
funds, which, as many learned from the documentaryInside
Job(2010), are
often substantial. (Ben Bernanke, a former academic economist and
ex-chairman of the Federal Reserve, earns $200,000-$400,000 for a single
appearance.)
Unlike
engineers and chemists, economists cannot point to concrete objects –
cell phones, plastic – to justify the high valuation of their
discipline. Nor, in the case of financial economics and macroeconomics,
can they point to the predictive power of their theories. Hedge funds
employ cutting-edge economists who command princely fees, but routinely
underperform index funds. Eight years ago, Warren Buffet made a 10-year,
$1 million bet that a portfolio of hedge funds would lose to the S&P
500, and it looks like he’s going to collect. In 1998, a fund that
boasted two Nobel Laureates as advisors collapsed, nearly causing a
global financial crisis.
The failure of the field to predict the 2008
crisis has also been well-documented. In 2003, for example, only five
years before the Great Recession, the Nobel Laureate Robert E Lucas Jrtoldthe
American Economic Association that ‘macroeconomics […] has succeeded:
its central problem of depression prevention has been solved’.
Short-term predictions fair little better – in April 2014, for instance,a
surveyof
67 economists yielded 100 per cent consensus: interest rates would rise
over the next six months. Instead, they fell. A lot.
Nonetheless,surveys
indicatethat
economists see their discipline as ‘the most scientific of the social
sciences’. What is the basis of this collective faith, shared by
universities, presidents and billionaires? Shouldn’t successful and
powerful people be the first to spot the exaggerated worth of a
discipline, and the least likely to pay for it?
In the
hypothetical worlds of rational markets, where much of economic theory
is set, perhaps. But real-world history tells a different story, of
mathematical models masquerading as science and a public eager to buy
them, mistaking elegant equations for empirical accuracy.
Jensen Comment
Academic accounting (accountics) scientists took economic
astrology a step further when their leading journals stopped encouraging and
publishing commentaries and replications of published articles ---
How Accountics Scientists Should Change:
"Frankly, Scarlett, after I get a hit for my resume inThe
Accounting ReviewI just
don't give a damn"
http://www.cs.trinity.edu/~rjensen/temp/AccounticsDamn.htm
Times are changing in social science research (including
economics) where misleading p-values are no longer the Holy Grail. Change
among accountics scientist will lag behind change in social science research
but some day leading academic accounting research journals may publish
articles without equations and/or articles of interest to some accounting
practitioner somewhere in the world ---
See below
Academic accounting researchers sheilded themselves from validity
challenges by refusing to publish commentaries and refusing to accept
replication studies for publication ---
http://faculty.trinity.edu/rjensen/TheoryTAR.htm
Data-fueled machine learning has spread to many corners of science and
industry and is beginning to make waves in addressing public-policy
questions as well. It’s relatively easy these days to automatically classify
complex things like text, speech, and photos, or to predict website traffic
tomorrow. It’s a whole different ballgame to ask a computer to explore how
raising the minimum wage might affect employment or to design an algorithm
to assign optimal treatments to every patient in a hospital.
The
vast majority of machine-learning applications today are just highly
functioning versions of simple tasks, says Susan Athey,
professor of economics at Stanford Graduate School of Business. They rely in
large part on something computers are especially good at: sifting through
vast reams of data to identify connections and patterns and thus make
accurate predictions. Prediction problems are simple, because, in a stable
environment, it doesn’t really matter how or why the algorithm operates;
it’s easy to measure performance just by seeing how well the program works
on test data. All of which means that you don’t have to be an expert to
deploy prediction algorithms with confidence.
Despite
the proliferation of data collection and computing prowess, machine-learning
algorithms aren’t so good at distinguishing between correlation and
causation — determining whether the connection between statistically linked
patterns is coincidental or the result of some cause-and-effect force. “Some
problems simply aren’t solvable with more data or more complex algorithms,”
Athey says.
If
machine-learning techniques are going to help address public-policy
problems, Athey says, we need to develop new ways of marrying them with
causal-inference methods. Doing so would greatly expand the potential of
big-data applications and transform our ability to design, evaluate, and
improve public-policy work.
What
Predictive Models Miss
As
government agencies and other public sector groups embrace big data, Athey
says it’s important to understand the realistic limitations of current
machine-learning methods. In a recent article
published in Science, she outlined a number of scenarios that
highlight the distinction between prediction problems and causal-inference
problems, and where common machine-learning applications would have trouble
drawing useful conclusions about cause and effect.
One
question that comes up in businesses is whether a firm should target
resources on retaining customers who have a high risk of attrition, or
“churn.” Predicting churn can be accomplished with off-the-shelf
machine-learning methods. However, the real problem is calculating the best
allocation of resources, which requires identifying those customers for whom
the causal effect of an intervention, such as offering discounts or
sending out targeted emails, is the highest. That’s a harder thing to
measure; it might require the firm to conduct a randomized experiment to
learn where intervention has the biggest benefits. Athey points to a recent
study that showed that in one firm that carried out a more rigorous
analysis, the overlap between customers with high risk of churn and those
for whom intervention works best was only 50%.
In another
case, predictive models already have been used to identify patients who,
though eligible for hip replacement surgery, should not be given the
operation due to the likelihood that they will soon die of other causes.
What those methods fail to solve is the much harder problem of prioritizing
patients who would most benefit from the procedure.
“If you’re
just trying to crunch big data and not thinking about everything that can go
wrong in confusing correlation and causality, you might think that putting a
bigger machine on your problem is going to solve things,” Athey says. “But
sometimes the answer’s just not in the data.”
That’s
especially true in many of the real-world contexts where public policy takes
shape, she says.
The gold
standard for picking apart correlation and causality is the randomized
controlled experiment, which allows for relatively straightforward
inferences about cause and effect. Such experiments are commonly used to
test the efficacy of new drugs: A randomly selected group of people with a
particular illness is given the drug while a second group with the same
illness is given a placebo. If a significant portion of the first group gets
better, the drug is probably the cause.
But such
experiments are not feasible in many real-world settings. For instance, it
would be politically and practically impossible to conduct a massive
controlled experiment examining what happens when the minimum wage is raised
or lowered across a variety of locations. Instead, policy analysts have to
rely on “observational data,” or data generated in ways other than through
random assignment. And drawing useful conclusions from observational data —
which are often muddied by uncontrolled and thus unreliable input — is a
challenge beyond the reach of common predictive methods.
Continued in article
Complacency at the Gates: A Field Report on
the Non-Impact of the ASA Statement on Statistical Significance and P-Values on
the Broader Research Community
University of Texas at
Dallas - Naveen Jindal School of Management
Date Written: July 5, 2019
Abstract
In 2016 the
American Statistical Association promulgated a statement consisting of six
principles for the conduct, interpretation, and reporting of tests of
statistical significance with the intended objective of improving statistical
practice. This article discusses the implications of a premier accounting journal’s
unconcerned response to a systematic application of these principles to its
published content for the ASA statement’s likely success in achieving its
objective of improving statistical practice. It concludes that if this is the
sort of response given to the ASA statement by a field of study where the
faithful representation of evidence is a fundamental principle of both practice
and academic study, then it is unlikely to have the impact that the ASA seeks.
It also questions whether recent efforts to ban commonly misused terms such as
“statistical significance” will, if successful, do more harm than good.
Early in January in a Chicago hotel, Campbell
Harvey gave a rip-Harvey’s term for
torturing the data until it confesses is “p-hacking,” a reference to the
p-value, a measure of statistical
significance. P-hacking is also known as overfitting, data-mining—or
data-snooping, the coinage of Andrew Lo, director of MIT’s Laboratory of
Financial Engineering. Says Lo: “The more you search over the past, the
more likely it is you are going to find exotic patterns that you happen
to like or focus on. Those patterns are least likely to repeat.”snorting
presidential address to the American Finance Association, the world’s
leading society for research on financial economics. To get published in
journals, he said, there’s a powerful temptation to torture the data
until it confesses—that is, to conduct round after round of tests in
search of a finding that can be claimed to be statistically significant.
Said Harvey, a professor at Duke University’s Fuqua School of Business:
“Unfortunately, our standard testing methods are often ill-equipped to
answer the questions that we pose.” He exhorted the group: “We are not
salespeople. We are scientists!”
The problems
Harvey identified in academia are as bad or worse in the investing
world. Mass-market products such as exchange-traded funds are being
concocted using the same flawed statistical techniques you find in
scholarly journals. Most of the empirical research in finance is likely
false, Harvey wrote in a paper with a Duke colleague, Yan Liu, in 2014.
“This implies that half the financial products (promising outperformance)
that companies are selling to clients are false.”
. . .
In the wrong hands, though, backtesting can go
horribly wrong. It once found that the best predictor of the S&P 500,
out of all the series in a batch of United Nations data, was butter
production in Bangladesh. The nerd webcomic xkcd by Randall
Munroe captures the ethos perfectly: It features a woman claiming jelly
beans cause acne. When a statistical test shows no evidence of an
effect, she revises her claim—it must depend on the flavor of jelly
bean. So the statistician tests 20 flavors. Nineteen show nothing. By
chance there’s a high correlation between jelly bean consumption and
acne breakouts for one flavor. The final panel of the cartoon is the
front page of a newspaper: “Green Jelly Beans Linked to Acne! 95%
Confidence. Only 5% Chance of Coincidence!”
It’s worse for financial data because
researchers have more knobs to twist in search of a prized “anomaly”—a
subtle pattern in the data that looks like it could be a moneymaker.
They can vary the period, the set of securities under consideration, or
even the statistical method. Negative findings go in a file drawer;
positive ones get submitted to a journal (tenure!) or made into an ETF
whose performance we rely on for retirement. Testing out-of-sample data
to keep yourself honest helps, but it doesn’t cure the problem. With
enough tests, eventually by chance even your safety check will show the
effect you want.
The key misconception has nothing to do with tail-area probabilities or
likelihoods or anything technical at all, but rather with the use of
significance testing to finesse real uncertainty.
Even authors of published articles in a top statistics journal are often
confused about the meaning of p-values, especially by treating 0.05, or
the range 0.05–0.15, as the location of a threshold. The underlying
problem seems to be deterministic thinking. To put it another way,
applied researchers and also statisticians are in the habit of demanding
more certainty than their data can legitimately supply. The problem is
not just that 0.05 is an arbitrary convention; rather, even a seemingly
wide range of p-values such as 0.01–0.10 cannot serve to classify
evidence in the desired way.
In our article, John and I discuss some natural solutions that won’t, on
their own, work:
–
Listen to the statisticians, or clarity in exposition
–
Confidence intervals instead of hypothesis tests
–
Bayesian interpretation of one-sided p-values
–
Focusing on “practical significance” instead of “statistical
significance”
–
Bayes factors
You can read our
article for
the reasons why we think the above proposed solutions won’t work.
From our summary:
We recommend saying No to binary conclusions . . . resist giving clean
answers when that is not warranted by the data. . . . It will be
difficult to resolve the many problems with p-values and “statistical
significance” without addressing the mistaken goal of certainty which
such methods have been used to pursue.
P.S. Along
similar lines, Stephen Jenkins sends along the similarly-themed article,
“‘Sing Me a Song with Social Significance’: The (Mis)Use of Statistical
Significance Testing in European Sociological Research,” by Fabrizio
Bernardi, Lela Chakhaia, and Liliya Leopold.
In a
recent article in PLOS One,
Don van
Ravenzwaaij and John Ioannidis argue that Bayes factors should be preferred
to significance testing (p-values) when assessing the effectiveness of new
drugs. At his blogsite The 20% Statistician,
Daniel Lakens argues that Bayes factors suffer from the same problems as
p-values. Namely, the combination of small effect sizes and sample sizes
leads to inconclusive conclusions no matter whether one uses p-values or
Bayes factors. The real challenge facing decision-making from statistical
studies comes from publication bias and underpowered studies. Both
significance testing and Bayes factors are relatively powerless (pun
intended) to overcome these more fundamental problems. To read more,
click here.
Author
Thomas R. Dyckman Professor Emeritus Cornell University
Abstract
This paper advocates abandoning null hypothesis
statistical tests (NHST) in favor of reporting confidence intervals. The
case against NHST, which has been made repeatedly in multiple
disciplines and is growing in awareness and acceptance, is introduced
and discussed. Accounting as an empirical research discipline appears to
be the last of research communities to face up to the inherent problems
of significance test use and abuse. The paper encourages adoption of a
meta-analysis approach which allows for the inclusion of replication
studies in the assessment of evidence. This approach requires abandoning
the typical NHST process and its reliance on p-values. However, given
that NHST has deep roots and wide “social acceptance” in the empirical
testing community, modifications to NHST are suggested so as to partly
counter the weakness of this statistical testing method.
Extended Quotation
. . .
2. Why The Frequentist Approach (NHSTs) Should be Abandoned in Favor of
a Bayesian Approach
Frequentist Approach:
The frequentist NHST relies on rejecting a null hypothesis of no effect
or relationship based on the probability, or “p-level”, of observing a
specific sample result X equal to or more extreme than the actual
observation X₀, conditional on the null hypothesis H₀ being true. In
symbols, this calculation yields a p-level = Pr(X≥X₀|H₀), where ≥
signifies “as or more discrepant with H₀ than X₀”. The origin of the
approach is generally credited to Karl Pearson (1900), who introduced it
in his χ²-test (Pearson actually called it the P, χ²-test). However, it
was Sir Ronald Fisher who is credited with naming and popularizing
statistical significance testing and p-values as promulgated in the many
editions of his classic books Statistical Methods for Research Workers
and The Design of Experiments. See Spielman (1974), Seidenfeld (1979),
Johnstone et al. (1986), Barnett (1999), Berger (2003) and Howson and
Urbach (2006) on the ideas and development of modern hypothesis tests (NHST).
The Bayesian Approach:
Probabilities, under the Bayesian approach, rely on informed beliefs
rather than physical quantities. They represent informed reasoned
guesses. In the Bayesian approach, the objective is the posterior (post
sample) belief concerning where a parameter, β in our case, is possibly
located. Bayes’ theorem allows us to use the sample data to update our
prior beliefs about the value of the parameter of interest. The revised
(posterior) distribution represents the new belief based on the prior
and the statistical method (the model) applied, and calculated using
Bayes theorem. Prior beliefs play an important role in the Bayesian
process. In fact, no data can be interpreted without prior beliefs
(“data cannot speak for themselves”).
Bayesians emphasize the unavoidably subjective
nature of the research process. The decision to select a models and
specific prior or family of priors is necessarily subjective, and the
sample data are seldom obtained objectively (Basturk et al., 2014).
Indeed, data quality has become a major problem with the advent of “big
data” and with the recognition that the rewards for publication tend to
induce gamesmanship and even fraud in the data selected for the study.
When the investigator experiences difficulty
and uncertainty in specifying a specific prior distribution, the use of
diffuse or “uninformative” prior is typically adopted. The idea is to
impose no strong prior belief on the analysis and hence allow the data
to have a bigger part in the final conclusions. Ultimately, enough data
will “swamp” any prior distribution, but in reality, where systems are
not stationary and no models is known to be “true”, there is always
subjectivity and room for revision in Bayesian posterior beliefs.
The Bayesian viewpoint is that this is a fact
of research life and needs to be faced and treated formally in the
analysis. Objectivity is not possible, so there is no gain from
pretending that it is. Formal Bayesian methods for coping with
subjectivity are easy to understand. For example, one approach is to ask
how robust the posterior distribution of belief about β is to different
possible prior distributions. If we can say that we come to essentially
the same qualitative belief over all feasible models and prior
distributions, or across the different priors that different people
hold, then that is perhaps the most objective that a statistical
conclusion can claim.
Continued in article
Question What is a Bayes Factor and why is it important?
In a trial of a new drug to cure cancer, 44 percent of 50 patients achieved
remission after treatment. Without the drug, only 32 percent of previous
patients did the same. The new treatment sounds promising, but is it better
than the standard?
That question is difficult, so statisticians tend to answer a different
question. They look at their results and compute something called a p-value.
If the p-value is less than 0.05, the results are “statistically
significant” – in other words, unlikely to be caused by just random chance.
The problem is, many statistically significant results
aren’t replicating.
A treatment that shows promise in one trial doesn’t show any benefit at all
when given to the next group of patients. This problem has become so severe
that
one psychology journal actually banned p-values
altogether.
My colleagues and I have studied this problem, and we think we know what’s
causing it. The bar for claiming statistical significance is simply too low.
Most hypotheses are false
The Open Science Collaboration, a nonprofit
organization focused on scientific research,
tried to replicate
100 published psychology experiments. While 97 of the initial experiments
reported statistically significant findings, only 36 of the replicated
studies did.
Several graduate students and I
used these data to estimate the probability that a randomly chosen
psychology experiment tested a real effect. We found that only about 7
percent did. In a similar study,
economist Anna Dreber and colleagues
estimated that only 9 percent of experiments would replicate.
Both analyses suggest that only about one in 13 new experimental treatments
in psychology – and probably many other social sciences – will turn out to
be a success.
This has important implications when interpreting p-values, particularly
when they’re close to 0.05.
The Bayes factor
P-values close to 0.05 are more likely to be due to random chance than most
people realize.
To understand the problem, let’s return to our imaginary drug trial.
Remember, 22 out of 50 patients on the new drug went into remission,
compared to an average of just 16 out of 50 patients on the old treatment.
The probability of seeing 22 or more successes out of 50 is 0.05 if the new
drug is no better than the old. That means the p-value for this experiment
is statistically significant. But we want to know whether the new treatment
is really an improvement, or if it’s no better than the old way of doing
things.
To find out, we need to combine the information contained in the data with
the information available before the experiment was conducted, or the “prior
odds.” The prior odds reflect factors that are not directly measured in the
study. For instance, they might account for the fact that in 10 other trials
of similar drugs, none proved to be successful.
If the new drug isn’t any better than the old drug, then statistics tells us
that the probability of seeing exactly 22 out of 50 successes in this trial
is 0.0235 – relatively low.
What if the new drug actually is better? We don’t actually know the success
rate of the new drug, but a good guess is that it’s close to the observed
success rate, 22 out of 50. If we assume that, then the probability of
observing exactly 22 out of 50 successes is 0.113 – about five times more
likely. (Not nearly 20 times more likely, though, as you might guess if you
knew the p-value from the experiment was 0.05.)
This ratio of the probabilities is called the Bayes
factor. We can use
Bayes theorem to combine the Bayes
factor with the prior odds to compute the probability that the new treatment
is better.
A megateam of reproducibility-minded scientists is renewing a
controversial proposal to raise the standard for statistical
significance in research studies. They want researchers to dump the
long-standing use of a probability value (p-value) of less than 0.05 as
the gold standard for significant results, and replace it with the much
stiffer p-value threshold of 0.005.
Backers of the change, which has been floated before, say it could
dramatically reduce the reporting of false-positive results—studies that
claim to find an effect when there is none—and so make more studies
reproducible. And they note that researchers in some fields, including
genome analysis, have already made a similar switch with beneficial
results.
“If we’re
going to be in a world where the research community expects some strict
cutoff … it’s better that that threshold be .005 than .05. That’s an
improvement over the status quo,” says behavioral economist Daniel
Benjamin of the University of Southern California in Los Angeles, first
author on the new paper, which was posted 22 July as a preprint article
on PsyArXiv and is slated for an upcoming issue of
Nature Human
Behavior. “It seemed like this was something that was
doable and easy, and had worked in other fields.”
But other scientists reject the idea of any absolute threshold for
significance. And some biomedical researchers worry the approach could
needlessly drive up the costs of drug trials. “I can’t be very
enthusiastic about it,” says biostatistician Stephen Senn of the
Luxembourg Institute of Health in Strassen. “I don’t think they’ve
really worked out the practical implications of what they’re talking
about.”
A fraught value
The
p-value is a notoriously
elusive concept for nonstatisticians.
Too often, it is misinterpreted to be the probability that the
hypothesis being tested is true, says Valen Johnson, a statistician
Texas A&M University in College Station and an author on the new paper.
The reality is more complicated. For a test of a new drug in a clinical
trial, for example, a p-value of 0.05 really means the results
observed—or even more extreme results—would occur in one in 20 trials if
the drug really had no benefit over the current standard of care. But
it’s often wrongly described as a 95% chance that the drug actually
works.
To
explain to a broader audience how weak the .05 statistical threshold
really is, Johnson joined with 71 collaborators on the new paper (which
partly reprisesan argument
Johnson made
for stricter p-values in a 2013 paper). Among the authors are some big
names in the study of scientific reproducibility, including psychologist
Brian Nosek of the University of Virginia in Charlottesville, who led areplication
effort of high-profile psychology studies
through the nonprofit Center for Open Science, and epidemiologist John
Ioannidis of Stanford University in Palo Alto, California, known for
pointing out
systemic flawsin
biomedical research.
The authors set up a scenario where the odds are one to 10 that any
given hypothesis researchers are testing is inherently true—that a drug
really has some benefit, for example, or a psychological intervention
really changes behavior. (Johnson says that some recent studies in the
social sciences support that idea.) If an experiment reveals an effect
with an accompanying p-value of .05, that would actually mean that the
null hypothesis—no real effect—is about three times more likely than the
hypothesis being tested. In other words, the evidence of a true effect
is relatively weak.
But under those same conditions (and assuming studies have 100% power to
detect a true effect)—requiring a p-value at or below .005 instead of
.05 would make for much stronger evidence: It would reduce the rate of
false-positive results from 33% to 5%, the paper explains.
“The whole choice of .05 as a default is really a kind of
numerology—there’s no scientific justification for it,” says Victor De
Gruttola of the Harvard School of Public Health in Boston. The paper
“exposes that there can be a false sense of security with the .05
default.” He doubts the results will be news to statisticians, “but I
think a lot of investigators whose primary focus is not on these kinds
of issues may be surprised.”
Significant, or just suggestive?
The
authors are careful not to endorse the use of p-values as the ultimate
measure of significance; many scientists have arguedthat they should
be abolished altogether. But
in the many fields where a p-value below .05 has become a gold standard,
the authors propose a rule of thumb for new findings: “Significant”
results should require a p-value below .005; results with p-values below
.05 but above .005 should be called merely “suggestive.”
Continued in article
Jensen Comment
As long as multiple regression software packages keep cranking out p-values
accounting research journals will still be worshipping at the alter of
p-values. The reason is that taking a way p-values adds immensely to the
labor of research.
The quickest way to change data analysts is for the software packages to
stop computing the p-values. But there will be ice skating in Hell before
that happens.
For one, it’s of little use to say that your
observations would be rare if there were no real difference between the
pills (which is what the p-value tells you), unless you can say whether
or not the observations would also be rare when there is a true
difference between the pills. Which brings us back to induction.
The problem of
induction was solved, in principle, by the Reverend Thomas Bayes in the
middle of the 18th century. He showed how
to convert the probability of the observations given a hypothesis (the
deductive problem) to what we actually want, the probability that the
hypothesis is true given some observations (the inductive problem). But
how to use his famous theorem in practice has been the subject of heated
debate ever since.
Take the proposition that the Earth goes round
the Sun. It either does or it doesn’t, so it’s hard to see how we could
pick a probability for this statement. Furthermore, the Bayesian
conversion involves assigning a value to the probability that your
hypothesis is right before any observations have been made (the ‘prior
probability’). Bayes’s theorem allows that prior probability to be
converted to what we want, the probability that the hypothesis is true
given some relevant observations, which is known as the ‘posterior
probability’.
These intangible probabilities persuaded Fisher
that Bayes’s approach wasn’t feasible. Instead, he proposed the wholly
deductive process of null hypothesis significance testing. The
realisation that this method, as it is commonly used, gives alarmingly
large numbers of false positive results has spurred several recent
attempts to bridge the gap.
There is one
uncontroversial application of Bayes’s theorem: diagnostic screening,
the tests that doctors give healthy people to detect warning signs of
disease. They’re a good way to understand the perils of the deductive
approach.
In theory, picking up on the early signs of
illness is obviously good. But in practice
there are usually so many false positive diagnoses that it just doesn’t
work very well. Take dementia. Roughly 1
per cent of the population suffer from mild cognitive impairment, which
might, but doesn’t always, lead to dementia. Suppose that the test is
quite a good one, in the sense that 95 per cent of the time it gives the
right (negative) answer for people who are free of the condition. That
means that 5 per cent of the people who don’t have cognitive impairment
will test, falsely, as positive. That doesn’t sound bad. It’s directly
analogous to tests of significance which will give 5 per cent of false
positives when there is no real effect, if we use a p-value of less than
5 per cent to mean ‘statistically significant’.
But in fact the screening test is not good –
it’s actually appallingly bad, because 86 per cent, not 5 per cent, of
all positive tests are false positives. So only 14 per cent of positive
tests are correct. This happens because most people don’t have the
condition, and so the false positives from these people (5 per cent of
99 per cent of the people), outweigh the number of true positives that
arise from the much smaller number of people who have the condition (80
per cent of 1 per cent of the people, if we assume 80 per cent of people
with the disease are detected successfully). There’s a YouTube video of
my attempt to explain this principle, or you can read my recent paper on
the subject.
Notice, though, that it’s possible to calculate
the disastrous false-positive rate for screening tests only because we
have estimates for the prevalence of the condition in the whole
population being tested. This is the prior probability that we need to
use Bayes’s theorem. If we return to the problem of tests of
significance, it’s not so easy. The analogue of the prevalence of
disease in the population becomes, in the case of significance tests,
the probability that there is a real difference between the pills before
the experiment is done – the prior probability that there’s a real
effect. And it’s usually impossible to make a good guess at the value of
this figure.
An example should make the idea more concrete.
Imagine testing 1,000 different drugs, one at a time, to sort out which
works and which doesn’t. You’d be lucky if 10 per cent of them were
effective, so let’s proceed by assuming a prevalence or prior
probability of 10 per cent. Say we observe a ‘just significant’ result,
for example, a P = 0.047 in a single test, and declare that this is
evidence that we have made a discovery. That claim will be wrong, not in
5 per cent of cases, as is commonly believed, but in 76 per cent of
cases. That is disastrously high. Just as in screening tests, the reason
for this large number of mistakes is that the number of false positives
in the tests where there is no real effect outweighs the number of true
positives that arise from the cases in which there is a real effect.
In general, though, we don’t know the real
prevalence of true effects. So, although we can calculate the p-value,
we can’t calculate the number of false positives. But what we can do is
give a minimum value for the false positive rate. To do this, we need
only assume that it’s not legitimate to say, before the observations are
made, that the odds that an effect is real are any higher than 50:50. To
do so would be to assume you’re more likely than not to be right before
the experiment even begins.
If we repeat the drug calculations using a
prevalence of 50 per cent rather than 10 per cent, we get a false
positive rate of 26 per cent, still much bigger than 5 per cent. Any
lower prevalence will result in an even higher false positive rate.
The upshot is that, if a scientist observes a
‘just significant’ result in a single test, say P = 0.047, and declares
that she’s made a discovery, that claim will be wrong at least 26 per
cent of the time, and probably more. No wonder then that there are
problems with reproducibility in areas of science that rely on tests of
significance.
Continued in article
Jensen Comment
Especially note the many replies to this article
. . .
David Colquhoun
https://aeon.co/conversations/what-should-be-done-to-improve-statistical-literacy#
I think that it’s quite hard to find a really good practical guide to
Bayesian analysis. By really good, I mean on that is critical about
priors and explains exactly what assumptions are being made. I fear that
one reason for this is that Bayesians often seem to have an evangelical
tendency that leads to them brushing the assumptions under the carpet. I
agree that Alexander Etz is a good place to start. but I do wonder how
much it will help when your faced with a particular set of observations
to analyze.
Henning Strandin ---
https://aeon.co/users/henning-strandin
Thank you for a good and useful article on the pitfalls of ignoring the
baseline. I have a couple of comments.
Bayes didn’t resolve the problem of induction, even in principle. The
problem of induction is the problem of knowing that the observations you
have made are relevant to some set of (perhaps as-yet) unobserved
events. In his Essay on Probabilities, Laplace illustrated the problem
in the same paragraph in which he suggests . . .
Karl Young
Nice article; as a Bayesian who was forced to quote p values in a couple
of medical physics papers for which the journal would have nothing else,
I appreciate the points made here. But even as a Bayesian one has to
acknowledge that there are a number of open problems besides just how to
estimate priors. E.g. what one really wants to know is given some
observations, how one’s hypothesis fares against as complete a list of
alternative hypothesis as can be mustered. Even assuming that one could
come up with such a list, calculating the probability that one’s
hypothesis best fits the observations in that case requires calculation
of a quantity called the evidence that is generally extremely difficult
(the reason that the diagnostic examples mentioned in the piece lead to
reasonable calculations is that calculating the evidence for the set of
proposed hypotheses, that either someone in the population has a disease
or doesn’t, is straightforward). So while I think Bayes is the
philosophically most coherent approach to analyzing data (doesn’t solve
the problem of induction but tries to at least manage it) there are
still a number of issues preventing it
Granger (1998;
2003) has
reminded us that if the sample size is sufficiently large, then
it's virtually impossible not to reject almost any hypothesis.
So, if the sample is very large and the p-values associated
with the estimated coefficients in a regression model are of the order
of, say, 0.10 or even 0.05, then this really bad
news. Much, much, smaller p-values are needed before we get all
excited about 'statistically significant' results when the sample size
is in the thousands, or even bigger. So, the p-values reported
above are mostly pretty marginal, as far as significance is
concerned. When you work out the p-values for the other 6
models I mentioned, they range from to 0.005 to 0.460. I've been
generous in the models I selected.
Here's another set of results taken from a second, really nice, paper
by
Ciecieriski et al. (2011) in the same
issue of Health Economics:
But after
writing about p-values again and again, and recently issuing a
correction on a
nearly year-old story over some erroneous
information regarding a study’s p-value (which I’d taken from the
scientists themselves and
their report),
I’ve come to think that the most fundamental problem with p-values is
that no one can really say what they are.
Last week, I
attended the inaugural
METRICS conference at Stanford, which brought
together some of the world’s leading experts on meta-science, or the
study of studies. I figured that if anyone could explain p-values in
plain English, these folks could. I was wrong.
Jensen Comment
In the case of accounting research the software tends to be statistical
packages like SAS or SPSS. Where errors arise is that most of the data comes
from purchased databases like CRSP, Compustat, and AuditAnalytics. The sad
news is that academic accounting research is almost never replicated. Even
more sad news is that when replicated errors in the data are rarely
discovered because both researchers and the replicators use the same
databases. Checking for errors in purchased databases is almost unheard of
among accounting researchers. This is why accounting research is almost
always considered truth the instant it's published. We really don't want to
find errors in academic accounting research because nobody cares if there
are errors --- certainly not practitioners who have no interest in the fun
and games of academic accounting research.
Jensen Comment
Academic accounting research has a worse flaw --- replication in accounting
research is a rare event due largely to the fact that leading accounting
research journals will not publish reports of replication efforts and
outcomes. One thing we can say about hypothesis testing in accounting
research is that the first test constitutes TRUTH!
http://faculty.trinity.edu/rjensen/TheoryTAR.htm
Jensen Comment
Academic accounting research has this same flaw plus a boatload of other
flaws.
What went wrong?
See below
Jensen Comment
Note that the following article has enormous implications for what is taught in
most Ph.D. programs in the social sciences, business, accounting, finance, and
other academic disciplines. Regression analysis has become the key to the
kingdom of academic research, a Ph.D. diploma, journal article publication,
tenure, and performance rewards in the Academy. Now the sky is falling, and soon
researchers skilled mostly at performing regression analysis are faced with the
problem of having to learn how to do real research.
A huge range of science projects are done
with multiple regression analysis. The results are often somewhere between
meaningless and quite damaging. ...
I hope that in the future, if I’m successful in
communicating with people about this, that there’ll be a kind of upfront
warning in New York Times articles: These data are based on multiple
regression analysis. This would be a sign that you probably shouldn’t read
the article because you’re quite likely to get non-information or
misinformation. RICHARD NISBETT is a professor of psychology and co-director
of the Culture and Cognition Program at the University of Michigan. He is
the author of Mindware: Tools for Smart Thinking; and The Geography of
Thought.
Richard Nisbett's Edge Bio Page.
THE CRUSADE AGAINST MULTIPLE REGRESSION ANALYSIS
The thing I’m most interested in right now has become a kind of crusade
against correlational statistical analysis—in particular, what’s called
multiple regression analysis. Say you want to find out whether taking
Vitamin E is associated with lower prostate cancer risk. You look at the
correlational evidence and indeed it turns out that men who take Vitamin E
have lower risk for prostate cancer. Then someone says, "Well, let’s see if
we do the actual experiment, what happens." And what happens when you do the
experiment is that Vitamin E contributes to the likelihood of prostate
cancer. How could there be differences? These happen a lot. The
correlational—the observational—evidence tells you one thing, the
experimental evidence tells you something completely different.
The thing I’m most interested in right now has
become a kind of crusade against correlational statistical analysis—in
particular, what’s called multiple regression analysis. Say you want to find
out whether taking Vitamin E is associated with lower prostate cancer risk.
You look at the correlational evidence and indeed it turns out that men who
take Vitamin E have lower risk for prostate cancer. Then someone says,
"Well, let’s see if we do the actual experiment, what happens." And what
happens when you do the experiment is that Vitamin E contributes to the
likelihood of prostate cancer. How could there be differences? These happen
a lot. The correlational—the observational—evidence tells you one thing, the
experimental evidence tells you something completely different.
In the case of health data, the big problem is
something that’s come to be called the healthy user bias, because the guy
who’s taking Vitamin E is also doing everything else right. A doctor or an
article has told him to take Vitamin E, so he does that, but he’s also the
guy who’s watching his weight and his cholesterol, gets plenty of exercise,
drinks alcohol in moderation, doesn’t smoke, has a high level of education,
and a high income. All of these things are likely to make you live longer,
to make you less subject to morbidity and mortality risks of all kinds. You
pull one thing out of that correlate and it’s going to look like Vitamin E
is terrific because it’s dragging all these other good things along with it.
This is not, by any means, limited to health
issues. A while back, I read a government report in The New York Times on
the safety of automobiles. The measure that they used was the deaths per
million drivers of each of these autos. It turns out that, for example,
there are enormously more deaths per million drivers who drive Ford F150
pickups than for people who drive Volvo station wagons. Most people’s
reaction, and certainly my initial reaction to it was, "Well, it sort of
figures—everybody knows that Volvos are safe."
Continued in article
Drawing Inferences From Very Large Data-Sets
David Johnstone wrote the following:
Indeed if you hold H0 the same and keep
changing the model, you will eventually (generally soon) get a significant
result, allowing "rejection of H0 at 5%", not because H0 is
necessarily false but because you have built upon a false model (of which
there are zillions, obviously).
Granger (1998;
2003) has
reminded us that if the sample size is sufficiently large, then it's
virtually impossible not to reject almost any hypothesis.
So, if the sample is very large and the p-values associated with
the estimated coefficients in a regression model are of the order of, say,
0.10 or even 0.05, then this really bad news. Much,
much, smaller p-values are needed before we get all excited about
'statistically significant' results when the sample size is in the
thousands, or even bigger. So, the p-values reported above are
mostly pretty marginal, as far as significance is concerned. When you work
out the p-values for the other 6 models I mentioned, they range
from to 0.005 to 0.460. I've been generous in the models I selected.
Here's another set of results taken from a second, really nice, paper by
Ciecieriski et al. (2011) in the same issue of
Health Economics:
Continued in article
Jensen Comment
My research suggest that over 90% of the recent papers published in The
Accounting Review use purchased databases that provide enormous sample sizes
in those papers. Their accountics science authors keep reporting those
meaningless levels of statistical significance.
What is even worse is when meaningless statistical significance tests are
used to support decisions.
With all of this emphasis
on "Big Data", I was pleased to see
this post on the Big Data
Econometrics blog, today.
When you have a sample that runs
to the thousands (billions?), the conventional significance
levels of 10%, 5%, 1% are completely inappropriate. You need to
be thinking in terms of tiny significance levels.
I discussed this in some
detail back in April of 2011, in a post titled, "Drawing
Inferences From Very Large Data-Sets".
If you're of those (many) applied
researchers who uses large cross-sections of data, and then
sprinkles the results tables with asterisks to signal
"significance" at the 5%, 10% levels, etc., then I urge
you read that earlier post.
It's sad to encounter so many
papers and seminar presentations in which the results, in
reality, are totally insignificant!
Page 206 Like scientists today in medical and economic and
other sizeless sciences, Pearson mistook a large sample size for the definite,
substantive significance---evidence s Hayek put it, of "wholes." But it was as
Hayek said "just an illusion." Pearson's columns of sparkling asterisks, though
quantitative in appearance and as appealing a is the simple truth of the sky,
signified nothing.
pp. 250-251 The textbooks are wrong. The teaching is wrong. The
seminar you just attended is wrong. The most prestigious journal in your
scientific field is wrong.
You are searching, we know,
for ways to avoid being wrong. Science, as Jeffreys said, is mainly a series of
approximations to discovering the sources of error. Science is a systematic way
of reducing wrongs or can be. Perhaps you feel frustrated by the random
epistemology of the mainstream and don't know what to do. Perhaps you've been
sedated by significance and lulled into silence. Perhaps you sense that the
power of a Roghamsted test against a plausible Dublin alternative is
statistically speaking low but you feel oppressed by the instrumental variable
one should dare not to wield. Perhaps you feel frazzled by what Morris Altman
(2004) called the "social psychology rhetoric of fear," the deeply embedded path
dependency that keeps the abuse of significance in circulation. You want to come
out of it. But perhaps you are cowed by the prestige of Fisherian dogma. Or,
worse thought, perhaps you are cynically willing to be corrupted if it will keep
a nice job
Bob Jensen's threads on the often way analysts, particularly accountics
scientists, often cheer for statistical significance of large sample outcomes
that praise statistical significance of insignificant results such as R2
values of .0001 ---
The Cult of Statistical Significance: How Standard Error Costs Us Jobs, Justice,
and Lives ---
http://www.cs.trinity.edu/~rjensen/temp/DeirdreMcCloskey/StatisticalSignificance01.htm
Those of you interested in tracking The
Accounting Review's trends in submissions, refereeing, and
acceptances'rejections should be interested in current senior editor Mark L.DeFond's
annual report at
http://aaajournals.org/doi/full/10.2308/accr-10477
This has become a huge process involving 18 editors and hundreds of referees.
TAR is still the leading accountics science journal of the American Accounting
Association. However, there are so many new specialty journals readers are apt
to find quality research in other AAA journals. TAR seemingly still does not
publish commentaries and articles without equations and has not yet caught on
the intitiatives of the Pathways Commission for more diversification in
research in the leading AAA research journal. Virtually all TAR editors still
worship p-values in empirical submissions.
But after
writing about p-values again and again, and recently issuing a correction on
a
nearly year-old story over some erroneous
information regarding a study’s p-value (which I’d taken from the scientists
themselves and
their report), I’ve
come to think that the most fundamental problem with p-values is that no one
can really say what they are.
Last week, I
attended the inaugural
METRICS conference at Stanford, which brought
together some of the world’s leading experts on meta-science, or the study
of studies. I figured that if anyone could explain p-values in plain
English, these folks could. I was wrong.
Continued in article
Jensen Comment
Why all the fuss? Accountics scientists have a perfectly logical explanation.
P-values are numbers that are pumped out of statistical analysis software
(mostly multiple regression software) that accounting research journal editors
think indicate the degree of causality or at least suggest the degree of
causality to readers. But the joke is on the editors, because there aren't any
readers.
November 30, 2015 reply from David
Johnstone
Dear
Bob, thankyou for this interesting stuff.
A big
part of the acceptance of P-values is that they easily give the look of
something having been found. So it’s an agency problem, where the
researchers do what makes their research outcomes easier and better looking.
There
is a lot more to it of course. I note with young staff that they face enough
hurdles in the need to get papers written and published without thinking
that the very techniques that they are trying to emulate might be flawed.
Rightfully, they say, “it’s not my job to question everything that I have
been shown and to get nowhere as a result”, nor can most believe that
something so established and revered can be wrong, that is just too
unthinkable and depressing. So the bandwagon goes on, and, as Bob says, no
one cares outside as no one much reads it.
I do
however get annoyed every time I hear decision makers carry on about
“evidence based” policy, as if no one can have a clue or form a vision or
strategy without first having the backing of some junk science by a
sociologist or educationist or accounting researcher who was just twisting
the world whichever way to get significant p-values and a good “story”. This
kind of cargo-culting, which is everywhere, does great harm to good or
sincere science, as it makes it hard for an outsider to tell the difference.
One
thing that does not get much of a hearing is that the statisticians
themselves must take a lot of blame. They had the chance to vote off P
values decades ago when they had to choose between frequentist and Bayesian
logic. They split into two camps with the frequentists in the great majority
but holding the weakest ground intellectually. The numbers are moving now,
as people that were not born when de Finetti, Savage, Lindley, Kadane and
others first said that p-values were ill-conceived logically. Accounting, of
course, being largely ignorant of there being any issue, and ultimately just
political, will not be leading the battle of ideas.
January 28, 2016 reply from Paul Williams
Bob,
Thank you for this. In accounting the problem is
even worse because at least in other fields it is plausible that one can
have "scientific" concepts and categories. Archival research in accounting
can only deal with interpretive concepts and the "scientific" categories are
often constructed for the one study in question. We make a lot of s... up so
that the results are consistent with the narrative (always a neoclassical
economic one) that informs the study. Measurement? Doesn't exist. How can
one seriously believe they are engaged in scientific research when their
"measurements" are the result of GAAP? Abe Briloff described our most
prestigious research (which Greg Waymire claimed in his AAA presidential
white paper "...threatens the discipline with extinction."). as simply "low
level financial statement analysis." Any research activity that is reduced
to a template (in JAE the table numbers are nearly the same from paper to
paper) you know you are in trouble. What is the scientific value of 50
control variables, two focus independent variables (correlated with the
controls), and one dependent variable that is always different from study to
study? This one variable at a time approach can go on into infinity with the
only result being a huge pile of anecdotes that no one can organize into any
coherent explanation of what is going on. As you have so eloquently and
relentlessly pointed out accountants never replicate anything. In archival
research it is not even possible to replicate since the researcher is unable
to provide (like any good scientist in physics, chemistry, biology, etc.) a
log book providing the detailed recipe it would take to actually replicate
what the researcher has done. Without the ability to independently replicate
the exact study, the status of that study is merely an anecdote. Given the
Hunton affair, perhaps we should not be so sanguine about trusting our
colleagues. This is particularly so since the leading U.S. journals have a
clear ideological bias -- if your results aren't consistent with the
received wisdom they won't be published.
The purpose of this paper is to make a case that
the accountics science monopoly of our doctoral programs and publish ed
research is seriously flawed, especially its lack of concern about
replication and focus on simplified arti ficial worlds that differ too much
from reality to creatively discover findings of greater relevance to
teachers of accounting and practitioners of accounting. Accountics
scientists themselves became a Cargo Cult.
The leading accountics science (an indeed the leading academic accounting
research journals) are The Accounting Review (TAR), the Journal of
Accounting Research (JAR), and the Journal of Accounting and Economics
(JAE). Publishing accountics science in these journals is a necessary condition
for nearly all accounting researchers at top R1 research universities in North
America.
On the AECM listserv, Bob Jensen and former TAR Senior Editor Steven
Kachelmeier have had an ongoing debate about accountics science relevance and
replication for well over a year in what Steve now calls a game of CalvinBall.
When Bob Jensen noted the lack of exacting replication in accountics science,
Steve's CalvinBall reply was that replication is the name of the game in
accountics science:
The answer to your question, "Do you really think
accounting researchers have the hots for replicating their own findings?" is
unequivocally YES,
though I am not sure about the word "hots." Still, replications in the sense
of replicating prior findings and then extending (or refuting) those
findings in different settings happen all the time, and they get published
regularly. I gave you four examples from one TAR issue alone (July 2011).
You seem to disqualify and ignore these kinds of replications because they
dare to also go beyond the original study. Or maybe they don't count for you
because they look at their own watches to replicate the time instead of
asking to borrow the original researcher's watch. But they count for me.
To which my CalvinBall reply to Steve is --- "WOW!" In the past four decades
of all this unequivocal replication in accountics science there's not been a
single scandal. Out of the thousands of accountics science papers published in
TAR, JAR, and JAE there's not been a single paper withdrawn after publication,
to my knowledge, because of a replication study discovery. Sure there have been
some quibbles about details in the findings and some improvements in statistical
significance by tweaking the regression models, but there's not been a
replication finding serious enough to force a publication retraction or serious
enough to force the resignation of an accountics scientist.
In real science, where more exacting replications really are the name of the
game, there have been many scandals over the past four decades. Nearly all top
science journals have retracted articles because independent researchers could
not exactly replicate the reported findings. And it's not all that rare to force
a real scientist to resign due to scandalous findings in replication efforts.
The most serious scandals entail faked data or even faked studies. These
types of scandals apparently have never been detected among thousands of
accountics science publications. The implication is that accountics
scientists are more honest as a group than real scientists. I guess that's
either good news or bad replicating.
Given the pressures brought to bear on accounting faculty to publish
accountics science articles, the accountics science scandal may be that
accountics science replications have never revealed a scandal --- to my
knowledge at least.
Harvard University psychologist Marc Hauser — a
well-known scientist and author of the book “Moral Minds’’ — is taking a
year-long leave after a lengthy internal investigation found evidence of
scientific misconduct in his laboratory.
The findings have resulted in the retraction of an
influential study that he led. “MH accepts responsibility for the error,’’
says the retraction of the study on whether monkeys learn rules, which was
published in 2002 in the journal Cognition.
Two other journals say they have been notified of
concerns in papers on which Hauser is listed as one of the main authors.
It is unusual for a scientist as prominent as
Hauser — a popular professor and eloquent communicator of science whose work
has often been featured on television and in newspapers — to be named in an
investigation of scientific misconduct. His research focuses on the
evolutionary roots of the human mind.
In a letter Hauser wrote this year to some Harvard
colleagues, he described the inquiry as painful. The letter, which was shown
to the Globe, said that his lab has been under investigation for three years
by a Harvard committee, and that evidence of misconduct was found. He
alluded to unspecified mistakes and oversights that he had made, and said he
will be on leave for the upcoming academic year.
Continued in article
Update: Hauser resigned from Harvard in 2011 after the published
research in question was retracted by the journals.
Not only have there been no similar reported accountics science scandals
called to my attention, I'm not aware of any investigations of impropriety that
were discovered among all those "replications" claimed by Steve.
My students are often horrified when I
tell them, truthfully, that one of the last pieces of information that I
look at when evaluating the results of an OLS regression, is the
coefficient of determination (R2), or its "adjusted"
counterpart. Fortunately, it doesn't take long to change their
perspective!
After all, we all know that with
time-series data, it's really easy to get a "high" R2 value,
because of the trend components in the data. With cross-section data,
really low R2 values are really common. For most of us, the
signs, magnitudes, and significance of the estimated parameters are of
primary interest. Then we worry about testing the assumptions underlying
our analysis. R2 is at the bottom of the list of priorities.
Now, let's return to the "problem" of
multicollinearity.
What do we mean by this term, anyway? This turns
out to be the key question!
Multicollinearity is a phenomenon associated with
our particular sample of data when we're trying to estimate a
regression model. Essentially, it's a situation where there is
insufficient information in the sample of data to enable us to
enable us to draw "reliable" inferences about the individual parameters
of the underlying (population) model.
I'll be elaborating more on the "informational content" aspect of this
phenomenon in a follow-up post. Yes, there are various sample measures
that we can compute and report, to help us gauge how severe this data
"problem" may be. But they're not statistical tests, in any sense
of the word
Because multicollinearity is a characteristic of the sample, and
not a characteristic of the population, you should immediately be
suspicious when someone starts talking about "testing for
multicollinearity". Right?
Apparently not everyone gets it!
There's an old paper by Farrar and Glauber (1967) which, on the face of
it might seem to take a different stance. In fact, if you were around
when this paper was published (or if you've bothered to actually read it
carefully), you'll know that this paper makes two contributions. First,
it provides a very sensible discussion of what multicollinearity is all
about. Second, the authors take some well known results from the
statistics literature (notably, by Wishart, 1928; Wilks, 1932; and
Bartlett, 1950) and use them to give "tests" of the hypothesis that the
regressor matrix, X, is orthogonal.
How can this be? Well, there's a simple explanation if you read the
Farrar and Glauber paper carefully, and note what assumptions are made
when they "borrow" the old statistics results. Specifically, there's an
explicit (and necessary) assumption that in the population the X
matrix is random, and that it follows a multivariate normal
distribution.
This assumption is, of course totally at odds with what is usually
assumed in the linear regression model! The "tests" that Farrar and
Glauber gave us aren't really tests of multicollinearity in the
sample. Unfortunately, this point wasn't fully appreciated by
everyone.
There are some sound suggestions in this paper, including looking at the
sample multiple correlations between each regressor, and all of
the other regressors. These, and other sample measures such as
variance inflation factors, are useful from a diagnostic viewpoint, but
they don't constitute tests of "zero multicollinearity".
So, why am I even mentioning the Farrar and Glauber paper now?
Well, I was intrigued to come across some STATA code (Shehata, 2012)
that allows one to implement the Farrar and Glauber "tests". I'm not
sure that this is really very helpful. Indeed, this seems to me to be a
great example of applying someone's results without understanding
(bothering to read?) the assumptions on which they're based!
Be careful out there - and be highly suspicious of strangers bearing
gifts!
Farrar, D. E. and R. R. Glauber, 1967. Multicollinearity in
regression analysis: The problem revisited. Review of Economics
and Statistics, 49, 92-107.
Shehata, E. A. E., 2012. FGTEST: Stata module to compute
Farrar-Glauber Multicollinearity Chi2, F, t tests.
Wilks, S. S., 1932. Certain generalizations in the analysis of
variance. Biometrika, 24, 477-494.
Wishart, J., 1928. The generalized product moment distribution
in samples from a multivariate normal population. Biometrika,
20A, 32-52.
With all of this emphasis
on "Big Data", I was pleased to see
this post on the Big Data
Econometrics blog, today.
When you have a sample that runs
to the thousands (billions?), the conventional significance
levels of 10%, 5%, 1% are completely inappropriate. You need to
be thinking in terms of tiny significance levels.
I discussed this in some
detail back in April of 2011, in a post titled, "Drawing
Inferences From Very Large Data-Sets".
If you're of those (many) applied
researchers who uses large cross-sections of data, and then
sprinkles the results tables with asterisks to signal
"significance" at the 5%, 10% levels, etc., then I urge
you read that earlier post.
It's sad to encounter so many
papers and seminar presentations in which the results, in
reality, are totally insignificant!
Granger (1998;
2003) has
reminded us that if the sample size is sufficiently large, then
it's virtually impossible not to reject almost any hypothesis.
So, if the sample is very large and the p-values associated
with the estimated coefficients in a regression model are of the order
of, say, 0.10 or even 0.05, then this really bad
news. Much, much, smaller p-values are needed before we get all
excited about 'statistically significant' results when the sample size
is in the thousands, or even bigger. So, the p-values reported
above are mostly pretty marginal, as far as significance is
concerned. When you work out the p-values for the other 6
models I mentioned, they range from to 0.005 to 0.460. I've been
generous in the models I selected.
Here's another set of results taken from a second, really nice, paper
by
Ciecieriski et al. (2011) in the same
issue of Health Economics:
Continued in article
Jensen Comment
My research suggest that over 90% of the recent papers published in TAR use
purchased databases that provide enormous sample sizes in those papers.
Their accountics science authors keep reporting those meaningless levels of
statistical significance.
What is even worse is when meaningless statistical significance tests are
used to support decisions.
Bob Jensen's threads on the often way analysts, particularly accountics
scientists, often cheer for statistical significance of large sample
outcomes that praise statistical significance of insignificant results such
as R2 values of .0001 ---
The Cult of Statistical Significance: How Standard Error Costs Us Jobs,
Justice, and Lives ---
http://www.cs.trinity.edu/~rjensen/temp/DeirdreMcCloskey/StatisticalSignificance01.htm
Jensen Comment
I really like the way David Giles thinks and writes about econometrics. He
does not pull his punches about validity testing.Bob Jensen's threads on
validity testing in accountics science ---
http://faculty.trinity.edu/rjensen/TheoryTAR.htm
DATABASE BIASES AND ERRORS
My casual studies of accountics science articles suggests that over 90% of those
studies rely exclusively on one or more public database whenever the studies use
data. I find few accountics science research into bias and errors of those
databases. Here's a short listing of research into these biases and errors, some
of which were published by accountics scientists ---
This page provides references for articles
that study specific aspects of CRSP, Compustat and other popular
sources of data used by researchers at Kellogg. If you know of any
additional references, please e-mail
researchcomputing-help@kellogg.northwestern.edu.
TODAY'S PH.D. STUDENTS
IS THERE A FUTURE GENERATION OF ACCOUNTING ACADEMICS OR ARE THEY A DYING
BREED - A UK PERSPECTIVE
by Vivien Beatte and Mary Jane Smith
Source: ICAS
Country: UK
Date: 20/12/2012
About the authors
......................................................................................................
72
About SATER
.........................................................................................................
73
EXECUTIVE SUMMARY
I’m a new PhD
[recently graduated].
What I notice most about our new faculty is that they are all culturally
quite different from those departing [retiring].
Background
One of the defining characteristics of a profession is
the existence of a related academic discipline, which engages in
teaching and research activities that support the profession. The
linkage of the profession with the university sector legitimises claims
to professionalism. In the US, severe faculty shortages in accounting
have been documented and attributed to inadequate renewal in terms of
PhD graduates (AAA, 2008; AAA/AAPLG, 2005). In the UK, too, there is a
very thin academic labour market for both the accounting and finance
disciplines, despite a large increase in PhD student numbers in these
disciplines in recent years. This rapid increase in numbers has created
concern regarding the quality of doctoral education generally (THES,
2009).
Aims of study and research approach
The aims of this study are to:
1. Document the current state
of the market for PhD studies in the UK in the accounting and
finance disciplines, in terms of supply, demand, student
demographics and employment destinations.
2. Investigate the degree of
satisfaction with current PhD supervisory processes.
3. Explore the implications
for accounting education and training in the UK, for the academic
accounting profession and for the public accounting profession. This
includes eliciting the views of organisations with an interest in
the academic accounting profession (i.e. professional accounting
bodies, the UK accounting standard-setter) regarding PhD and faculty
issues.
To address these issues, databases
were compiled to allow questionnaire surveys to be undertaken of three
groups: current PhD students, recently graduated PhD students and
supervisors across pre-1992 and post-1992 institutions. The year 1992
marked a structural shift in the UK university sector. Government policy
sought to increase the proportion of school leavers entering university
from approximately 12% to 40% by awarding university status to
polytechnic institutions. In the present study, these new, less
research-focused universities are labelled ‘post-1992’ while the
established, more research-focused institutions are labelled ‘pre-1992’.
It was anticipated that this difference in research emphasis could
affect certain PhD supervisory issues.
One hundred and seventy-six
respondents completed the current PhD student survey, with variations
being completed by 73 recently graduated students and 299 academic
staff. Across the three groups, the 548 responses represent a 22%
response rate. Ninety-seven follow-up interviews were conducted to
explore the issues further. An additional five interviews were conducted
with representatives from the UK professional bodies (ICAS, ICAEW, and
ACCA) and the UK Accounting Standards Board (ASB).
Key findings
Current market for PhD studies in the UK (research aim
1)
•
Nationality. The
proportion of current PhD students of British nationality is found
to be very low (approximately 20%) and markedly lower than the
comparable proportion of US nationals in the US (50%). The vast
majority of PhD students come from outside Europe, with a
significant proportion coming from Asia (33% of current students).
Interview evidence suggested that the trend of students coming from
Asia may start to reverse due to a relaxation in the entry
requirements applied by US institutions (a key competitor nation for
PhDs).
•
Disincentives for British students. British students are discouraged
from undertaking a PhD by the lower levels of financial reward
associated with an academic career in comparison to the
profession/industry.
• Mode
of study. In pre-1992 institutions, the vast majority of students
are enrolled full-time (87%), with part-time study being more common
in post-1992 institutions (only 65% full-time).
•
Funding of PhD studies. Thirty percent of current students are
financed by university/departmental scholarships, some of which have
significant teaching/ administrative duties attached. Employer or
overseas government sources are also common (31%) and are generally
linked to a requirement for the student to return home after the PhD
is completed.
•
Professional qualification. In pre-1992 institutions, only 23% of
current PhD students are members of a professional accounting body,
rising to 38% in post-1992 institutions. The corresponding figures
for recently graduated students are 13% and 29%, respectively, while
those for supervisors are 39% and 66%, respectively. Looking to the
future, a continuation in the documented UK decline in the
proportion of professionally qualified academics (Brown et al.,
2007) can be predicted.
•
PhD topic area. From
the questionnaire survey of current students, a more or less even
split between finance and accounting topics is apparent. However,
from the questionnaire survey of recently graduated students,
finance appears more popular than financial accounting. Only a very
small proportion of current students appear to be researching in
management accounting, a phenomenon that is attributed, at least in
part, to the lack of databases.
•
Career plans.
The vast majority of current PhD students intended to pursue an
academic career (64%), however, only 34% of current students in
pre-1992 institutions were intending to apply for an academic
position in the UK, with the proportion being even lower in
post-1992 institutions (23%). Approximately one-third of current
students intended to other countries to work in academia, many of
them obligated to do so by way of their funding.
Satisfaction with current PhD supervisory processes
(research aim 2)
•
Overall satisfaction.
Current and recently graduated students are generally very satisfied
with their supervisors’ availability, assistance and encouragement.
•
Additional pastoral support. Some overseas students sought
additional emotional and practical support which was not always
available.
•
Adverse consequences of institutional pressure to increase PhD
numbers. These included student perceptions of poor value-for-money
(especially for privately funded students); supervisors taking
students outside their areas of expertise; and supervisors taking
students of inadequate quality.
•
Additional supervisory problems. Supervisor relocations disrupted
the PhD, especially if alternative supervisors did not have the same
level of knowledge in the topic area. Significant pressure to
complete within three to four years, due to university performance
indicators and funding restrictions, adversely impacted the quality
of the final thesis and placed supervisors under stress.
• PhDs
fit for purpose.
The ability of PhD programmes to produce accounting academics who
are fit for purpose in terms of teaching was seriously questioned.
The purpose of researching in areas so far removed from teaching and
of interest/ assistance to the profession was also cause for
concern.
Policy implications, including profession/regulator
concerns (research aim 3)
•
Changing demographics.
In contrast to the current student sample, a large majority of those
responding to the supervisor survey were British across both
pre-1992 and post-1992 institutions (71% and 84%, respectively). A
substantial proportion of these academic staff moved from the
profession several decades earlier without a PhD qualification.
•
Dissatisfaction of current generation of academic staff. Many
current faculty doubted that they would make the same career
decision in today’s academic environment. This was due to the
decreased freedom and flexibility of an academic career, the lack of
career prospects for new lecturers, the reduced prestige associated
with academia, and the severe lack of financial rewards compared to
the profession. The potential to lose members of the current
generation to academic institutions outside the UK was also evident.
• Need
for professionally-qualified accounting academics. This need in
terms of teaching, research, and other service provision to students
was strongly advocated, yet severe structural difficulties in
fulfilling this need exist as the PhD is now seen as a pre-requisite
for securing a research and teaching contract in universities.
Although some accounting and finance academics expressed scepticism
as to the value placed on the academic function by the profession,
representatives from the accounting profession were keen to
acknowledge the necessity of professionally-qualified academics.
•
Consequences of lack of professionally-qualified accounting
academics. Representatives from the profession were aware that the
inability of institutions to recruit professionally-qualified
academics had led to the loss of course accreditations (in
particular in the areas of audit and tax) and the employment of
staff on teachingonly contracts. However, this was perhaps less of a
concern to the profession than might be expected, due to the low
overall proportion of entrants with ‘relevant’ degrees.
•
Policy-relevance of academic research. All interested parties
expressed concern regarding the general lack of policy-relevance of
academic research and the increasing divergence between the
accounting profession and academia.
•
Future of the discipline.
Creating a future generation of accounting academics in the UK
relies heavily on recruiting those completing UK PhD programmes into
UK institutions. The potential, in terms of the number of students
enrolled on PhD programmes, is currently there. However, only a
minority are potential candidates for UK academia, as they are
either required to (or chose to) return to their home country.
Current members of the academic accounting community foresee a bleak
future, in which the discipline withers, due to staff shortages, the
emergence of a clear demarcation between teaching and research
institutions and/or a loss of distinctiveness by becoming subsumed
within business schools. Representatives from the profession were
concerned by this prospect, feeling that it would adversely impact
upon claims to be a profession. For some, accounting academics were
predicted as a dying breed!
Conclusions and recommendations
Continued in article
Jensen Comment
Among the parts not quoted above, the complaint is repeated that in the U.K.
the ties between Ph.D. programs and the practicing profession are weaker
than in other parts of Europe. This is also a huge complaint raised in the
United States in the AAA Pathways Commission Report.
Accounting programs should promote
curricular flexibility to capture a new generation of students who
are more technologically savvy, less patient with traditional
teaching methods, and more wary of the career opportunities in
accounting, according to a report released today by the
Pathways Commission, which studies the
future of higher education for accounting.
In 2008, the U.S. Treasury Department's
Advisory Committee on the Auditing Profession recommended that the
American Accounting Association and the American Institute of
Certified Public Accountants form a commission to study the future
structure and content of accounting education, and the Pathways
Commission was formed to fulfill this recommendation and establish a
national higher education strategy for accounting.
In the report, the commission acknowledges
that some sporadic changes have been adopted, but it seeks to put in
place a structure for much more regular and ambitious changes.
The report includes seven recommendations:
Integrate accounting research,
education and practice for students, practitioners and educators
by bringing professionally oriented faculty more fully into
education programs.
Promote accessibility of
doctoral education by allowing for flexible content and
structure in doctoral programs and developing multiple pathways
for degrees. The current path to an accounting Ph.D. includes
lengthy, full-time residential programs and research training
that is for the most part confined to quantitative rather than
qualitative methods. More flexible programs -- that might be
part-time, focus on applied research and emphasize training in
teaching methods and curriculum development -- would appeal to
graduate students with professional experience and candidates
with families, according to the report.
Increase recognition and support
for high-quality teaching and connect faculty review, promotion
and tenure processes with teaching quality so that teaching is
respected as a critical component in achieving each
institution's mission. According to the report, accounting
programs must balance recognition for work and accomplishments
-- fed by increasing competition among institutions and programs
-- along with recognition for teaching excellence.
Develop curriculum models, engaging
learning resources and mechanisms to easily share them, as well
as enhancing faculty development opportunities to sustain a
robust curriculum that addresses a new generation of students
who are more at home with technology and less patient with
traditional teaching methods.
Improve the ability to attract
high-potential, diverse entrants into the profession.
Create mechanisms for collecting,
analyzing and disseminating information about the market needs
by establishing a national committee on information needs,
projecting future supply and demand for accounting professionals
and faculty, and enhancing the benefits of a high school
accounting education.
Establish an implementation process to
address these and future recommendations by creating structures
and mechanisms to support a continuous, sustainable change
process.
According to the report, its two sponsoring
organizations -- the American Accounting Association and the
American Institute of Certified Public Accountants -- will support
the effort to carry out the report's recommendations, and they are
finalizing a strategy for conducting this effort.
Hsihui Chang, a professor and head of
Drexel University’s accounting department, said colleges must
prepare students for the accounting field by encouraging three
qualities: integrity, analytical skills and a global viewpoint.
“You need to look at things in a global
scope,” he said. “One thing we’re always thinking about is how can
we attract students from diverse groups?” Chang said the
department’s faculty comprises members from several different
countries, and the university also has four student organizations
dedicated to accounting -- including one for Asian students and one
for Hispanic students.
He said the university hosts guest speakers
and accounting career days to provide information to prospective
accounting students about career options: “They find out, ‘Hey, this
seems to be quite exciting.’ ”
Jimmy Ye, a professor and chair of the
accounting department at Baruch College of the City University of
New York, wrote in an email to Inside Higher Ed that his
department is already fulfilling some of the report’s
recommendations by inviting professionals from accounting firms into
classrooms and bringing in research staff from accounting firms to
interact with faculty members and Ph.D. students.
Ye also said the AICPA should collect and
analyze supply and demand trends in the accounting profession -- but
not just in the short term. “Higher education does not just train
students for getting their first jobs,” he wrote. “I would like to
see some study on the career tracks of college accounting
graduates.”
Mohamed Hussein, a professor and head of
the accounting department at the University of Connecticut, also
offered ways for the commission to expand its recommendations. He
said the recommendations can’t be fully put into practice with the
current structure of accounting education.
“There are two parts to this: one part is
being able to have an innovative curriculum that will include
changes in technology, changes in the economics of the firm,
including risk, international issues and regulation,” he said. “And
the other part is making sure that the students will take advantage
of all this innovation.”
The university offers courses on some of
these issues as electives, but it can’t fit all of the information
in those courses into the major’s required courses, he said.
Bob, A good place to start is to jettison
pretenses of accounting being a science. As Anthony Hopwood noted in
his presidential address, accounting is a practice. The tools of
science are certainly useful, but using those tools to investigate
accounting problems is quite a different matter than claiming that
accounting is a science. Teleology doesn't enter the picture in the
sciences -- nature is governed by laws, not purposes. Accounting is
nothing but a purposeful activity and must (as Jagdish has
eloquently noted here and in his Critical Perspectives on Accounting
article) deal with values, law and ethics. As Einstein said, "In
nature there are no rewards or punishments, only consequences." For
a social practice like accounting to pretend there are only
consequences (as if economics was a science that deals only with
"natural kinds) has been a major failing of the academy in
fulfilling its responsibilities to a discipline that also claims to
be a profession. In spite of a "professional economist's" claims
made here that economics is a science, there is quite some
controversy over that even within the economic community. Ha-Joon
Chang, another professional economist at Cambridge U. had this to
say about the economics discipline: "Recognizing that the boundaries
of the market are ambiguous and cannot be determined in an objective
way lets us realize that economics is not a science like physics or
chemistry, but a political exercise. Free-market economists may want
you to believe that the correct boundaries of the market can be
scientifically determined, but this is incorrect. If the boundaries
of what you are studying cannot be scientifically determined what
you are doing is not a science (23 Things They Don't Tell You About
Capitalism, p. 10)." The silly persistence of professional
accountants in asserting that accounting is apolitical and aethical
may be a rationalization they require, but for academics to harbor
the same beliefs seems to be a decidedly unscientific posture to
take. In one of Ed Arrington's articles published some time ago, he
argued that accounting's pretenses of being scientific are risible.
As he said (as near as I can recall): "Watching the positive
accounting show, Einstein's gods must be rolling in the aisles."
Jensen Conclusion
It would seem that the complaints about accounting doctoral programs in the
United Kingdom and the United States have common threads, especially in
complaints about the way accounting doctoral programs and curricula have
divorced themselves from the practicing profession. As I mentioned above, if
you mention this to a group of accountics scientists they will run for cover
in an effort to preserve their pretense of being scientists in the
accounting profession, scientists who rarely replicate findings, will not
publish commentaries on their findings, and do not communicate in the social
media such as the AAA Commons. They don't give a damn about much of anything
except counting their publications that nobody in the practicing profession
wants to read.
"By almost any market test, economics is the
premier social science," Stanford University economist Edward Lazear
wrote just over a decade ago. "The field attracts
the most students, enjoys the attention of policy-makers and journalists,
and gains notice, both positive and negative, from other scientists."
Lazear went on to describe how economists, with the
University of Chicago's Gary Becker
leading the way, had been running roughshod over
the other social sciences — using economic tools to study crime, the family,
accounting, corporate management, and countless other not strictly economic
topics. "Economic imperialism" was the name he gave to this phenomenon (and
to his article, which was published in the
February 2000 issue of the Quarterly Journal
of Economics). And in his view it was a benevolent reign. "The power of
economics lies in its rigor," he wrote. "Economics is scientific; it follows
the scientific method of stating a formal refutable theory, testing theory,
and revising theory based on the evidence. Economics succeeds where
other social scientists fail because economists are willing to abstract."
Triumphalism like that calls for a
comeuppance, of course. So, as the nation's (and a lot of the
world's) economists gather this weekend in San Diego for their
annual
hoedown, it's worth asking: Are there any signs
that the imperialist era of economics might finally be coming to an end?
Lazear acknowledged one such indicator in his
article — the invasion of economics by psychological teachings about
cognitive bias. Two years later, in 2002, the co-leader of that invasion,
Princeton psychology professor Daniel Kahneman,
won an economics Nobel (the other co-leader, Amos
Tversky, had died in 1996). But while behavioral economics has since
solidified its status as an important part of the discipline, it hasn't come
close to conquering it. On the really big questions — how to run the
economy, for example — the mainstream view described by Lazear has continued
to dominate. Economists have also continued their imperialist habit of
delving into other fields: 2005's
Freakonomics, co-authored by Becker disciple
Steven Levitt, was a prime example of this — and sold millions of copies. As
for Lazear, he got himself appointed chairman of President George W. Bush's
Council of Economic Advisers in 2006.
And then, well, things didn't go so well. The
financial crisis and subsequent economic downturn — which Lazear
somewhat infamously downplayed while in office —
have put a big dent in the credibility of the macro side of the discipline.
The issue isn't that economists have nothing interesting to say about the
crisis. It's that they have so many different things to say about it. As MIT
financial economist Andrew Lo found after reading 11 accounts of the crisis
by academic economists (along with nine by journalists, plus former Treasury
Secretary Hank Paulson's personal account), there is massive disagreement
not just on why the crisis happened but on what actually happened. "Many of
us like to think of financial economics as a science,"
Lo
wrote, "but complex events like the financial
crisis suggest that this conceit may be more wishful thinking than reality."
Part of the issue is that Lazear's description of
the scientific way in which economics supposedly works (state a theory, test
it, revise) doesn't really apply in the case of a once-in-a-lifetime
financial crisis. I tend to think it doesn't apply for macroeconomics in
general. As economist Paul Samuelson
is said to have said, "We have but one sample of
history." Meaning that you can never get truly scientific answers
out of GDP or unemployment numbers.
That's why Lord Robert Skidelsky
recommended a couple of years ago that while
microeconomists could be allowed to proceed along pretty much the same
statistical and mathematical path they'd been following, graduate education
in macroeconomics needed to be dramatically revamped and supplemented with
instruction in ethics, philosophy, and politics.
I'm not aware of this actually happening in any top
economics PhD program (let me know if I'm wrong), despite the efforts of
George Soros's
Institute for New Economic Thinking and others.
What I've noticed instead, though, is an increasing confidence and boldness
among those who study economic issues through the lens of other academic
disciplines.
A couple of years ago I spent a weekend with a
bunch of business historians and
came away impressed mainly by how embattled most of them felt.
Lately, though, I've found myself talking to and
reading a little of the work of sociologists and political scientists, and
coming away impressed with how adept they are in quantitative methods, how
knowledgeable they are about economics, and how willing they are to
challenge economic orthodoxy. The two main writings I'm thinking about were
unpublished drafts that will be coming out later in HBR and from
the HBR Press, so I don't have links — but I get the sense that there are a
lot of good examples out there, and that after years of looking mainly to
mainstream economics journals I should be broadening my scope. (Two
recommendations I've gotten from Harvard government professor
Dan
Carpenter: Capitalizing
on Crisis: The Political Origins of the Rise of Finance, by
Sociologist Greta Krippner, and The
New Global Rulers: The Privatization of Regulation in the World Economy,
by political scientists Tim Büthe and Walter Mattli.)
Even anthropology, that most downtrodden of the
social sciences, has been encroaching on economists' turf. When a top
executive at the world's largest asset manager (Peter Fisher of BlackRock)
lists
Debt: The First 5,000 Years by anthropologist
(and Occupy Wall Streeter)
David
Graeber as
one of his top reads of 2012, you know something's
going on.
Continued in article
Jensen Comment
Harvard's Justin Fox was an Plenary Speaker at the 2011 American Accounting
Association Annual Meetings.
Those readers who have access to the AAA Commons may view his video at
http://commons.aaahq.org/posts/7bdb75d3d2
Forwarded by Jim Martin
An interesting controversy in economics sounds
familiar.
According to Ronald Coase, it is time to reengage the severely
impoverished
field of economics with the economy. He is a 101 year old Nobel Laureate
in
economics and professor emeritus at the University of Chicago Law
School. He
and Ning Wang of Arizona State University are launching a new journal,
Man and the Economy.
An economist once said that he hated the
physical scientists because they stole all the easy research problems.
In a sense this is so true in one context. The earth does not change its
rotation speed and path just because that speed and path are discovered
by research. But people and social cohorts often change just because
their behaviors are discovered by researcers.
Physical systems like gravity do not change with understanding of their
behavior. Social and economic systems change with discovery. For
example, economic and computer networking systems that work great in
theory and initially become corrupted as smart folks learn how to
exploit the systems.
Hence in social science we must not only discover behavior but discover
behavior that changes because we discover that behavior and discover
behavior that changes because we discover the changes in behavior and so
on and so on.
Except for quantum physics it must be nice to be a physical scientist
doing research on stationary systems. One reason mathematics of the
physical sciences fails us when extended to economics and the social
sciences in general is that these sciences entail nonstationary systems.
Equilibrium conditions are seldom are reached. This, for example, is why
Malthus was correct for an eye blink in astronomical time.
Ronald Coase published his career-making paper,
“The Nature of the Firm,” 75 years ago. He won the Nobel prize for
economics in 1991. In a lecture in 2002, he argued that physics has
moved beyond the assumptions of Isaac Newton, and biology beyond Darwin.
(Not that he knew them.) But economics, he said, had failed to advance
past the efficient-market assumptions of Adam Smith. This year Coase, a
professor emeritus at the University of Chicago Law School, is
attempting to start a new academic journal ambitiously titled Man and
the Economy. The premise: Economics is broken. Coase’s journal is still
just a plan, but his frustration with orthodox economics has energized
his followers.
The financial crisis forced economists to
confront the limitations of their profession. Former Federal Reserve
Chairman Alan Greenspan admitted as much when he told Congress in
October 2008 that markets might not regulate themselves after all. Coase
says the problem runs deeper: Economists study abstractions and numbers,
instead of firms and people. He doesn’t believe this can be fixed by
tweaking models. An entire generation of economists must be encouraged
to think differently.
The idea for the journal stems from his
collaboration with Ning Wang, an assistant professor at the School of
Politics and Global Studies at Arizona State University who grew up in a
rice- and fish-farming village in the Hubei province of China. Coase,
101, began working with Wang in the 1990s at the University of Chicago.
Neither has a degree in economics; the two understood each other. “We’re
not constrained by a mainstream, orthodox view,” says Wang. “A lot of
people would see this as a weakness.” Coase declined to be interviewed.
When Coase and Wang hosted a conference on
China in 2008, they noticed that many Chinese academics had never talked
to either policymakers or entrepreneurs from their own country. They had
learned only what Coase calls “blackboard economics,” sets of theories
and mathematical relationships between bits of data. “I came from
China,” says Wang. “We have a lot of nationals come here; they’re taught
game theory and econometrics. Then they’re going home … without a basic
understanding of how the real world functions.”
In an essay published on Nov. 20 in Harvard
Business Review, Coase argues that in the early 20th century, economists
began to focus on relationships among statistical measures, rather than
problems that firms have with production or people have with decisions.
Economists began writing for each other, instead of for other
disciplines or for the business community. “It is suicidal for the field
to slide into a hard science of choice,” Coase writes in HBR, “ignoring
the influences of society, history, culture, and politics on the working
of the economy.” (By “choice,” he means ever more complex versions of
price and demand curves.) Most economists, he argues, work with measures
like gross domestic product and the unemployment rate that are too
removed from how businesses actually work.
The solution for Coase and Wang is a journal
that presents case studies, historical comparisons, and qualitative
data—not just numbers but ideas, too. In top economics journals, says
Wang, “people think as long as you have a big data set, that’s enough.
You can do all kinds of modeling and regression, and it looks scientific
enough.” Julie Nelson, chairwoman of the economics department at the
University of Massachusetts Boston says economists want the kind of
immutable laws that physicists operate under. But Adam Smith’s 1776 idea
that people are driven by self-interest is not the same as the law of
gravity. “Ask an economist if they’d like to be thought of as a
sociologist,” she says, “and they’ll look at you with terror in their
eyes.”
Christopher Sims, a professor at Princeton
University who won the Nobel prize last year for his work in
macroeconomics, recognizes the problem. “We’re always abstracting and
hoping that the resulting abstractions capture enough of the truth so
that we know what’s going on,” he says. The kind of work that Coase and
Wang are interested in, he says, is “not fashionable now. It’s hard to
make it a science.” Where Coase and Wang see too little demand for new
ideas, Sims sees too little supply. Both he and Nelson, who studies how
economics is taught, describe a process at graduate schools that selects
for economists inclined to focus on abstract modeling.
We
commemorate the 50th anniversary of Ball and Brown [1968] by chronicling its
impact on capital market research in accounting. We trace the evolution of
various research paths that post-Ball and Brown [1968] researchers took as
they sought to build on the foundation laid by Ball and Brown [1968] to
create a body of research on the usefulness, timeliness, and other
properties of accounting numbers. We discuss how those paths often link back
to the groundwork laid and questions originally posed in Ball and Brown
[1968].
Keywords: Ball and Brown, earnings, earnings-return relation, earnings
usefulness, earnings timeliness, asymmetric timeliness, conservatism,
association study, event study, information content, value relevance,
positive economics, efficient markets hypothesis, market efficiency,
post-announcement drift
Jensen Comment
Occasionally I receive messages questioning why I pick on TAR when in fact
my complaints are really with accountics scientists and accountics science
in general.
Problem 1 --- Control Over Research Methods Allowed in Doctoral
Programs and Leading
Academic Accounting Research Journals
Accountics scientists control the leading accounting research journals and
only allow archival (data mining), experimental, and analytical research
methods into those journals. Their referees shun other methods like case
method research, field studies, accounting history studies, commentaries,
and criticisms of accountics science.
This is the major theme of Anthony Hopwood, Paul Williams, Bob Sterling, Bob
Kaplan, Steve Zeff, Dan Stone, and others ---
http://faculty.trinity.edu/rjensen/TheoryTAR.htm#Appendix01
Since there are so many other accounting research journals in academe and
in the practitioner profession, why single out TAR and the other very "top"
journals because they refuse to publish any articles without equations
and/or statistical inference tables. Accounting researchers have hundreds of
other alternatives for publishing their research.
I'm critical of TAR referees because they're symbolic of today's many
problems with the way the accountics scientists have taken over the research
arm of accounting higher education. Over the past five decades they've taken
over all AACSB doctoral programs with a philosophy that "it's our way or
the highway" for students seeking PhD or DBA degrees ---
http://faculty.trinity.edu/rjensen/Theory01.htm#DoctoralPrograms
In
the United States, following the Gordon/Howell and Pierson reports in the
1950s, our accounting doctoral programs and leading academic journals bet
the farm on the social sciences without taking the due cautions of realizing
why the social sciences are called "soft sciences." They're soft because
"not everything that can be counted, counts. And not everything that counts
can be counted."
Be Careful What You
Wish For
Academic accountants wanted to become more respectable on their campuses by
creating accountics scientists in literally all North American accounting
doctoral programs. Accountics scientists virtually all that our PhD and DBA
programs graduated over the ensuing decades and they took on an elitist
attitude that it really did not matter if their research became ignored by
practitioners and those professors who merely taught accounting.
One of my complaints
with accountics scientists is that they appear to be unconcerned that they
are not not real scientists. In real science the primary concern in
validity, especially validation by replication. In accountics science
validation and replication are seldom of concern. Real scientists react to
their critics. Accountics scientists ignore their critics.
Another complaint is
that accountics scientists only take on research that they can model. The
ignore the many problems, particularly problems faced by the accountancy
profession, that they cannot attack with equations and statistical
inference.
"Research
on Accounting Should Learn From the Past" by Michael H. Granof and
Stephen A. Zeff, Chronicle of HigherEducation, March 21, 2008
The
unintended consequence has been that interesting and researchable
questions in accounting are essentially being ignored.
By confining the major thrust in research to phenomena that can be
mathematically modeled or derived from electronic databases, academic
accountants have failed to advance the profession in ways that are
expected of them and of which they are capable.
Academic research has unquestionably broadened the views of standards
setters as to the role of accounting information and how it affects the
decisions of individual investors as well as the capital markets.
Nevertheless, it has had scant influence on the standards themselves.
Continued in
article
Problem 2 --- Paranoia Regarding Validity Testing and Commentaries on
their Research This is the major theme of Bob Jensen, Paul Williams, Joni Young and
others
574 Shields Against Validity Challenges in Plato's Cave ---
http://faculty.trinity.edu/rjensen/TheoryTAR.htm
Problem 3 --- Lack of Concern over Being Ignored by Accountancy Teachers and Practitioners
Accountics scientists only communicate through their research journals that
are virtually ignored by most accountancy teachers and practitioners. Thus
they are mostly gaming in Plato's Cave and having little impact on the
outside world, which is a major criticism raised by then AAA President Judy
Rayburn and Roger Hermanson and others
http://faculty.trinity.edu/rjensen/395wpTAR/Web/TAR395wp.htm
Also see
http://faculty.trinity.edu/rjensen/theory01.htm#WhatWentWrong
Some accountics scientists have even
warned against doing research for the practicing profession as a
"vocational virus."
Joel
Demski steers us away from the clinical side of the accountancy
profession by saying we should avoid that pesky “vocational virus.”
(See below).
The (Random House) dictionary defines
"academic" as "pertaining to areas of study that are not primarily
vocational or applied , as the humanities or pure mathematics."
Clearly, the short answer to the question is no, accounting is not
an academic discipline. Joel Demski, "Is Accounting an Academic Discipline?"
Accounting Horizons, June 2007, pp. 153-157
Statistically there are a few youngsters
who came to academia for the joy of learning, who are yet relatively
untainted by the vocational virus.
I urge you to nurture your taste for learning, to follow your joy.
That is the path of scholarship, and it is the only one with any
possibility of turning us back toward the academy. Joel Demski, "Is Accounting an Academic Discipline?
American Accounting Association Plenary Session" August 9, 2006 ---
http://faculty.trinity.edu/rjensen//theory/00overview/theory01.htm
Too
many accountancy doctoral programs have immunized themselves against
the “vocational virus.” The problem lies not in requiring doctoral
degrees in our leading colleges and universities. The problem is
that we’ve been neglecting the clinical needs of our profession.
Perhaps the real underlying reason is that our clinical problems are
so immense that academic accountants quake in fear of having to make
contributions to the clinical side of accountancy as opposed to the
clinical side of finance, economics, and psychology.
Problem 4 --- Ignoring Critics: The Accountics Science Wall of Silence
Leading scholars critical of accountics science included Anthony Hopwood,
Paul Williams Roger Hermanson, Bob Sterling, Judy Rayburn, Bob Kaplan, Steve
Zeff, Joni Young, Bob Sterling, Jane Mutchler, Dan Stone, Bob Jensen,
and many others. The most frustrating thing for these critics is that
accountics scientists are content with being the highest paid faculty on
their campuses and their monopoly control of accounting PhD programs
(limiting outputs of graduates)
to a point where they literally ignore they critics and rarely, if ever,
respond to criticisms.
See
http://faculty.trinity.edu/rjensen/395wpTAR/Web/TAR395wp.htm
In the first 40 years of
TAR, an accounting “scholar” was first and foremost an expert on
accounting. After 1960, following the Gordon and Howell Report, the
perception of what it took to be a “scholar” changed to quantitative
modeling. It became advantageous for an “accounting” researcher to have
a degree in mathematics, management science, mathematical economics,
psychometrics, or econometrics. Being a mere accountant no longer was
sufficient credentials to be deemed a scholarly researcher. Many
doctoral programs stripped much of the accounting content out of the
curriculum and sent students to mathematics and social science
departments for courses. Scholarship on accounting standards became too
much of a time diversion for faculty who were “leading scholars.”
Particularly relevant in this regard is Dennis Beresford’s address to
the AAA membership at the 2005 Annual AAA Meetings in San Francisco:
In my eight years in teaching I’ve concluded that way too many of
us don’t stay relatively up to date on professional issues. Most
of us have some experience as an auditor, corporate accountant, or in
some similar type of work. That’s great, but things change quickly these
days.
Beresford [2005]
Jane Mutchler made a similar appeal for accounting professors
to become more involved in the accounting profession when she was
President of the AAA [Mutchler, 2004, p. 3].
In the last 40 years,
TAR’s publication preferences shifted toward problems amenable to
scientific research, with esoteric models requiring accountics skills in
place of accounting expertise. When Professor Beresford attempted to
publish his remarks, an Accounting Horizons referee’s report to
him contained the following revealing reply about “leading scholars” in
accounting research:
1. The paper provides specific recommendations for things that
accounting academics should be doing to make the accounting profession
better. However (unless the author believes that academics' time is a
free good) this would presumably take academics' time away from what
they are currently doing. While following the author's advice might make
the accounting profession better, what is being made worse? In other
words, suppose I stop reading current academic research and start
reading news about current developments in accounting standards. Who is
made better off and who is made worse off by this reallocation of my
time? Presumably my students are marginally better off, because I can
tell them some new stuff in class about current accounting standards,
and this might possibly have some limited benefit on their careers. But
haven't I made my colleagues in my department worse off if they depend
on me for research advice, and haven't I made my university worse off if
its academic reputation suffers because I'm no longer considered a
leading scholar? Why does making the accounting profession better
take precedence over everything else an academic does with their time? As quoted in Jensen [2006a]
The above quotation illustrates the consequences of editorial
policies of TAR and several other leading accounting research journals.
To be considered a “leading scholar” in accountancy, one’s research must
employ mathematically-based economic/behavioral theory and quantitative
modeling. Most TAR articles published in the past two decades support
this contention. But according to AAA President Judy Rayburn and other
recent AAA presidents, this scientific focus may not be in the best
interests of accountancy academicians or the accountancy profession.
In terms of citations,
TAR fails on two accounts. Citation rates are low in practitioner
journals because the scientific paradigm is too narrow, thereby
discouraging researchers from focusing on problems of great interest to
practitioners that seemingly just do not fit the scientific paradigm due
to lack of quality data, too many missing variables, and suspected non-stationarities.
TAR editors are loath to open TAR up to non-scientific methods so that
really interesting accounting problems are neglected in TAR. Those
non-scientific methods include case method studies, traditional
historical method investigations, and normative deductions.
In the other account,
TAR citation rates are low in academic journals outside accounting
because the methods and techniques being used (like CAPM and options
pricing models) were discovered elsewhere and accounting researchers are
not sought out for discoveries of scientific methods and models. The
intersection of models and topics that do appear in TAR seemingly are
borrowed models and uninteresting topics outside the academic discipline
of accounting.
We close with a
quotation from Scott McLemee demonstrating that what happened among
accountancy academics over the past four decades is not unlike what
happened in other academic disciplines that developed “internal dynamics
of esoteric disciplines,” communicating among themselves in loops
detached from their underlying professions. McLemee’s [2006] article
stems from Bender [1993].
“Knowledge and competence increasingly developed out of the
internal dynamics of esoteric disciplines rather than within the context
of shared perceptions of public needs,” writes Bender. “This is not to
say that professionalized disciplines or the modern service professions
that imitated them became socially irresponsible. But their
contributions to society began to flow from their own self-definitions
rather than from a reciprocal engagement with general public discourse.”
Now, there is a definite note of sadness in Bender’s narrative –
as there always tends to be in accounts of theshift from Gemeinschaftto Gesellschaft.Yet it is also clear that the transformation
from civic to disciplinary professionalism was necessary.
“The new disciplines offered relatively precise subject matter and
procedures,” Bender concedes, “at a time when both were greatly
confused. The new professionalism also promised guarantees of competence
— certification — in an era when criteria of intellectual authority were
vague and professional performance was unreliable.”
But in the epilogue to Intellect and Public Life,
Bender suggests that the process eventually went too far. “The risk now
is precisely the opposite,” he writes. “Academe is threatened by the
twin dangers of fossilization and scholasticism (of three types: tedium,
high tech, and radical chic). The agenda for the next decade, at least
as I see it, ought to be the opening up of the disciplines, the
ventilating of professional communities that have come to share too much
and that have become too self-referential.”
For the good of the AAA membership and
the profession of accountancy in general, one hopes that the changes in
publication and editorial policies at TAR proposed by President Rayburn
[2005, p. 4] will result in the “opening up” of topics and research
methods produced by “leading scholars.”
Picking on TAR is merely symbolic of my concerns with the larger problem
of the what I view are much larger problems caused by the take over of the
research arm of academic accountancy.
What is an Exacting Replication?
I define an exacting replication as one in which the findings are reproducible
by independent researchers using the IAPUC Gold Book standards for
reproducibility. Steve makes a big deal about time extensions when making such
exacting replications almost impossible in accountics science. He states:
By "exacting replication," you appear to mean doing
exactly what the original researcher did -- no more and no less. So if one
wishes to replicate a study conducted with data from 2000 to 2008, one had
better not extend it to 2009, as that clearly would not be "exacting." Or,
to borrow a metaphor I've used earlier, if you'd like to replicate my
assertion that it is currently 8:54 a.m., ask to borrow my watch -- you
can't look at your watch because that wouldn't be an "exacting" replication.
That's CalvinBall bull since in many of these time extensions it's also
possible to conduct an exacting replication. Richard Sansing pointed out the how
he conducted an exacting replication of the findings in Dhaliwal, Li and R.
Trezevant (2003), "Is a dividend tax penalty
incorporated into the return on a firm’s common stock?," Journal of
Accounting and Economics 35: 155-178. Although Richard and his coauthor
extend the Dhaliwal findings they first conducted an exacting replication in
their paper published in The Accounting Review 85 (May
2010): 849-875.
My quibble with Richard is mostly that conducting an exacting replication of
the Dhaliwal et al. paper was not exactly a burning (hot)
issue if nobody bothered to replicate that award winning JAE paper for seven
years.
This begs the question of why there are not more frequent and timely exacting
replications conducted in accountics science if the databases themselves are
commercially available like the CRSP, Compustat, and AuditAnalytics databases.
Exacting replications from these databases are relatively easy and cheap to
conduct. My contention here is that there's no incentive to excitedly conduct
exacting replications if the accountics journals will not even publish
commentaries about published studies. Steve and I've played CalvinBall with the
commentaries issue before. He contends that TAR editors do not prevent
commentaries from being published in TAR. The barriers to validity questioning
commentaries in TAR are the 574 referees who won't accept submitted commentaries
---
http://faculty.trinity.edu/rjensen/TheoryTAR.htm#ColdWater
Exacting replications of behavioral experiments in accountics science is more
difficult and costly because the replicators must conduct their own experiments
by collecting their own data. But it seems to me that it's no more difficult in
accountics science than in performing exacting replications that are reported in
the research literature of psychology. However, psychologists often have more
incentives to conduct exacting replications for the following reasons that I
surmise:
Practicing psychologists are more demanding of validity tests of
research findings. Practicing accountants seem to pretty much ignore
behavioral experiments published in TAR, JAR, and JAE such that there's not
as much pressure brought to bear on validity testing of accountics science
findings. One test of practitioner lack of interest is the lack of citation
of accountics science in practitioner journals.
Psychology researchers have more incentives to replicate experiments of
others since there are more outlets for publication credits of replication
studies, especially in psychology journals that encourage commentaries on
published research ---
http://faculty.trinity.edu/rjensen/TheoryTAR.htm#TARversusJEC
My opinion remains that accountics science will never be a real science until
exacting replication of research findings become the name of the game in
accountics science. This includes exacting replications of behavioral
experiments as well as analysis of public data from CRSP, Compustat,
AuditAnalytics, and other commercial databases. Note that willingness of
accountics science authors to share their private data for replication purposes
is a very good thing (I fought for this when I was on the AAA Executive
Committee), but conducting replication studies of such data does not hold up
well under the IAPUC Gold Book.
Note, however, that lack of exacting replication and other validity testing
in general are only part of the huge problems with accountics science. The
biggest problem, in my judgment, is the way accountics scientists have
established monopoly powers over accounting doctoral programs, faculty hiring
criteria, faculty performance criteria, and pay scales. Accounting researchers
using other methodologies like case and field research become second class
faculty.
Since the odds of getting a case or field study published are so low, very
few of such studies are even submitted for publication in TAR in recent years.
Replication of these is a non-issue in TAR.
"Annual Report and Editorial Commentary for The Accounting Review,"
by Steven J. Kachelmeier The University of Texas at Austin, The
Accounting Review, November 2009, Page 2056.
Insert Table
There's not much hope for case, field, survey, and other non-accountics
researchers to publish in the leading research journal of the American
Accounting Association.
"We fervently hope that the research pendulum will soon swing back from the
narrow lines of inquiry that dominate today's leading journals to a rediscovery
of the richness of what accounting research can be. For that to occur, deans and
the current generation of academic accountants must
give it a push."
Granif and Zeff ---
http://www.trinity.edu/rjensen/TheoryTAR.htm#Appendix01
Michael H. Granof is a professor of accounting at the McCombs School of
Business at the University of Texas at Austin. Stephen A. Zeff is a
professor of accounting at the Jesse H. Jones Graduate School of Management at
Rice University.
I admit that I'm just one of those
professors heeding the Granof and Zeff call to "give it a push," but it's
hard to get accountics professors to give up their monopoly on TAR, JAR, JAE,
and in recent years Accounting Horizons. It's even harder to get them to
give up their iron monopoly clasp on North American Accountancy Doctoral
Programs ---
http://www.trinity.edu/rjensen/Theory01.htm#DoctoralPrograms
September 9, 2011 reply from Paul Williams
Bob,
I have avoided chiming in on this thread; have gone down this same road and
it is a cul-de-sac. But I want to say that this line of argument is a
clever one. The answer to your rhetorical question is, No, they aren't
more ethical than other "scientists." As you tout the Kaplan
speech I would add the caution that before he raised the issue of practice,
he still had to praise the accomplishments of "accountics" research by
claiming numerous times that this research has led us to greater
understanding about analysts, markets, info. content, contracting, etc.
However, none of that is actually true. As a panelist at the AAA
meeting I juxtaposed Kaplan's praise for what accountics research has taught
us with Paul Krugman's observations about Larry Summer's 1999 observation
that GAAP is what makes US capital markets so stable and efficient. Of
course, as Krugman noted, none of that turned out to be true. And if
that isn't true, then Kaplan's assessment of accountics research isn't
credible, either. If we actually did understand what he claimed we now
understand much better than we did before, the financial crisis of 2008
(still ongoing) would not have happened. The title of my talk was (the
panel was organized by Cheryl McWatters) "The Epistemology of
Ignorance." An obsessive preoccupation with method could be a choice not to
understand certain things-- a choice to rigorously understand things as you
already think they are or want so desperately to continue to believe for
reasons other than scientific ones.
Paul
September 10, 2011 message from Bob Jensen
Hi Raza,
Please don't get me wrong. As an old accountics researcher myself, I'm
all in favor of continuing accountics research full speed ahead. The
younger mathematicians like Richard Sansing are doing it better these
days. What I'm upset about is the way the accountics science quants took
over TAR, AH, accounting faculty performance standards in R1
universities, and virtually all accounting doctoral programs in North
America.
Monopolies are not all bad --- they generally do great good they for
mankind. The problem is that monopolies shut out the competition. In the
case of accountics science, the accountics scientists have shut out
competing research methods to a point where accounting doctoral students
must write accountics science dissertations, and TAR referees will not
open the door to case studies, field studies, accounting history
studies, or commentaries critical of accountics science findings in TAR.
The sad thing is that even if we open up our doctoral programs to other
research methodologies, the students themselves may prefer accountics
science research. It's generally easier to apply regression models to
CRSP, Compustat, and Audit Analytics databases than have to go off
campus to collect data and come up with clever ideas to improve
accounting practice in ways that will amaze practitioners.
Another problem with accountics science is that this monopoly has not
created incentives for validity checking of accountics science findings.
This has prevented accountics science from being real science where
validity checking is a necessary condition for research and publication.
If TAR invited commentaries on validity testing of TAR publications, I
think there would be more replication efforts.
If TAR commenced a practitioners' forum where practitioners were
"assigned" to discuss TAR articles, perhaps there would be more
published insights into possible relevance of accountics science to the
practice of accountancy. I put "assign" in quotations since
practitioners may have to be nudged in some ways to get them to critique
accountics science articles.
There are some technical areas where practitioners have more expertise
than accountics scientists, particularly in the areas of insurance
accounting, pension accounting, goodwill impairment testing, accounting
for derivative financial instruments, hedge accounting, etc. Perhaps
these practitioner experts might even publish a "research needs" forum
in TAR such that our very bright accountics scientists would be inspired
to focus their many talents on some accountancy practice technical
problems.
My main criticism of accountics scientists is that the 600+ TAR referees
have shut down critical commentaries of their works and the recent
editors of TAR have been unimaginative when in thinking of ways to
motivate replication research, TAR article commentaries, and focus of
accountics scientists on professional practice problems.
Particularly note the module on TAR versus AMR and AMJ
September 10, 2011 reply from Bob Jensen (known on the AECM as Calvin of
Calvin and Hobbes)
This is a reply to Steve Kachelmeier, former Senior Editor of The Accounting
Review (TAR)
I agree Steve and will not bait you further in a game of Calvin Ball.
It is, however, strange to me that exacting replication
(reproducibility) is such a necessary condition to almost all of real
science empiricism and such a small part of accountics science
empiricism.
My only answer to this is that the findings themselves in science seem
to have greater importance to both the scientists interested in the
findings and the outside worlds affected by those findings.
It seems to me that empirical findings that are not replicated with as
much exactness as possible are little more than theories that have only
been tested once but we can never be sure that the tests were not faked
or contain serious undetected errors for other reasons.
It is sad that the accountics science system really is not designed to
guard against fakers and careless researchers who in a few instances
probably get great performance evaluations for their hits in TAR, JAR,
and JAE. It is doubly sad since internal controls play such an
enormous role in our profession but not in our accoutics science.
I thank you for being a noted accountics scientist who was willing to
play Calvin Ball.with me for a while. I want to stress that this is not
really a game with me. I do want to make a difference in the maturation
of accountics science into real science. Exacting replications in
accountics science would be an enormous giant step in the real-science
direction.
Allowing validity-questioning commentaries in TAR would be a smaller
start in that direction but nevertheless a start. Yes I know that it was
your 574 TAR referees who blocked the few commentaries that were
submitted to TAR about validity questions. But the AAA Publications
Committees and you as Senior Editor could've done more to encourage both
submissions of more commentaries and submissions of more non-accountics
research papers to TAR --- cases, field studies, history studies, AIS
studies, and (horrors) normative research.
In any case thanks for playing Calvin Ball with me. Paul Williams and
Jagdish Gangolly played Calvin Ball with me for a while on an entirely
different issue --- capitalism versus socialism versus bastardized
versions of both that evolve in the real world.
Hopefully there's been some value added on the AECM in my games of
Calvin Ball.
Even though my Calvin Ball opponents have walked off the field, I will
continue to invite others to play against me on the AECM.
And I'm certain this will not be the end to my saying that accountics
farmers are more interested in their tractors than their harvests. This
may one day be my epitaph.
Respectfully,
Calvin
The Accounting Review 2011 Annual Report
Hi Steve,
Thank you so much for providing such a detailed and permanent 2011 TAR fiscal
year annual report ended May 31, 2011 ---
http://aaajournals.org/
You are commended during your service as TAR Senior Editor for having to deal
with greatly increased numbers of submissions. This must've kept you up late
many nights in faithful service to the AAA. And writing letters of rejections to
friends and colleagues must've been a very painful chore at times. And having to
communicate repeatedly with so many associate editors and referees must've been
tough for so many years. I can understand why some TAR editors acquired health
problems. I'm grateful that you seem to still be healthy and vigorous.
I'm also grateful that you communicate with us on the AECM. This is more than
I can say for other former TAR editors and most AAA Executive Committee members
who not only ignore us on the AECM, but they also do not communicate very much
at all on the AAA Commons.
I'm really not replying to start another round of debate on the AECM using
your fine annual report. But I can't resist noting that I just do not see the
trend increasing for acceptance of papers that are not accountics science papers
appearing in TAR.
One of the tables of greatest interest to me is Panel D of Table 3 which is
shown below:
What you define as "All Other Methods" comprises 7% leaving 93% for
Analytical, Empirical Archival, and Experimental. However, this does not
necessarily mean that 7% of the acceptances did not contain mathematical
equations and statistical testing such that what I would define as accountics
science acceptances for 2011 constitute something far greater than 93%. For
example, you've already pointed out to us that case method and field study
papers published in TAR during 2011 contain statistical inference testing and
equations. They just do not meet the formal tests as having random samples.
Presidential scholar papers are published automatically (e.g., Kaplan's March
2011) paper, such that perhaps only 15 accepted Other Methods papers passed
through the refereeing process. Your July 2011 Editorial was possibly included
in the Other Methods such that possibly only 13 Other Methods papers passed
through the refereeing process. And over half of these were "Managerial" and
most of those contain equations such that 2011 was a typical year in which
nearly all the published TAR papers in 2011 meet my definition of accountics
science (some of which do not have scientific samples) ---
http://faculty.trinity.edu/rjensen/395wpTAR/Web/TAR395wp.htm
We can conclude that in 2011 that having equations in papers accepted by
referees was virtually a necessary condition for acceptance by referees in 2011
as has been the case for decades.
Whatever happened to accounting history publications in TAR? Did accounting
historians simply give up on getting a TAR hit?
Whatever happened to normative method papers if they do not meet the
mathematical tests of being Analytical?
Whatever happened to scholarly commentary?
November 22, 2011 reply from Steve Kachelmeier
First, Table 3 in the 2011 Annual Report
(submissions and acceptances by area) only includes manuscripts that went
through the regular blind reviewing process. That is, it excludes invited
presidential scholar lectures, editorials, book reviews, etc. So "other"
means "other regular submissions."
Second, you are correct Bob that "other" continues
to represent a small percentage of the total acceptances. But "other" is
also a very small percentage of the total submissions. As I state explicitly
in the report, Table 3 does not prove that TAR is sufficienty diverse. It
does, however, provide evidence that TAR acceptances by topical area (or by
method) are nearly identically proportional to TAR submissions by topical
area (or by method).
Third, for a great example of a recently published
TAR study with substantial historical content, see Madsen's analysis of the
historical development of standardization in accounting that we published in
in the September 2011 issue. I conditionally accepted Madsen's submission in
the first round, backed by favorable reports from two reviewers with
expertise in accounting history and standardization.
Take care,
Steve
November 23, 2011 reply from Bob Jensen
Hi Steve,
Thank you for the clarification.
Interestingly, Madsen's September 2011 historical study (which came out
after your report's May 2011 cutoff date) is a heavy accountics science
paper with a historical focus.
It would be interesting to whether such a paper would've been accepted by
TAR referees without the factor (actually principal components) analysis.
Personally, I doubt any history paper would be accepted without equations
and quantitative analysis. Once again I suspect
that accountics science farmers are more interested in their tractors than
in their harvests.
In the case of Madsen's paper, if I were a
referee I would probably challenge the robustness of the principal
components and loadings ---
http://en.wikipedia.org/wiki/Principle_components_analysis
Actually factor analysis in general like nonlinear multiple regression and
adaptive versions thereof suffer greatly from lack of robustness. Sometimes
quantitative models gild the lily to a fault.
Bob Kaplan's Presidential Scholar historical study was published, but
this was not subjected to the usual TAR refereeing process.
The History of The Accounting Review paper written by Jean Heck and Bob
Jensen which won a best paper award from the Accounting Historians Journal
was initially flatly rejected by TAR. I was never quite certain if the main
reason was that it did not contain equations or if the main reason was that
it was critical of TAR editorship and refereeing. In any case it was flatly
rejected by TAR, including a rejection by one referee who refused to put
reasons in writing for feed\back to Jean and me.
“An Analysis of the Evolution of Research Contributions by The
Accounting Review: 1926-2005,” (with Jean Heck), Accounting
Historians Journal, Volume 34, No. 2, December 2007, pp. 109-142.
I would argue that accounting history papers, normative methods papers,
and scholarly commentary papers (like Bob Kaplan's plenary address) are not
submitted to TAR because of the general perception among the AAA membership
that such submissions do not have a snowball's chance in Hell of being
accepted unless they are also accountics science papers.
It's a waste of time and money to submit papers to TAR that are not
accountics science papers.
In spite of differences of opinion, I do thank you for the years of
blood, sweat, and tears that you gave us as Senior Editor of TAR.
And I wish you and all U.S. subscribers to the AECM a very Happy
Thanksgiving. Special thanks to Barry and Julie and the AAA staff for
keeping the AECM listserv up and running.
Respectfully,
Bob Jensen
I think leading academic researchers avoid applied research for the
profession because making seminal and creative discoveries that practitioners
had not already discovered is enormously difficult.
Accounting academe is threatened by the twin dangers of fossilization and
scholasticism (of three types: tedium, high tech, and radical chic)
From Jean Heck and Bob Jensen ---
http://faculty.trinity.edu/rjensen/395wpTAR/Web/TAR395wp.htm
“Knowledge and competence increasingly developed
out of the internal dynamics of esoteric disciplines rather than within the
context of shared perceptions of public needs,” writes Bender. “This is not
to say that professionalized disciplines or the modern service professions
that imitated them became socially irresponsible. But their contributions to
society began to flow from their own self-definitions rather than from a
reciprocal engagement with general public discourse.”
Now, there is a definite note of sadness in Bender’s narrative – as there
always tends to be in accounts
of theshift from Gemeinschaftto
Gesellschaft.Yet it is also clear
that the transformation from civic to disciplinary professionalism was
necessary.
“The new disciplines offered relatively precise subject matter and
procedures,” Bender concedes, “at a time when both were greatly confused.
The new professionalism also promised guarantees of competence —
certification — in an era when criteria of intellectual authority were vague
and professional performance was unreliable.”
But in the epilogue to Intellect and Public Life, Bender
suggests that the process eventually went too far. “The risk now is
precisely the opposite,” he writes. “Academe is threatened by the twin
dangers of fossilization and scholasticism (of three types: tedium, high
tech, and radical chic).
The agenda for the next decade, at least as I see it, ought to be the
opening up of the disciplines, the ventilating of professional communities
that have come to share too much and that have become too self-referential.”
Jensen Comment
I think accountics researchers often use purchased databases (e.g.,
Compustat, AuditAnalytics, and CRSP) without questioning the possibility of
data errors and limitation. For example, we recently took a look at the
accounting litigation database of AuditAnalytics and found many serious
omissions.
These databases are used by multiple accountics researchers, thereby
compounding the felony,.
Quantification — describing reality with
numbers — is a trend that seems only to be accelerating. From digital
technology to business and financial models, we interact with the world
by means of quantification.
While we all interact with the world through
more-or-less inflexible models, mathematics contributes to this lack of
flexibility because it is seemingly precise and objective. Even though
mathematical models can be very complex, you can use them without
understanding them very well. A trader
need not really understand the financial engineering models that he may
use on daily basis. This uncritical acceptance
amounts to the assumption that reality is identical to our rational
reconstruction of reality — for example, that the economy or the stock
market is captured by our latest model.
Hitting the bottom line is certainly easier when you know with precision
what that bottom line is. Numbers give you this precision, making you
feel more secure about where you are going — higher revenues, lower
costs. Defining the risk of an unlikely event may make us feel like
we've dealt with the threat. This is part of the contribution of the
"quants"
on Wall Street, people with doctorates in math and
physics. They bring with them a culture of quantification that they
carry over from the mathematical and physical sciences and then apply to
economic and financial situations. The complex mathematical models that
they use may be brilliant, but the better they are the greater their
potential is to misrepresent the actual, human situation that they are
looking at. Because they give people like CEOs and politicians the idea
that everything is understood and under control, these models often have
the perverse effect of generating new, unanticipated problems.
What we misunderstand is that introducing
mathematics and quantification into any situation subtly changes that
situation and this needs to be taken into account. We are attached to
our analytic and computational tools and have become blind to their
limitations.
Consider the following four issues:
Statistical models are all based
on the notion of randomness, but no one can really understand
randomness. Many people use the word random without
realizing that random means what it says — randomness cannot be
predicted or controlled. A model of randomness is no longer true
randomness.
Because they are logically
consistent, mathematical models screen out ambiguity.
Ambiguity is real, but business and financial models have little to
no room for it. Ambiguity arises whenever there are two (or more)
courses of action that are equally important yet conflict with one
another. For example, we need nuclear reactors to solve some of our
energy needs and to mitigate global warming. At the same time,
nuclear power, as we see from Japan, comes with huge downsides. This
same ambiguity is at the heart of most policy and business
decisions, but mathematical models have taken out the ambiguity.
Putting a situation into numbers
enforces the belief that things are linear and events are
necessarily comparable since for any two numbers one is
larger and one is smaller. Suppose that you modeled teaching on a
scale that goes from 1 to 10. You would conclude that a teacher with
a score of 8.3 was better than one with 6.8, but this would
inevitably ignore all kinds of qualitative factors. Models simplify
things by ignoring certain aspects of the situation, but we can
never be sure which factors should be included and which should be
omitted.
Any system that involves human
behavior, like economics or finance, is inherently self-referential.
We are all participants in, not just observers of, these systems.
Self-referential systems are notoriously difficult to control and
predict because they are often chaotic, not deterministic. Most
mathematical models do not take this element of self-reference
seriously and anyhow chaotic systems, by definition, cannot be
predicted.
How do we make use of the realization that
uncertainty is inevitable and our best models have blind spots? Simple
acknowledgment that uncertainty is unavoidable already changes things in
a fundamental way. However, this acknowledgment must be authentic and
must overcome our psychological aversion to uncertainty. Uncertainty
tends to make situations more complex and, therefore, projects more
costly — another reason why it tends to be ignored or downplayed.
Continued in article
A Pair of Grumpy Old Accountants Ask a Question About Accounting Leadership
Where Are the Accounting Profession's Leaders?
By: Anthony H. Catanach Jr. and J. Edward Ketz
SmartPros, May 2011
http://accounting.smartpros.com/x71917.xml
These are the concluding remarks by Tony and Ed:
Tom Selling has gone so
far as to suggest that part of the audit model problem might be that:
…auditors might
be good at verification of things which are capable of being
verified, and very little else.
If Tom is right, then we
may be closer to the edge of the fall than we realized, and too late for
even credible leadership to help.
Jensen Comment
I still don't see why financial statements cannot have multiple columns with
the first column devoted to measurement that auditors can verify such as
amortized historical costs. Then we can add more columns as verification
drifts off into the foggy ether of fair value accounting and changes in
earnings that may or may not ever be realized (e.g., not ever for
held-to-maturity assets and liabilities that will not be liquidated until
maturity).
As to leadership, don't look to our academy
for leaders in the profession. Academe was overtaken decades by accountics
faculty who really do not make many if any significant contributions to
practitioner journals, the AICPA, the IMA, and other professional bodies
except in certain specialized subtopics like AIS, history, and tax ---
http://faculty.trinity.edu/rjensen/Theory01.htm#WhatWentWrong
Accounting Scholarship that Advances
Professional Knowledge and Practice
Robert S. Kaplan The Accounting Review, March 2011, Volume 86, Issue 2,
Although all three speakers provided
inspirational presentations, Steve Zeff and I both concluded that Bob
Kaplan’s presentation was possibly the best that we had ever viewed among
all past AAA plenary sessions. And we’ve seen a lot of plenary sessions in
our long professional careers.
Now that Kaplan’s
video is available I
cannot overstress the importance that accounting educators and researchers
watch the video of Bob Kaplan's August 4, 2010 plenary presentation
Note that to watch the entire Kaplan video ---
http://commons.aaahq.org/hives/531d5280c3/posts?postTypeName=session+video
I think the video is only available to AAA members.
Don’t miss the history map of Africa analogy to academic accounting
research!!!!!
When Peter Diamond was a graduate student at
MIT in the early 1960s, he spent much of his time studying the elegant
new models of perfectly functioning markets that were all the rage in
those days. Most important of all was the
general equilibrium model assembled in the
1950s by Kenneth Arrow and Gerard Debreu, often referred to as the
mathematical proof of the existence of Adam Smith's "invisible hand."
Working through the Arrow-Debreu proofs was a major part of the MIT grad
student experience. At least, that's what Diamond told me a few years
ago. (If I ever find the notes of that conversation, I'll offer up some
quotes.)
.
Diamond certainly learned well. In a long
career spent almost entirely at MIT, he became known for
work of staggering theoretical sophistication.
As economist Steven Levitt put it today:
.
He wrote the kind of papers that I would have
to read four or five times to get a handle on what he was doing, and
even then, I couldn't understand it all.
.
But Diamond wasn't out to further prove the
perfection of markets. He was trying instead to show how, with the
injection of the tiniest bit of reality, the perfect-market models he'd
learned so well in grad school began to break down. Today he won a third
of the
Sveriges Riksbank Prize in Economic Sciences in Memory
of Alfred Nobel (it's not technically a "Nobel
Prize"), mainly for a paper he wrote in 1971 that explored how the
injection of friction between buyers and sellers, in the form of what he
called "search costs," prices would end up at a level far removed from
what a perfect competition model would predict. The two economists who
shared the prize with him, Dale Mortensen of Northwestern University and
Christopher Pissarides of the London School of Economics, later
elaborated on this insight with regard to job markets (as did Diamond).
.
The exact practical implications of this work
can be a little hard to define — although Catherine Rampell makes a
valiant and mostly successful effort in The
New York Times. What this year's prize does clearly indicate is that the
Nobel committee believes economic theory is messy and getting messier
(no, I didn't come up with this insight on my own; my colleague Tim
Sullivan had to nudge me). The last Nobel awarded for an
all-encompassing mathematical theory of how the economic world fits
together was to
Robert Lucas in 1995 for his work on rational
expectations. Since then (with the arguable exceptions of the prizes
awarded to
Robert Merton and Myron Scholes in 1997 for options-pricing
and to Fynn Kydland and Edward Prescott in 2004
for real-business-cycle theory) the Nobel crew has chosen to honor
either interesting economic side projects or work that muddies the
elegance of those grand postwar theories of rational actors buying and
selling under conditions of perfect competition.
The 2001 prize for work exploring the impact
on markets of asymmetric information, awarded to George Akerlof, Michael
Spence and Joseph Stiglitz, was probably most similar to this year's
model (and, not coincidentally, Akerlof and Stiglitz were also MIT grad
students in the 1960s).
.
The implications of messier economics are
interesting to contemplate. The core insight of mainstream economics —
that incentives matter — continues to hold up well. And on the whole,
markets appear to do a better job of channeling those incentives to
useful ends than any other form of economic organization. But beyond
that, the answers one can derive from economic theory — especially
answers that address the functioning of the entire economy — are
complicated and often contradictory. Meaning that sometimes we
non-economists are just going to have to figure things out for ourselves.
.
Jensen Comment
Not mentioned but certainly implied is the increased complexity of
replicating and validating empirical models in terms of assumptions, missing
variables, and data error. Increasing complexity will affect accountics
researchers less since replicating and validating is of less concern among
accountics researchers ---
http://faculty.trinity.edu/rjensen/TheoryTAR.htm
Steven J. Kachelmeier's July 2011 Editorial as Departing Senior Editor
of The Accounting Review (TAR)
One of the more surprising things
I have learned from my experience as Senior Editor of
The Accounting
Review is just how often a
‘‘hot
topic’’
generates multiple
submissions that pursue similar research objectives. Though one might
view such situations as enhancing the credibility of research findings
through the independent efforts of multiple research teams, they often
result in unfavorable reactions from reviewers who question the
incremental contribution of a subsequent study that does not materially
advance the findings already documented in a previous study, even if the
two (or more) efforts were initiated independently and pursued more or
less concurrently. I understand the reason for a high incremental
contribution standard in a top-tier journal that faces capacity
constraints and deals with about 500 new submissions per year.
Nevertheless, I must admit that I sometimes feel bad writing a rejection
letter on a good study, just because some other research team beat the
authors to press with similar conclusions documented a few months
earlier. Research, it seems, operates in a highly competitive arena.
Fortunately, from time to time, we
receive related but still distinct submissions that, in combination,
capture synergies (and reviewer support) by viewing a broad research
question from different perspectives. The two articles comprising this
issue’s forum are a classic case in point. Though both studies reach the
same basic conclusion that material weaknesses in internal controls over
financial reporting result in negative repercussions for the cost of
debt financing, Dhaliwal et al. (2011) do so by examining the public
market for corporate debt instruments, whereas Kim et al. (2011) examine
private debt contracting with financial institutions. These different
perspectives enable the two research teams to pursue different secondary
analyses, such as Dhaliwal et al.’s examination of the sensitivity of
the reported findings to bank monitoring and Kim et al.’s examination of
debt covenants.
Both studies also overlap with yet
a third recent effort in this arena, recently published in the
Journal of
Accounting Research by Costello
and Wittenberg-Moerman (2011). Although the overall
‘‘punch
line’’
is similar in all three studies (material
internal control weaknesses result in a higher cost of debt), I am
intrigued by a ‘‘mini-debate’’
of sorts on the different
conclusions reache by Costello and Wittenberg-Moerman (2011) and
by Kim et al. (2011) for the effect of material weaknesses on debt
covenants. Specifically, Costello and Wittenberg-Moerman (2011, 116)
find that ‘‘serious,
fraud-related weaknesses result in a significant decrease in financial
covenants,’’
presumably because banks substitute more
direct protections in such instances, whereas Kim et al.
Published Online: July 2011
(2011) assert from their cross-sectional
design that company-level material weaknesses are associated with
more
financial covenants
in debt contracting.
In reconciling these conflicting
findings, Costello and Wittenberg-Moerman (2011, 116) attribute the Kim
et al. (2011) result to underlying
‘‘differences
in more fundamental firm characteristics, such as riskiness and
information opacity,’’
given that, cross-sectionally, material
weakness firms have a greater number of financial covenants than do
non-material weakness firms even
before the disclosure of the
material weakness in internal controls. Kim et al. (2011) counter that
they control for risk and opacity characteristics, and that advance
leakage of internal control problems could still result in a debt
covenant effect due to internal controls rather than underlying firm
characteristics. Kim et al. (2011) also report from a supplemental
change analysis that, comparing the pre- and post-SOX 404 periods, the
number of debt covenants falls for companies both with
and without
material weaknesses
in internal controls, raising the question of whether the
Costello and Wittenberg-Moerman
(2011) finding reflects a reaction to the disclosures or simply a more
general trend of a declining number of debt covenants affecting all
firms around that time period. I urge readers to take a look at both
articles, along with Dhaliwal et al. (2011), and draw their own
conclusions. Indeed, I believe that these sorts . . .
Continued in article
Jensen Comment
Without admitting to it, I think Steve has been embarrassed, along with many
other accountics researchers, about the virtual absence of validation and
replication of accounting science (accountics) research studies over the
past five decades. For the most part, accountics articles are either ignored
or accepted as truth without validation. Behavioral and capital markets
empirical studies are rarely (ever?) replicated. Analytical studies make
tremendous leaps of faith in terms of underlying assumptions that are rarely
challenged (such as the assumption of equations depicting utility functions
of corporations).
Accounting science thereby has become a pseudo
science where highly paid accountics professor referees are protecting each
others' butts ---
"574 Shields Against Validity Challenges in Plato's Cave" ---
http://faculty.trinity.edu/rjensen/TheoryTAR.htm
The above link contains Steve's rejoinders on the replication debate.
In the above editorial he's telling us that there is a middle ground for
validation of accountics studies. When researchers independently come to
similar conclusions using different data sets and different quantitative
analyses they are in a sense validating each others' work without truly
replicating each others' work.
I agree with Steve on this, but I would also argue that these types of
"validation" is too little to late relative to genuine science where
replication and true validation are essential to the very definition of
science. The types independent but related research that Steve is discussing
above is too infrequent and haphazard to fall into the realm of validation
and replication.
When's the last time you witnesses a TAR author criticizing the research
of another TAR author (TAR does not publish critical commentaries)?
Are TAR articles really all that above criticism? Even though I admire Steve's scholarship,
dedication, and sacrifice, I hope future TAR editors will work harder at
turning accountics research into real science!
Dirty Rotten Strategies: How We Trick Ourselves and Others
Into Solving the Wrong Problems Precisely by
Ian I. Mitroff and
Abraham Silvers (Stanford University Press; November 2009, 192 pages;
$24.95 but Amazon sells it new for $12.95
People and organizations are perfectly capable
of making the most outrageous missteps. But, how does a person,
organization, or society know that it is committing an error? And, how
can we tell that when others are steering us down wrong paths?
Dirty Rotten Strategies delves into how
organizations and interest groups lure us into solving the "wrong
problems" with intricate, but inaccurate, solutions. Authors Ian I.
Mitroff and Abraham Silvers argue that we can never be sure if we have
set our sights on the wrong problem, but there are definite signals that
can alert us to this possibility.
While explaining how to detect and avoid dirty
rotten strategies, the authors put the media, healthcare, national
security, academia, and organized religion under the microscope. They
offer a biting critique that examines the failure of these major
institutions to accurately define our most pressing problems. For
example, the U.S. healthcare industry strives to be the most
technologically advanced in the world, but, our cutting-edge system does
not ensure top-quality care to the largest number of people.
Readers will find that far too many
institutions have enormous incentives to let us devise elaborate
solutions to the wrong problems. As Thomas Pynchon said," If they can
get you asking the wrong questions, then they don't have to worry about
the answers."
From a political perspective, this book shows
why liberals and conservatives define problems differently, and
demonstrates how each political view is incomplete without the other.
Our concerns are no longer solely liberal or conservative. In fact, we
can no longer trust a single group to define issues across the
institutions explored in this book and beyond.
Dirty Rotten Strategies is a bipartisan call
for anyone who is ready to think outside the box to address our major
concerns as a society—starting today.
Jensen Comment
This strikes me a bit like our problem with the billions of dollars spent by
major universities in accountics research that is virtually ignored by the
accounting profession and business firms and investors worldwide for the
past four decades.
What went wrong with accountics research and how did it have some "dirty
rotten strategies?"
Accountics is the mathematical science of values.
Charles Sprague [1887] as quoted by McMillan [1998, p. 1][NH1]
At the same time, it's possible to take the "Dirty Rotten Strategies"
thesis too far in academe and in life. For example, should we eliminate the
entire space exploration program and divert the money to improving high
speed rail service between major urban centers in the United States? History
is replete with examples of where what seemed like a "dirty rotten" waste of
money turned out to have a very high benefit to cost ratios in the long run,
e.g., the contributions of basic particle physics research to the ultimate
warming of our New England houses from the Yankee Nuclear Power Plant.
I'm less optimistic about the ultimate benefit to cost ratio of
accountics research and manned space exploration, but who knows?
I've been wrong 2,195 times in my life. Accountants keep track of
everything.
Isaac Newton on Mathematical Certainty and Method by Niccolo
Guicciardini (MIT Press; October 2009, 422 pages; $55).
A study of Newton's philosophy of mathematics; topics include how the
British scientist distanced himself from Descartes and Leibniz and saw
himself as the heir of the ancients.
When Preconceived Notions Stand in the Way of Academic Scholarship and
Research
I think the article below extends well beyond the realm of traditional
politics and extends into other worlds of academe
So I was intrigued to read
a news story in the Boston Globe about research in political
behavior. It turns out that people who have
made up their minds are not receptive to information that doesn't
support their beliefs. I tracked down some of the research mentioned in
the article to see how the studies were conducted. (I'm nerdy that way.)
Essentially, James Kuklinski and others
found that people who held strong beliefs
wouldn't let facts stand in their way. Those who were the least well
informed were also the group that were the most confident in their
mistaken beliefs. (I use "mistaken" here because they were factually
wrong, and those misperceptions of fact conspired with their opinions
about what policies should be taken.) Brendan Nyhan and Jason Reifler
recently
devised several experimental procedures to see
how people respond to corrections in information. Not well, apparently.
When people read false information and then a correction to it, they
tend to dig in their heels and become even more convinced of the wrong
information, a "back fire" effect that increases their insistence on
misinformation being correct.
This is all very depressing. We have enough of
a challenge giving students the knowhow to locate good information. I am
reminded of
James
Elbow's notion of the "believing game." Rather
than teach students the art of taking a text apart and arguing with it,
like a dog worrying a dead squirrel, he thought there was some value in
entering into ideas and doing our best to understand them from the
inside rather than take a defensive position and try to disprove them as
a means of understanding. I am also reminded of
research done by Keith Oatley (and
discussed by him here) that suggests that
those who read fiction engage in a kind of simulation of reality that
leads them to become more empathetic - and more open to experiences that
they haven't had.
Continued in article
A PS to this little paper chase of mine - this
exercise of tracing sources mentioned in a news story convinces me we
need to do a much better job of making research findings accessible in
every sense of the word. When you are engaged in a debate online, the
links that are easily found to support your position tend to come from
in the form of opinion pieces and news stories. So much of our scholarly
work is locked up behind paywalls that even finding research referred to
in these opinion and news sources takes a lot of detective skill and
patience, and when you find them you can't provide links that work. If
we want our work to matter, if we want the evidence we gather to make a
difference, we need to think about making it more accessible, not just
in terms of readability, but findabilty. Kudos to the authors who have
made their work open access, and kudos to those publishers and libraries
who help.
Abstract: This essay, following up on the
recent Sy and Tinker [2005] and Tyson and Oldroyd [2007] debate, argues
that accounting history research needs to present critiques of the
present state of accounting’s authoritative concepts and principles,
theory, and present-day practices. It proposes that accounting history
research could benefit by adopting a genealogical, “effective” history
approach. It outlines four fundamental strengths of traditional history
– investigate only the real with facts; the past is a permanent
dimension of the present; history has much to say about the present; and
the past, present, and future constitute a seamless continuum. It
identifies Nietzsche’s major concerns with traditional history,
contrasts it with his genealogical approach, and reviews Foucault’s
[1977] follow up to Nietzsche’s approach. Two examples of genealogical
historiography are presented – Williams’ [1994] exposition of the major
shift in British discourse regarding slavery and Macintosh et al.’s
[2000] genealogy of the accounting sign of income from feudal times to
the present. The paper critiques some of the early Foucauldian-based
accounting research, as well as some more recent studies from this
perspective. It concludes that adopting a genealogical historical
approach would enable accounting history research to become effective
history by presenting critiques of accounting’s present state.
Jonathan Spence came
here to deliver a speech, but don't let that fool you: his address --
the 39th Annual Jefferson Lecture in the Humanities, which took place
Thursday -- in no way resembled the sort typically associated with D.C.
The Jefferson Lecture
is sponsored by the National Endowment for the Humanities, which
describes the lecture as "the most prestigious honor the federal
government bestows for distinguished intellectual achievement in the
humanities." Those
chosen for the distinction are typically
academics or creative types (or both) -- but, given the setting, the
sponsor, and the nature of the award (which "recognizes an individual...
who has the ability to communicate the knowledge and wisdom of the
humanities in a broad, appealing way"), Jefferson Lecturers have
historically taken the opportunity to make a larger (and sometimes
tacitly political) point related to the humanities. Last year,
controversial bioethicist
Leon Kass used his lecture
to criticize the way the humanities are taught and researched at
American universities; in 2007,
Harvey Mansfield argued, with many subtle
political allusions, that the social sciences are in dire need of "the
help of literature and history";
Tom Wolfe's 2006 lecture discussed how the
humanities shed light on modern culture (and lamented the current state
of that culture on campuses); 2005 lecturer Donald Kagan and 2004
lecturer Helen Vendler offered opposing views on which disciplines of
the humanities are most crucial, and why.
If any of those in the
crowd (noticeably larger than last year's) at the Warner Theater last
night were familiar with the Jefferson Lectures of years prior, they
were in for a surprise.
Spence is Sterling
Professor of History Emeritus at Yale University, whose faculty he
joined in 1966. His specialty has always been China -- his 14 books on
Chinese history include 1990's The Search for Modern China, upon
whose publication the New York Times
accurately predicted that it would
"undoubtedly become a standard text on the subject" -- and his lecture
was entitled "When
Minds Met: China and the West in the Seventeenth Century."
Even this relatively specific appellation,
however, conveys a misleading breadth, for Spence's lecture focused
almost exclusively on three men -- Shen Fuzong, an exceptionally learned
Chinese traveler; Thomas Hyde, an English scholar of history and
language; and Robert Boyle, also English, a scientist and philosopher of
considerable renown -- and one year: 1687.
In his lecture, Spence
gave what may (or may not) have been one brief acknowledgment that he'd
chosen an unusually narrow topic of discourse: "It is a commonplace, I
think, that the sources that underpin our concept of the humanities, as
a focus for our thinking, are expected to be broadly inclusive." But,
for himself, Spence dismissed that notion in one more sentence: "...as a
historian I have always been drawn to the apparently small-scale
happenings in circumscribed settings, out of which we can tease a more
expansive story."
Thus he dedicated the
rest of his lecture to the story of those three historical figures in
the year 1687. Shen had traveled to Europe in the company of one of his
teachers, a Flemish Jesuit priest who was co-editing a book of the
sayings of Confucius from Chinese into Latin. Hyde, librarian at the
University of Oxford's Bodleian Library, invited Shen there to assist
him with the cataloging of some Chinese books -- and also because Hyde,
who in that era would have been called an Orientalist, wanted to learn
Chinese himself. After a brief stay at Oxford, Shen returned to London,
bearing a letter of introduction from Hyde to his friend Boyle; the
letter recommended that Boyle meet and converse with the Chinese
scholar. The letter had to be convincing, Spence explained, because
Boyle's reputation was by then widespread, and "he was so inundated with
curious visitors that at times he had to withdraw into self-enforced
seclusion...."
Shen did meet Boyle at
least once; Boyle's work diary mentions their discussion of the Chinese
language and its scholars (a conversation that, like all of those
between Shen and Hyde, must have taken place in Latin: Shen's Latin was
excellent, but he did not, evidently, know English). And Hyde maintained
correspondence not only with his old friend Boyle -- over the years, the
two had "discussed Arabic and Persian texts, Malay grammars... and how
to access books from Tangier, Constantinople and Bombay" as well as "the
chemical constituents of sal ammoniac and amber, the effectiveness of
certain Mexican herbs... current studies of human blood and air, the
nature of papyrus, the writings of Ramon Llull and the use of elixirs
and alchemy in the treatment of illnesses" -- but also with Shen, until
around the time of the latter's departure from England for Portugal in
the spring of 1688.The letters between Shen and Hyde covered such topics
as "Chinese vocabulary... China's units of weights and measurements...
the workings of the Chinese examination system and bureaucracy... [and]
the Chinese Buddhist belief in the transmigration of souls."
"All three men,"
Spence ultimately concluded, "though so different, shared certain basic
ideas about human knowledge: these included... the importance of
linguistic precision, the need for broad-based comparative studies, the
role of clarity in argument, the need for thorough scrutiny of
philosophical and theological principles.... Theirs, though brief, had
been a real meeting of the minds. And the values they shared remain,
well over three hundred years later, the kind that we can seek to
practice even in our own hurried lives."
That final point was
the closest Spence came to suggesting a particular take-home message for
his audience; however, in an interview with Inside Higher Ed,
held that morning in the lobby of the Willard Hotel, he did mention a
few ideas that he was hoping to convey. For one thing, Spence said,
given the current importance of U.S.-China relations, he hopes this much
older, smaller-scale example of dialogue between the East and West will
"give some perspective to that."
"Historians," he said,
"try to get people away from just focusing on the present; they try to
give them some sort of stronger sense of continuity, human continuity.
And I just like the range of things, these three people that draw
together, and they're writing their letters to each other, and their few
meetings... and in that short time they talk about examination systems,
they talk about language, competition, they talk about medicine, they
talk about -- I was fascinated, they talk about chess..... All these
things seemed to me to flow together, and I think they'd make an
interesting -- I hope they'd make an interesting -- package about
cultural contact."
There's a message in
that, Spence said: "to make our range of contact as wide as possible,
and to use our intelligence about how to do this."
Another issue raised
in the lecture, Spence said -- "maybe a small point, but perhaps worth
making" -- has to do with the teaching and learning of languages; Hyde
dreamed of bringing native speakers of various Eastern languages to
Oxford, to establish a college of languages. "Why should everybody else
on the planet speak English?" Spence asked. "I mean, why should they?"
But on the larger
importance of the humanities, and their current status in higher
education and society at large, Spence was reluctant to make a strong
argument. "It's not just a case of encouraging humanities in the
abstract; it's having something to say.... The main search should be for
what is the most meaningful thing you can achieve with the humanities,
how can you share some kind of broader cultural values, or how can you
learn things about yourself or other societies. The challenge is to use
the humane intelligence and see what can be built on that."
And when it comes to
funding, "any government has to put its priorities somewhere, and this
does usually mean cutting something."
His lecture, Spence
said, isn't "meant to be exactly a political speech, you know, I hope
people understand that."
For the most part,
those in attendance seemed more than satisfied. Spence's talk was
punctuated frequently by warm laughter from the audience -- whom he
indulged shamelessly, often departing from his prepared remarks to
expound upon details that interested him, or to make additional jokes
whenever the crowd found one of his remarks especially humorous. When he
finished, the applause was long and loud, and one woman remarked
audibly, "That was amazing!"; her companion replied, "Nice, really
nice!"
But at least a few
people reacted with more ambivalence. One group of young attendees, who
identified themselves as fans of Spence, having been students of his as
undergraduates at Yale, said that while they'd enjoyed the lecture, they
had been hoping that Spence would make a more explicit connection
between his topic and issues of current cultural or political relevance.
One noted that, in his introductory remarks that evening, NEH Chairman
James Leach had described the purpose of the Jefferson Lecture as being
"to narrow the gap between the world of academia and public affairs,"
and had emphasized the Endowment's goal of "bridging cultures."
There was an "irony,"
this young man said, in the fact that Spence's lecture precisely
addressed the bridging of two cultures, but Spence hadn't made a bridge
between his own remarks -- which the audience member interpreted as "a
clarion call for better scholarship" -- and any other realm.
"Listeners," he said (possibly referring to himself), "want something
that's cut and dry, that's tweetable."
The possibility of
such complaints about his speech had arisen during Inside Higher Ed'sinterview with Spence that morning; he hadn't seemed concerned. "I'm
not going to sort of over-apologize to the audience... they've chosen to
come to hear about the seventeenth century" -- he chuckled -- "I think
we announced that!"
The Immature Pseudo Sciences of Manamatics and Accountics
Let's face, for purposes of tenure and promotion and prestige in top
business schools the only kind of research that counts are "testable
knowledge-based claims." Accounting and business professors are wasting
their time trying to do research on tough real-world problems that can't be
modeled and tested! This is a a sign of the immaturity of academic business
research.
Of course over in the science and humanities divisions, where creativity
is given more credence and researchers are encouraged to attack the most
difficult problems imaginable, top researchers can publish normative
reasoning and creative thinking, even poetic thinking, about problems not
yet amenable to testable hypotheses.
When the great scientists enter the land of testable hypotheses they
often discover that the poets have paved the roads. It's like the army
mopping up after the marines landed beforehand.
Manamatics (a play on "accountics") and the journal called The
Academy of Management Review
While the public clamors for the return of managerial
leadership in ethics and social responsibility, surprisingly little research
on the subject exists, and what does get published doesn't appear in the top
journals. The reasons are varied, but perhaps more than anything it's that
those journals are exclusively empirical: Take The Academy of Management
Review, the only top journal devoted to management theory.
Its mission statement says it publishes only "testable
knowledge-based claims." Unfortunately,
that excludes most of what counts as ethics, which is primarily a
conceptual, a priori discipline akin to law and philosophy. We wouldn't
require, for example, that theses on the nature of justice or logic be
empirically testable, although we still consider them "knowledge based."
Julian Friedland, "Where Business Meets Philosophy: the Matter of
Ethics," Chronicle of Higher Education, November 8, 2009 ---
http://chronicle.com/article/Where-Business-Meets/49053/
It remains to be seen if many business
professors will achieve tenure by doing ethics properly speaking. Most
of what now gets published in top business journals under the rubric of
"ethics" is limited to empirical studies of the success of various
policies presumed as ethical ("the effects of management consistency on
employee loyalty and efficiency," perhaps). Although valuable, such
research does precious little to hone the mission of business itself.
While the public clamors for the return of
managerial leadership in ethics and social responsibility, surprisingly
little research on the subject exists, and what does get published
doesn't appear in the top journals. The reasons are varied, but perhaps
more than anything it's that those journals are exclusively empirical:
Take The Academy of Management Review, the only top journal devoted to
management theory. Its mission statement says it publishes only
"testable knowledge-based claims." Unfortunately, that excludes most of
what counts as ethics, which is primarily a conceptual, a priori
discipline akin to law and philosophy. We wouldn't require, for example,
that theses on the nature of justice or logic be empirically testable,
although we still consider them "knowledge based."
The major business journals have a
responsibility to open the ivory-tower gates to a priori arguments on
the ethical nature and mission of business. After all, the top business
schools, which are a model for the rest, are naturally interested in
hiring academics who publish in the top journals. One solution is for at
least one or two of the top journals to rewrite their mission statements
to expressly include articles applying ethical theory to business. They
could start by creating special ethics sections in the same way that
some have already created critical-essay sections. Another solution is
for academics to do more reading and referencing of existing
business-ethics journals. Through more references in the wider
literature, those journals can rise to the top. Until such changes
occur, business ethics will largely remain a second-class area of
research, primarily concerned with teaching.
Meanwhile, although I seem to notice more
tenure-track positions in business ethics appearing every year—a step in
the right direction—many required business-ethics courses are taught by
relative outsiders. They are usually non-tenure-track hires from the
private sector or, like me, from various other academic disciplines,
such as psychology, law, and philosophy. In my years as a philosopher in
business schools, I've often held a place at once exalted and reviled.
It's provocative and alluring. But it can also be about as fitting as a
pony in a pack of wolves. During my three years at a previous college I
became accepted—even a valued colleague of many. But deans sometimes
treated me with the kind of suspicion normally suited to a double agent
behind enemy lines.
For a business-ethics curriculum to succeed, it
must be at least somewhat philosophical. And that is difficult to
establish in the university context, in which departments are loath to
give up turf. Not surprisingly, few business Ph.D. programs offer any
real training in ethical theory. Naturally, dissertations in applied
ethics are generally written in philosophy departments, and those
addressing business are rare, since few philosophers are schooled in
business practices. Business schools should begin collaborating with
centers for applied ethics, which seem to be cropping up almost
everywhere in philosophy departments. Conversely, philosophers in
applied ethics should reach out to business and law professors
interested in ethics. With that kind of academic infrastructure, real
prog ress can be made.
Perhaps then fewer business students will view
their major mainly as a means to gainful employment, and might instead
see it as a force of social prog ress. Colleges like mine, which root
their students in ethics and liberal arts, are training them to think
for themselves. Business schools that fail to do so are clinging to the
past.
Continued in article
Julian Friedland is an assistant professor of business ethics at
Eastern Connecticut State University and editor of "Doing Well and Good:
The Human Face of the New Capitalism" (Information Age Publishing,
2009).
November 10, 2009 reply from Dan Stone, Univ. of
Kentucky
[dstone@UKY.EDU]
Applause to Bob for taking on (once again) an
important issue and speaking sharp truths.
Lest we overstate the problem, there are outlets
that publish business ethics research, including qualitative work and even
poetry. Some top-of- the-head journals: Journal of Business Ethics,
Accounting and the Public Interest, J of Economic Psychology, Critical
Perspectives in Accounting, and many other outlets that I am forgetting in
my haste to get back to writing a paper about an ethical issue in accounting
which I hope to publish in a business journal.
Cheers,
Dan S.
November 11, 2009 reply from Bob Jensen
Hi Dan,
Yes there are other journals, but our top accounting
and business research universities still primarily count manamatics and
accountics journal hits for promotion and tenure. Especially note my
reference below to the Dialog section of the AMR. The present Editor of The
Accounting Review as a matter of policy refuses to publish any Commentary
(Dialog). By doing so a non-mathematics hit might slip into somebody’s
resume. Horrors!
Added Jensen Comment Our
top accounting and business research universities still primarily count
manamatics and accountics journal hits for promotion and tenure. Especially
note my reference below to the Dialog section of the AMR. The present Editor
of The Accounting Review as a matter of policy refuses to publish any
Commentary (Dialog). By doing so a non-mathematics hit might slip into
somebody’s resume. Horrors!
Even worse is that virtually all accountics doctoral
programs have one and only one goal --- prepare accounting doctoral students
for publishing in accountics research journals.
Leading manamatics
journals and accountics journals deny publishing papers that fail to have
"testable knowledge-based claims."
The problem here is that
they thereby deny most (maybe over 95%) of research on some of the most
interesting theory in management and accountancy. For example, weigh the
great history of the “Theories of Management” against what miniscule portion
is amenable to testable hypotheses.
Thus I remind you that
just as the army comes in and perfects the work done by the marines that
landed first, so the manamatics and accountics researchers find that when
they land the roads have already been paved by the "searchers" who are
theorists, the philosophers, and even the poets. They might even be senior
manmatics and accountics researchers unshackled by the restraints of their
journal editors and former doctoral programs.
Manamatics and accountics
journals are pseudo science journals because, by not publishing confirming
and independent replications studies as a matter of policy, they discourage
researchers from conducting independent replication studies. A disconfirming
replication study has a slim chance of being published, but the odds of
disconfirming and publishing are so low that the world is forced in over 99%
of the published studies to accept the one and only manamatics or accountics
study as truth. Physical scientists would laugh their heads off if the ever
cared two hoots about manamatics or accountics.
One thing I’ve noticed is
that social scientists are increasingly concerned about independent
replications. Unfortunately this has not rubbed off onto editors of The
Academy of Management Review, The Accounting Review, the
Journal of Accounting Research, and the Journal of Accounting and
Economics.
The present editor of
The Accounting Review independently dictates a policy of not publishing
any submitted commentaries. This is sad. Even
the manamatics journal The Academy of Management Review has a Dialogue
Section ---
http://www.aom.pace.edu/AMR/info.html
Dialogue
Dialogue is a forum for readers who wish to comment briefly on material
recently published in
AMR.
Readers who wish to submit material for publication in the Dialogue section
should address only
AMR
articles or dialogues. Dialogue comments must be timely, typically submitted
within three months of the publication date of the material on which the
dialogue author is commenting. When the dialogue comments pertain to an
article, note, or book review, the author(s) will be asked to comment as
well. Dialogue submissions should not exceed five double-spaced manuscript
pages including references. Also, an Abstract should not be included in a
Dialogue. The Editor will make publishing decisions regarding them,
typically without outside review.
I hope some of you keep
the pressure mounting on our accountics journal editors. Someday accountics
may become something more than pseudo science with knowledge that is rarely,
rarely verified.
Gary Sundem,
while editor of TAR and while AAA President, made a major point of saying
that the accounting profession should not look to empirical research for
"new theories."
The following is a quote from the 1993
President’s Message of Gary Sundem, President’s Message. Accounting
Education News 21 (3). 3.
Although empirical
scientific method has made many positive contributions to accounting
research, it is not the method that is likely to generate new theories,
though it will be useful in testing them. For example, Einstein’s theories
were not developed empirically, but they relied on understanding the
empirical evidence and they were tested empirically. Both the development
and testing of theories should be recognized as acceptable accounting
research.
If we ever had an accounting Einstein in the past four
decades, that accounting Einstein probably could’ve never published in TAR,
JAR, JAE, CAR, or even AH (in later years). Hence, we do not look to these
“leading” research journals of the accounting academy for the development of
new theories that perhaps cannot be immediately tested.
November 11, 2009 reply from Paul Williams
Dan, I second that. What is even
more farcical about the claim to be concerned with only testable knowledge
claims is that few, if any, of the claims made in those journals are
actually testable. The Accounting Review has the same policy, though it is
tacit: only empirical or analytical or so I was scolded by an associate
editor. Of course that is a rule observed in the breach. TAR does publish
"opinion" pieces but only if the opinion is politically correct. Aristotle
identified three kinds of knowledge: episteme (scientific), techne
(technical) and phronesis (wisdom/ethics), the latter of which he declared
the most important. For a practice that alleges itself to be a "profession"
accounting certainly does have an odd literature, as Bob has so frequently
reminded us. I would add to your list: Business Ethics Quarterly, AOS, AAAJ
and Research on Professional Responsibility and Ethics in Accounting
Paul
Hi Paul,
Accounting researchers have virtually given up submitting anything by
accountics papers replete with equations to The Accounting Review. Only the
naive submit case or field studies (zero chance of acceptance), and the same
people who bet the farm on boxcars at the crap table or a lame horse in the
Kentucky Derby might submit a survey (about a six percent chance of
acceptance). However, the survey cannot be a field study.
It's just as well. How could there be any advancement of knowledge in a
field or case study sample of one? At best that's just an anecdote seeking
to "search" for knowledge rather than "research" knowledge.
How can a survey contribute to knowledge since surveys are generally
exploratory rather than tightly controlled empirical tests?
Better to have a linear model in a non-stationary and nonlinear world
that is has missing variables and probably an uninteresting hypothesis ---
but always seeking Alpha.that will never be subject to
replication/verification in pseudo science.
"Annual Report and Editorial Commentary for The Accounting Review,"
by Steven J. Kachelmeier The University of Texas at Austin, The
Accounting Review, November 2009, Page 2056.
No commentaries are allowed under the present TAR editor. Disconfirming
replications might be be accepted by this editor, but replication research
is rarely conducted to even discover disconfirming evidence. One
disconfirming study is scheduled to be published in TAR in May (so I'm told
by the present TAR editor who has been kindly corresponding with me).
"Annual Report and Editorial Commentary for The Accounting Review,"
by Steven J. Kachelmeier The University of Texas at Austin, The
Accounting Review, November 2009, Page 2056.
Jensen Comment 1
The present TAR editor states the following on Page 2054:
Several authors (e.g., Bonner et al. 2006;
Heck and Jensen 2007;
Hopwood 2007; Tuttle and Dillard 2007) have
lamented the perceived narrowness of contemporary accounting
scholarship, mostly with respect to the perception that the discipline
is ‘‘consolidating around the area of financial accounting’’ (Tuttle and
Dillard 2007, 395), particularly of the empirical-archival ‘‘capital
markets’’ variety. Writings of this nature generally imply (if not
explicitly state) that accounting journals and editorial biases are part
of the problem. However, journals can only publish what they receive,
such that a more comprehensive analysis compels consideration of both
articles published and the underlying submission base rates. Former AAA
President Shyam Sunder told me once that journals are intellectual
mirrors of the scholarly communities they reflect.
To this I have one word --- hogwash! Editors reap what sow. Accountics
researcher editors are more interested in the tractors than in the harvests.
Clear back in 1987, TAR editor Gary Sundem reported very similar outcomes to
those shown above. If you've not accepted case studies, field studies,
surveys, normative papers, history papers, and theory mullings for over 20
years, what do you expect will be submitted?
Submitting to TAR takes time and money just to have a paper reviewed. Why
bother if there's virtually no chance of acceptance? Gene Heck and I
mistakenly submitted a history paper to TAR in 2006 that was resoundingly
rejected by referees who loudly proclaimed our critical of TAR and
accountics should never see the light of day. Then when it was accepted
by The Accounting Historians Journal it even one a monetary prize as
one of the top papers published in 2007: An Analysis of the Contributions of The
Accounting Review Across 80 Years: 1926-2005 ---
http://faculty.trinity.edu/rjensen/395wpTAR/Web/TAR395wp.htm
Jensen Comment 2
Along these lines I reviewed a forthcoming paper accepted by TAR that is not
yet published. It is a wonderful paper by a scholar who really understands
the professional accounting questions of interest. However, in order to
stretch it for publication in TAR, it had to focus on some uninspired and,
in my opinion, naive "testable hypotheses." However, when I overlooked the
rather useless statistical testing, I found the paper highly informative and
worthwhile. There are really some interesting items published in most of
TAR papers in the past 20 years. However, they are seldom reflected in the
accountics parts of the papers. Look for the history and the narratives
apart from the mathematics.
I developed several modules concerning what went wrong with accounting/accountics
research in the past four decades. Topics to be covered include the following:
Robust statistics are statistics with good
performance for data drawn from a wide range of probability
distributions, especially for distributions that are not normally
distributed. Robust statistical methods have been developed for many
common problems, such as estimating location, scale and regression
parameters. One motivation is to produce statistical methods that are
not unduly affected by outliers. Another motivation is to provide
methods with good performance when there are small departures from
parametric distributions. For example, robust methods work well for
mixtures of two normal distributions with different standard-deviations,
for example, one and three; under this model, non-robust methods like a
t-test work badly.
Continued in article
Jensen Comment
To this might be added that models that grow adaptively by adding components
in sequencing are not robust if the mere order in which components are added
changes the outcome of the ultimate model.
David Johnstone wrote the following:
Indeed if you hold H0 the same and keep
changing the model, you will eventually (generally soon) get a
significant result, allowing “rejection of H0 at 5%”, not because H0 is
necessarily false but because you have built upon a false model (of
which there are zillions, obviously).
Jensen Comment
I spent a goodly part of two think-tank years trying in vain to invent
robust adaptive regression and clustering models where I tried to adaptively
reduce modeling error by adding missing variables and covariance components.
To my great frustration I found that adaptive regression and cluster
analysis seems to almost always suffer from lack of robustness. Different
outcomes can be obtained simply because of the order in which new components
are added to the model, i.e., ordering of inputs changes the model
solutions.
Accountics scientists who declare they have "significant results" may
also have non-robust results that they fail to analyze.
When you combine issues on non-robustness with the impossibility of
testing for covariance you have a real mess in accountics science and
econometrics in general.
It's relatively uncommon for accountics scientists to criticize each
others' published works. A notable exception is as follows:
"Selection Models in Accounting Research," by Clive S. Lennox, Jere R.
Francis, and Zitian Wang, The Accounting Review, March 2012, Vol.
87, No. 2, pp. 589-616.
This study explains the challenges associated with
the Heckman (1979) procedure to control for selection bias, assesses the
quality of its application in accounting research, and offers guidance for
better implementation of selection models. A survey of 75 recent accounting
articles in leading journals reveals that many researchers implement the
technique in a mechanical way with relatively little appreciation of
important econometric issues and problems surrounding its use. Using
empirical examples motivated by prior research, we illustrate that selection
models are fragile and can yield quite literally any possible outcome in
response to fairly minor changes in model specification. We conclude with
guidance on how researchers can better implement selection models that will
provide more convincing evidence on potential selection bias, including the
need to justify model specifications and careful sensitivity analyses with
respect to robustness and multicollinearity.
. . .
CONCLUSIONS
Our review of the accounting literature indicates
that some studies have implemented the selection model in a questionable
manner. Accounting researchers often impose ad hoc exclusion restrictions or
no exclusion restrictions whatsoever. Using empirical examples and a
replication of a published study, we demonstrate that such practices can
yield results that are too fragile to be considered reliable. In our
empirical examples, a researcher could obtain quite literally any outcome by
making relatively minor and apparently innocuous changes to the set of
exclusionary variables, including choosing a null set. One set of exclusion
restrictions would lead the researcher to conclude that selection bias is a
significant problem, while an alternative set involving rather minor changes
would give the opposite conclusion. Thus, claims about the existence and
direction of selection bias can be sensitive to the researcher's set of
exclusion restrictions.
Our examples also illustrate that the selection
model is vulnerable to high levels of multicollinearity, which can
exacerbate the bias that arises when a model is misspecified (Thursby 1988).
Moreover, the potential for misspecification is high in the selection model
because inferences about the existence and direction of selection bias
depend entirely on the researcher's assumptions about the appropriate
functional form and exclusion restrictions. In addition, high
multicollinearity means that the statistical insignificance of the inverse
Mills' ratio is not a reliable guide as to the absence of selection bias.
Even when the inverse Mills' ratio is statistically insignificant,
inferences from the selection model can be different from those obtained
without the inverse Mills' ratio. In this situation, the selection model
indicates that it is legitimate to omit the inverse Mills' ratio, and yet,
omitting the inverse Mills' ratio gives different inferences for the
treatment variable because multicollinearity is then much lower.
In short, researchers are faced with the following
trade-off. On the one hand, selection models can be fragile and suffer from
multicollinearity problems, which hinder their reliability. On the other
hand, the selection model potentially provides more reliable inferences by
controlling for endogeneity bias if the researcher can find good exclusion
restrictions, and if the models are found to be robust to minor
specification changes. The importance of these advantages and disadvantages
depends on the specific empirical setting, so it would be inappropriate for
us to make a general statement about when the selection model should be
used. Instead, researchers need to critically appraise the quality of their
exclusion restrictions and assess whether there are problems of fragility
and multicollinearity in their specific empirical setting that might limit
the effectiveness of selection models relative to OLS.
Another way to control for unobservable factors
that are correlated with the endogenous regressor (D) is to use panel data.
Though it may be true that many unobservable factors impact the choice of D,
as long as those unobservable characteristics remain constant during the
period of study, they can be controlled for using a fixed effects research
design. In this case, panel data tests that control for unobserved
differences between the treatment group (D = 1) and the control group (D =
0) will eliminate the potential bias caused by endogeneity as long as the
unobserved source of the endogeneity is time-invariant (e.g., Baltagi 1995;
Meyer 1995; Bertrand et al. 2004). The advantages of such a
difference-in-differences research design are well recognized by accounting
researchers (e.g., Altamuro et al. 2005; Desai et al. 2006; Hail and Leuz
2009; Hanlon et al. 2008). As a caveat, however, we note that the
time-invariance of unobservables is a strong assumption that cannot be
empirically validated. Moreover, the standard errors in such panel data
tests need to be corrected for serial correlation because otherwise there is
a danger of over-rejecting the null hypothesis that D has no effect on Y
(Bertrand et al. 2004).10
Finally, we note that there is a recent trend in
the accounting literature to use samples that are matched based on their
propensity scores (e.g., Armstrong et al. 2010; Lawrence et al. 2011). An
advantage of propensity score matching (PSM) is that there is no MILLS
variable and so the researcher is not required to find valid Z variables
(Heckman et al. 1997; Heckman and Navarro-Lozano 2004). However, such
matching has two important limitations. First, selection is assumed to occur
only on observable characteristics. That is, the error term in the first
stage model is correlated with the independent variables in the second stage
(i.e., u is correlated with X and/or Z), but there is no selection on
unobservables (i.e., u and υ are uncorrelated). In contrast, the purpose of
the selection model is to control for endogeneity that arises from
unobservables (i.e., the correlation between u and υ). Therefore, propensity
score matching should not be viewed as a replacement for the selection model
(Tucker 2010).
A second limitation arises if the treatment
variable affects the company's matching attributes. For example, suppose
that a company's choice of auditor affects its subsequent ability to raise
external capital. This would mean that companies with higher quality
auditors would grow faster. Suppose also that the company's characteristics
at the time the auditor is first chosen cannot be observed. Instead, we
match at some stacked calendar time where some companies have been using the
same auditor for 20 years and others for not very long. Then, if we matched
on company size, we would be throwing out the companies that have become
large because they have benefited from high-quality audits. Such companies
do not look like suitable “matches,” insofar as they are much larger than
the companies in the control group that have low-quality auditors. In this
situation, propensity matching could bias toward a non-result because the
treatment variable (auditor choice) affects the company's matching
attributes (e.g., its size). It is beyond the scope of this study to provide
a more thorough assessment of the advantages and disadvantages of propensity
score matching in accounting applications, so we leave this important issue
to future research.
Jensen Comment
To this we might add that it's impossible in these linear models to test for
multicollinearity.
Now, let's return to the "problem" of
multicollinearity.
What do we mean by this term, anyway? This
turns out to be the key question!
Multicollinearity is a phenomenon associated
with our particular sample of data when we're trying to
estimate a regression model. Essentially, it's a situation where
there is insufficient information in the sample of data to
enable us to enable us to draw "reliable" inferences about the
individual parameters of the underlying (population) model.
I'll be elaborating more on the "informational content" aspect of
this phenomenon in a follow-up post. Yes, there are various sample
measures that we can compute and report, to help us gauge how severe
this data "problem" may be. But they're not statistical tests,
in any sense of the word
Because multicollinearity is a characteristic of the sample,
and not a characteristic of the population, you should
immediately be suspicious when someone starts talking about "testing
for multicollinearity". Right?
Apparently not everyone gets it!
There's an old paper by Farrar and Glauber (1967) which, on the face
of it might seem to take a different stance. In fact, if you were
around when this paper was published (or if you've bothered to
actually read it carefully), you'll know that this paper makes two
contributions. First, it provides a very sensible discussion of what
multicollinearity is all about. Second, the authors take some well
known results from the statistics literature (notably, by Wishart,
1928; Wilks, 1932; and Bartlett, 1950) and use them to give "tests"
of the hypothesis that the regressor matrix, X, is orthogonal.
How can this be? Well, there's a simple explanation if you read the
Farrar and Glauber paper carefully, and note what assumptions are
made when they "borrow" the old statistics results. Specifically,
there's an explicit (and necessary) assumption that in the
population the X matrix is random, and that it follows a
multivariate normal distribution.
This assumption is, of course totally at odds with what is usually
assumed in the linear regression model! The "tests" that Farrar and
Glauber gave us aren't really tests of multicollinearity in the
sample. Unfortunately, this point wasn't fully appreciated by
everyone.
There are some sound suggestions in this paper, including looking at
the sample multiple correlations between each regressor, and
all of the other regressors. These, and other sample measures
such as variance inflation factors, are useful from a diagnostic
viewpoint, but they don't constitute tests of "zero
multicollinearity".
So, why am I even mentioning the Farrar and Glauber paper now?
Well, I was intrigued to come across some STATA code (Shehata, 2012)
that allows one to implement the Farrar and Glauber "tests". I'm not
sure that this is really very helpful. Indeed, this seems to me to
be a great example of applying someone's results without
understanding (bothering to read?) the assumptions on which they're
based!
Be careful out there - and be highly suspicious of strangers bearing
gifts!
Farrar, D. E. and R. R. Glauber, 1967. Multicollinearity in
regression analysis: The problem revisited. Review of
Economics and Statistics, 49, 92-107.
Shehata, E. A. E., 2012. FGTEST: Stata module to compute
Farrar-Glauber Multicollinearity Chi2, F, t tests.
Wilks, S. S., 1932. Certain generalizations in the analysis
of variance. Biometrika, 24, 477-494.
Wishart, J., 1928. The generalized product moment
distribution in samples from a multivariate normal population.
Biometrika, 20A, 32-52.
Thank you Jagdish for adding another doubt in to the validity of more
than four decades of accountics science worship.
"Weak statistical standards implicated in scientific irreproducibility:
One-quarter of studies that meet commonly used statistical cutoff may be
false." by Erika Check Hayden, Nature, November 11, 2013 ---
http://www.nature.com/news/weak-statistical-standards-implicated-in-scientific-irreproducibility-1.14131
The
plague of non-reproducibility in science may
be mostly due to scientists’ use of weak statistical tests, as shown by
an innovative method developed by statistician Valen Johnson, at Texas
A&M University in College Station.
Johnson compared the strength of two types of
tests: frequentist tests, which measure how unlikely a finding is to
occur by chance, and Bayesian tests, which measure the likelihood that a
particular hypothesis is correct given data collected in the study. The
strength of the results given by these two types of tests had not been
compared before, because they ask slightly different types of questions.
So Johnson developed a method that makes the
results given by the tests — the P value in the frequentist
paradigm, and the Bayes factor in the Bayesian paradigm — directly
comparable. Unlike frequentist tests, which use objective calculations
to reject a null hypothesis, Bayesian tests require the tester to define
an alternative hypothesis to be tested — a subjective process. But
Johnson developed a 'uniformly most powerful' Bayesian test that defines
the alternative hypothesis in a standard way, so that it “maximizes the
probability that the Bayes factor in favor of the alternate hypothesis
exceeds a specified threshold,” he writes in his paper. This threshold
can be chosen so that Bayesian tests and frequentist tests will both
reject the null hypothesis for the same test results.
Johnson then used these uniformly most powerful
tests to compare P values to Bayes factors. When he did so, he
found that a P value of 0.05 or less — commonly considered
evidence in support of a hypothesis in fields such as social science, in
which
non-reproducibility has become a serious issue —
corresponds to Bayes factors of between 3 and 5,
which are considered weak evidence to support a finding.
False positives
Indeed, as many as 17–25% of such findings are
probably false, Johnson calculates1.
He advocates for scientists to use more stringent P values of
0.005 or less to support their findings, and thinks that the use of the
0.05 standard might account for most of the problem of
non-reproducibility in science — even more than other issues, such as
biases and scientific misconduct.
“Very few studies that fail to replicate are
based on P values of 0.005 or smaller,” Johnson says.
Some other mathematicians said that though
there have been many calls for researchers to use more stringent tests2,
the new paper makes an important contribution by laying bare exactly how
lax the 0.05 standard is.
“It shows once more that standards of evidence
that are in common use throughout the empirical sciences are dangerously
lenient,” says mathematical psychologist Eric-Jan Wagenmakers of the
University of Amsterdam. “Previous arguments centered on ‘P-hacking’,
that is, abusing standard statistical procedures to obtain the desired
results. The Johnson paper shows that there is something wrong with the
P value itself.”
Other researchers, though, said it would be
difficult to change the mindset of scientists who have become wedded to
the 0.05 cutoff. One implication of the work, for instance, is that
studies will have to include more subjects to reach these more stringent
cutoffs, which will require more time and money.
“The family of Bayesian methods has been well
developed over many decades now, but somehow we are stuck to using
frequentist approaches,” says physician John Ioannidis of Stanford
University in California, who studies the causes of non-reproducibility.
“I hope this paper has better luck in changing the world.”
I teach a class for our
MAcc program titled Accounting Policy and Research, although it is
mainly the former. With respect to the latter, I introduce the students
to the FASB Codification and they do three major cases that I develop
that involve having to research financial accounting issues and prepare
reports for a CFO or Partner based on the results of their research.
Needless to say, the cases involve issues where there are no clear cut
answers and the students must use the Codification, the concepts
statements, and practical examples of what other companies have done in
somewhat similar situations. I also insist that their reports comment on
related audit, tax, and broader business issues and not be limited to
just what they believe to be the "correct" GAAP answer.
Denny Beresford
October 18, 2009 reply
from Bob Jensen
First I want to point out that
the FASB Codification database is now included
in Comperio such that if your college gets access to Comperio,
you may not need the AAA site license. Also the IASB library is included in
Comperio such that no added purchases in international licenses is required.
Of course Comperio a very comprehensive research library and costly
accounting research library ---
http://www.pwc.com/gx/en/comperio/index.jhtml
Whether your company reports under US GAAP, IFRS, or both, Comperio's
recently enhanced functionality offers you the ability to navigate both sets
of financial reporting requirements using one accounting research tool. That
tool gives you access to the same PwC interpretive guidance our own
professional audit staff uses.
If
you can see this page, you can use Comperio—there’s no software to install:
just Go to the Comperio Web site and start researching! Content covers the
FASB, EITF, AICPA, IASB, IFAC, PCAOB, SEC, FASAB and GASB, as well as the
requirements of eight key countries from around the world. Plus, we've added
the FASB’s new Accounting Standards Codification, which was launched in July
2009 as the single source of authoritative US accounting standards.
If the course on “accounting
research” is to be much like a law school course on “legal research,” it
should focus on where to find answers. Denny suggested, among other things,
teaching students how to use the FASB Codification database.
As an extension, I recommend
teaching students how to use PwC’s Comperio Virtual Library of Accounting
Research ---
http://www.pwc.com/gx/en/comperio/index.jhtml
The biggest problem is the cost of a multi-user site license, although at
Trinity University our program was so small that we could teach some of the
basics with a single-user site license (which is not restricted to a given
user, but does restrict the use to one user at a time).
Such a course could also include
some tax research if the tax courses are finding it cumbersome to teach both
tax and tax research. Your college probably already has at least one tax
research license such as CCH.
Since it is so common in the
profession to use search engines, perhaps some attention could be given
to “how scholars conduct searches” ---
http://faculty.trinity.edu/rjensen/Searchh.htm#Scholars
Most definitely the above link should be studied by doctoral students.
However, undergraduates might also learn some of the basics of scholarly
search.
Bob Jensen
ASC = Accounting Standard Codification of the FASB
which
introduces the ASC. This video has potential value at the beginning of
the semester to acquaint students with the ASC. I am thinking about
posting the clip to AAA commons. But, where should it be posted and
does this type of thing get posted in multiple interest group areas?
Any
thoughts / suggestions?
Zane Swanson www.askaref.com
a handheld device source of ASC information
Jensen Comment
A disappointment for colleges and students is that access to the Codification
database is not free. The FASB does offer deeply discounted prices to colleges
but not to individual teachers or students.
This is a great video helper for learning
how to use the FASB.s Codification database.
An enormous disappointment to me is how the
Codification omits many, many illustrations in the
pre-codification pronouncements that are still available
electronically as PDF files. In particular, the best way to
learn a very complicated standard like FAS 133 is to study
the illustrations in the original FAS 133, FAS 138, etc.
The FASB paid a fortune for experts to develop
the illustrations in the pre-codification pronouncements. It's
sad that those investments are wasted in the Codification
database.
Clinging to Myths in Academe and Failure to Replicate
and Authenticate Research Findings
But sadly, the academic profession shows a strong
tendency to create stable and self-sustaining but completely false legends of
its own, and hang on to them grimly, transmitting them from article to article
and from textbook to textbook like software viruses spreading between students'
Macintoshes . . . But the lack of little things like verisimilitude and
substantiation are not enough to stop a myth. Martin tracks the great Eskimo
vocabulary hoax through successively more careless repetitions and embroiderings
in a number of popular books on language. Roger Brown's Words and Things (1958,
234-36), attributing the example to Whorf, provides an early example of careless
popularization and perversion of the issue. His numbers disagree with both Boas
and Whorf (he says there are "three Eskimo words for snow", apparently getting
this from figure 10 in Whorf's paper; perhaps he only looked at the pictures).'
Linguistics Hoax: Pullum-Eskimo Vocabulary Hoax, 1991 ---
http://www.cs.trinity.edu/~rjensen/temp/Pullum-Eskimo-VocabHoax.pdf
Article forwarded by Jagdish Gangolly
Nobel prize-winner Daniel Kahneman has issued a
strongly worded call to one group of psychologists to restore the
credibility of their field by creating a replication ring to check each
others’ results.
Kahneman, a psychologist at Princeton
University in New Jersey, addressed his
open e-mail to researchers who work on social
priming, the study of how subtle cues can unconsciously influence our
thoughts or behaviour. For example, volunteers might walk more slowly
down a corridor after seeing words related to old age1,
or fare better in general-knowledge tests after writing down the
attributes of a typical professor2.
Such tests are widely used in psychology, and
Kahneman counts himself as a “general believer” in priming effects. But
in his e-mail, seen by Nature, he writes that there is a “train
wreck looming” for the field, due to a “storm of doubt” about the
robustness of priming results.
Under fire
This scepticism has been fed by failed attempts
to replicate classic priming studies, increasing concerns about
replicability in psychology more broadly (see 'Bad
Copy'), and the exposure of fraudulent social
psychologists such as Diederik Stapel, Dirk Smeesters and Lawrence Sanna,
who used priming techniques in their work.
“For all these reasons, right or wrong, your
field is now the poster child for doubts about the integrity of
psychological research,” Kahneman writes. “I believe that you should
collectively do something about this mess.”
Kahneman’s chief concern is that graduate
students who have conducted priming research may find it difficult to
get jobs after being associated with a field that is being visibly
questioned.
“Kahneman is a hard man to ignore. I suspect
that everybody who got a message from him read it immediately,” says
Brian Nosek, a social psychologist at the University of Virginia in
Charlottesville.David Funder, at the
University of California, Riverside, and president-elect of the Society
for Personality and Social Psychology, worries that the debate about
priming has descended into angry defensiveness rather than a scientific
discussion about data. “I think the e-mail hits exactly the right tone,”
he says. “If this doesn’t work, I don’t know what will.”
Hal Pashler, a cognitive psychologist at the
University of California, San Diego, says that several groups, including
his own, have already tried to replicate well-known social-priming
findings, but have not been able to reproduce any of the effects. “These
are quite simple experiments and the replication attempts are well
powered, so it is all very puzzling. The field needs to get to the
bottom of this, and the quicker the better.”
Chain of replication
To address this problem, Kahneman recommends
that established social psychologists set up a “daisy chain” of
replications. Each lab would try to repeat a priming effect demonstrated
by its neighbour, supervised by someone from the replicated lab. Both
parties would record every detail of the methods, commit beforehand to
publish the results, and make all data openly available.
Kahneman thinks that such collaborations are
necessary because priming effects are subtle, and could be undermined by
small experimental changes.
Norbert Schwarz, a social psychologist at the
University of Michigan in Ann Arbor who received the e-mail, says that
priming studies attract sceptical attention because their results are
often surprising, not necessarily because they are scientifically
flawed.. “There is no empirical evidence that work in this area is more
or less replicable than work in other areas,” he says, although the
“iconic status” of individual findings has distracted from a larger body
of supportive evidence.
“You can think of this as psychology’s version
of the climate-change debate,” says Schwarz. “The consensus of the vast
majority of psychologists closely familiar with work in this area gets
drowned out by claims of a few persistent priming sceptics.”
Still, Schwarz broadly supports Kahneman’s
suggestion. “I will participate in such a daisy-chain if the field
decides that it is something that should be implemented,” says Schwarz,
but not if it is “merely directed at one single area of research”.
The lack of validation is an enormous problem in accountics science, but
the saving grace is that nobody much cares 574 Shields Against Validity Challenges in Plato's Cave
---
http://faculty.trinity.edu/rjensen/TheoryTAR.htm
The Now-Dubious Hawthorne Effect and the Need for Research Replication
(something that's virtually non-existent in accounting research)
Since empirical accounting research studies are almost never replicated, I've
long contended that "accountics" farmers are more interested in their tractors
than their harvests. Accounting research is almost all form rather than
substance.
Sometimes experimental outcomes impounded for years in textbooks become
viewed as "laws" by students, professors, and consultants. One example, is the
Hawthorne Effect impounded into psychology and management textbooks for the for
more than 50 years ---
http://en.wikipedia.org/wiki/Hawthorne_Effect
But Steven Levitt and John List, two economists at
the University of Chicago, discovered that the data had survived the decades in
two archives in Milwaukee and Boston, and decided to subject them to econometric
analysis. The Hawthorne experiments had another surprise in store for them.
Contrary to the descriptions in the literature, they found no systematic
evidence that levels of productivity in the factory rose whenever changes in
lighting were implemented.
"Light work," The Economist, June 4, 2009, Page 74 ---
http://www.economist.com/finance/displaystory.cfm?story_id=13788427
One problem is that if old experiments are not periodically verified in terms
of new analysis of old data or replications using new data, they become urban
legends in the literature.
If you're going to attack empirical accounting research, hit it where it
has no defenses!
One type of accounting research is "Spade Research" and our leading
Sam Spade in recent decades was Abe Briloff when he was at Baruch College in
NYC. Abe and his students diligently poured over accounting reports and
dug up where companies and/or their auditors violated accounting standards,
rules, and professional ethics. He was not at all popular in the accounting
profession because he was so good at his work. Zeff and Granof wrote as
follows:
Floyd Norris, the chief financial
correspondent of The New York Times, titled a 2006 speech to the
American Accounting Association "Where Is the Next Abe Briloff?" Abe
Briloff is a rare academic accountant. He has devoted his career to
examining the financial statements of publicly traded companies and
censuring firms that he believes have engaged in abusive accounting
practices. Most of his work has been published in Barron's and in
several books — almost none in academic journals. An accounting gadfly
in the mold of Ralph Nader, he has criticized existing accounting
practices in a way that has not only embarrassed the miscreants but has
caused the rule-making authorities to issue new and more-rigorous
standards. As Norris correctly suggested in his talk, if the academic
community had produced more Abe Briloffs, there would have been fewer
corporate accounting meltdowns.
"Research on Accounting Should Learn From the
Past," by Michael H. Granof and Stephen A. Zeff, Chronicle of Higher
Education, March 21, 2008
In the 1960s and 1970s leading academic accounting researchers
abandoned "Spade" work and loosely organized what might be termed an
Accounting Center for Disease Control where spading was replaced with mining
of databases using increasingly-sophisticated accountics (mathematical)
models. Leading academic accounting research journals virtually stopped
publishing anything but accountics research ---
http://faculty.trinity.edu/rjensen/395wpTAR/Web/TAR395wp.htm
In the past five decades readers of leading academic accounting
research journals had to accept on faith that there were no math errors in
the analysis. The reason is that no empirical accounting research is
ever exactly replicated and verified. In fact the leading academic
accounting research journals adopted policies against publishing
replications or even commentaries. The Accounting Review (TAR) does
technically allow commentaries, but in reality only about one appears each
decade.
Many of the empirical research studies are rooted in privately
collected databases that are never verified for accuracy and freedom from
bias.
On occasion empirical studies are partly verified with anecdotal
evidence. For example the excellent empirical study of Eric Lie in
Management Science on backdating of options was partly verified by court
decisions, fines, and prison sentences of some backdating executives.
However, anecdotal evidence has severe limitations since it can be cherry
picked to either validate or repudiate empirical findings at the same time.
See
http://en.wikipedia.org/wiki/Options_backdating
Replication is part and parcel to the scientific method. All
important findings in the natural sciences are replicated our verified by
some rigorous approach that convinces scientists about accuracy and freedom
from bias.
One of my most popular quotations is that "empirical
accounting farmers are more interested in their tractors than in their
harvests." When papers are presented at meetings most of the
focus is on the horsepower and driving capabilities of the tractors
(mathematical models). If the harvests were of importance to the accounting
profession, the profession would insist on replication and verification. But
the accounting profession mostly shrugs off academic accounting research as
sophisticated efforts to prove the obvious. There are few surprises in
empirical accounting research.
Another sad part about our leading academic accounting research
journals is that they have such a poor citation record relative to our
academic brethren in finance, marketing, and management. American
Accounting Association President Judy Rayburn made citation outdomes the
centerpiece of her emotional (and failed) attempt to get leading academic
accounting research journals to accept research paradigms other than
accountics paradigms ---
http://faculty.trinity.edu/rjensen/395wpTAR/Web/TAR.htm
But the saddest part of all is that the Accounting Center for Disease
Control literally took over every doctoral program in the United States
(slightly excepting Central Florida University and Kennesaw State University) by requiring that all
accounting doctoral graduates be econometricians or psychometricians. As
a result doctoral programs realistically require five years beyond the
masters degree. Accountants who enter these programs must spend years
learning mathematics, statistics, econometrics, and psychometrics.
Mathematicians who enter these programs must spend years learning
accounting. The bottom line is that practicing accountants who would like to
become accounting professors are turned off by having to study five years of
accountics. Each year the shortage of graduates from accounting doctoral
programs in North America becomes increasingly critical/
The American Accounting Association (AAA) has a new research report on
the future supply and demand for accounting faculty. There's a whole lot
of depressing colored graphics and white-knuckle handwringing about
anticipated shortages of new doctoral graduates and faculty aging, but
there's no solution offered ---
http://aaahq.org/temp/phd/AccountingFacultyUSCollegesUniv.pdf
Since empirical accounting research studies are almost never replicated, I've
long contended that "accountics" farmers are more interested in their tractors
than their harvests. Accounting research is almost all form rather than
substance.
June 11, 2009 reply from David Fordham, James Madison University
[fordhadr@JMU.EDU]
Bob (et al):
As my generation would have said: "right on".
One of my many vices is an interest in several
fields besides accounting. About a quarter of a century ago, I remember two
physicists at UofU (Stanley Pons and Martin Fleischmann, if memory serves)
who published a report about cold fusion (which technically, if you read
their paper, wasn't real fusion to start with, but alas the popular press
took their usual liberty with the facts to sell stories).
F&P's experiments were replicated out the wazoo,
and interestingly enough, their results were reproduced on an intermittent
basis: sometimes the results came up, and sometimes they didn't, using the
same experimental design over and over. To this day, those who duplicated
the results believe in their findings, while those who didn't pooh-pooh the
idea.
Because the majority of attempts didn't reproduce
the results, interest in the experiment seems to have waned, lending
credence to the idea that science is something of a democracy (complete with
lobbying, wasteful spending, campaigning, shameless lying to drum up votes,
and massive corruption) after all. If too many people vote against you,
you're toast.
But back to replications: The disappointing thing
about F&P is, no one seems to be pursuing the question of WHY the
replications produced varying results. To my mind, the question of why
replications sometimes worked and sometimes didn't was an important question
worth pursuing, but (sigh) the vagaries of the "marketplace for research",
influenced so unseemly by the vitriolic criticism of the self-proclaimed
pundits of the day on the quiet majority, seem to have let the
really-important question just fade away into the abyss of oblivion.
And I believe this is one of the maladies affecting
accounting research (assuming one buys into the position that accounting
research is beset by maladies): We seem to have lost interest in pursuing
the really important questions -- ones that might end up making a difference
-- by listening to the pundits who seem to hold undue influence over the
silent majority.
David Fordham (who never really left the abyss to
start with...)
JMU
Question
Why are accountics science journal articles cited in other accountics science
research papers so often?
Answer
Scroll down deep in this message to learn about a coercion scheme to proliferate
citations in the reference sections of journal articles. It works like this. A
prestigious accountics science research journal "suggests" that you cite some of
its previously-published articles before making a decision to accept your
submission. Scroll down deep to find out how it works.
A
survey published today in Science
shows that journal editors often ask prospective authors to add
superfluous citations of the journal to articles, and authors
feel they can’t refuse. (The Science paper is for subscribers
only, but you can read a summary here.) The extra citations
artificially inflate a journal’s impact and prestige. About
6,600 academics responded to the survey, and about 20 percent
said they had been asked to add such citations even though no
editor or reviewer had said their article was deficient without
them. About 60 percent of those surveyed said they would comply
with such a request, which was most often aimed at junior
faculty members.
Freakonomish and Simkinish processes in auditing pracice
The IASB and FASB are moving us ever closer into requiring subjective
evaluations of unique items for which CPA auditors have no comparative
advantages in evaluation. For example, CPAs have no comparative advantage in
estimating the value of unique parcels of real estate (every parcel of real
estate is unique). Another example would be the ERP system of Union Carbide
that has value to Union Carbide but cannot be dismantled and resold to any
other company.
The problem with many subjective evaluations is that the so-called
experts on those items are not consistent in their own evaluations. For
example, real estate appraisers are notoriously inconsistent, which is what
led to many of the subprime mortgage scandals when appraisers were placing
enormous values on tract housing as if the real estate bubble would never
burst. And placing a fair value on the ERP system of Union Carbide is more
of an art than a science due to so many unknowns in the future of that
worldwide company.
Freakonomish and Simkinish processes in accounting research
Secondly, accounting researchers may want to track Freakonomics and
the related works of Mikhail Simkin at UCLA. Professor Simkin made quite a
name for himself evaluating subjective evaluators and in illustrating the
art and science of subjective and science evaluations ---
http://www.ee.ucla.edu/~simkin/
And the tendency of accounting researchers to accept their empirical and
analytical academic publications as truth that does not even need a single
independent and exacting replication if Freakonomish and Simkinish in and of
itself ---
http://faculty.trinity.edu/rjensen/TheoryTAR.htm
"Measuring The Quality Of Abstract Art: Abstract artists are only 4
per cent better than child artists, according to a controversial new way of
evaluating paintings," MIT's Technology Review, June 14, 2011 ---
http://www.technologyreview.com/blog/arxiv/26882/?nlid=4597
Here's a bit of mischief from Mikhail Simkin at
the University of California, Los Angeles.
Simkin has a made a name for himself evaluating
the relative performance of various groups and individuals. On this
blog, we've looked at his work on the performance of
congress,
physicists and even
World War I
flying aces.
Today, he turns his attention to abstract
artists. For some time now, Simkin has a run an online quiz in which he
asks people to label abstract pictures either real art or fake. It's
fun--give
it a go.
One average, people answer correctly about 66
per cent of the time, which is significantly better than chance.
Various people have interpreted this result
(and others like it) as a challenge to the common claim that abstract
art by well-know artists is indistinguishable from art created by
children or animals.
Today, Simkin uses this 66 per cent figure as a
way of evaluating the work of well known artists. In particular, he asks
how much better these professional artists are than children.
First, he points out the results of another
well known experiment in which people are asked to evaluate weights by
picking them up. As the weights become more similar, it is harder to
tell which is heavier. In fact, people will say that a 100g weight is
heavier than a 96g weight only 72 per cent of the time.
"This means that there is less perceptible
difference between an abstractionist and child/animal than between 100
and 96g," says Simkin.
So on this basis, if you were to allocate
artistic 'weight' to artists and gave an abstract artist 100g, you would
have to give a child or animal 96g. In other words, there is only a 4
per cent difference between them.
That's not much!
Simkin goes on to say this is equivalent in
chess to the difference between a novice and the next ranking up, a
D-class amateur.
Question
What is "the" major difference between medical research and accounting research
published in top research journals?
Answer
Medical researchers publish a lot of research that is "misleading, exaggerated,
or flat-out wrong." The difference is that medical research eventually discovers
and corrects most published research errors. Accounting researchers rarely
discover their errors and leave these errors set in stone ad infinitum
because of a combination of factors that discourage replication and retesting of
hypotheses. To compound the problem, accounting researchers commonly purchase
their data from outfits like Audit Analytics and Compustat and make no effort to
check the validity of the data they have purchased. If some type of rare
research finding validation takes place, accounting researchers go on using the
same data. More commonly, once research using this data is initially published
in accounting research journals, independent accounting researchers do not even
replicate the research efforts to discover whether the original researchers made
errors ---
http://faculty.trinity.edu/rjensen/TheoryTAR.htm
Nearly always published accounting research, accounting research findings are
deemed truth as long they are published in top accounting research journals.
Fortunately, this is not the case in medical research even though long delays in
discovering medical research truth may be very harmful and costly.
MUCH OF WHAT MEDICAL RESEARCHERS CONCLUDE IN THEIR
STUDIES IS MISLEADING, EXAGGERATED, OR FLAT-OUT WRONG. SO WHY ARE DOCTORS—TO A
STRIKING EXTENT—STILL DRAWING UPON MISINFORMATION IN THEIR EVERYDAY PRACTICE?
DR. JOHN IOANNIDIS HAS SPENT HIS CAREER CHALLENGING HIS PEERS BY EXPOSING THEIR
BAD SCIENCE.
But beyond the headlines, Ioannidis was shocked at
the range and reach of the reversals he was seeing in everyday medical
research. “Randomized controlled trials,” which compare how one group
responds to a treatment against how an identical group fares without the
treatment, had long been considered nearly unshakable evidence, but they,
too, ended up being wrong some of the time. “I realized even our
gold-standard research had a lot of problems,” he says. Baffled, he started
looking for the specific ways in which studies were going wrong. And before
long he discovered that the range of errors being committed was astonishing:
from what questions researchers posed, to how they set up the studies, to
which patients they recruited for the studies, to which measurements they
took, to how they analyzed the data, to how they presented their results, to
how particular studies came to be published in medical journals.
This array suggested a bigger, underlying
dysfunction, and Ioannidis thought he knew what it was. “The studies were
biased,” he says. “Sometimes they were overtly biased. Sometimes it was
difficult to see the bias, but it was there.” Researchers headed into their
studies wanting certain results—and, lo and behold, they were getting them.
We think of the scientific process as being objective, rigorous, and even
ruthless in separating out what is true from what we merely wish to be true,
but in fact it’s easy to manipulate results, even unintentionally or
unconsciously. “At every step in the process, there is room to distort
results, a way to make a stronger claim or to select what is going to be
concluded,” says Ioannidis. “There is an intellectual conflict of interest
that pressures researchers to find whatever it is that is most likely to get
them funded.”
One of the more surprising things
I have learned from my experience as Senior Editor of
The Accounting
Review is just how often a
‘‘hot
topic’’
generates multiple
submissions that pursue similar research objectives. Though one might
view such situations as enhancing the credibility of research findings
through the independent efforts of multiple research teams, they often
result in unfavorable reactions from reviewers who question the
incremental contribution of a subsequent study that does not materially
advance the findings already documented in a previous study, even if the
two (or more) efforts were initiated independently and pursued more or
less concurrently. I understand the reason for a high incremental
contribution standard in a top-tier journal that faces capacity
constraints and deals with about 500 new submissions per year.
Nevertheless, I must admit that I sometimes feel bad writing a rejection
letter on a good study, just because some other research team beat the
authors to press with similar conclusions documented a few months
earlier. Research, it seems, operates in a highly competitive arena.
Fortunately, from time to time, we
receive related but still distinct submissions that, in combination,
capture synergies (and reviewer support) by viewing a broad research
question from different perspectives. The two articles comprising this
issue’s forum are a classic case in point. Though both studies reach the
same basic conclusion that material weaknesses in internal controls over
financial reporting result in negative repercussions for the cost of
debt financing, Dhaliwal et al. (2011) do so by examining the public
market for corporate debt instruments, whereas Kim et al. (2011) examine
private debt contracting with financial institutions. These different
perspectives enable the two research teams to pursue different secondary
analyses, such as Dhaliwal et al.’s examination of the sensitivity of
the reported findings to bank monitoring and Kim et al.’s examination of
debt covenants.
Both studies also overlap with yet
a third recent effort in this arena, recently published in the
Journal of
Accounting Research by Costello
and Wittenberg-Moerman (2011). Although the overall
‘‘punch
line’’
is similar in all three studies (material
internal control weaknesses result in a higher cost of debt), I am
intrigued by a ‘‘mini-debate’’
of sorts on the different
conclusions reache by Costello and Wittenberg-Moerman (2011) and
by Kim et al. (2011) for the effect of material weaknesses on debt
covenants. Specifically, Costello and Wittenberg-Moerman (2011, 116)
find that ‘‘serious,
fraud-related weaknesses result in a significant decrease in financial
covenants,’’
presumably because banks substitute more
direct protections in such instances, whereas Kim et al.
Published Online: July 2011
(2011) assert from their cross-sectional
design that company-level material weaknesses are associated with
more
financial covenants
in debt contracting.
In reconciling these conflicting
findings, Costello and Wittenberg-Moerman (2011, 116) attribute the Kim
et al. (2011) result to underlying
‘‘differences
in more fundamental firm characteristics, such as riskiness and
information opacity,’’
given that, cross-sectionally, material
weakness firms have a greater number of financial covenants than do
non-material weakness firms even
before the disclosure of the
material weakness in internal controls. Kim et al. (2011) counter that
they control for risk and opacity characteristics, and that advance
leakage of internal control problems could still result in a debt
covenant effect due to internal controls rather than underlying firm
characteristics. Kim et al. (2011) also report from a supplemental
change analysis that, comparing the pre- and post-SOX 404 periods, the
number of debt covenants falls for companies both with
and without
material weaknesses
in internal controls, raising the question of whether the
Costello and Wittenberg-Moerman
(2011) finding reflects a reaction to the disclosures or simply a more
general trend of a declining number of debt covenants affecting all
firms around that time period. I urge readers to take a look at both
articles, along with Dhaliwal et al. (2011), and draw their own
conclusions. Indeed, I believe that these sorts . . .
Continued in article
Jensen Comment
Without admitting to it, I think Steve has been embarrassed, along with many
other accountics researchers, about the virtual absence of validation and
replication of accounting science (accountics) research studies over the
past five decades. For the most part, accountics articles are either ignored
or accepted as truth without validation. Behavioral and capital markets
empirical studies are rarely (ever?) replicated. Analytical studies make
tremendous leaps of faith in terms of underlying assumptions that are rarely
challenged (such as the assumption of equations depicting utility functions
of corporations).
Accounting science thereby has become a pseudo
science where highly paid accountics professor referees are protecting each
others' butts ---
"574 Shields Against Validity Challenges in Plato's Cave" ---
http://faculty.trinity.edu/rjensen/TheoryTAR.htm
The above link contains Steve's rejoinders on the replication debate.
In the above editorial he's telling us that there is a middle ground for
validation of accountics studies. When researchers independently come to
similar conclusions using different data sets and different quantitative
analyses they are in a sense validating each others' work without truly
replicating each others' work.
I agree with Steve on this, but I would also argue that these types of
"validation" is too little to late relative to genuine science where
replication and true validation are essential to the very definition of
science. The types independent but related research that Steve is discussing
above is too infrequent and haphazard to fall into the realm of validation
and replication.
When's the last time you witnesses a TAR author criticizing the research
of another TAR author (TAR does not publish critical commentaries)?
Are TAR articles really all that above criticism? Even though I admire Steve's scholarship,
dedication, and sacrifice, I hope future TAR editors will work harder at
turning accountics research into real science!
Arrogant professors often assume that practitioner journals mostly
publish fluff. In reality, practitioner journals often publish technical
jargon papers for which academic experts are nonexistent or very rare finds
by journal editors.
One of the great myths in academe is that academic research journals are
more technical than practitioner journals. In reality sometimes academic
journal editors cannot find a professor to referee a technical paper such as
a very technical paper in insurance accounting, international tax
accounting, ERP, XBRL, or many of the esoteric subtopics in FAS 133.
In reality, practitioner journals sometimes publish articles that are
deemed too technical for academic accounting research journals. I mentioned
previously that I submitted a rejoinder article to Issues in Accounting
Education on accounting for derivative financial instruments for which the
Editor could not find a single professor to referee the article. The IAE
Editor then found to technical practitioners in Big Four firms to referee my
paper ---
http://faculty.trinity.edu/rjensen/CaseAmendment.htm
As a second illustration, two of my best technical submissions were
turned back by academic journal editors with comments that they were too
narrow and too technical for their academic readership. I then found a
practitioner journal that had both papers refereed by Wall Street experts
--- http://faculty.trinity.edu/rjensen/Resume.htm#Published
I have thought about what practice focused
accounting research would comprise and I have some difficulty seeing
what it might be. For academic research to benefit practice necessitates
that there be some generic problem of interest to practitioners. In
civil engineering, for example, academic research might contribute by
looking at the attributes of some new building material. Medicine
benefits by study of new drugs or surgical techniques and so on. But
accounting happens at the level of the particular. Each accounting
problem is unique to itself. Accounting is the process by which double
entry is applied to produce a representation of what happened (or what
might happen I suppose).
Short of the academic actually participating in
the messy practice of accounting I don’t see how they can contribute to
the real business of accounting. But then that might be the answer. In
my practice I have more accounting problems than I can practically deal
with … where are the academics and their students to help me?
June 12, 2011 reply from Bob Jensen
Hi Robert,
Research is defined as a contribution to new knowledge whereas
scholarship is the mastery of existing knowledge.
You raise three questions of interest.
The most important question is whether research on professional
problems is making a valuable contribution to the practice of
accounting? Obviously there have been valuable and monumental
changes in the practice of accounting such that it's obvious that
somewhere at some time new knowledge (research) contributed to those
changes in accounting practice. Otherwise accountants would still
be sitting on three-legged stools making journal entries and
postings with quill pens.
The second question is whether academic researchers made the
seminal contributions to valuable contributions to the practice of
accounting?
The third question is whether academic accounting researchers
made valuable additions to seminal contributions to of practitioners
and researchers in other academic disciplines?
The most important question is whether research (new
knowledge) on professional problems is making a valuable
contribution to the practice of accounting?
The answer to the first question is a resounding yes, although the
"value" of "new knowledge" contributions varies greatly by topical area.
Where would tax practice be today without research on international and
domestic taxation, including legal and economic research? Where would
accounting information systems (AIS) be today without research on
design, software, security, hardware, etc. be without research? In your
specialty, where would forensic accounting be today without research on
how and why frauds and other types of cheating take place?
The second question is whether academic researchers
made the seminal contributions to valuable contributions to the practice
of accounting?
The second question is difficult and in some cases impossible to answer
unless a "eureka moment" actually transpired that led to improvements in
accounting practice. In most instances those monumental "eureka moments"
just did not happen as research accumulated like bricks being added to a
building. Or the "eureka moments" transpired so far down at the
foundation level that they're sometimes forgotten when adding bricks to
the upper walls. For example, we can trace computer hardware back to the
"eureka moment" of the conception of a transistor (Shockley) and
millions of other Eureka moments in science and engineering technology
taking place over the past 100 years or even further back in time if we
want to delve into the "eureka moments" in electricity.
On occasion we've identified some "eureka moments" to accounting
practices. Bob Kaplan traces ABC costing back to such a moment in a John
Deere factory. Dale Flesher traced dollar-value LIFO back to a
practitioner. But those eureka moments are seldom identified since more
often than not changes in accounting practice are rooted in new
knowledge in underlying disciplines of science and engineering and the
social sciences, including economics. When there've been "eureka
moments" leading to changes in accounting practice, those moments
are almost never attributed to academic researchers. Understandably they
arise from practitioners themselves seeking ways to improve their job
functions and contributions.
Many changes in accounting practices are rooted in new knowledge of
financial contracting. Although options contracts can be traced back to
the Roman empire, things like interest rate swaps are rooted in an IBM
contract in the 1980s. And a defeasance contract can be traced back to
an Exxon contract in the 1980s. Major contributions to practice such as
the Black-Scholes Option Pricing Model can be traced to seminal moments
of academic researchers, but these seminal moments more often than not
took place outside the discipline of accounting.
Many "eureka moments" in fraud can be traced back to the perpetrators
themselves who dreamed up frauds that the rest of the world had never
dreamed of before the frauds actually transpired. Sometimes the clever
thinkers had not even finished high school.
The pickings are pretty slim when if we try to award "Walker Prizes"
to accounting professors who made "eureka moment" seminal contributions
to changes in accounting practice. As I stated above, changes in
accounting practice came more from bricks being laid in a building than
where one brick is designated as a cornerstone. The American Accounting
Association has made five "Seminal Contributions to Accounting
Literature Awards" over the years, but I doubt that most practitioners
can name even one of the seminal literature pieces, although some
might've expected Bob Kaplan to get an award for his work in ABC
Costing. But Bob will be the first to admit that the seminal
contribution to ABC Costing came from unknown practitioners in a John
Deere plant. The other recipients, including the Ball and Brown
initial award, built upon earlier research with seminal contributions in
economics and finance ---
http://aaahq.org/awards/awrd2win.htm
In any case, the changes in accounting practice that took place due to
these particular seminal contributions are very difficult to link.
Practitioners most likely would not have made any of these seminal
research award.
The third question is whether academic accounting
researchers made valuable additions to seminal contributions of
practitioners and academic researchers in other academic disciplines?
If we confine ourselves to those contributions that changed practice, we
must conclude that academic accountants have their names etched into
parts of bricks put into practice buildings. Often the incremental value
of academic accounting research is mixed into the clay and mortar along
with other ingredients such that "Walker Prizes" would be very difficult
to award in terms of a what a particular author contributed to a
particular brick in the wall of practice. Certainly tax professors have
added ingredients to changes in accounting practice. AIS professors like
Bill McCarthy have added ingredients to changes in AIS practice. The
academic works of some professors like Mary Barth have added ingredients
to accounting standards even if we cannot point to a particular
contribution that stands out above all other contributions.
Most practitioners (more than 99%) probably cannot name a single
winner of the NCAL Award and randomly picked academic accounting
teachers probably cannot do much better if pressed to name the title
and/or author of one of the literature pieces that won the monetary NCAL
Award. Most of these awards have been accoutics research awards chosen
by accountics research professors. Some NCAL Award winning articles,
especially before 1979, were actually aimed at changing accounting
practice but the changes are generally difficult to trace into practice.
There are no Nobel Prize winners here where practitioners can remember
the importance of the literature piece.
Many of the contributions of academic accounting researchers have
been important in theory even if they did not have marked impact on
practice. My best example here is the 1976 NCAL Award to Yuji Ijiri. The
contributions of Yuji to accounting practice in the Year 2080 may be
more appreciated by practitioners than it is in the Year 2011 in part
because as of 2011 Yuji's contributions are just not yet practical for
practitioners. The same might be said for Carl Devine and many of the
other recipients of this prize.
Very few NCAL Award recipients had immediate and marked impact on
practice, although the contribution of Eric Lie is an exception.
Regulators pounced upon his findings and changed practice immediately.
Sadly he is a finance professor receiving an accounting prize for an
article published in a non-accounting journal. Such is life on occasion
when awarding a Notable Contribution to Accounting Literature.
In Conclusion
In conclusion Robert, I would have to argue that accounting practice has
changed greatly in the past 700 years due to new knowledge, and new
knowledge was generated mostly by some type of research. More often than
not it was not accounting practitioners or academics who made the
seminal contributions. And more often than not the seminal contributions
were probably made by accounting practitioners vis-à-vis accounting
professors, but it is naive to deny that accounting professors did not
make research contributions that added to the clay and mortar going into
the brick walls of accounting practice.
My best example of changes in accounting practice is XBRL that is now
having and will soon have an even more monumental impact upon accounting
practice. If we try to provide seminal awards to developers of XBRL
where do we start since XBRL builds upon so many research contributions
leading up to XBRL ---
http://faculty.trinity.edu/rjensen/XBRLandOLAP.htm#Timeline
XBRL is but one brick laid upon all the bricks that are laid under
this brick ---
http://faculty.trinity.edu/rjensen/XBRLandOLAP.htm
STATIC WEB TIMELINE
Hypertext--->
PC---> GUI,Mouse --->
GML,SGML --->Internet --->Hypermedia--->HTML, HTTP,
WWW ---> DYNAMIC WEB TIMELINE
CGI,Java,JavaScript,DHTML,ActiveX,ASP ---> XML/SMIL --->RDF
and OWL ---> OLAP ---> XBRL
- SEMANTIC WEB
Charles Hoffman, a CPA practitioner, should probably get seminal
credit for making the leap from XML to the XBRL reporting system. But
since Charlie made his seminal contribution, many academic researchers
in accounting and outside accounting have made valuable contributions to
this evolving change in practice in accountancy.
It's new knowledge that leads to change Robert, and new knowledge is
research!
And research contributions are only seldom identified "eureka moments."
Bob Jensen's threads on accounting theory and research are at:
Poorly designed and executed accounting
research experiments
that are rarely, I mean very, very rarely, authenticated
Most published behavioral experiments in the top accounting journals are
virtually worthless because they are never replicated or otherwise
authenticated. Secondly most of them are cheap shots using students as
surrogates for real-world experiments in tasks that cannot be extrapolated
to the real world. The classic example of a meaningless experiment is the
Carnegie-Mellon University dissertation study by Andy Stedry.
An interesting early classic was
Andy Stedry's thesis at Carnegie-Mellon entitled Budget Control and Cost
Behavior that was published in 1960 by Prentice-Hall. Subjects
(students) in that experiment filled water bottles. Firstly, the task
itself that took each students only minutes to accomplish would be difficult
to extrapolate to real-world production lines operating day-in and day-out
in eight-hour shifts. Secondly, student tasks for nominal rewards (a few
dollars) are difficult to extrapolate to the real world where workers depend
upon production tasks for life support of themselves and their families.
Students play games; workers make livings.
The "Science
of the Sophomore" Revisited: From Conjecture to Empiricism
MICHAEL E.
GORDON
L. ALLEN SLADE
University of Tennessee, Knoxville
NEAL SCHMITT
Michigan State University
Academy
of Management Review, 1986, Vol. 11. No. 1. 191-207
The
controversy over using college students as subjects in applied research
has been a topic of philosophical discourse and empirical
investigation. Thirty-two studies are reviewed in which students and
nonstudents participated as subjects under identical conditions. In
studies reporting statistical tests of between-group differences,
the preponderance of findings indicated that the experimental results
differed in the two samples. By
contrast, no major differences associated with the type of subject were
reported in the majority of studies which did not employ statistical
procedures to compare the findings in the two samples. Explanations for
differences in the sample are offered, and serve as a basis for
recommendations for future research
Continued at
http://faculty.trinity.edu/rjensen/student1.htm
In science
there’s little doubt about what happens when one team is unable to replicate
the original team’s findings (sometimes with different methods). For
example, I doubt whether Eric Lie’s empirical findings on options backdating
would’ve had much impact if so much anecdotal evidence commenced to verify
Lie’s findings, especially the mounting court cases.
What happens in
science when one team is unable to replicate the original work it inspires a
raft of other teams to attempt replications. Eventually the truth emerges
--- I don’t think that scientists leave many unanswered questions about the
original harvest.
I was responsible for an afternoon workshop and enjoyed the
privilege to sit in on the tail end of the morning workshop on
journal editing conducted by Linda and Mike Bamber. (At the time
Linda was Editor of The Accounting Review).
I have great respect for both Linda and Mike, and my criticism
here applies to the editorial policies of the American Accounting
Association and other publishers of top accounting research
journals. In no way am I criticizing Linda and Mike for the huge
volunteer effort that both of them are giving to The Accounting
Review (TAR).
Mike’s presentation focused upon a recent publication in TAR
based upon a behavioral survey of 25 auditors. Mike greatly praised
the research and the article’s write up. My question afterwards was
whether TAR would accept an identical replication study that
confirmed the outcomes published original TAR publication. The
answer was absolutely NO! One
subsequent TAR editor even told me it would be confusing of the
replication contradicted the original study.
Now think of the absurdity of the above policy on publishing
replications. Scientists would shake their heads and snicker at
accounting research. No scientific experiment is considered worthy
until it has been independently replicated multiple times. Science
professors thus have an advantage over accounting professors in
playing the “journal hits” game for promotion and tenure, because
their top journals will publish replications. Scientists are
constantly seeking truth and challenging whether it’s really the
truth.
Thus I come to my main point that is far beyond the co-authorship
issue that stimulated this message. My main point is that in
academic accounting research publishing, we are more concerned with
the cleverness of the research than in the “truth” of the findings
themselves.
Have I become too much of a cynic in my old age? Except in a
limited number of capital markets events studies, have accounting
researchers published replications due to genuine interest by the
public in whether the earlier findings hold true? Or do we hold the
findings as self-evident on the basis of one published study with as
few as 25 test subjects? Or is there any interest in the findings
themselves to the general public apart from interest in the methods
and techniques of interest to researchers themselves?
This is
replication effort eventually failed: In Accounting We Need More of
This
Purdue University is investigating “extremely serious” concerns
about the research of Rusi Taleyarkhan, a professor of nuclear
engineering who has published articles saying that he had produced
nuclear fusion in a tabletop experiment,
The New York Timesreported.
While the research was published in Science in 2002, the findings
have faced increasing skepticism because other scientists have been
unable to replicate them. Taleyarkhan did not respond to inquiries
from The Times about the investigation. Inside Higher Ed, March 08, 2006 ---
http://www.insidehighered.com/index.php/news/2006/03/08/qt
The New York Times March 9 report is at
http://www.nytimes.com/2006/03/08/science/08fusion.html?_r=1&oref=slogin
April 22, 2012 reply from Bob Jensen
Steve Kachelmeier wrote:
"I am very proud to have accepted and
published the Magilke, Mayhew, and Pike experiment, and I think
it is excellent research, blending both psychology and economic
insights to examine issues of clear importance to accounting and
auditing. In fact, the hypocrisy somewhat amazes me that, amidst
all the complaining about a perceived excess of financial
empirical-archival (or what you so fondly call "accountics"
studies), even those studies that are quite different in style
also provoke wrath."
I
read the first 25 or so pages of the paper. As an actual
audit committee member, I feel comfortable in saying that
the assumptions going into the experiment design make no
sense whatsoever. And using students to "compete to be
hired" as audit committee members is preposterous.
I
have served on five audit committees of large public
companies, all as chairman. My compensation has included
cash, stock options, restricted stock, and unrestricted
stock. The value of those options has gone from zero to
seven figures and back to zero and there have been similar
fluctuations in the value of the stock. In no case did I
ever sell a share or exercise an option prior to leaving a
board. And in every case my *only *objective as an audit
committee member was to do my best to insure that the
company followed GAAP to the best of its abilities and that
the auditors did the very best audit possible.
No
system is perfect and not all audit committee members are
perfect (certainly not me!). But I believe that the vast
majority of directors want to do the right thing. Audit
committee members take their responsibilities extremely
seriously as evidenced by the very large number of seminars,
newsletters, etc. to keep us up to date. It's too bad that
accounting researchers can't find ways to actually measure
what is going on in practice rather than revert to silly
exercises like this paper. To have it published in the
leading accounting journal shows how out of touch the
academy truly is, I'm afraid.
Denny Beresford
Bob Jensen's Reply
Thanks Steve, but if if the Maglke, Mayhew, and Pike experiment
was such excellent research, why did no independent accountics
science researchers or practitioners find it worthy of being
validated?
The least likely accountics
science research studies to be replicated are accountics
behavioral experiments that are usually quite similar to
psychology experiments and commonly use student surrogates for
real life professionals? Why is that these studies are so very,
very rarely replicated by independent researchers using either
other student surrogates or real world professionals?
Why are these accountics
behavioral experiments virtually never worthy of replication?
Years ago I was hired, along
with another accounting professor, by the FASB to evaluate
research proposals on investigating the impact of FAS 13. The
FASB reported to us that they were interested in capital markets
studies and case studies. The one thing they explicitly stated,
however, was that they were not interested in behavioral
experiments. Wonder why?
Question
Are college students good surrogates for real life studies?
The majority of behavioral experiments in accounting have used students as
experimental subjects.
The WSJ interviewed experts on use of student surrogates. Here's
what they found:
Many of the numbers that make news about how we
feel, think and behave are derived from studying a narrow population:
college students. It's cheap for social scientists to tap into the on-campus
research pool -- everyone from psychology majors who must participate in
studies for course credit to students who respond to posters promising a few
bucks if they sign up.
Consider just three studies that have received
press in the past month. In one, muscular men were twice as likely as their
less well-built brethren to have had more than three sex partners -- at
least according to 99 UCLA undergraduates. Another, an examination of six
separate studies that tape-recorded college students' conversations, found
that women, despite being stereotyped as relatively chatty, spoke just 3%
more words each day than men. And in the third, 40 undergraduates at
Washington University in St. Louis were 6% more likely to complete verbal
jokes and 14% more likely to complete visual jests than 41 older study
participants.
College students are "essentially free," says Brian
Nosek, a psychology professor at the University of Virginia. "We walk out of
our office, and there they are." The epitome of a convenience sample, they
have become the basis for what some critics call the "science of the
sophomore."
But psychologists may be getting what they pay for.
College students aren't representative by age, wealth, income, educational
level or geographic location. "What if you studied 7-year-old kids and made
inferences about geriatrics?" asks Robert Peterson, a marketing professor at
the University of Texas, Austin. "Everyone would say you can't do that. But
you can use these college students."
Prof. Peterson scoured the literature for examples
of studies that examined the same psychological relationships in students
and nonstudents. In almost half of the 63 relationships he examined, there
were major discrepancies between students and nonstudents: The two groups
either produced contradictory results, or one showed an effect at least
twice as great as the other.
In a follow-up study, not yet published, Prof.
Peterson demonstrated that even college students are far from homogeneous.
With help from faculty at 58 schools in 31 states, he surveyed undergraduate
business students across the country and found that they vary widely from
school to school. That means a professor studying the relationship between
students' attitudes toward capitalism and business ethics at one school
could reach a sharply different conclusion than a professor at another
school.
"People have always been aware of this issue,"
Prof. Peterson says, but many have chosen to ignore it. A 1986 paper by
David Sears, a UCLA psychology professor, documented the increased use of
college students for research in the prior quarter century and explored the
potential biases that might introduce. In the meantime, the use of college
students has, if anything, risen, researchers say.
Authors of the recent studies on sex, chattiness
and humor acknowledge the limitations of their research pool. But they argue
that college students do just fine for purposes of studying basic cognitive
processes. Others agree. "If you think all people have the same attitudes as
introductory psychology students, that's really problematic," says Tony
Bogaert, a psychology professor at Brock University in St. Catharines,
Ontario. "But if you're looking at cognitive processes, intro psych students
probably work OK."
After all, every study is hampered by possible
differences between those who volunteer to participate and those who don't,
whether they're college students or a broader group.
In any case, the fault often lies not with the
researchers, who are careful not to overstate the impact of their findings,
but with the news articles suggesting the numbers apply to all humanity.
"Even if you only focus on college students, the results are still
generalizable to millions of Americans," says David Frederick, a UCLA
psychology graduate student and lead author of the study on muscularity and
sex partners.
Prof. Nosek, a critic of the science of the
sophomore, responds that college students are still developing their
personalities and behavior. "There is no other time outside my life as an
undergraduate where I thought it would be a good idea to wear all my clothes
inside out," he says, or to "stay up for as many hours in a row as I could
just to see what happens."
To widen the pool of people answering questions
about, say, all-nighters, Prof. Nosek has submitted a proposal to the
National Institutes of Health to fund the creation of an international,
online research panel. That would build on studies his laboratory has
already administered online at ProjectImplicit.net.
Online research has its own problems, but at least
it taps into the hundreds of millions of people who are online globally,
rather than just the hundreds of people enrolled in Psych 101.
"The scientific reward structure does not benefit
someone who puts in the enormous effort" to create a representative research
sample, Prof. Nosek says. "The way to change researchers' data habits is to
make it easier to collect data in a more generalizable way."
The Now-Dubious Hawthorne Effect and the Need for Research
Replication
(something that's virtually non-existent in accounting research)
Since empirical accounting research studies are almost never
replicated, I've long contended that "accountics" farmers are more
interested in their tractors than their harvests. Accounting
research is almost all form rather than substance.
Sometimes experimental outcomes impounded for years in textbooks
become viewed as "laws" by students, professors, and consultants.
One example, is the Hawthorne Effect impounded into psychology and
management textbooks for the for more than 50 years ---
http://en.wikipedia.org/wiki/Hawthorne_Effect
But Steven Levitt and John List, two
economists at the University of Chicago, discovered that the data
had survived the decades in two archives in Milwaukee and Boston,
and decided to subject them to econometric analysis. The Hawthorne
experiments had another surprise in store for them. Contrary to the
descriptions in the literature, they found no systematic evidence
that levels of productivity in the factory rose whenever changes in
lighting were implemented.
"Light work," The Economist, June 4, 2009, Page 74 ---
http://www.economist.com/finance/displaystory.cfm?story_id=13788427
One problem is that if old experiments are not periodically
verified in terms of new analysis of old data or replications using
new data, they become urban legends in the literature.
A scientist in any serious scientific
discipline, such as genetics, would be in serious trouble if his
fellow scientists were unable to confirm or replicate his claim to
have found the gene for fatness. He would gain a reputation as being
'unreliable' and universities would be reluctant to employ him. This
self-imposed insistence on rigorous methodology is however missing
from contemporary epidemiology; indeed the most striking feature is
the insouciance with which epidemiologists announce their findings,
as if they do not expect anybody to take them seriously. It would,
after all, be a very serious matter if drinking alcohol really did
cause breast cancer. James Le Fanu ---
http://www.open2.net/truthwillout/human_genome/article/genome_fanu.htm
Bob Jensen's threads on replication are at
http://faculty.trinity.edu/rjensen//theory/00overview/theory01.htm#Replication
If you're going to attack empirical accounting research, hit
it where it has no defenses!
One type of accounting research is "Spade Research" and
our leading Sam Spade in recent decades was Abe Briloff when he
was at Baruch College in NYC. Abe and his students
diligently poured over accounting reports and dug up where
companies and/or their auditors violated accounting standards,
rules, and professional ethics. He was not at all popular in the
accounting profession because he was so good at his work. Zeff
and Granof wrote as follows:
Floyd Norris, the chief
financial correspondent of The New York Times, titled a 2006
speech to the American Accounting Association "Where Is the
Next Abe Briloff?" Abe Briloff is a rare academic
accountant. He has devoted his career to examining the
financial statements of publicly traded companies and
censuring firms that he believes have engaged in abusive
accounting practices. Most of his work has been published in
Barron's and in several books — almost none in academic
journals. An accounting gadfly in the mold of Ralph Nader,
he has criticized existing accounting practices in a way
that has not only embarrassed the miscreants but has caused
the rule-making authorities to issue new and more-rigorous
standards. As Norris correctly suggested in his talk, if the
academic community had produced more Abe Briloffs, there
would have been fewer corporate accounting meltdowns.
"Research on Accounting Should Learn
From the Past," by Michael H. Granof and Stephen A. Zeff,
Chronicle of Higher Education, March 21, 2008
In the 1960s and 1970s leading academic accounting
researchers abandoned "Spade" work and loosely organized what
might be termed an Accounting Center for Disease Control where
spading was replaced with mining of databases using
increasingly-sophisticated accountics (mathematical) models.
Leading academic accounting research journals virtually stopped
publishing anything but accountics research ---
http://faculty.trinity.edu/rjensen/395wpTAR/Web/TAR395wp.htm
In the past five decades readers of leading academic
accounting research journals had to accept on faith that there
were no math errors in the analysis. The reason is that no
empirical accounting research is ever exactly replicated and
verified. In fact the leading academic accounting research
journals adopted policies against publishing replications or
even commentaries. The Accounting Review (TAR) does technically
allow commentaries, but in reality only about one appears each
decade.
Many of the empirical research studies are rooted in
privately collected databases that are never verified for
accuracy and freedom from bias.
On occasion empirical studies are partly verified with
anecdotal evidence. For example the excellent empirical
study of Eric Lie in Management Science on backdating of
options was partly verified by court decisions, fines, and
prison sentences of some backdating executives. However,
anecdotal evidence has severe limitations since it can be cherry
picked to either validate or repudiate empirical findings at the
same time. See
http://en.wikipedia.org/wiki/Options_backdating
Replication is part and parcel to the scientific method.
All important findings in the natural sciences are replicated
our verified by some rigorous approach that convinces scientists
about accuracy and freedom from bias.
One of my most popular quotations is that "empirical
accounting farmers are more interested in their tractors than in
their harvests." When papers are presented at
meetings most of the focus is on the horsepower and driving
capabilities of the tractors (mathematical models). If the
harvests were of importance to the accounting profession, the
profession would insist on replication and verification. But the
accounting profession mostly shrugs off academic accounting
research as sophisticated efforts to prove the obvious. There
are few surprises in empirical accounting research.
Another sad part about our leading academic accounting
research journals is that they have such a poor citation record
relative to our academic brethren in finance, marketing, and
management. American Accounting Association President Judy
Rayburn made citation outdomes the centerpiece of her emotional
(and failed) attempt to get leading academic accounting research
journals to accept research paradigms other than accountics
paradigms ---
http://faculty.trinity.edu/rjensen/395wpTAR/Web/TAR.htm
But the saddest part of all is that the Accounting Center
for Disease Control literally took over every doctoral program
in the United States (slightly excepting Central Florida
University and Kennesaw State University) by requiring that all accounting doctoral graduates
be econometricians or psychometricians. As a result doctoral
programs realistically require five years beyond the masters
degree. Accountants who enter these programs must spend years
learning mathematics, statistics, econometrics, and
psychometrics. Mathematicians who enter these programs must
spend years learning accounting. The bottom line is that
practicing accountants who would like to become accounting
professors are turned off by having to study five years of
accountics. Each year the shortage of graduates from accounting
doctoral programs in North America becomes increasingly
critical/
The American Accounting Association (AAA) has a new
research report on the future supply and demand for accounting
faculty. There's a whole lot of depressing colored graphics
and white-knuckle handwringing about anticipated shortages of
new doctoral graduates and faculty aging, but there's no
solution offered ---
http://aaahq.org/temp/phd/AccountingFacultyUSCollegesUniv.pdf
Since empirical accounting research studies are almost never
replicated, I've long contended that "accountics" farmers are more
interested in their tractors than their harvests. Accounting
research is almost all form rather than substance.
June 11, 2009 reply from David Fordham, James Madison University
[fordhadr@JMU.EDU]
Bob (et al):
As my generation would have said:
"right on".
One of my many vices is an interest in
several fields besides accounting. About a quarter of a century
ago, I remember two physicists at UofU (Stanley Pons and Martin
Fleischmann, if memory serves) who published a report about cold
fusion (which technically, if you read their paper, wasn't real
fusion to start with, but alas the popular press took their
usual liberty with the facts to sell stories).
F&P's experiments were replicated out
the wazoo, and interestingly enough, their results were
reproduced on an intermittent basis: sometimes the results came
up, and sometimes they didn't, using the same experimental
design over and over. To this day, those who duplicated the
results believe in their findings, while those who didn't
pooh-pooh the idea.
Because the majority of attempts didn't
reproduce the results, interest in the experiment seems to have
waned, lending credence to the idea that science is something of
a democracy (complete with lobbying, wasteful spending,
campaigning, shameless lying to drum up votes, and massive
corruption) after all. If too many people vote against you,
you're toast.
But back to replications: The
disappointing thing about F&P is, no one seems to be pursuing
the question of WHY the replications produced varying results.
To my mind, the question of why replications sometimes worked
and sometimes didn't was an important question worth pursuing,
but (sigh) the vagaries of the "marketplace for research",
influenced so unseemly by the vitriolic criticism of the
self-proclaimed pundits of the day on the quiet majority, seem
to have let the really-important question just fade away into
the abyss of oblivion.
And I believe this is one of the
maladies affecting accounting research (assuming one buys into
the position that accounting research is beset by maladies): We
seem to have lost interest in pursuing the really important
questions -- ones that might end up making a difference -- by
listening to the pundits who seem to hold undue influence over
the silent majority.
David Fordham (who never really left
the abyss to start with...)
JMU
But sadly, the academic profession shows
a strong tendency to create stable and self-sustaining but
completely false legends of its own, and hang on to them grimly,
transmitting them from article to article and from textbook to
textbook like software viruses spreading between students'
Macintoshes . . . But the lack of little things like verisimilitude
and substantiation are not enough to stop a myth. Martin tracks the
great Eskimo vocabulary hoax through successively more careless
repetitions and embroiderings in a number of popular books on
language. Roger Brown's Words and Things (1958, 234-36), attributing
the example to Whorf, provides an early example of careless
popularization and perversion of the issue. His numbers disagree
with both Boas and Whorf (he says there are "three Eskimo words for
snow", apparently getting this from figure 10 in Whorf's paper;
perhaps he only looked at the pictures).'
Linguistics Hoax: Pullum-Eskimo Vocabulary Hoax, 1991 ---
http://www.cs.trinity.edu/~rjensen/temp/Pullum-Eskimo-VocabHoax.pdf
Forwarded by Jagdish Gangolly
Steve Kachelmeier wrote: "In accounting, by contrast,
experiments often use professionals as participants, and they are in
much shorter supply. Even for those researchers (like me) who
conduct experiments with students, there is always compensation
involved, and participation is always strictly voluntary. Suffice it to say
that these aspects make our participants more difficult to get and more
costly, such that a full-scale replication project like this would
probably be cost-prohibitive."
Jensen Comment
I think if you, Steve, tabulated all the behavioral experiments
conducted by accountics scientists over the past three decades that
you will find that the overwhelming majority of the studies were
conducted on students, including many of the studies that you
approved as Senior Editor of TAR.
In general I have serious doubts about using student decision makers
in artificial and simplistic experiments where they play the
hypothetical roles of real world decision makers.
An example of a meaningless experiment using students as
surrogates is provided below.
Abstract:
We use experimental markets to examine stock-based
compensation's impact on the objectivity of participants serving
as audit committee members. We compare audit committee member
reporting objectivity under three regimes: no stock-based
compensation, stock-based compensation linked to current
shareholders, and stock-based compensation linked to future
shareholders. Our experiments show that student participants
serving as audit committee members prefer biased reporting when
compensated with stock-based compensation. Audit committee
members compensated with current stock-based compensation prefer
aggressive reporting, and audit committee members compensated
with future stock-based compensation prefer overly conservative
reporting. We find that audit committee members who do not
receive stock-based compensation are the most objective. Our
study suggests that stock-based compensation impacts audit
committee member preferences for biased reporting, suggesting
the need for additional research in this area.
Jensen Comment
I hate to keep repeating myself, but this will probably go down as
one of those student experiments that have dubious extrapolations to
the real world. The student compensation is nowhere near the
possible compensations of real board members of real corporations.
My traditional example here is my banker friend who gambles for
relatively large stakes with his poker-playing friends, but never
gambles even small time time with his local Bangor bank.
Even more discouraging is
that following decades of publications of empirical academic
research, the findings will simply be accepted as truth without ever
replicating the outcomes as would be required in real science. In
science, it's the replications that are more eagerly anticipated
than the original studies. But this is not the case in accounting
research ---
http://faculty.trinity.edu/rjensen/theory01.htm#Replication
Probably the most
fascinating study of an audit committee is the history of the
infamous Audit Committee of Enron. Evidence in retrospect seems to
point to the fact that the Audit Committee and the Board of
Directors (Bob Jaedicke was on both Boards) were truly deceived by
clever and unscrupulous Enron executives. Probably the most
penetrating study of what happened was the after-the-fact Power's
Study conducted by the Board itself ---
http://faculty.trinity.edu/rjensen/FraudEnron.htm
There are times when I'm more impressed by a sample of one than a
sample of students in an artificial experiment that is never
replicated.
I read
the first 25 or so pages of the paper. As an actual audit
committee member, I feel comfortable in saying that the
assumptions going into the experiment design make no sense
whatsoever. And using students to "compete to be hired" as audit
committee members is preposterous.
I have
served on five audit committees of large public companies, all
as chairman. My compensation has included cash, stock options,
restricted stock, and unrestricted stock. The value of those
options has gone from zero to seven figures and back to zero and
there have been similar fluctuations in the value of the stock.
In no case did I ever sell a share or exercise an option prior
to leaving a board. And in every case my *only *objective as an
audit committee member was to do my best to insure that the
company followed GAAP to the best of its abilities and that the
auditors did the very best audit possible.
No
system is perfect and not all audit committee members are
perfect (certainly not me!). But I believe that the vast
majority of directors want to do the right thing. Audit
committee members take their responsibilities extremely
seriously as evidenced by the very large number of seminars,
newsletters, etc. to keep us up to date. It's too bad that
accounting researchers can't find ways to actually measure what
is going on in practice rather than revert to silly exercises
like this paper. To have it published in the leading accounting
journal shows how out of touch the academy truly is, I'm afraid.
Denny
Beresford
July 8, 2009 reply from Bob
Jensen
Hi Denny,
It's clear why TAR
didn't send you this manuscript to referee. It would be
dangerous to have experienced audit committee members have an
input to this type of accountics research that takes place in
the academy's sandbox.
> > > I'm disturbed by the tone of
this discussion, implying that most of > accounting
research/publication is just a big game.
I think it is fair to say that some
members of this group view accounting research as a game, and a
rigged one at that. Other members of this group do not share
that view. Keeping these different perspectives in mind is
helpful when trying to make sense of the discussion.
Richard
June 17, 2009 reply from Bob Jensen
Hi Richard,
I think you're correct Richard, but until academic accountics
researchers and their leading journals begin to take replication
more seriously, it's very hard to believe in non-replicated
harvests of accountics research. Those that are truly serious
about accounting research must become more serious about
authenticating accounting research.
Perhaps it would seem less of a game if independent
researchers took the trouble to replicate findings. On occasion
there are some replications (such as the verification of Eric
Lie's stock options backdating research), but publication of
replications is indeed rare.
> I'm disturbed by the tone of this
discussion, implying that most of > accounting
research/publication is just a big game. It seems to demean
our
> efforts in a Pogo-like way (we are being our own worst
enemy if we don't
> respect our own work). Does some game-playing occur?
Undoubtedly. Is it
> the norm? I don't think so (though it's always possible
that I'm naive and
> out-of-touch)
A Pogo-like way is healthy because Pogo
was thoughtful enough to face some realities. I have done
considerable work on the structure of the US academy (as has
Bob) and the way Bob characterizes it is closer to the truth --
when work deserves to be disparaged, intellectual honesty
compels us to disparage it. At an AAA meeting a number of years
ago I listened to an editor of one of our most prominent US
accounting journals offer the following alternative hypothesis
to the one that the academy was structured to advance accounting
knowledge: "We have constructed a game to identify who the
cleverest people are so we know who to give the money to."
The research on the structure of our
academy, if viewed with an open, Pogo-like mind suggests that
this alternative hypothesis is more credible than one of being
honestly engaged in understanding (if that were the case our
research would not be almost entirely structured as tests of
conventional economic theories that are constructed not be
testable).
I have served numerous times on our
university's promotion and tenure committee. I chaired it this
past year. I have reviewed the dossiers of people from many
disciplines. In the process I have learned quite a bit about the
cultures of other disciplines. The discussion about multiple
authors, which is the rule in the hard sciences (sometimes there
are literally dozens of them), is an interesting contrast. Those
disciplines have developed protocols on the order of author
listing (it isn't alphabetical) that reflects the relative
contributions of the authors to the project.
I've seen people denied tenure because
they were not the "lead" author on enough papers. It is a system
that is self-reinforcing. Is it abused? Sure, what one isn't,
but it seems to work reasonably well. Accounting has no such
protocol. At my shop we have reached the point where the same
credit is given to a person on a three-author paper as is given
to a person with a single authored paper. Without the protocol
that exists in the natural sciences on credit for multiple
authors, there is little other way to describe our process as
other than a game.
Another protocol in the laboratory or
bench sciences is the maintenance of a lab journal. You can
always spot a lab scientist at our faculty senate meetings
because they are the people taking notes in a bound journal (a
diary). Because replication is crucial to science, there is a
moral imperative that an experimental scientist keep a precise
record of each step in the experimental process. He or she must
provide the exact recipe so that any scientist is able to
produce the result. (One of the most interesting studies of the
sociology of science involved the lab journals of Millikin
reporting his various iterations of the oil-drop experiment;
guess which ones he published -- you guessed it -- the ones most
consistent with his prior beliefs.
Without those lab journals, this
knowledge would be lost forever). Most of the work published in
our leading accounting journals is laboratory work (accountics,
as Bob describes it). Data are gathered (usually selected from a
publicly available data source) and all manner of choices are
made by the experimenter in conducting the experiment before the
final published result is obtained. For example, do we know what
truncation decisions were made or how many different models were
run before the published one arose? But we have no requirement
that the experimenter keep a detailed log of all of these
choices. We have to rely on the recipe given in the article
itself, which is seldom sufficient to replicate what was
actually done.
When Bill Cooper suggested that the AAA
require authors publishing in TAR to provide their data (not
their logs, because they don't have them) to the public, our
noted accounting scientists screamed bloody murder. We still
have only a voluntary disclosure policy. If we were truly
serious about learning something from our work, we would mandate
that sufficient information be provided to allow anyone to
replicate the experiments before we publishe the results. That
we don't do that may say something about us.
For the interested: Adil E. Shamoo and
David B. Resnik, Responsible Conduct of Research, 2003,
Oxford University Press. I took a course in this taught by one
of NC State's philosophers. There is a huge literature on
appropriate research conduct in the sciences (social and
natural). In accounting there is practically none. For a
discipline whose alleged expertise is "controls" we have
virtually none over the research process. Guess we are all
saints.
Thanks for an excellent post. For those
interested, the Shamoo and Resnik text you mention is now into
its second edition
Adil E. Shamoo and David B. Resnik,
Responsible Conduct of Research # Paperback: 440 pages #
Publisher: Oxford University Press; Second Edition edition (Feb
24 2009) # Language: English # ISBN-10: 019536824X # ISBN-13:
978-0195368246
To be clear about what I think (as if
anybody cares), I think that a substantial amount of game
playing takes place, but accounting research itself does not
need to be characterized as a game. I believe that (1) there are
many incentives to manipulate the system for personal gain, (2)
many accounting professors participate in the system and play
games because they are forced to participate and game playing
seems to be efficient and effective, and (3) there are enough
ethically challenged amongst the accounting professoriate to
justify a general world view of skepticism.
Dave Albrecht
June 20, 2009 reply from Bob Jensen
Hi David,
I wish I could repeat some private
messages I'm receiving from accounting professors about
(ratting?) how some of their colleagues are gaming the
research/publishing system.
Most mention a 99-1 model or its
near-equivalent. Others mention the 98-1-1 model. The worst is a
message revealing a 94-1-1-1-1-1-1-model.
Of course I believe many, probably most,
joint authoring efforts are legitimate for reasons astutely
mentioned by Ron Huefner. But there also is a lot a gaming going
on.
Paul Williams notes that at every
juncture empirical accounting researchers make subjective
decisions that make it almost impossible to truly replicate
outcomes. In a private message he notes that a top researcher
(who chaired a lot of doctoral dissertations) made an on-campus
presentation in which he admitted to 16 times in his research
study being presented where he made decisions that would've made
it virtually impossible to independently replicate his work. The
source of the data was a commercial database that can be
purchased by anybody, but it alone would not have been
sufficient for research outcomes authentication.
It would seem that if the top research
journals announced a change in policy and invited submissions of
research replications there might be few submissions that
actually authenticate earlier published outcomes. Until
accounting researchers commence
keeping "lab journal" (and making them available to teams of
authentication researchers) I doubt that there will be serious
replication of empirical academic accounting research. Until
then we must, in the words of Paul Williams, regard our
empirical accounting researchers as "saints."
What's more
disheartening are reports of failed efforts to replicate the
empirical results of some of the AAA's Seminal and/or Notable
contributions award winners. The makes me wonder if another type
of gaming (selectively massaging of data) is going on at the
highest level of prestige in academic accounting research.
Judging the Relevance of Fair Values for Financial Statements
Since fair value accounting is arguably the hottest accounting
theory/practice topic among accounting standard setters and financial
analysts these days, I was naturally attracted to the following accountics
science research article:
"Judging the Relevance of Fair Values for Financial Statements," by Lisa
Koonce, Karen K. Nelson, and Catherine M. Shakespeare, The Accounting
Review, Volume 86, 2075-2098.November 2011, pp. 2075-2098
ABSTRACT:
We conduct three experiments to test if
investors' views about fair value are contingent on whether the
financial instrument in question is an asset or liability, whether fair
values produce gains or losses, and whether the item will or will not be
sold/settled soon. We draw on counterfactual reasoning theory from
psychology, which suggests that these factors are likely to influence
whether investors consider fair value as providing information about
forgone opportunities. The latter, in turn, is predicted to influence
investors' fair value relevance judgments. Results are generally
supportive of the notion that judgments about the relevance of fair
value are contingent. Attempts to influence investors' fair value
relevance judgments by providing them with information about forgone
opportunities are met with mixed success. In particular, our results are
sensitive to the type of information provided and indicate the
difficulty of overcoming investors' (apparent) strong beliefs about fair
value.
. . .
Fair value proponents maintain that, no matter
the circumstance, fair value provides information about forgone
opportunities that affect the economics of the firm (Hague and Willis
1999). That is, proponents of fair value would argue that such
information is always relevant to evaluating a firm.
To be concrete, consider the following example.
Company X issues bonds payable at par in the amount of $1,000,000. Two
years after issuing the bonds, interest rates fall and so the fair value
of the bonds is $1,200,000. From a discounted cash flow perspective,
although the cash outflows have not changed, the discount rate has
decreased. This denominator change leads to a greater negative present
value associated with Company X having debt with fixed cash
outflows—that is, it leads to a fair value loss. A fair value advocate
would argue that the $200,000 loss is always relevant to the evaluation
of the firm as it represents a forgone opportunity—that is, the present
value of the additional interest cost (i.e., above current market rates)
that Company X will pay over the remaining term of the bond, essentially
because Company X did not refinance before rates changed (Hague and
Willis 1999). Accordingly, fair value advocates would maintain that
Company X's valuation should decrease as its cash flows are higher than
an otherwise identical company (say, Company Y) that financed after the
rate decrease. Stated differently, at the end of the financing period,
Company X's cash balance will be lower than Company Y's (because X is
paying a higher interest rate) and, thus, each firm's valuation should
reflect this real economic difference.4
If investors follow the logic of the fair value
advocate and consider fair value gains and losses as representing
forgone opportunities, they are essentially engaging in a process that
psychologists call counterfactual reasoning (Roese 1997). In this type
of reasoning, individuals “undo” outcomes by changing (or mutating) the
cause that led to them. For example, if only the driver had not taken an
unusual route home late at night, he would not have gotten into an
accident. In the fair value domain, the calculation of fair value is
based on the same type of simulation as counterfactual
reasoning—“undoing” the actual contractual interest rate and replacing
it with the current market rate of interest that the company would be
paying if management had undertaken an alternative set of actions (i.e.,
the forgone opportunity). As the above numerical example illustrates,
determining the amount of the fair value gain or loss is fairly
mechanical once an interest (or discount) rate change occurs. The more
subtle effect is whether the investor considers the fair value gain or
loss as a forgone opportunity and thus relevant to evaluating the firm.
If investors do (do not) follow a process similar to counterfactual
reasoning, they are more (are less) likely to judge fair value
measurements as relevant.
Thinking about fair value in terms of
counterfactual reasoning is helpful, as this theory suggests when
investors' fair value judgments are likely to depend on context. Prior
research in psychology indicates that counterfactual thinking is more
likely when events are seen as abnormal versus normal, when negative
rather than positive events occur, when the outcome or antecedent is
mutable or changeable, or when the outcome is close versus more distant
in time (Roese and Olson 1995). Drawing on this research, we identify
three fair value contexts for financial instruments—namely, assets
versus liabilities, gains versus losses, and held to maturity versus
sold/settled soon—that we posit will cause investors to change their
fair value relevance judgments.5 That is, we predict that investors'
views about the relevance of fair value will not be unwavering, as
proponents of fair value would maintain, but rather will be contingent
on context. Relevance of Fair Value Depending on Context
Fair value accounting is currently being used
for financial instruments that are either assets or liabilities (but not
for equity items). In addition, fair value accounting produces both
gains and losses. Accordingly, a natural question is whether investors
reason differently about the relevance of fair value for assets versus
liabilities and for gains versus losses. Counterfactual reasoning theory
suggests that investors treat these situations differently.
Turning first to gains and losses, prior
literature (e.g., Roese 1997) indicates that counterfactual reasoning is
more likely when undesirable outcomes occur. Here, individuals tend to
evaluate the undesirable outcome by determining how easy it is to
mentally undo it. In the fair value context, this would entail reasoning
about how the fair value loss could have been avoided. In contrast,
counterfactual reasoning is less likely with desirable outcomes like
fair value gains. In the case of such desirable outcomes, individuals
have less need to understand the cause of the gain and are unlikely to
mentally undo the outcome (Roese 1997). Accordingly, we hypothesize:
H1:
Individuals will judge fair value losses as
more relevant than fair value gains.
In the context of assets versus liabilities,
counterfactual reasoning theory suggests that the more mutable an item
is (i.e., the easier an outcome can be undone), the more likely an
individual will engage in counterfactual reasoning (McGill and
Tenbrunsel 2000). For example, if a parachuter falls to his death,
individuals are more likely to consider mutable factors in considering
how he could have avoided death. That is, “if only he had rechecked the
safety cord before jumping” is more likely to be considered (i.e., it is
more mutable) than “if only gravity were not at work.”
We predict that, in the eyes of investors,
financial assets are perceived to be more mutable than financial
liabilities. In other words, it is easier to consider an alternative set
of actions for assets than for liabilities. This idea comes from the
line of reasoning that individuals generally think they can more easily
sell, for example, a bond investment than they can settle a home loan.
That is, it is easier for them to simulate an alternative set of actions
for (i.e., counterfactually reason about) assets than liabilities.6
Accordingly, we hypothesize: H2:
Individuals will judge the fair value of
financial assets as more relevant than the fair value of financial
liabilities.
Finally, we posit that management's intent
likely influences investors' judgments about fair value relevance.
Research shows that perceived closeness to an outcome affects whether
individuals engage in counterfactual reasoning (Meyers-Levy and
Maheswaran 1992). For example, a traveler who misses his/her flight by
five minutes is more likely to engage in counterfactual reasoning (i.e.,
“if only I had run the yellow stop light, I'd have made it to the gate
on time”) than a traveler who misses the flight by one hour. Drawing on
this idea, we maintain that individuals will be more inclined to think
about “if only” when the financial instrument is to be sold/settled soon
as compared to when it is to be held to maturity. Counterfactual
reasoning seems particularly likely here, particularly in the case of
loss outcomes. Individuals will likely think, for example, “if only the
company had sold the investment before the fair value decreased, they
would not be in this position today.” Accordingly, we hypothesize: H3:
Individuals will judge the fair value of
financial instruments that are to be sold/settled soon as more relevant
than those that are to be held to maturity. Changing Investor Judgments
about Fair Value Relevance
Because we conjecture that investors' judgments
about fair value relevance will depend on the context, we believe it is
possible to desensitize their judgments to context (Arkes 1991). In
particular, we surmise that providing information about forgone
opportunities should influence investors' understanding of the fair
value change and, ultimately, will influence their fair value relevance
judgments. This approach of providing individuals with a summary of the
information that they may not normally consider is frequently employed
as a “fix” in various decision settings (Arkes 1991). We summarize our
expectations in the following hypothesis. H4:
Individuals will judge the relevance of fair
value for financial instruments as greater when they are given
information about forgone alternatives.
Continued in article
Jensen Comment
I like this paper in terms of it's originality and clever ideas in terms of
accounting theory, especially the concept of counterfactual reasoning.
But like nearly all accountics behavioral experiments reported over the
past four decades, I'm disappointed in how the hypotheses were actually
tested. I'm also disappointed in the virtual lack of validity testing and
replication of behavioral accounting studies, but it's too early to
speculate on future replication studies of this particular November 2011
article.
To their credit, Professors Koonce, Nelson, and Shakespeare conducted
three experiments rather than just one experiment, although from a picky
point of view these would not constitute independent replications in science
---
http://faculty.trinity.edu/rjensen/TheoryTAR.htm
Also to their credit the sample sizes are large enough to almost make
statistical inference testing superfluous.
But I just cannot get excited about extrapolating research findings form
students as surrogates for investors and analysts in the real world. This is
a typical example of where accountics researchers tried to do their research
without having to set foot off campus.
Even if these researchers had stepped off campus to conduct their
experiments on real-world investors and analysts, I have difficulty with
assigning the research subjects artificial/hypothetical tasks even though my
own doctoral thesis entailed submitting hypothetical proxy reports to
real-world security analysts. My favorite criticism is an anecdotal
experience with one banker who was an extremely close friend when I lived in
Bangor, Maine while on the faculty of the University of Maine. I played
poker or bridge with this banker at least once a week. With relatively small
stakes in a card game he was a reckless fool in his betting and nearly
always came up a money loser at the end of the night. But in real life he
was a Yankee banker who was known in the area for his tight-fisted
conservatism.
And thus I have a dilemma. Even if there are ten replications of these
experiments using real world investors and analysts I cannot get excited
about the accountics science outcomes. I would place much more faith in a
protocol analysis of one randomly selected CFA, but protocol researchers are
not allowed to publish their small sample studies in TAR, JAR, or JAE. They
can, however, find publishing outlets in social science research journals.
http://en.wikipedia.org/wiki/Protocol_analysis
The best known protocol analysis in accounting and finance was the
award-winning doctoral thesis research of Geoffrey Clarkson at
Carnegie-Mellon, although the integrity of his research was later
challenged.
Few
studies have examined the impact of age on
reactivity to concurrent think-aloud (TA) verbal
reports. An initial
study with 30 younger and 31 older adults revealed
that thinking aloud improves older adult performance
on a short form of the Raven's Matrices (Bors &
Stokes, 1998, Educational and Psychological
Measurement, 58, p. 382) but did not affect other
tasks. In the replication experiment, 30
older adults (mean age = 73.0) performed the Raven's
Matrices and three other tasks to replicate and
extend the findings of the initial study. Once again
older adults performed significantly better only on
the Raven's Matrices while thinking aloud.
Performance gains
on this task were substantial (d = 0.73 and 0.92 in
Experiments 1 and 2, respectively), corresponding to
a fluid intelligence increase of nearly one standard
deviation.
Source: "How to Gain
Eleven IQ Points in Ten Minutes: Thinking Aloud
Improves Raven's Matrices Performance in Older
Adults" from Aging, Neuropsychology, and Cognition,
Volume 17, Issue 2 March 2010 , pages 191 - 204
Speaking of smarts and genius,
if you haven't read it, Dave Eggers' book
A Heartbreaking Work of
Staggering Geniusis a lot of
fun. I highly recommend the introduction, oddly
enough.
This takes me back to long ago to "Protocol Analysis" when having
subjects think aloud was documented in an effort to examine what information
was used and how it was used in decision making. One of the first Protocol
Analysis studies that I can recall was at Carnegie-Mellon when Geoffrey
Clarkson wrote a doctoral thesis on a bank's portfolio manager thinking
aloud while making portfolio investment decisions for clients. Although
there were belated questions about the integrity of Jeff's study, one thing
that stuck out in my mind is how accounting choices (LIFO vs. FIFO,
straight-line vs. accelerated depreciation) were ignored entirely when the
decision maker analyzed financial statements. This is one of those now rare
books that I still have in some pile in my studio: Geoffrey Clarkson,
Portfolio Selection-A Simulation of. Trust Investment(Englewood Cliffs, N. J.: Prentice-Hall,. Inc., 1962)
Clarkson reached a controversial conclusion that his model could choose the
same portfolios as the live decision maker. That was the part that was later
questioned by researchers.
Another application of Protocol Analysis was the doctoral thesis of Stan
Biggs.
As cited in The Accounting Review in January, 1988 ---
http://www.jstor.org/pss/247685
By the way, this one one of those former years when TAR had a section for
"Small Sample Studies" (those fell by the board in later years)
Added Jensen Comment
An early precursor of the concept of "counterfactual reasoning" is
"functional fixation"
Accounting History Trivia
What accounting professors coined the phrase "functional fixation" in 1966
and in what particular accounting context?
Hint 1
Two of the three authors were my Ph.D. program advisors at Stanford
University years ago.
Hint 2
Bob Ashton did some cognitive experimentation of functional fixation that
was published in the Journal of Accounting Research a decade later in
1976.
Answer
Y. Ijiri, R.K. Jaedicke and K.E. Knight, "The Effects of Accounting
Alternatives on Management Decisions," in R.K. Jaedicke, Y. Ijiri and 0.
Nelson (Eds.), Research in Accounting Measurement , American
Accounting Association, 1966, pp. 18
Recently, several accounting studies have made
use of concepts and relationships from the field of cognitive
psychology. For example, Ijiri, Jaedicke and Knight employed the notion
of functional fixation to describe an individual's adaptiveness to a
change in accounting process. Similarly, Livingstone referred to
learning sets in explaining why some 2 utilities were slow in adjusting
to accounting changes. In addition, Revsine employed the conceptual
abstractness construct to speculate on its possible moderating effects
in an experimental situation, and on its significance with respect to
information overload. Yet, despite this interest in relationships
between cognitive factors and information usage, little empirical study
has been done of the role that cognitive factors may play in accounting.
To become more inventive, new research
suggests, we should start thinking about common items in terms of their
component parts, decoupling their names from their uses.
When we think of an object (a candle, say) we
tend to think of its name, appearance, and purpose all at once. We have
expectations about how the candle works and what we can do with it.
Psychologists call this rigid thinking "functional fixedness."
Tony McCaffrey, a postdoctoral researcher at
the University of Massachusetts Amherst, developed a two-step "generic
parts technique," which trains people to overcome functional fixedness.
First, break down the items at hand into their basic parts, then name
each part in a way that does not imply meaning. Using his technique, a
candle becomes wax and string. Seeing the wick as a string is key:
calling it a "wick" implies that its use is to be lit, but calling it a
"string" opens up new possibilities.
Subjects he trained in this technique readily
mastered it and solved 67% more problems requiring creative insight than
subjects who did not learn the technique, according to his study
published in March in Psychological Science.
For instance, when given metal rings and a
candle and asked to connect the rings together, those who named the
candle's generic parts realized the wick could be used to tie up the
rings. Another problem asked subjects to build a simple circuit board
with a terminal, wires and a screwdriver, but the wires were too short.
Those who renamed the shaft of the screwdriver a "four-inch length of
metal" realized it could be used to bridge the gap and conduct
electricity.
Continued in article
More on Where Accountics Research Went Wrong
June 10, 2010 reply from Richard Sansing
Dan,
I'm confident that you can answer the question
you posed, but since you asked me I will answer.
The TAR article by Fellingham and Newman,
"Strategic considerations in auditing", The Accounting Review 60
(October): 634-50, is certainly a compression of the audit process.
I find it insightful because it highlights the difference in alpha and
beta risks when auditors and clients are thought of as self-interested,
maximizing agents.
Richard Sansing
June 11, 2011 reply from Bob Jensen
Hi Richard,
Has there ever been an audit that
measured Type II (Beta) error?? Do you have some great examples where
Type II error is actually measured (or specified) in TAR, JAR, or JAE
articles?
There are only a few, very few, books
that I keep beside my computer work station inside the cottage. Most of
my books are on shelves in my outside studio that's now more of a
library than an office. One of my prized textbooks that I always keep
close at hand is an old statistics textbook. I keep it beside me because
it's the best book I've ever studied regarding Type tI error. It reminds
me of how quality control engineers often measure Type II error, whereas
accounting researchers almost never measure Type II error.
In one of my statistics courses
(Stanford) years ago from Jerry Lieberman, we used that fantastic
Engineering Statistics textbook book authored by Bowker and Lieberman
that contained OC curves for Type II error.
In practice, Type II errors are seldom
measured in statistical inference due to lack of robustness regarding
distributional assumption errors (notably unknown standard deviations) ,
although quality control guys sometimes know enough about the
distributions and standard deviations to test for Type II error using
Operating Characteristic Curves. Also there are trade offs since the
Type I and Type II errors are not independent of one another. Accounting
researchers take the easy way out by testing Type I error and ignoring
Type II error even though in most instances Type II error is the most
interesting error in empirical research.
Of course increasing sample sizes solved
many of these Type I and II inference testing problems, but for very
large sample sizes what's the point of inference testing in the first
place? I often chuckle at capital markets studies that do inference
testing on very large sample sizes. These seem to be just window
dressing to appease journal referees.
What might be more interesting in
auditing are Type III and Type IV errors discussed by Mitroff and
Silvers in their 2009 book entitled Dirty Rotten Strategies (ISBN
978-0-8047-5996-0). Type III errors arise from skilled investigation of
the wrong questions. Type IV errors are similar except they entail
deliberately selecting the wrong questions to investigate.
Has anybody ever tested Type III error
in TAR, JAR, or JAE?
Bob Jensen
June 12, 2011 replies from Dan Stone and
from Paul Williams
> Thanks Richard,
>
> Got it. Thanks
for clarifying. Based on your response, here's a draft
> letter from you,
Professor Demski, and Professor Zimmerman to parents,
> administrators,
and legislators.
Dan Stone
Dan,
I have resisted
entering this thread, but your hypothetical letter compels me to
provide a few anecdotes about the 10% of the insightful compression
papers that do make it into print. The first two are very public
episodes. Watts and Zimmerman's Notable Contribution prize winning
paper that "verified" the believability of P/A stories was
replicated by McKee, Bell and Boatsman. The significance of the
replication was that it made more realistic statistical assumptions
and, voila, the significance went away. Of course that didn't deter
anyone from continuing to tell this story or at least seek to tell
richer, more insightful stories.
The second involves
another notable contribution paper published by W&Z, the famous
Market for Excuses paper. As Charles Christensen and later Tinker
and Puxty demonstrated the paper was incoherent from the start since
it was self-contradictory (among many other flaws). The paper may
have been good libertarian politics but it was not very good
science.
My third anecdote
involves a comment I wrote for Advances in Public Interest
Accounting many years ago. It was a comment on a paper by Ed
Arrington. In that comment I used a widely cited P/A paper (one
that made Larry Brown's list in his AOS classic papers paper) as an
example to illustrate the ideologicial blinders that afflict too
many accounting researchers; we always tend to find what we are
looking for -- perhaps because the insightful compressions we are
looking for have to be consistent with Demski and Zimmerman's views
on the way the world should be (it certainly isn't the way the world
is). One comment I made on this P/A paper pertained to the
statistical analysis and it was, basically, that the statistically
significant variables really explained nothing and that there was no
story there.
To seek assurance I was
on some kind of solid ground I took my comments and the paper to a
colleague who was an econometrician (a University of Chicago Ph.D).
Back in those days there was no college of management at NC State,
only the department of economics and business, which was comprised
of all economists except one finance prof and the folks in
accounting. Three days after I gave him the material he called me
into to his office to assure me I was correct in my interpretation
and he made a gesture quite profound, given the metaphor about waste
baskets. He picked up the paper (published in one of the premier
journals) and threw it in his waste basket. He said, "That is where
this paper belongs." My issue with TAR, etc. is just this -- even
the 10% of papers we do publish aren't very good "science" (which is
not definitive of a "form" that scholarship must have).
Abstract:
We use experimental markets to examine stock-based
compensation's impact on the objectivity of participants serving
as audit committee members. We compare audit committee member
reporting objectivity under three regimes: no stock-based
compensation, stock-based compensation linked to current
shareholders, and stock-based compensation linked to future
shareholders. Our experiments show that student participants
serving as audit committee members prefer biased reporting when
compensated with stock-based compensation. Audit committee
members compensated with current stock-based compensation prefer
aggressive reporting, and audit committee members compensated
with future stock-based compensation prefer overly conservative
reporting. We find that audit committee members who do not
receive stock-based compensation are the most objective. Our
study suggests that stock-based compensation impacts audit
committee member preferences for biased reporting, suggesting
the need for additional research in this area.
Jensen Comment
I hate to keep repeating myself, but this will probably go down as
one of those student experiments that have dubious extrapolations to
the real world. The student compensation is nowhere near the
possible compensations of real board members of real corporations.
My traditional example here is my banker friend who gambles for
relatively large stakes with his poker-playing friends, but never
gambles even small time time with his local Bangor bank.
Even more discouraging is
that following decades of publications of empirical academic
research, the findings will simply be accepted as truth without ever
replicating the outcomes as would be required in real science. In
science, it's the replications that are more eagerly anticipated than
the original studies. But this is not the case in accounting
research ---
http://faculty.trinity.edu/rjensen/theory01.htm#Replication
Probably the most
fascinating study of an audit committee is the history of the
infamous Audit Committee of Enron. Evidence in retrospect seems to
point to the fact that the Audit Committee and the Board of
Directors (Bob Jaedicke was on both Boards) were truly deceived by
clever and unscrupulous Enron executives. Probably the most
penetrating study of what happened was the after-the-fact Power's
Study conducted by the Board itself ---
http://faculty.trinity.edu/rjensen/FraudEnron.htm
There are times when I'm more impressed by a sample of one than a
sample of students in an artificial experiment that is never
replicated.
I read
the first 25 or so pages of the paper. As an actual audit
committee member, I feel comfortable in saying that the
assumptions going into the experiment design make no sense
whatsoever. And using students to "compete to be hired" as audit
committee members is preposterous.
I have
served on five audit committees of large public companies, all
as chairman. My compensation has included cash, stock options,
restricted stock, and unrestricted stock. The value of those
options has gone from zero to seven figures and back to zero and
there have been similar fluctuations in the value of the stock.
In no case did I ever sell a share or exercise an option prior
to leaving a board. And in every case my *only *objective as an
audit committee member was to do my best to insure that the
company followed GAAP to the best of its abilities and that the
auditors did the very best audit possible.
No
system is perfect and not all audit committee members are
perfect (certainly not me!). But I believe that the vast
majority of directors want to do the right thing. Audit
committee members take their responsibilities extremely
seriously as evidenced by the very large number of seminars,
newsletters, etc. to keep us up to date. It's too bad that
accounting researchers can't find ways to actually measure what
is going on in practice rather than revert to silly exercises
like this paper. To have it published in the leading accounting
journal shows how out of touch the academy truly is, I'm afraid.
Denny
Beresford
July 8, 2009 reply from Bob
Jensen
Hi Denny,
It's clear why TAR
didn't send you this manuscript to referee. It would be
dangerous to have experienced audit committee members have an
input to this type of accountics research that takes place in
the academy's sandbox.
Economic
Theory Errors That Become Accounting Theory Errors in Analytics
Where analytical mathematics in accountics research made a huge mistake relying
on flawed economic theory and interval/ratio scaling
Jensen Comment
The same applies to not over-relying on historical data in valuation. My
favorite case study that I used for this in teaching is the following:
Questrom vs. Federated Department
Stores, Inc.: A Question of Equity Value," by University of Alabama faculty
members by Gary Taylor, William Sampson, and Benton Gup, May 2001
edition of Issues in Accounting Education ---
http://faculty.trinity.edu/rjensen/roi.htm
Jensen Comment
I want to especially thank
David Stout, Editor of the May 2001
edition of Issues in Accounting Education. There has been
something special in all the editions edited by David, but the May
edition is very special to me. All the articles in that edition are
helpful, but I want to call attention to three articles that I will use
intently in my graduate Accounting Theory course.
"Questrom vs. Federated
Department Stores, Inc.: A Question of Equity Value," by University
of Alabama faculty members Gary Taylor, William Sampson, and
Benton Gup, pp. 223-256.
This is perhaps the best short case that I've ever read. It will
undoubtedly help my students better understand weighted average cost
of capital, free cash flow valuation, and the residual income
model. The three student handouts are outstanding. Bravo to
Taylor, Sampson, and Gup.
"Using the Residual-Income
Stock Price Valuation Model to Teach and Learn Ratio Analysis," by
Robert Halsey, pp. 257-276.
What a follow-up case to the Questrom case mentioned above! I have
long used the Dupont Formula in courses and nearly always use the
excellent paper entitled "Disaggregating the ROE:
A New Approach," by T.I. Selling and C.P.
Stickney,Accounting Horizons, December 1990,
pp. 9-17. Halsey's paper guides students through the swamp of stock
price valuation using the residual income model (which by the way is
one of the few academic accounting models that has had a major
impact on accounting practice, especially consulting practice in
equity valuation by CPA firms).
"Developing Risk Skills:
An Investigation of Business Risks and Controls at Prudential
Insurance Company of America," by Paul Walker, Bill Shenkir, and
Stephen Hunn, pp. 291
I will use this case to vividly illustrate the "tone-at-the-top"
importance of business ethics and risk analysis. This is case is
easy to read and highly informative.
The second is the comment that Joan Robinson made
about American Keynsians: that their theories were so flimsy that they had to
put math into them. In accounting academia, the shortest path to respectability
seems to be to use math (and statistics), whether meaningful or not. Professor Jagdish Gangolly, SUNY
Albany
"Measuring Pension Liabilities under GASB Statement No. 68," by John W.
Mortimer and Linda R. Henderson, Accounting Horizons, September 2014,
Vol. 28, No. 3, pp. 421-454 ---
http://aaajournals.org/doi/full/10.2308/acch-50710
While retired government employees clearly depend on public sector
defined benefit pension funds, these plans also contribute significantly
to U.S. state and national economies. Growing public concern about the
funding adequacy of these plans, hard hit by the great recession, raises
questions about their future viability. After several years of study,
the Governmental Accounting Standards Board (GASB) approved two new
standards, GASB 67 and 68, with the goal of substantially improving the
accounting for and transparency of financial reporting of
state/municipal public employee defined benefit pension plans. GASB 68,
the focus of this paper, requires state/municipal governments to
calculate and report a net pension liability based on a single discount
rate that combines the rate of return on funded plan assets with a
low-risk index rate on the unfunded portion of the liability. This paper
illustrates the calculation of estimates for GASB 68 reportable net
pension liabilities, funded ratios, and single discount rates for 48
fiscal year state employee defined benefit plans by using an innovative
valuation model and readily available data. The results show
statistically significant increases in reportable net pension
liabilities and decreases in the estimated hypothetical GASB 68 funded
ratios and single discount rates. Our sensitivity analyses examine the
effect of changes in the low-risk rate and time period on these results.
We find that reported discount rates of weaker plans approach the
low-risk rate, resulting in higher pension liabilities and creating
policy incentives to increase risky assets in pension portfolios.
Levels of Measurement ---
http://en.wikipedia.org/wiki/Level_of_measurement Note: The difference between covariance and correlation analysis is
largely the difference between interval vs. ratio scales
1 theory of scale types
1.1 Nominal scale
1.2 Ordinal scale
1.3 Cardinal: Interval scale (no common zero point)
1.4 Cardinal: Ratio measurement (having a common zero point)
2 Debate on classification scheme
3 Scale types and Stevens' "operational theory of measurement"
4 Notes
5 References
6 See also 7 External links
Economists distinguish between
cardinal utility and
ordinal utility. When cardinal utility is used,
the magnitude of utility differences is treated as an ethically or
behaviorally significant quantity. On the other hand, ordinal utility
captures only ranking and not strength of preferences. An important example
of a cardinal utility is the probability of achieving some target.
Utility functions of both sorts assign
real numbers ("utils") to members of a choice set.
For example, suppose a cup of orange juice has utility of 120 utils, a cup
of tea has a utility of 80 utils, and a cup of water has a utility of 40
utils. When speaking of cardinal utility, it could be concluded that the cup
of orange juice is better than the cup of tea by exactly the same amount by
which the cup of tea is better than the cup of water. One is not entitled to
conclude, however, that the cup of tea is two thirds as good as the cup of
juice, because this conclusion would depend not only on magnitudes of
utility differences, but also on the "zero" of utility.
It is tempting when dealing with cardinal utility
to aggregate utilities across persons. The argument against this is that
interpersonal comparisons of utility are suspect because there is no good
way to interpret how different people value consumption bundles.
When ordinal utilities are used, differences in
utils are treated as ethically or behaviorally meaningless: the utility
values assigned encode a full behavioral ordering between members of a
choice set, but nothing about strength of preferences. In the above
example, it would only be possible to say that juice is preferred to tea to
water, but no more.
Neoclassical economics has largely retreated from
using cardinal utility functions as the basic objects of economic analysis,
in favor of considering agent
preferences over choice sets. As will be seen in
subsequent sections, however, preference relations can often be rationalized
as utility functions satisfying a variety of useful properties.
Ordinal utility functions are equivalent
up to monotone transformations, while cardinal
utilities are equivalent up to positive linear transformations.
“Recent research has
revealed errors at the foundations of economic theory, game theory, and
other disciplines including utility scale values” Oh no say it ain’t so….
"For five years, Li's formula, known as a
Gaussian copula function, looked like an unambiguously positive
breakthrough, a piece of financial technology that allowed hugely
complex risks to be modeled with more ease and accuracy than ever
before. With his brilliant spark of mathematical legerdemain, Li made it
possible for traders to sell vast quantities of new securities,
expanding financial markets to unimaginable levels.
His method was adopted by everybody from bond
investors and Wall Street banks to ratings agencies and regulators. And
it became so deeply entrenched—and was making people so much money—that
warnings about its limitations were largely ignored.
Then the model fell apart." The article goes on to show that correlations
are at the heart of the problem.
"The reason that ratings agencies and investors
felt so safe with the triple-A tranches was that they believed there was
no way hundreds of homeowners would all default on their loans at the
same time. One person might lose his job, another might fall ill. But
those are individual calamities that don't affect the mortgage pool much
as a whole: Everybody else is still making their payments on time.
But not all calamities are individual, and
tranching still hadn't solved all the problems of mortgage-pool risk.
Some things, like falling house prices, affect a large number of people
at once. If home values in your neighborhood decline and you lose some
of your equity, there's a good chance your neighbors will lose theirs as
well. If, as a result, you default on your mortgage, there's a higher
probability they will default, too. That's called correlation—the degree
to which one variable moves in line with another—and measuring it is an
important part of determining how risky mortgage bonds are."
I would highly recommend reading the entire thing that gets much more
involved with the
actual formula etc.
The
“math error” might truly be have been an error or it might have simply been a
gamble with what was perceived as miniscule odds of total market failure.
Something similar happened in the case of the trillion-dollar disastrous 1993
collapse of Long Term Capital Management formed by Nobel Prize winning
economists and their doctoral students who took similar gambles that ignored the
“miniscule odds” of world market collapse -- -
http://faculty.trinity.edu/rjensen/FraudRotten.htm#LTCM
The rhetorical question is whether the failure is ignorance in model building or
risk taking using the model?
Wall Street’s Math Wizards Forgot a Few Variables What wasn’t recognized was the importance of a
different species of risk — liquidity risk,” Stephen Figlewski, a professor of
finance at the Leonard N. Stern School of Business at New York University, told
The Times. “When trust in counterparties is lost, and markets freeze up so there
are no prices,” he said, it “really showed how different the real world was from
our models.
DealBook, The New York Times, September 14, 2009 ---
http://dealbook.blogs.nytimes.com/2009/09/14/wall-streets-math-wizards-forgot-a-few-variables/
2012 AAA Meeting Plenary
Speakers and Response Panel Videos ---
http://commons.aaahq.org/hives/20a292d7e9/summary
I think you have to be a an AAA member and log into the AAA Commons to view
these videos.
Bob Jensen is an obscure speaker following the handsome Rob Bloomfield
in the 1.02 Deirdre McCloskey Follow-up Panel—Video ---
http://commons.aaahq.org/posts/a0be33f7fc
What a wonderful speaker Deidre McCloskey!
Reminded me of JR Hicks who also was a stammerer. For an economist, I
was amazed by her deep and remarkable understanding of statistics.
It was nice to hear about Gossett, perhaps the
only human being who got along well with both Karl Pearson and R.A.
Fisher, getting along with the latter itself a Herculean feat.
Gosset was helped in the mathematical
derivation of small sample theory by Karl Pearson, he did not appreciate
its importance, it was left to his nemesis R.A. Fisher. It is remarkable
that he could work with these two giants who couldn't stand each other.
I remember my father (who designed experiments
in horticulture for a living) telling me the virtues of balanced designs
at the same time my professors in school were extolling the virtues of
randomisation.
In Gosset we also find seeds of Bayesian
thinking in his writings.
While I have always had a great regard for
Fisher (visit to the tree he planted at the Indian Statistical Institute
in Calcutta was for me more of a pilgrimage), I think his influence on
the development of statistics was less than ideal.
Regards,
Jagdish
Jagdish S. Gangolly
Department of Informatics College of Computing & Information
State University of New York at Albany
Harriman Campus, Building 7A, Suite 220
Albany, NY 12222 Phone: 518-956-8251, Fax: 518-956-8247
Hi Jagdish,
You're one of the few people who can really appreciate Deidre's scholarship
in history, economics, and statistics. When she stumbled for what seemed
like forever trying to get a word out, it helped afterwards when trying to
remember that word.
Interestingly, two Nobel economists slugged out the very essence of theory
some years back. Herb Simon insisted that the purpose of theory was to
explain. Milton Friedman went off on the F-Twist tangent saying that it was
enough if a theory merely predicted. I lost some (certainly not all) respect
for Friedman over this. Deidre, who knew Milton, claims that deep in his
heart, Milton did not ultimately believe this to the degree that it is
attributed to him. Of course Deidre herself is not a great admirer of Neyman,
Savage, or Fisher.
Friedman's essay
"The
Methodology of Positive Economics" (1953)
provided the
epistemological pattern for his own subsequent
research and to a degree that of the Chicago School. There he argued
that economics as science should be free of value judgments for
it to be objective. Moreover, a useful economic theory should be judged
not by its descriptive realism but by its simplicity and fruitfulness as
an engine of prediction. That is, students should measure the accuracy
of its predictions, rather than the 'soundness of its assumptions'. His
argument was part of an ongoing debate among such statisticians as
Jerzy Neyman,
Leonard Savage, and
Ronald Fisher.
In
particular, a dominant trend in critical theory was the rejection of
the concept of objectivity as something that rests on a more or less
naive epistemology: a simple belief that “facts” exist in some
pristine state untouched by “theory.” To avoid being naive, the
dutiful student learned to insist that, after all, all facts come to
us embedded in various assumptions about the world. Hence (ta da!)
“objectivity” exists only within an agreed-upon framework. It is
relative to that framework. So it isn’t really objective....
What
Mohanty found in his readings of the philosophy of science were much
less naïve, and more robust, conceptions of objectivity than the
straw men being thrashed by young Foucauldians at the time. We are
not all prisoners of our paradigms. Some theoretical frameworks
permit the discovery of new facts and the testing of interpretations
or hypotheses. Others do not. In short, objectivity is a possibility
and a goal — not just in the natural sciences, but for social
inquiry and humanistic research as well.
Mohanty’s
major theoretical statement on PPR arrived in 1997 with Literary
Theory and the Claims of History: Postmodernism, Objectivity,
Multicultural Politics (Cornell University Press). Because
poststructurally inspired notions of cultural relativism are usually
understood to be left wing in intention, there is often a tendency
to assume that hard-edged notions of objectivity must have
conservative implications. But Mohanty’s work went very much against
the current.
“Since the
lowest common principle of evaluation is all that I can invoke,”
wrote Mohanty, complaining about certain strains of multicultural
relativism, “I cannot — and consequently need not — think about how
your space impinges on mine or how my history is defined together
with yours. If that is the case, I may have started by declaring a
pious political wish, but I end up denying that I need to take you
seriously.”
PPR
did not require throwing out the multicultural baby with the
relativist bathwater, however. It meant developing ways to think
about cultural identity and its discontents. A number of Mohanty’s
students and scholarly colleagues have pursued the implications of
postpositive identity politics.
I’ve written elsewhere
about Moya, an associate professor of English at Stanford University
who has played an important role in developing PPR ideas about
identity. And one academic critic has written
an interesting review essay
on early postpositive scholarship — highly recommended for anyone
with a hankering for more cultural theory right about now.
Not
everybody with a sophisticated epistemological critique manages to
turn it into a functioning think tank — which is what started to
happen when people in the postpositive circle started organizing the
first Future of Minority Studies meetings at Cornell and Stanford in
2000. Others followed at the University of Michigan and at the
University of Wisconsin in Madison. Two years ago FMS applied for a
grant from Mellon Foundation, receiving $350,000 to create a series
of programs for graduate students and junior faculty from minority
backgrounds.
The FMS
Summer Institute, first held in 2005, is a two-week seminar with
about a dozen participants — most of them ABD or just starting their
first tenure-track jobs. The institute is followed by a much larger
colloquium (the part I got to attend last week). As schools of
thought in the humanities go, the postpositivists are remarkably
light on the in-group jargon. Someone emerging from the Institute
does not, it seems, need a translator to be understood by the
uninitated. Nor was there a dominant theme at the various panels I
heard.
Rather, the
distinctive quality of FMS discourse seems to derive from a certain
very clear, but largely unstated, assumption: It can be useful for
scholars concerned with issues particular to one group to listen to
the research being done on problems pertaining to other groups.
That sounds
pretty simple. But there is rather more behind it than the belief
that we should all just try to get along. Diversity (of background,
of experience, of disciplinary formation) is not something that
exists alongside or in addition to whatever happens in the “real
world.” It is an inescapable and enabling condition of life in a
more or less democratic society. And anyone who wants it to become
more democratic, rather than less, has an interest in learning to
understand both its inequities and how other people are affected by
them.
A case in
point might be the findings discussed by Claude Steele, a professor
of psychology at Stanford, in a panel on Friday. His paper reviewed
some of the research on “identity contingencies,” meaning “things
you have to deal with because of your social identity.” One such
contingency is what he called “stereotype threat” — a situation in
which an individual becomes aware of the risk that what you are
doing will confirm some established negative quality associated with
your group. And in keeping with the threat, there is a tendency to
become vigilant and defensive.
Steele did
not just have a string of concepts to put up on PowerPoint. He had
research findings on how stereotype threat can affect education. The
most striking involved results from a puzzle-solving test given to
groups of white and black students. When the test was described as a
game, the scores for the black students were excellent —
conspicuously higher, in fact, than the scores of white students.
But in experiments where the very same puzzle was described as an
intelligence test, the results were reversed. The black kids scores
dropped by about half, while the graph for their white peers spiked.
The only
variable? How the puzzle was framed — with distracting thoughts
about African-American performance on IQ tests creating “stereotype
threat” in a way that game-playing did not.
Steele also
cited an experiment in which white engineering students were given a
mathematics test. Just beforehand, some groups were told that Asian
students usually did really well on this particular test. Others
were simply handed the test without comment. Students who heard
about their Asian competitors tended to get much lower scores than
the control group.
Extrapolate
from the social psychologist’s experiments with the effect of a few
innocent-sounding remarks — and imagine the cumulative effect of
more overt forms of domination. The picture is one of a culture that
is profoundly wasteful, even destructive, of the best abilities of
many of its members.
“It’s not
easy for minority folks to discuss these things,” Satya Mohanty told
me on the final day of the colloquium. “But I don’t think we can
afford to wait until it becomes comfortable to start thinking about
them. Our future depends on it. By ‘our’ I mean everyone’s future.
How we enrich and deepen our democratic society and institutions
depends on the answers we come up with now.”
Earlier this year,
Oxford University Press published a major new work on postpositivist
theory,
Visible Identities: Race, Gender, and the Self,by Linda
Martin Alcoff, a professor of philosophy at Syracuse University.
Several essays from the book are available at
the
author’s Web site.
A few weeks ago, TechCrunch published a piece
arguing software is better at investing than 99% of human investment
advisors. That post, titled
Thankfully, Software Is Eating The Personal Investing World,
pointed out the advantages of engineering-driven
software solutions versus emotionally driven human judgment. Perhaps not
surprisingly, some commenters (including some financial advisors) seized the
moment to call into question one of the foundations of software-based
investing, Modern Portfolio Theory.
Given the doubts raised by a small but vocal
chorus, it’s worth spending some time to ask if we need a new investing
paradigm and if so, what it should be. Answering that question helps show
why MPT still is the best investment methodology out there; it enables the
automated, low-cost investment management offered by a new wave of Internet
startups including
Wealthfront
(which I advise),
Personal Capital,
Future Advisor
and SigFig.
The basic questions being raised about MPT run
something like this:
Hasn’t recent experience – i.e., the financial
crisis — shown that diversification doesn’t work?
Shouldn’t we primarily worry about “Black
Swan” events and unforeseen risk?
Don’t these unknown unknowns mean we must
develop a new approach to investing?
Let’s begin by briefly laying out the key insights
of MPT.
MPT is based in part on the assumption that most
investors don’t like risk and need to be compensated for bearing it. That
compensation comes in the form of higher average returns. Historical data
strongly supports this assumption. For example, from 1926 to 2011 the
average (geometric) return on U.S. Treasury Bills was 3.6%. Over the same
period the average return on large company stocks was 9.8%; that on small
company stocks was 11.2% ( See 2012 Ibbotson Stocks, Bonds, Bills and
Inflation (SBBI) Valuation Yearbook, Morningstar, Inc., page 23. ). Stocks,
of course, are much riskier than Treasuries, so we expect them to have
higher average returns — and they do.
One of MPT’s key insights is that while investors
need to be compensated to bear risk, not all risks are rewarded. The market
does not reward risks that can be “diversified away” by holding a bundle of
investments, instead of a single investment. By recognizing that not all
risks are rewarded, MPT helped establish the idea that a diversified
portfolio can help investors earn a higher return for the same amount of
risk.
To understand which risks can be diversified away,
and why, consider Zynga. Zynga hit $14.69 in March and has since dropped to
less than $2 per share. Based on what’s happened over the past few months,
the major risks associated with Zynga’s stock are things such as delays in
new game development, the fickle taste of consumers and changes on Facebook
that affect users’ engagement with Zynga’s games.
For company insiders, who have much of their wealth
tied up in the company, Zynga is clearly a risky investment. Although those
insiders are exposed to huge risks, they aren’t the investors who determine
the “risk premium” for Zynga. (A stock’s risk premium is the extra return
the stock is expected to earn that compensates for the stock’s risk.)
Rather, institutional funds and other large
investors establish the risk premium by deciding what price they’re willing
to pay to hold Zynga in their diversified portfolios. If a Zynga game is
delayed, and Zynga’s stock price drops, that decline has a miniscule effect
on a diversified shareholder’s portfolio returns. Because of this, the
market does not price in that particular risk. Even the overall turbulence
in many Internet stocks won’t be problematic for investors who are well
diversified in their portfolios.
Modern Portfolio Theory focuses on constructing
portfolios that avoid exposing the investor to those kinds of unrewarded
risks. The main lesson is that investors should choose portfolios that lie
on the Efficient Frontier, the mathematically defined curve that describes
the relationship between risk and reward. To be on the frontier, a portfolio
must provide the highest expected return (largest reward) among all
portfolios having the same level of risk. The Internet startups construct
well-diversified portfolios designed to be efficient with the right
combination of risk and return for their clients.
Now let’s ask if anything in the past five years
casts doubt on these basic tenets of Modern Portfolio Theory. The answer is
clearly, “No.” First and foremost, nothing has changed the fact that there
are many unrewarded risks, and that investors should avoid these risks. The
major risks of Zynga stock remain diversifiable risks, and unless you’re
willing to trade illegally on inside information about, say, upcoming
changes to Facebook’s gaming policies, you should avoid holding a
concentrated position in Zynga.
The efficient frontier is still the desirable place
to be, and it makes no sense to follow a policy that puts you in a position
well below that frontier.
Most of the people who say that “diversification
failed” in the financial crisis have in mind not the diversification gains
associated with avoiding concentrated investments in companies like Zynga,
but the diversification gains that come from investing across many different
asset classes, such as domestic stocks, foreign stocks, real estate and
bonds. Those critics aren’t challenging the idea of diversification in
general – probably because such an effort would be nonsensical.
True, diversification across asset classes didn’t
shelter investors from 2008’s turmoil. In that year, the S&P 500 index fell
37%, the MSCI EAFE index (the index of developed markets outside North
America) fell by 43%, the MSCI Emerging Market index fell by 53%, the Dow
Jones Commodities Index fell by 35%, and the Lehman High Yield Bond Index
fell by 26%. The historical record shows that in times of economic distress,
asset class returns tend to move in the same direction and be more highly
correlated. These increased correlations are no doubt due to the increased
importance of macro factors driving corporate cash flows. The increased
correlations limit, but do not eliminate, diversification’s value. It would
be foolish to conclude from this that you should be undiversified. If a seat
belt doesn’t provide perfect protection, it still makes sense to wear one.
Statistics show it’s better to wear a seatbelt than to not wear one.
Similarly, statistics show diversification reduces risk, and that you are
better off diversifying than not.
Timing the market
The obvious question to ask anyone who insists
diversification across asset classes is not effective is: What is the
alternative? Some say “Time the market.” Make sure you hold an asset class
when it is earning good returns, but sell as soon as things are about to go
south. Even better, take short positions when the outlook is negative. With
a trustworthy crystal ball, this is a winning strategy. The potential gains
are huge. If you had perfect foresight and could time the S&P 500
on a daily basis, you could have turned $1,000 on Jan. 1, 2000, into
$120,975,000 on Dec. 31, 2009, just by going in and out of the market. If
you could also short the market when appropriate, the gains would have been
even more spectacular!
Sometimes, it seems someone may have a fairly
reliable crystal ball. Consider John Paulson, who in 2007 and 2008 seemed so
prescient in profiting from the subprime market’s collapse. It appears,
however, that Mr. Paulson’s crystal ball became less reliable after his
stunning success in 2007. His Advantage Plus fund experienced more than a
50% loss in 2011. Separating luck from skill is often difficult.
Some people try to come up with a way to time the
market based on historical data. In fact a large number of strategies will
work well “in the back test.” The question is whether any system is reliable
enough to use for future investing.
There are at least three reasons to be cautious
about substituting a timing system for diversification.
First, a timing system that does not work can
impose significant transaction costs (including avoidable adverse tax
consequences) on the investor for no gain.
Second, an ill-founded timing strategy
generally exposes the investor to risk that is unrewarded. In other
words, it puts the investor below the frontier, which is not a good
place to be.
Third, a timing system’s success may create
the seeds of its own destruction. If too many investors blindly follow
the strategy, prices will be driven to erase any putative gains that
might have been there, turning the strategy into a losing proposition.
Also, a timing strategy designed to “beat the market” must involve
trading into “good” positions and away from “bad” ones. That means there
must be a sucker (or several suckers) available to take on the other
(losing) sides. (No doubt in most cases each party to the trade thinks
the sucker is on the other side.)
Black Swans
What about those Black Swans? Doesn’t MPT ignore
the possibility that we can be surprised by the unexpected? Isn’t it
impossible to measure risk when there are unknown unknowns?
Most people recognize that financial markets are
not like simple games of chance where risk can be quantified precisely. As
we’ve seen (e.g., the “Black Monday” stock market crash of 1987 and the
“flash crash” of 2010), the markets can produce extreme events that hardly
anyone contemplated as a possibility. As opposed to poker, where we always
draw from the same 52-card deck, in financial markets, asset returns are
drawn from changing distributions as the world economy and financial
relationships change.
Some Black Swan events turned out to have limited
effects on investors over the long term. Although the market dropped
precipitously in October 1987, it was close to fully recovered in June 1988.
The flash crash was confined to a single day.
This is not to say that all “surprise” events are transitory. The Great
Depression followed the stock market crash of 1929, and the effects of the
financial crisis in 2007 and 2008 linger on five years later.
The question is, how should we respond to
uncertainties and Black Swans? One sensible way is to be more diligent in
quantifying the risks we can see. For example, since extreme events don’t
happen often, we’re likely to be misled if we base our risk assessment on
what has occurred over short time periods. We shouldn’t conclude that just
because housing prices haven’t gone down over 20 years that a housing
decline is not a meaningful risk. In the case of natural disasters like
earthquakes, tsunamis, asteroid strikes and solar storms, the long run could
be very long indeed. While we can’t capture all risks by looking far back in
time, taking into account long-term data means we’re less likely to be
surprised.
Some people suggest you should respond to the risk
of unknown unknowns by investing very conservatively. This means allocating
most of the portfolio to “safe assets” and significantly reducing exposure
to risky assets, which are likely to be affected by Black Swan surprises.
This response is consistent with MPT. If you worry about Black Swans, you
are, for all intents and purposes, a very risk-averse investor. The MPT
portfolio position for very risk-averse investors is a position on the
efficient frontier that has little risk.
The cost of investing in a low-risk position is a
lower expected return (recall that historically the average return on stocks
was about three times that on U.S. Treasuries), but maybe you think that’s a
price worth paying. Can everyone take extremely conservative positions to
avoid Black Swan risk? This clearly won’t work, because some investors must
hold risky assets. If all investors try to avoid Black Swan events, the
prices of those risky assets will fall to a point where the forecasted
returns become too large to ignore.
Continued in article
Jensen Comment
All quant theories and strategies in finance are based upon some foundational
assumptions that in rare instances turn into the
Achilles'
heel of the entire superstructure. The classic example is the wonderful
theory and arbitrage strategy of Long Term Capital Management (LTCM) formed by
the best quants in finance (two with Nobel Prizes in economics). After
remarkable successes one nickel at a time in a secret global arbitrage strategy
based heavily on the Black-Scholes Model, LTCM placed a trillion dollar bet that
failed dramatically and became the only hedge fund that nearly imploded all of
Wall Street. At a heavy cost, Wall Street investment bankers pooled billions of
dollars to quietly shut down LTCM ---
http://faculty.trinity.edu/rjensen/FraudRotten.htm#LTCM
So what was the Achilles heal of the arbitrage strategy of LTCM? It was an
assumption that a huge portion of the global financial market would not collapse
all at once. Low and behold, the Asian financial markets collapsed all at once
and left LTCM naked and dangling from a speculative cliff.
There is a tremendous (one of the best
videos I've ever seen on the Black-Scholes Model) PBS Nova video called
"Trillion Dollar Bet" explaining why LTCM
collapsed. Go to
http://www.pbs.org/wgbh/nova/stockmarket/
This video is in the media libraries on most college campuses. I highly
recommend showing this video to students. It is extremely well done and
exciting to watch.
The principal
policy issue arising out of the events surrounding the near collapse of LTCM
is how to constrain excessive leverage. By increasing the chance that
problems at one financial institution could be transmitted to other
institutions, excessive leverage can increase the likelihood of a general
breakdown in the functioning of financial markets. This issue is not limited
to hedge funds; other financial institutions are often larger and more
highly leveraged than most hedge funds.
The video and above reports, however, do not delve into the tax shelter
pushed by Myron Scholes and his other LTCM partners. A nice summary of the tax
shelter case with links to other documents can be found at
http://www.cambridgefinance.com/CFP-LTCM.pdf
The above August 27,
2004 ruling by Judge Janet Bond Arterton rounds out the "Trillion Dollar Bet."
The classic and enormous scandal was
Long Term Capital led by Nobel Prize winning Merton and Scholes (actually the
blame is shared with their devoted doctoral students). There is a tremendous
(one of the best videos I've ever seen on the Black-Scholes Model) PBS Nova
video ("Trillion Dollar Bet") explaining why LTC collapsed. Go to
http://www.pbs.org/wgbh/nova/stockmarket/
Another illustration of the Achilles' heel of a popular mathematical theory
and strategy is the 2008 collapse mortgage-backed CDO financial risk bonds based
upon David Li's Gaussian copula function of risk diversification in portfolios.
The Achilles' heel was the assumption that the real estate bubble would not
burst to a point where millions of subprime mortgages would all go into default
at roughly the same time.
"For five years, Li's formula, known as a
Gaussian copula function, looked like an unambiguously positive
breakthrough, a piece of financial technology that allowed hugely
complex risks to be modeled with more ease and accuracy than ever
before. With his brilliant spark of mathematical legerdemain, Li made it
possible for traders to sell vast quantities of new securities,
expanding financial markets to unimaginable levels.
His method was adopted by everybody from bond
investors and Wall Street banks to ratings agencies and regulators. And
it became so deeply entrenched—and was making people so much money—that
warnings about its limitations were largely ignored.
Then the model fell apart." The article goes on to show that correlations
are at the heart of the problem.
"The reason that ratings agencies and investors
felt so safe with the triple-A tranches was that they believed there was
no way hundreds of homeowners would all default on their loans at the
same time. One person might lose his job, another might fall ill. But
those are individual calamities that don't affect the mortgage pool much
as a whole: Everybody else is still making their payments on time.
But not all calamities are individual, and
tranching still hadn't solved all the problems of mortgage-pool risk.
Some things, like falling house prices, affect a large number of people
at once. If home values in your neighborhood decline and you lose some
of your equity, there's a good chance your neighbors will lose theirs as
well. If, as a result, you default on your mortgage, there's a higher
probability they will default, too. That's called correlation—the degree
to which one variable moves in line with another—and measuring it is an
important part of determining how risky mortgage bonds are."
I would highly recommend reading the entire thing that gets much more
involved with the
actual formula etc.
The
“math error” might truly be have been an error or it might have simply been a
gamble with what was perceived as miniscule odds of total market failure.
Something similar happened in the case of the trillion-dollar disastrous 1993
collapse of Long Term Capital Management formed by Nobel Prize winning
economists and their doctoral students who took similar gambles that ignored the
“miniscule odds” of world market collapse -- -
http://faculty.trinity.edu/rjensen/FraudRotten.htm#LTCM
The rhetorical question is whether the failure is ignorance in model building or
risk taking using the model?
ROBERT RUBIN was Bill Clinton’s treasury
secretary. He has worked at the top of Goldman Sachs and Citigroup. But he
made arguably the single most influential decision of his long career in
1983, when as head of risk arbitrage at Goldman he went to the MIT Sloan
School of Management in Cambridge, Massachusetts, to hire an economist
called Fischer Black.
A decade earlier Myron Scholes, Robert
Merton and Black had explained how to use share prices to calculate the
value of derivatives. The Black-Scholes options-pricing model was more than
a piece of geeky mathematics. It was a manifesto, part of a revolution that
put an end to the anti-intellectualism of American finance and transformed
financial markets from bull rings into today’s quantitative powerhouses.
Yet, in a roundabout way, Black’s approach also led to some of the late
boom’s most disastrous lapses.
Derivatives markets are not new, nor are
they an exclusively Western phenomenon. Mr Merton has described how Osaka’s
Dojima rice market offered forward contracts in the 17th century and
organised futures trading by the 18th century. However, the growth of
derivatives in the 36 years since Black’s formula was published has taken
them from the periphery of financial services to the core.
In “The Partnership”, a history of Goldman
Sachs, Charles Ellis records how the derivatives markets took off. The
International Monetary Market opened in 1972; Congress allowed trade in
commodity options in 1976; S&P 500 futures launched in 1982, and options on
those futures a year later. The Chicago Board Options Exchange traded 911
contracts on April 26th 1973, its first day (and only one month before
Black-Scholes appeared in print). In 2007 the CBOE’s volume of contracts
reached almost 1 trillion.
Trading has exploded partly because
derivatives are useful. After America came off the gold standard in 1971,
businesses wanted a way of protecting themselves against the movements in
exchange rates, just as they sought protection against swings in interest
rates after Paul Volcker, Mr Greenspan’s predecessor as chairman of the Fed,
tackled inflation in the 1980s. Equity options enabled investors to lay off
general risk so that they could concentrate on the specific types of
corporate risk they wanted to trade.
The other force behind the explosion in
derivatives trading was the combination of mathematics and computing. Before
Black-Scholes, option prices had been little more than educated guesses. The
new model showed how to work out an option price from the known price-behaviour
of a share and a bond. It is as if you had a formula for working out the
price of a fruit salad from the prices of the apples and oranges that went
into it, explains Emanuel Derman, a physicist who later took Black’s job at
Goldman. Confidence in pricing gave buyers and sellers the courage to pile
into derivatives. The better that real prices correlate with the unknown
option price, the more confidently you can take on any level of risk. “In a
thirsty world filled with hydrogen and oxygen,” Mr Derman has written,
“someone had finally worked out how to synthesise H2O.”
Poetry in Brownian motion Black-Scholes is
just a model, not a complete description of the world. Every model makes
simplifications, but some of the simplifications in Black-Scholes looked as
if they would matter. For instance, the maths it uses to describe how share
prices move comes from the equations in physics that describe the diffusion
of heat. The idea is that share prices follow some gentle random walk away
from an equilibrium, rather like motes of dust jiggling around in Brownian
motion. In fact, share-price movements are more violent than that.
Over the years the “quants” have found
ways to cope with this—better ways to deal with, as it were, quirks in the
prices of fruit and fruit salad. For a start, you can concentrate on the
short-run volatility of prices, which in some ways tends to behave more like
the Brownian motion that Black imagined. The quants can introduce sudden
jumps or tweak their models to match actual share-price movements more
closely. Mr Derman, who is now a professor at New York’s Columbia University
and a partner at Prisma Capital Partners, a fund of hedge funds, did some of
his best-known work modelling what is called the “volatility smile”—an
anomaly in options markets that first appeared after the 1987 stockmarket
crash when investors would pay extra for protection against another imminent
fall in share prices.
The fixes can make models complex and
unwieldy, confusing traders or deterring them from taking up new ideas.
There is a constant danger that behaviour in the market changes, as it did
after the 1987 crash, or that liquidity suddenly dries up, as it has done in
this crisis. But the quants are usually pragmatic enough to cope. They are
not seeking truth or elegance, just a way of capturing the behaviour of a
market and of linking an unobservable or illiquid price to prices in traded
markets. The limit to the quants’ tinkering has been not mathematics but the
speed, power and cost of computers. Nobody has any use for a model which
takes so long to compute that the markets leave it behind.
The idea behind quantitative finance is to
manage risk. You make money by taking known risks and hedging the rest. And
in this crash foreign-exchange, interest-rate and equity derivatives models
have so far behaved roughly as they should.
A muddle of mortgages Yet the idea behind
modelling got garbled when pools of mortgages were bundled up into
collateralised-debt obligations (CDOs). The principle is simple enough.
Imagine a waterfall of mortgage payments: the AAA investors at the top catch
their share, the next in line take their share from what remains, and so on.
At the bottom are the “equity investors” who get nothing if people default
on their mortgage payments and the money runs out.
Despite theory, CDOs were hopeless, at
least with hindsight (doesn’t that phrase come easily?). The cash flowing
from mortgage payments into a single CDO had to filter up through several
layers. Assets were bundled into a pool, securitised, stuffed into a CDO,
bits of that plugged into the next CDO and so on and on. Each source of a
CDO had interminable pages of its own documentation and conditions, and a
typical CDO might receive income from several hundred sources. It was a
lawyer’s paradise.
This baffling complexity could hardly be
more different from an equity or an interest rate. It made CDOs impossible
to model in anything but the most rudimentary way—all the more so because
each one contained a unique combination of underlying assets. Each CDO would
be sold on the basis of its own scenario, using central assumptions about
the future of interest rates and defaults to “demonstrate” the payouts over,
say, the next 30 years. This central scenario would then be “stress-tested”
to show that the CDO was robust—though oddly the tests did not include a 20%
fall in house prices.
This was modelling at its most feeble.
Derivatives model an unknown price from today’s known market prices. By
contrast, modelling from history is dangerous. There was no guarantee that
the future would be like the past, if only because the American housing
market had never before been buoyed up by a frenzy of CDOs. In any case,
there are not enough past housing data to form a rich statistical picture of
the market—especially if you decide not to include the 1930s nationwide fall
in house prices in your sample.
Neither could the models take account of
falling mortgage-underwriting standards. Mr Rajan of the University of
Chicago says academic research suggests mortgage originators, keen to
automate their procedures, stopped giving potential borrowers lengthy
interviews because they could not easily quantify the firmness of someone’s
handshake or the fixity of their gaze. Such things turned out to be better
predictors of default than credit scores or loan-to-value ratios, but the
investors at the end of a long chain of securities could not monitor lending
decisions.
The issuers of CDOs asked rating agencies
to assess their quality. Although the agencies insist that they did a
thorough job, a senior quant at a large bank says that the agencies’ models
were even less sophisticated than the issuers’. For instance, a BBB tranche
in a CDO might pay out in full if the defaults remained below 6%, and not at
all once they went above 6.5%. That is an all-or-nothing sort of return,
quite different from a BBB corporate bond, say. And yet, because both shared
the same BBB rating, they would be modelled in the same way.
Issuers like to have an edge over the
rating agencies. By paying one for rating the CDOs, some may have laid
themselves open to a conflict of interest. With help from companies like
Codefarm, an outfit from Brighton in Britain that knew the agencies’ models
for corporate CDOs, issuers could build securities with any risk profile
they chose, including those made up from lower-quality ingredients that
would nevertheless win AAA ratings. Codefarm has recently applied for
administration.
There is a saying on Wall Street that the
test of a product is whether clients will buy it. Would they have bought
into CDOs had it not been for the dazzling performance of the quants in
foreign-exchange, interest-rate and equity derivatives? There is every sign
that the issuing banks believed their own sales patter. The banks so liked
CDOs that they held on to a lot of their own issues, even when the idea
behind the business had been to sell them on. They also lent buyers much of
the money to bid for CDOs, certain that the securities were a sound
investment. With CDOs in deep trouble, the lenders are now suffering.
Modern finance is supposed to be all about
measuring risks, yet corporate and mortgage-backed CDOs were a leap in the
dark. According to Mr Derman, with Black-Scholes “you know what you are
assuming when you use the model, and you know exactly what has been swept
out of view, and hence you can think clearly about what you may have
overlooked.” By contrast, with CDOs “you don’t quite know what you are
ignoring, so you don’t know how to adjust for its inadequacies.”
Now that the world has moved far beyond
any of the scenarios that the CDO issuers modelled, investors’ quantitative
grasp of the payouts has fizzled into blank uncertainty. That makes it hard
to put any value on them, driving away possible buyers. The trillion-dollar
bet on mortgages has gone disastrously wrong. The hope is that the
trillion-dollar bet on companies does not end up that way too.
Continued in article
Closing Jensen Comment
So is portfolio diversification theory dead? I hardly think so. But if any
lesson is to be learned is that we should question those critical underlying
assumptions in Plato's Cave before worldwide strategies are implemented that
overlook the Achilles' heel of those critical underlying assumptions.
The advertisement warns of speculative financial
bubbles. It mocks a group of gullible Frenchmen seduced into a silly,
18th-century investment scheme, noting that the modern shareholder, armed
with superior information, can avoid the pitfalls of the past. “How
different the position of the investor today!” the ad enthuses.
It ran in The Saturday Evening Post on Sept. 14,
1929. A month later, the stock market crashed.
“Everyone wants to think they’re smarter than the
poor souls in developing countries, and smarter than their predecessors,”
says
Carmen M. Reinhart,
an economist at the
University of Maryland. “They’re wrong. And we can
prove it.”
Like a pair of financial sleuths, Ms. Reinhart and
her collaborator from
Harvard,
Kenneth S. Rogoff, have spent years investigating
wreckage scattered across documents from nearly a millennium of economic
crises and collapses. They have wandered the basements of rare-book
libraries, riffled through monks’ yellowed journals and begged central banks
worldwide for centuries-old debt records. And they have manually entered
their findings, digit by digit, into one of the biggest spreadsheets you’ve
ever seen.
Their handiwork is contained in their recent best
seller, “This
Time Is Different,” a quantitative reconstruction
of hundreds of historical episodes in which perfectly smart people made
perfectly disastrous decisions. It is a panoramic opus, both geographically
and temporally, covering crises from 66 countries over the last 800 years.
The book, and Ms. Reinhart’s and Mr. Rogoff’s own
professional journeys as economists, zero in on some of the broader
shortcomings of their trade — thrown into harsh relief by economists’
widespread failure to anticipate or address the
financial crisis that began in 2007.
“The mainstream of academic research in
macroeconomics puts theoretical coherence and elegance first, and
investigating the data second,” says Mr. Rogoff. For that reason, he says,
much of the profession’s celebrated work “was not terribly useful in either
predicting the financial crisis, or in assessing how it would it play out
once it happened.”
“People almost pride themselves on not paying
attention to current events,” he says.
In the past, other economists often took the same
empirical approach as the Reinhart-Rogoff team. But this approach fell into
disfavor over the last few decades as economists glorified financial papers
that were theory-rich and data-poor.
Much of that theory-driven work, critics say, is
built on the same disassembled and reassembled sets of data points —
generally from just the last 25 years or so and from the same handful of
rich countries — that quants have whisked into ever more dazzling and
complicated mathematical formations.
But in the wake of the recent crisis, a few
economists — like Professors Reinhart and Rogoff, and other like-minded
colleagues like Barry Eichengreen and Alan Taylor — have been encouraging
others in their field to look beyond hermetically sealed theoretical models
and into the historical record.
“There is so much inbredness in this profession,”
says Ms. Reinhart. “They all read the same sources. They all use the same
data sets. They all talk to the same people. There is endless extrapolation
on extrapolation on extrapolation, and for years that is what has been
rewarded.”
ONE of Ken Rogoff’s favorite economics jokes — yes,
there are economics jokes — is “the one about the lamppost”: A drunk on his
way home from a bar one night realizes that he has dropped his keys. He gets
down on his hands and knees and starts groping around beneath a lamppost. A
policeman asks what he’s doing.
“I lost my keys in the park,” says the drunk.
“Then why are you looking for them under the
lamppost?” asks the puzzled cop.
“Because,” says the drunk, “that’s where the light
is.”
Mr. Rogoff, 57, has spent a lifetime exploring
places and ideas off the beaten track. Tall, thin and bespectacled, he grew
up in Rochester. There, he attended a “tough inner-city school,” where his
“true liberal parents” — a radiologist and a librarian — sent him so he
would be exposed to students from a variety of social and economic classes.
He received a chess set for his 13th birthday, and
he quickly discovered that he was something of a prodigy, a fact he decided
to hide so he wouldn’t get beaten up in the lunchroom.
“I think chess may be a relatively cool thing for
kids to do now, on par with soccer or other sports,” he says. “It really
wasn’t then.”
Soon, he began traveling alone to competitions
around the United States, paying his way with his prize winnings. He earned
the rank of American “master” by the age of 14, was a New York State Open
champion and soon became a “senior master,” the highest national title.
When he was 16, he left home against his parents’
wishes to become a professional chess player in Europe. He enrolled
fleetingly in high schools in London and Sarajevo, Yugoslavia, but rarely
attended. “I wasn’t quite sure what I was supposed to be doing,” he recalls.
He spent the next 18 months or so wandering to
competitions around Europe, supporting himself with winnings and by
participating in exhibitions in which he played dozens of opponents
simultaneously, sometimes while wearing a blindfold.
Occasionally, he slept in five-star hotels, but
other nights, when his prize winnings thinned, he crashed in grimy train
stations. He had few friends, and spent most of his time alone, studying
chess and analyzing previous games. Clean-cut and favoring a coat and tie
these days, he described himself as a ragged “hippie” during his time in
Europe. He also found life in Eastern Europe friendly but strained, he says,
throttled by black markets, scarcity and unmet government promises.
After much hand-wringing, he decided to return to
the United States to attend Yale, which overlooked his threadbare high
school transcript. He considered majoring in Russian until Jeremy Bulow, a
classmate who is now an economics professor at Stanford, began evangelizing
about economics.
Mr. Rogoff took an econometrics course, reveling in
its precision and rigor, and went on to focus on comparative economic
systems. He interrupted a brief stint in a graduate program in economics at
the Massachusetts Institute of Technology to prepare for the world chess
championships, which were held only every three years.
After becoming an “international grandmaster,” the
highest title awarded in chess, when he was 25, he decided to quit chess
entirely and to return to M.I.T. He did so because he had snared the
grandmaster title and because he realized that he would probably never be
ranked No. 1.
He says it took him a long time to get over the
game, and the euphoric, almost omnipotent highs of his past victories.
“To this day I get letters, maybe every two years,
from top players asking me: ‘How do I quit? I want to quit like you did, and
I can’t figure out how to do it,’ ” he says. “I tell them that it’s hard to
go from being at the top of a field, because you really feel that way when
you’re playing chess and winning, to being at the bottom — and they need to
prepare themselves for that.”
He returned to M.I.T., rushed through what he
acknowledges was a mediocre doctoral dissertation, and then became a
researcher at the Federal Reserve — where he said he had good role models
who taught him how to be, at last, “professional” and “serious.”
Teaching stints followed, before the International
Monetary Fund chose him as its chief economist in 2001. It was at the I.M.F.
that he began collaborating with a relatively unfamiliar economist named
Carmen Reinhart, whom he appointed as his deputy after admiring her work
from afar.
MS. REINHART, 54, is hardly a household name. And,
unlike Mr. Rogoff, she has never been hired by an Ivy League school. But
measured by how often her work is cited by colleagues and others, this woman
whom several colleagues describe as a “firecracker” is, by a long shot, the
most influential female economist in the world.
Like Mr. Rogoff, she took a circuitous route to her
present position.
Born in Havana as Carmen Castellanos, she is
quick-witted and favors bright, boldly printed blouses and blazers. As a
girl, she memorized the lore of pirates and their trade routes, which she
says was her first exposure to the idea that economic fortunes — and state
revenue in particular — “can suddenly disappear without warning.”
She also lived with more personal financial and
social instability. After her family fled Havana for the United States with
just three suitcases when she was 10, her father traded a comfortable living
as an accountant for long, less lucrative hours as a carpenter. Her mother,
who had never worked outside the home before, became a seamstress.
“Most kids don’t grow up with that kind of real
economic shock,” she says. “But I learned the value of scarcity, and even
the sort of tensions between East and West. And at a very early age that had
an imprint on me.”
With a passion for art and literature — even today,
her academic papers pun on the writings of Gabriel García Márquez — she
enrolled in a two-year college in Miami, intending to study fashion
merchandising. Then, on a whim, she took an economics course and got hooked.
When she went to Florida International University
to study economics, she met Peter Montiel, an M.I.T. graduate who was
teaching there. Recognizing her talent, he helped her apply to a top-tier
graduate program in economics, at Columbia University.
At Columbia, she met her future husband, Vincent
Reinhart, who is now an occasional co-author with her. They married while in
graduate school, and she quit school before writing her dissertation to try
to make some money on Wall Street.
“We were newlyweds, and neither of us had a penny
to our name,” she says. She left school so that they “could have nice things
and a house, the kind of things I imagined a family should have.”
She spent a few years at Bear Stearns, including
one as chief economist, before deciding to finish her graduate work at
Columbia and return to her true love: data mining. “I have a talent for
rounding up data like cattle, all over the plain,” she says.
After earning her doctorate in 1988, Ms. Reinhart
started work at the I.M.F.
“Carmen in many ways pioneered a bigger segment in
economics, this push to look at history more,” says Mr. Rogoff, explaining
why he chose her. “She was just so ahead of the curve.”
She honed her knack for economic archaeology at the
I.M.F., spending several years performing “checkups” on member countries to
make sure they were in good economic health.
While at the fund, she teamed up with Graciela
Kaminsky, another member of that exceptionally rare species — the female
economist — to write their seminal paper, “The Twin Crises.”
The article looked at the interaction between
banking and currency crises, and why contemporary theory couldn’t explain
why those ugly events usually happened together. The paper bore one of Ms.
Reinhart’s hallmarks: a vast web of data, compiled from 20 countries over
several decades.
In digging through old records and piecing together
a vast puzzle of disconnected data points, her ultimate goal, in that paper
and others, has always been “to see the forest,” she says, “and explain it.”
Ms. Reinhart has bounced back and forth across the
Beltway: she left the I.M.F. in Washington and began teaching in 1996 at the
University of Maryland, from which Mr. Rogoff recruited her when he needed a
deputy at the I.M.F. in 2001. When she left that post, she returned to the
university.
Despite the large following that her work has
drawn, she says she feels that the heavyweights of her profession have
looked down upon her research as useful but too simplistic.
“You know, everything is simple when it’s clearly
explained,” she contends. “It’s like with Sherlock Holmes. He goes through
this incredible deductive process from Point A to Point B, and by the time
he explains everything, it makes so much sense that it sounds obvious and
simple. It doesn’t sound clever anymore.”
But, she says, “economists love being clever.”
“THIS TIME IS DIFFERENT” was published last
September, just as the nation was coming to grips with a financial crisis
that had nearly spiraled out of control and a job market that lay in
tatters. Despite bailout after bailout, stimulus after stimulus, economic
armageddon still seemed nigh.
Given this backdrop, it’s perhaps not surprising
that a book arguing that the crisis was a rerun, and not a wholly novel
catastrophe, managed to become a best seller. So far, nearly 100,000 copies
have been sold, according to its publisher, the Princeton University Press.
Still, its authors laugh when asked about the
book’s opportune timing.
“We didn’t start the book thinking that, ‘Oh, in
exactly seven years there will be a housing bust leading to a global
financial crisis that will be the perfect environment in which to sell this
giant book,’ ” says Mr. Rogoff. “But I suppose the way things work, we
expected that whenever the book came out there would probably be some crisis
or other to peg it to.”
They began the book around 2003, not long after Mr.
Rogoff lured Ms. Reinhart back to the I.M.F. to serve as his deputy. The
pair had already been collaborating fruitfully, finding that her dogged
pursuit of data and his more theoretical public policy eye were well
matched.
Although their book is studiously nonideological,
and is more focused on patterns than on policy recommendations, it has
become fodder for the highly charged debate over the recent growth in
government debt.
Continued in article
It might be summarized as: Finance Professors have a
long ways to go before fully understanding capital structure! Jim Mahar
Abstract:
This paper surveys 4 major capital structure theories: trade-off, pecking
order, signaling and market timing. For each theory, a basic model and its
major implications are presented. These implications are compared to the
available evidence. This is followed by an overview of pros and cons for
each theory. A discussion of major recent papers and suggestions for future
research are provided.
"The
Economics of Structured Finance,"
by Joshua D. Coval, Jakub Jurek, and Erik Stafford, Working Paper 09-060,
Harvard Business School, 2008 --- http://www.hbs.edu/research/pdf/09-060.pdf
The essence of structured finance activities is the pooling of economic assets
(e.g. loans, bonds, mortgages) and subsequent issuance of a prioritized capital
structure of claims, known as tranches, against these collateral pools. As a
result of the prioritization scheme used in structuring claims, many of the
manufactured tranches are far safer than the average asset in the underlying
pool. This ability of structured finance to repackage risks and create “safe”
assets from otherwise risky collateral led to a dramatic expansion in the
issuance of structured securities, most of which were viewed by investors to be
virtually risk-free and certified as such by the rating agencies. At the core of
the recent financial market crisis has been the discovery that these securities
are actually far riskier than originally advertised.
We examine how the process of securitization allowed trillions of dollars of
risky assets to be transformed into securities that were widely considered to be
safe, and argue that two key features of the structured finance machinery fueled
its spectacular growth. First, we show that most securities could only have
received high credit ratings if the rating agencies were extraordinarily
confident about their ability to estimate the underlying securities’ default
risks, and how likely defaults were to be correlated. Using the prototypical
structured finance security – the collateralized debt obligation (CDO) –
as an example, we illustrate that issuing a capital structure amplifies errors
in evaluating the risk of the underlying securities. In particular, we show how
modest imprecision in the parameter estimates can lead to variation in the
default risk of the structured finance securities which is sufficient, for
example, to cause a security rated AAA to default with reasonable likelihood.
A second, equally neglected feature of the securitization process is that it
substitutes risks that are largely diversifiable for risks that are highly
systematic. As a result, securities produced by structured finance activities
have far less chance of surviving a severe economic downturn than traditional
corporate securities of equal rating. Moreover, because the default risk of
senior tranches is concentrated in systematically adverse economic states,
investors should demand far larger risk premia for holding structured claims
than for holding comparably rated corporate bonds. We argue that both of these
features of structured finance products – the extreme fragility of their ratings
to modest imprecision in evaluating underlying risks and their exposure to
systematic risks – go a long way in explaining the spectacular rise and fall of
structured finance.
For over a century, agencies such as Moody’s, Standard and Poor’s and Fitch have
gathered and analyzed a wide range of financial, industry, and economic
information to arrive at independent assessments on the creditworthiness of
various entities, giving rise to the now widely popular rating scales (AAA, AA,
A, BBB and so on). Until recently, the agencies focused the majority of their
business on single-name corporate finance—that is, issues of creditworthiness of
financial instruments that can be clearly ascribed to a single company. In
recent years, the business model of credit rating agencies has expanded beyond
their historical role to include the nascent field of structured finance.
From its beginnings, the market for structured securities evolved as a “rated”
market, in which the risk of tranches was assessed by credit rating agencies.
Issuers of structured finance products were eager to have their new products
rated on the same scale as bonds so that investors subject to ratings-based
constraints would be able to purchase the securities. By having these new
securities rated, the issuers created an illusion of comparability with existing
“single-name” securities. This provided access to a large pool of potential
buyers for what otherwise would have been perceived as very complex derivative
securities.
During the past decade, risks of all kinds have been repackaged to create vast
quantities of triple-A rated securities with competitive yields. By mid-2007,
there were 37,000 structured finance issues in the U.S. alone with the top
rating (Scholtes and Beales, 2007). According to Fitch Ratings (2007), roughly
60 percent of all global structured products were AAA-rated, in contrast to less
than 1 percent of the corporate issues. By offering AAA-ratings along with
attractive yields during a period of relatively low interest rates, these
products were eagerly bought up by investors around the world. In turn,
structured finance activities grew to represent a large fraction of Wall Street
and rating agency revenues in a relatively short period of time. By 2006,
structured finance issuance led Wall Street to record revenue and compensation
levels. The same year, Moody’s Corporation reported that 44 percent of its
revenues came from rating structured finance products, surpassing the 32 percent
of revenues from their traditional business of rating corporate bonds.
By 2008, everything had changed. Global issuance of collateralized debt
obligations slowed to a crawl. Wall Street banks were forced to incur massive
write-downs. Rating agency revenues from rating structured finance products
disappeared virtually overnight and the stock prices of these companies fell by
50 percent, suggesting the market viewed the revenue declines as permanent. A
huge fraction of existing products saw their ratings downgraded, with the
downgrades being particularly widespread among what are called “asset-backed
security” collateralized debt obligations—which are comprised of pools of
mortgage, credit card, and auto loan securities. For example, 27 of the 30
tranches of asset-backed collateralized debt obligations underwritten by Merrill
Lynch in 2007, saw their triple-A ratings downgraded to “junk” (Craig, Smith,
and Ng, 2008). Overall, in 2007, Moody’s downgraded 31 percent of all tranches
for asset-backed collateralized debt obligations it had rated and 14 percent of
those nitially rated AAA (Bank of International Settlements, 2008). By mid-2008,
structured finance activity was effectively shut down, and the president of
Standard & Poor’s, Deven Sharma, expected it to remain so for “years” (“S&P
President,” 2008).
This paper investigates the spectacular rise and fall of structured finance. We
begin by examining how the structured finance machinery works. We construct some
simple examples of collateralized debt obligations that show how pooling and
tranching a collection of assets permits credit enhancement of the senior
claims. We then explore the challenge faced by rating agencies, examining, in
particular, the parameter and modeling assumptions that are required to arrive
at accurate ratings of structured finance products. We then conclude with an
assessment of what went wrong and the relative importance of rating agency
errors, investor credulity, and perverse incentives and suspect behavior on the
part of issuers, rating agencies, and borrowers.
Manufacturing AAA-rated Securities
Manufacturing securities of a given credit rating requires tailoring the
cash-flow risk of these securities – as measured by the likelihood of default
and the magnitude of loss incurred in the event of a default – to satisfy the
guidelines set forth by the credit rating agencies. Structured finance allows
originators to accomplish this goal by means of a two-step procedure involving
pooling and tranching.
In the first step, a large collection of credit sensitive assets is assembled in
a portfolio, which is typically referred to as a special purpose vehicle. The
special purpose vehicle is separate from the originator’s balance sheet to
isolate the credit risk of its liabilities – the tranches – from the balance
sheet of the originator. If the special purpose vehicle issued claims that were
not prioritized and were simply fractional claims to the payoff on the
underlying portfolio, the structure would be known as a pass-through
securitization. At this stage, since the expected portfolio loss is equal to the
mean expected loss on the underlying securities, the portfolio’s credit rating
would be given by the average rating of the securities in the underlying pool.
The pass-through securitization claims would inherit this rating, thus achieving
no credit enhancement.
By contrast, to manufacture a range of securities with different cash flow
risks, structured finance issues a capital structure of prioritized claims,
known as tranches, against the underlying collateral pool. The tranches
are prioritized in how they absorb losses from the underlying portfolio. For
example, senior tranches only absorb losses after the junior claims have been
exhausted, which allows senior tranches to obtain credit ratings in excess of
the average rating on the average for the collateral pool as a whole. The degree
of protection offered by the junior claims, or overcollateralization, plays a
crucial role in determining the credit rating for a more senior tranche, because
it determines the largest portfolio loss that can be sustained before the senior
claim is impaired.
Until recently it has been assumed that the problem
of constructing preference scales on which mathematical operations can be
performed was solved by von Neumann and Morgenstern’s utility theory. This
is an important problem because until the publication of von Neumann and
Morgenstern’s Theory of Games and Economic Behavior in 1944, the possibility
of measurement of non-physical variables such as preference had been an open
question and also because preference measurement underpins economic theory,
theory of games, and decision theory. Recent research1 has revealed
errors at the foundations of economic theory, game theory, and other
disciplines including the inapplicability of the operations of addition and
multiplication on utility scale values. The mathematical foundations of
economic theory have been reconstructed but additional corrections are
required.
Favorite Excerpt (Via Nova Scotia)
Utility theory, which underpins economic theory as
well as theory of games and decision theory, cannot serve as a
foundation for mathematical methods in any scientific discipline. The
operations of addition and multiplication are not applicable on scale values
in any version of utility theory and, in addition to other shortcomings,
although von Neumann and Morgenstern’s utility axioms are consistent in the
abstract, the interpretation of the empirical utility operation in terms of
lotteries and prizes creates an intrinsic contradiction: theory permits
lotteries that are prizes and has a rule for assigning values to prizes and
a different, conflicting, rule for assigning values to lotteries. For a
prize which is a lottery ticket, the conflicting rules are contradictory.
it has been assumed that the problem of
constructing preference scales on which mathematical operations can be
performed was solved by von Neumann and Morgenstern’s utility theory. This
is an important problem because until the publication of von Neumann and
Morgenstern’s
Theory of Games
and Economic Behavior in 1944, the possibility of
measurement of non-physical variables such as preference had been an open
question and also because preference measurement underpins economic theory,
theory of games, and decision theory. Recent research1
1 This is a summary of J. Barzilai,
"Preference Function Modeling: The Mathematical Foundations of Decision
Theory," pp. 1—37, to appear in
Trends in MCDA,
José Figueira, Salvatore Greco, Matthias Ehrgott (Eds.). A pre-print is
posted at www.ScientificMetrics.comhas revealed errors at the foundations of
economic theory, game theory, and other disciplines including the
inapplicability of the operations of addition and multiplication on utility
scale values. The mathematical foundations of economic theory have been
reconstructed but additional corrections are required.
Can Psychological variables be measured?
The construction of the
mathematical foundations of any scienti
fic
discipline requires the identification
of the conditions that must be satisfied
in order to enable the application of the mathematical operations of linear
algebra and calculus. In addition, the mathematical foundations of social
science disciplines, including economic theory, require the application of
mathematical operations to
non-physical
variables, i.e, to variables that describe
psychological or subjective properties such as
utility
or
preference.
Whether psychological properties
can be measured, and hence whether mathematical operations can be applied to
psychological variables, remained an open question when in 1940 a Committee
appointed by the British Association for the Advancement of Science in 1932
"to consider and report upon the possibility of Quantitative Estimates of
Sensory Events" published its Final Report. An Interim Report, published in
1938, included "a statement arguing that sensation intensities are not
measurable" as well as a statement arguing that sensation intensities are
measurable. These opposing views were not reconciled in the Final Report.
The position that psychological
variables cannot be measured is summarized by J. Guild in the Final Report
in the context of measurement of
sensation as follows: Jonathan
Barzilai 2 2009
I submit that any law
purporting to express a quantitative relation between sensation
intensity and stimulus intensity is not merely false but is in fact
meaningless unless and until a meaning can be given to the concept of
addition as applied to sensation. No such meaning has ever been defined.
When we say that one length is twice another or one mass is twice
another we know what is meant: we know that certain practical operations
have been defined
for the addition of lengths or masses, and it is in terms of these
operations, and in no other terms whatever, that we are able to
interpret a numerical relation between lengths and masses. But if we say
that one sensation intensity is twice another nobody knows what the
statement, if true, would imply.
The Mathematical Modelling Framework
To re-state Guild’s position in
current terminology the following is needed. By an empirical system
E
we mean a set of empirical
objects
together with
operations
(i.e. functions) and possibly the relation of
order
which characterize the property under measurement. A
mathematical model
M
of the empirical system
E
is a set with operations that reflect
the empirical operations in
E
as well as the order in
E
when
E
is ordered. A scale
s
is a mapping of the objects in
E
into the objects in
M
that reflects
the structure of
E
into
M
(in technical terms, a scale is a homomorphism from
E
into
M).
The purpose of modelling
E
by
M
is to enable the application of mathematical operations on
the elements of the mathematical system
M:
"the object of measurement is to
enable the powerful weapon of mathematical analysis to be applied to the
subject matter of science" (Campbell, 1920).
The framework of
mathematical modelling is essential. To enable the application of
mathematical operations in a given empirical system, the empirical objects
are mapped to mathematical objects on which these operations are performed.
In mathematical terms, these mappings are functions from the set of
empirical objects to the set of mathematical objects (typically the real
numbers for reasons that are explained by the reconstructed theory). Given
two sets, a large number of mappings from one to the other can be
constructed, most of which are not related to the characterization of the
property under measurement: A given property must be characterized by
empirical operations which are specific
to this property and these property-specific
empirical operations are then reflected
to corresponding operations in the mathematical model. Measurement scales
are those mappings that reflect
the specific
empirical operations which characterize the given property to corresponding
operations in the mathematical model. Empirical addition can easily be
described for variables such as
mass
and
length
and it has been implicitly assumed that the structure
of psychological scales is similar to the structure of
mass
and
length
scales.
In terms of this
universally accepted fundamental framework, Guild states that for
psychological variables it is not possible to construct a scale that reflects
the empirical operation of addition because such an empirical (or
"practical") addition operation has not been defined;
if the empirical operation does not exist, its mathematical reflection
does not exist as well.
Von Neumann and Morgenstern’s Game Theory
In
Theory of Games and Economic Behavior
von Neumann and Morgenstern proposed game
theory as "the proper instrument with which to develop a theory of economic
Jonathan Barzilai 3 2009
behavior." Applying
mathematical methods to economic theory requires the application of the
mathematical operations which these methods employ to economic variables
including
utility
or
preference
which, in turn, requires
addressing the problem of psychological measurement since preference is a
not a physical property of empirical objects. In particular, if the
operations of addition and multiplication, which are elementary mathematical
tools, are not applicable, very limited results can be attained.
Since establishing the
applicability of addition and multiplication is a prerequisite for a
discussion of the mathematical foundations of economic theory, von Neumann
and Morgenstern needed to construct a mathematical model for
preference measurement in
which addition and multiplication are applicable.
Von Neumann and Morgenstern’s Error
Measurement scales for
mass
or
length
are unique up to a multiplicative constant so that the
scale
tqs×=for
q0>is
equivalent to the scale
s
for these variables. Since scales for physical variables such
as time
and
potential
energy are unique up to an additive and a
multiplicative constant (tpqs×+=),
the structure of psychological scales is not necessarily similar to the
structure of
mass
and
length
scales. Motivated by this
uniqueness argument, von Neumann and Morgenstern constructed a mathematical
model for preference measurement, based on an empirical operation that
mimics the "center of gravity" operation, where the scales that satisfy
their utility axioms are unique up to an additive and a multiplicative
constant.
Until recently it has not
been realized that this construction does not solve the problem that von
Neumann and Morgenstern needed to solve. What is needed is a construction of
preference scales where the operations of addition and multiplication are
applicable in the mathematical system
M
which is the range of each scale, i.e. operations such as
sa()sb()sc()+=where
the sum of two elements of
M
is another element of
M.
In scale transformations of the form
tpqs×+=the
operations are not performed in
M
but in the set
S
of all scales where one scale in
S
is transformed into another element of
S.
Addition and multiplication in scale transformations of the form
tpqs×+=,
which characterize scale uniqueness, do not imply that addition and
multiplication are applicable on scale values in
M
and it follows that the problem of
applicability of addition and multiplication on scale values was not solved
by von Neumann and Morgenstern and consequently, until recently, there has
been no basis for the application of these operations in economic theory.
This has led to
application of mathematical operations in an incorrect form or where they
are not applicable and to additional errors in game theory, economic theory,
and other social sciences. The use of utility sums in game theory and
economics is an error: The correct model for
position,
an elementary variable of geometry and physics, is that of a one-dimensional
affine
space, i.e. a straight line with unmarked
zero
and
one,
as there is neither an absolute zero nor absolute one in this space (the
space is a homogeneous
field).
In an affine
space the sum of points is undefined.
For example, since
potential
energy and
time
have no absolute zero or one, they are modelled by an
affine
straight line and the sum of potential energies
e1e2+or
times t1t2+is
undefined.
To emphasize, even on a single time scale with one and the same unit,
t1t2+is
undefined.
Point differences
in an affine
space form a vector space and the Jonathan Barzilai 4 2009
sum of potential energy
differences
Δe1Δe2+and
time differences
Δt1Δt2+are
defined.
The implication for game theory and economics is that where addition and
multiplication are enabled, i.e. for affine
utility scale values, utility sums are undefined.
This is the case not just in welfare economics which deals with utility sums
of different
persons but also in the case of a utility scale of a single person: the
utility sum
ua()ub()+is
undefined.
Another fundamental error
in economic theory is the notion that ordinal utility scales are sufficient
to carry out differentiation
in economic theory. The operation of differentiation
is not applicable on ordinal scales because addition and multiplication are
not applicable on such scales. It is inconceivable that anyone would claim
that ordinal temperature measurement is a sufficient
foundation for the operation of differentiation
in thermodynamics yet, in his
Manual of
Political Economy, Pareto claims that "the entire
theory of economic equilibrium is independent of the notions of (economic)
utility"
by which is meant that ordinal utility scales are
sufficient
to carry out the development of economic equilibrium theory where marginal
utility — the partial derivative of a utility function — plays a central
role. Pareto’s claim has been amplified
by other economists and appears throughout the literature of modern economic
theory. An ordinal utility function cannot be differentiated
and, conversely, a utility function that satisfies
a differential
condition cannot be an ordinal utility scale.
In game theory, the undefined
sum vS()vT()+where vS()and vT()are
the values of coalitions
S
and
T,
appears in the definition
of von Neumann and Morgenstern’s characteristic function of a game, a
central concept of theory. Similarly, the sum of imputations, which are
utilities, is undefined
and throughout the literature of game theory, the treatment of the division
of the "payoff"
among the players in a coalition has no foundation. The characteristic
function is ill-defined
for another reason as well: The value of an object is not a physical
property of the object and the definition
of valuerequires
specifying both
what
is being valued and
whose
values are being measured, but
whose
values are being reflected
by the characteristic function is not specifed in theory. All game
theory concepts that depend on values where it is not specified
whose values are being measured are ill-defined
including the concept of imputations, von Neumann and Morgenstern’s solution
of a game, and Shapley’s Value in all its variants and generalizations.
Moreover, since the current definition
of an n-person
game employs the ill-defined
concept of the characteristic function, this definition
of a game has no foundation.
The application of
mathematical operations such as addition and multiplication requires the
mathematical modelling of economic systems by corresponding mathematical
systems. Since the property under measurement is an integral part of the
mathematical modelling framework and money is not a property of objects,
preference measurement is the only way to introduce the real numbers and
operations on them to economics and game theory. It follows that it is not
possible to escape the need to construct preference functions by assuming
that payoffs
are in money units and that each player has a utility function which is
linear in terms of money.
These are not the only
errors at the foundations of game theory. Aumann and Dreze write under the
title "When All is Said and Done, How Should You Play and What Should You
Expect?" that seventy-seven years after it was born in 1928, strategic
Jonathan Barzilai 5 2009 game theory
has not gotten beyond the optimal strategies which rational players should
play according to von Neumann’s minimax theorem of two-person zero-sum
games; that when the game is not two-person zero-sum none of the equilibrium
theories tell the players how to play; and that the "Harsanyi-Selten
selection theory does choose a unique equilibrium, composed of a well-defined
strategy for each player and having a well-defined
expected outcome. But nobody — least of all Harsanyi and Selten themselves —
would actually recommend using these strategies." This indicates that while
the meaning of
n-person
games’ solutions is in question, game theorists universally accept the
minimax strategy as a reasonable — in fact
the only
— solution for rational players in two-person zero-sum
games. However, the minimax solution of two-person zero-sum game theory,
which Aumann considers a vital cornerstone of game theory, prescribes to the
players "optimal" strategies that cannot be described as conservative or
rational; "the" value of two-person zero-sum game theory is not unique and
consequently is ill-defined;
and the minimax solution divorces choice probabilities from choice
consequences which is a fundamental error that indicates that this problem
is formulated incorrectly.
Utility theory, which
underpins economic theory as well as theory of games and decision
theory, cannot serve as a foundation for mathematical methods in any scientific
discipline. The operations of addition and multiplication are not applicable
on scale values in any version of utility theory and, in addition to other
shortcomings, although von Neumann and Morgenstern’s utility axioms are
consistent in the abstract, the interpretation of the empirical utility
operation in terms of lotteries and prizes creates an intrinsic
contradiction: theory permits lotteries that are prizes and has a rule
for assigning values to prizes and a different,
conflicting,
rule for assigning values to lotteries. For a prize which is a lottery
ticket, the conflicting
rules are contradictory.
In summary, the fundamental issue of
applicability of the operations of addition and multiplication to scale
values was not resolved by von Neumann and Morgenstern’s utility theory and
the mathematical foundations of economic theory and other social sciences
need to be corrected to account for the conditions that must be satisfied
for the mathematical operations of linear algebra and calculus to be
applicable.
A few weeks ago, TechCrunch published a piece
arguing software is better at investing than 99% of human investment
advisors. That post, titled
Thankfully, Software Is Eating The Personal Investing World,
pointed out the advantages of engineering-driven
software solutions versus emotionally driven human judgment. Perhaps not
surprisingly, some commenters (including some financial advisors) seized the
moment to call into question one of the foundations of software-based
investing, Modern Portfolio Theory.
Given the doubts raised by a small but vocal
chorus, it’s worth spending some time to ask if we need a new investing
paradigm and if so, what it should be. Answering that question helps show
why MPT still is the best investment methodology out there; it enables the
automated, low-cost investment management offered by a new wave of Internet
startups including
Wealthfront
(which I advise),
Personal Capital,
Future Advisor
and SigFig.
The basic questions being raised about MPT run
something like this:
Hasn’t recent experience – i.e., the financial
crisis — shown that diversification doesn’t work?
Shouldn’t we primarily worry about “Black
Swan” events and unforeseen risk?
Don’t these unknown unknowns mean we must
develop a new approach to investing?
Let’s begin by briefly laying out the key insights
of MPT.
MPT is based in part on the assumption that most
investors don’t like risk and need to be compensated for bearing it. That
compensation comes in the form of higher average returns. Historical data
strongly supports this assumption. For example, from 1926 to 2011 the
average (geometric) return on U.S. Treasury Bills was 3.6%. Over the same
period the average return on large company stocks was 9.8%; that on small
company stocks was 11.2% ( See 2012 Ibbotson Stocks, Bonds, Bills and
Inflation (SBBI) Valuation Yearbook, Morningstar, Inc., page 23. ). Stocks,
of course, are much riskier than Treasuries, so we expect them to have
higher average returns — and they do.
One of MPT’s key insights is that while investors
need to be compensated to bear risk, not all risks are rewarded. The market
does not reward risks that can be “diversified away” by holding a bundle of
investments, instead of a single investment. By recognizing that not all
risks are rewarded, MPT helped establish the idea that a diversified
portfolio can help investors earn a higher return for the same amount of
risk.
To understand which risks can be diversified away,
and why, consider Zynga. Zynga hit $14.69 in March and has since dropped to
less than $2 per share. Based on what’s happened over the past few months,
the major risks associated with Zynga’s stock are things such as delays in
new game development, the fickle taste of consumers and changes on Facebook
that affect users’ engagement with Zynga’s games.
For company insiders, who have much of their wealth
tied up in the company, Zynga is clearly a risky investment. Although those
insiders are exposed to huge risks, they aren’t the investors who determine
the “risk premium” for Zynga. (A stock’s risk premium is the extra return
the stock is expected to earn that compensates for the stock’s risk.)
Rather, institutional funds and other large
investors establish the risk premium by deciding what price they’re willing
to pay to hold Zynga in their diversified portfolios. If a Zynga game is
delayed, and Zynga’s stock price drops, that decline has a miniscule effect
on a diversified shareholder’s portfolio returns. Because of this, the
market does not price in that particular risk. Even the overall turbulence
in many Internet stocks won’t be problematic for investors who are well
diversified in their portfolios.
Modern Portfolio Theory focuses on constructing
portfolios that avoid exposing the investor to those kinds of unrewarded
risks. The main lesson is that investors should choose portfolios that lie
on the Efficient Frontier, the mathematically defined curve that describes
the relationship between risk and reward. To be on the frontier, a portfolio
must provide the highest expected return (largest reward) among all
portfolios having the same level of risk. The Internet startups construct
well-diversified portfolios designed to be efficient with the right
combination of risk and return for their clients.
Now let’s ask if anything in the past five years
casts doubt on these basic tenets of Modern Portfolio Theory. The answer is
clearly, “No.” First and foremost, nothing has changed the fact that there
are many unrewarded risks, and that investors should avoid these risks. The
major risks of Zynga stock remain diversifiable risks, and unless you’re
willing to trade illegally on inside information about, say, upcoming
changes to Facebook’s gaming policies, you should avoid holding a
concentrated position in Zynga.
The efficient frontier is still the desirable place
to be, and it makes no sense to follow a policy that puts you in a position
well below that frontier.
Most of the people who say that “diversification
failed” in the financial crisis have in mind not the diversification gains
associated with avoiding concentrated investments in companies like Zynga,
but the diversification gains that come from investing across many different
asset classes, such as domestic stocks, foreign stocks, real estate and
bonds. Those critics aren’t challenging the idea of diversification in
general – probably because such an effort would be nonsensical.
True, diversification across asset classes didn’t
shelter investors from 2008’s turmoil. In that year, the S&P 500 index fell
37%, the MSCI EAFE index (the index of developed markets outside North
America) fell by 43%, the MSCI Emerging Market index fell by 53%, the Dow
Jones Commodities Index fell by 35%, and the Lehman High Yield Bond Index
fell by 26%. The historical record shows that in times of economic distress,
asset class returns tend to move in the same direction and be more highly
correlated. These increased correlations are no doubt due to the increased
importance of macro factors driving corporate cash flows. The increased
correlations limit, but do not eliminate, diversification’s value. It would
be foolish to conclude from this that you should be undiversified. If a seat
belt doesn’t provide perfect protection, it still makes sense to wear one.
Statistics show it’s better to wear a seatbelt than to not wear one.
Similarly, statistics show diversification reduces risk, and that you are
better off diversifying than not.
Timing the market
The obvious question to ask anyone who insists
diversification across asset classes is not effective is: What is the
alternative? Some say “Time the market.” Make sure you hold an asset class
when it is earning good returns, but sell as soon as things are about to go
south. Even better, take short positions when the outlook is negative. With
a trustworthy crystal ball, this is a winning strategy. The potential gains
are huge. If you had perfect foresight and could time the S&P 500
on a daily basis, you could have turned $1,000 on Jan. 1, 2000, into
$120,975,000 on Dec. 31, 2009, just by going in and out of the market. If
you could also short the market when appropriate, the gains would have been
even more spectacular!
Sometimes, it seems someone may have a fairly
reliable crystal ball. Consider John Paulson, who in 2007 and 2008 seemed so
prescient in profiting from the subprime market’s collapse. It appears,
however, that Mr. Paulson’s crystal ball became less reliable after his
stunning success in 2007. His Advantage Plus fund experienced more than a
50% loss in 2011. Separating luck from skill is often difficult.
Some people try to come up with a way to time the
market based on historical data. In fact a large number of strategies will
work well “in the back test.” The question is whether any system is reliable
enough to use for future investing.
There are at least three reasons to be cautious
about substituting a timing system for diversification.
First, a timing system that does not work can
impose significant transaction costs (including avoidable adverse tax
consequences) on the investor for no gain.
Second, an ill-founded timing strategy
generally exposes the investor to risk that is unrewarded. In other
words, it puts the investor below the frontier, which is not a good
place to be.
Third, a timing system’s success may create
the seeds of its own destruction. If too many investors blindly follow
the strategy, prices will be driven to erase any putative gains that
might have been there, turning the strategy into a losing proposition.
Also, a timing strategy designed to “beat the market” must involve
trading into “good” positions and away from “bad” ones. That means there
must be a sucker (or several suckers) available to take on the other
(losing) sides. (No doubt in most cases each party to the trade thinks
the sucker is on the other side.)
Black Swans
What about those Black Swans? Doesn’t MPT ignore
the possibility that we can be surprised by the unexpected? Isn’t it
impossible to measure risk when there are unknown unknowns?
Most people recognize that financial markets are
not like simple games of chance where risk can be quantified precisely. As
we’ve seen (e.g., the “Black Monday” stock market crash of 1987 and the
“flash crash” of 2010), the markets can produce extreme events that hardly
anyone contemplated as a possibility. As opposed to poker, where we always
draw from the same 52-card deck, in financial markets, asset returns are
drawn from changing distributions as the world economy and financial
relationships change.
Some Black Swan events turned out to have limited
effects on investors over the long term. Although the market dropped
precipitously in October 1987, it was close to fully recovered in June 1988.
The flash crash was confined to a single day.
This is not to say that all “surprise” events are transitory. The Great
Depression followed the stock market crash of 1929, and the effects of the
financial crisis in 2007 and 2008 linger on five years later.
The question is, how should we respond to
uncertainties and Black Swans? One sensible way is to be more diligent in
quantifying the risks we can see. For example, since extreme events don’t
happen often, we’re likely to be misled if we base our risk assessment on
what has occurred over short time periods. We shouldn’t conclude that just
because housing prices haven’t gone down over 20 years that a housing
decline is not a meaningful risk. In the case of natural disasters like
earthquakes, tsunamis, asteroid strikes and solar storms, the long run could
be very long indeed. While we can’t capture all risks by looking far back in
time, taking into account long-term data means we’re less likely to be
surprised.
Some people suggest you should respond to the risk
of unknown unknowns by investing very conservatively. This means allocating
most of the portfolio to “safe assets” and significantly reducing exposure
to risky assets, which are likely to be affected by Black Swan surprises.
This response is consistent with MPT. If you worry about Black Swans, you
are, for all intents and purposes, a very risk-averse investor. The MPT
portfolio position for very risk-averse investors is a position on the
efficient frontier that has little risk.
The cost of investing in a low-risk position is a
lower expected return (recall that historically the average return on stocks
was about three times that on U.S. Treasuries), but maybe you think that’s a
price worth paying. Can everyone take extremely conservative positions to
avoid Black Swan risk? This clearly won’t work, because some investors must
hold risky assets. If all investors try to avoid Black Swan events, the
prices of those risky assets will fall to a point where the forecasted
returns become too large to ignore.
Continued in article
Jensen Comment
All quant theories and strategies in finance are based upon some foundational
assumptions that in rare instances turn into the
Achilles'
heel of the entire superstructure. The classic example is the wonderful
theory and arbitrage strategy of Long Term Capital Management (LTCM) formed by
the best quants in finance (two with Nobel Prizes in economics). After
remarkable successes one nickel at a time in a secret global arbitrage strategy
based heavily on the Black-Scholes Model, LTCM placed a trillion dollar bet that
failed dramatically and became the only hedge fund that nearly imploded all of
Wall Street. At a heavy cost, Wall Street investment bankers pooled billions of
dollars to quietly shut down LTCM ---
http://faculty.trinity.edu/rjensen/FraudRotten.htm#LTCM
So what was the Achilles heal of the arbitrage strategy of LTCM? It was an
assumption that a huge portion of the global financial market would not collapse
all at once. Low and behold, the Asian financial markets collapsed all at once
and left LTCM naked and dangling from a speculative cliff.
There is a tremendous (one of the best
videos I've ever seen on the Black-Scholes Model) PBS Nova video called
"Trillion Dollar Bet" explaining why LTCM
collapsed. Go to
http://www.pbs.org/wgbh/nova/stockmarket/
This video is in the media libraries on most college campuses. I highly
recommend showing this video to students. It is extremely well done and
exciting to watch.
The principal
policy issue arising out of the events surrounding the near collapse of LTCM
is how to constrain excessive leverage. By increasing the chance that
problems at one financial institution could be transmitted to other
institutions, excessive leverage can increase the likelihood of a general
breakdown in the functioning of financial markets. This issue is not limited
to hedge funds; other financial institutions are often larger and more
highly leveraged than most hedge funds.
The video and above reports, however, do not delve into the tax shelter
pushed by Myron Scholes and his other LTCM partners. A nice summary of the tax
shelter case with links to other documents can be found at
http://www.cambridgefinance.com/CFP-LTCM.pdf
The above August 27,
2004 ruling by Judge Janet Bond Arterton rounds out the "Trillion Dollar Bet."
The classic and enormous scandal was
Long Term Capital led by Nobel Prize winning Merton and Scholes (actually the
blame is shared with their devoted doctoral students). There is a tremendous
(one of the best videos I've ever seen on the Black-Scholes Model) PBS Nova
video ("Trillion Dollar Bet") explaining why LTC collapsed. Go to
http://www.pbs.org/wgbh/nova/stockmarket/
Another illustration of the Achilles' heel of a popular mathematical theory
and strategy is the 2008 collapse mortgage-backed CDO financial risk bonds based
upon David Li's Gaussian copula function of risk diversification in portfolios.
The Achilles' heel was the assumption that the real estate bubble would not
burst to a point where millions of subprime mortgages would all go into default
at roughly the same time.
"For five years, Li's formula, known as a
Gaussian copula function, looked like an unambiguously positive
breakthrough, a piece of financial technology that allowed hugely
complex risks to be modeled with more ease and accuracy than ever
before. With his brilliant spark of mathematical legerdemain, Li made it
possible for traders to sell vast quantities of new securities,
expanding financial markets to unimaginable levels.
His method was adopted by everybody from bond
investors and Wall Street banks to ratings agencies and regulators. And
it became so deeply entrenched—and was making people so much money—that
warnings about its limitations were largely ignored.
Then the model fell apart." The article goes on to show that correlations
are at the heart of the problem.
"The reason that ratings agencies and investors
felt so safe with the triple-A tranches was that they believed there was
no way hundreds of homeowners would all default on their loans at the
same time. One person might lose his job, another might fall ill. But
those are individual calamities that don't affect the mortgage pool much
as a whole: Everybody else is still making their payments on time.
But not all calamities are individual, and
tranching still hadn't solved all the problems of mortgage-pool risk.
Some things, like falling house prices, affect a large number of people
at once. If home values in your neighborhood decline and you lose some
of your equity, there's a good chance your neighbors will lose theirs as
well. If, as a result, you default on your mortgage, there's a higher
probability they will default, too. That's called correlation—the degree
to which one variable moves in line with another—and measuring it is an
important part of determining how risky mortgage bonds are."
I would highly recommend reading the entire thing that gets much more
involved with the
actual formula etc.
The
“math error” might truly be have been an error or it might have simply been a
gamble with what was perceived as miniscule odds of total market failure.
Something similar happened in the case of the trillion-dollar disastrous 1993
collapse of Long Term Capital Management formed by Nobel Prize winning
economists and their doctoral students who took similar gambles that ignored the
“miniscule odds” of world market collapse -- -
http://faculty.trinity.edu/rjensen/FraudRotten.htm#LTCM
The rhetorical question is whether the failure is ignorance in model building or
risk taking using the model?
ROBERT RUBIN was Bill Clinton’s treasury
secretary. He has worked at the top of Goldman Sachs and Citigroup. But he
made arguably the single most influential decision of his long career in
1983, when as head of risk arbitrage at Goldman he went to the MIT Sloan
School of Management in Cambridge, Massachusetts, to hire an economist
called Fischer Black.
A decade earlier Myron Scholes, Robert
Merton and Black had explained how to use share prices to calculate the
value of derivatives. The Black-Scholes options-pricing model was more than
a piece of geeky mathematics. It was a manifesto, part of a revolution that
put an end to the anti-intellectualism of American finance and transformed
financial markets from bull rings into today’s quantitative powerhouses.
Yet, in a roundabout way, Black’s approach also led to some of the late
boom’s most disastrous lapses.
Derivatives markets are not new, nor are
they an exclusively Western phenomenon. Mr Merton has described how Osaka’s
Dojima rice market offered forward contracts in the 17th century and
organised futures trading by the 18th century. However, the growth of
derivatives in the 36 years since Black’s formula was published has taken
them from the periphery of financial services to the core.
In “The Partnership”, a history of Goldman
Sachs, Charles Ellis records how the derivatives markets took off. The
International Monetary Market opened in 1972; Congress allowed trade in
commodity options in 1976; S&P 500 futures launched in 1982, and options on
those futures a year later. The Chicago Board Options Exchange traded 911
contracts on April 26th 1973, its first day (and only one month before
Black-Scholes appeared in print). In 2007 the CBOE’s volume of contracts
reached almost 1 trillion.
Trading has exploded partly because
derivatives are useful. After America came off the gold standard in 1971,
businesses wanted a way of protecting themselves against the movements in
exchange rates, just as they sought protection against swings in interest
rates after Paul Volcker, Mr Greenspan’s predecessor as chairman of the Fed,
tackled inflation in the 1980s. Equity options enabled investors to lay off
general risk so that they could concentrate on the specific types of
corporate risk they wanted to trade.
The other force behind the explosion in
derivatives trading was the combination of mathematics and computing. Before
Black-Scholes, option prices had been little more than educated guesses. The
new model showed how to work out an option price from the known price-behaviour
of a share and a bond. It is as if you had a formula for working out the
price of a fruit salad from the prices of the apples and oranges that went
into it, explains Emanuel Derman, a physicist who later took Black’s job at
Goldman. Confidence in pricing gave buyers and sellers the courage to pile
into derivatives. The better that real prices correlate with the unknown
option price, the more confidently you can take on any level of risk. “In a
thirsty world filled with hydrogen and oxygen,” Mr Derman has written,
“someone had finally worked out how to synthesise H2O.”
Poetry in Brownian motion Black-Scholes is
just a model, not a complete description of the world. Every model makes
simplifications, but some of the simplifications in Black-Scholes looked as
if they would matter. For instance, the maths it uses to describe how share
prices move comes from the equations in physics that describe the diffusion
of heat. The idea is that share prices follow some gentle random walk away
from an equilibrium, rather like motes of dust jiggling around in Brownian
motion. In fact, share-price movements are more violent than that.
Over the years the “quants” have found
ways to cope with this—better ways to deal with, as it were, quirks in the
prices of fruit and fruit salad. For a start, you can concentrate on the
short-run volatility of prices, which in some ways tends to behave more like
the Brownian motion that Black imagined. The quants can introduce sudden
jumps or tweak their models to match actual share-price movements more
closely. Mr Derman, who is now a professor at New York’s Columbia University
and a partner at Prisma Capital Partners, a fund of hedge funds, did some of
his best-known work modelling what is called the “volatility smile”—an
anomaly in options markets that first appeared after the 1987 stockmarket
crash when investors would pay extra for protection against another imminent
fall in share prices.
The fixes can make models complex and
unwieldy, confusing traders or deterring them from taking up new ideas.
There is a constant danger that behaviour in the market changes, as it did
after the 1987 crash, or that liquidity suddenly dries up, as it has done in
this crisis. But the quants are usually pragmatic enough to cope. They are
not seeking truth or elegance, just a way of capturing the behaviour of a
market and of linking an unobservable or illiquid price to prices in traded
markets. The limit to the quants’ tinkering has been not mathematics but the
speed, power and cost of computers. Nobody has any use for a model which
takes so long to compute that the markets leave it behind.
The idea behind quantitative finance is to
manage risk. You make money by taking known risks and hedging the rest. And
in this crash foreign-exchange, interest-rate and equity derivatives models
have so far behaved roughly as they should.
A muddle of mortgages Yet the idea behind
modelling got garbled when pools of mortgages were bundled up into
collateralised-debt obligations (CDOs). The principle is simple enough.
Imagine a waterfall of mortgage payments: the AAA investors at the top catch
their share, the next in line take their share from what remains, and so on.
At the bottom are the “equity investors” who get nothing if people default
on their mortgage payments and the money runs out.
Despite theory, CDOs were hopeless, at
least with hindsight (doesn’t that phrase come easily?). The cash flowing
from mortgage payments into a single CDO had to filter up through several
layers. Assets were bundled into a pool, securitised, stuffed into a CDO,
bits of that plugged into the next CDO and so on and on. Each source of a
CDO had interminable pages of its own documentation and conditions, and a
typical CDO might receive income from several hundred sources. It was a
lawyer’s paradise.
This baffling complexity could hardly be
more different from an equity or an interest rate. It made CDOs impossible
to model in anything but the most rudimentary way—all the more so because
each one contained a unique combination of underlying assets. Each CDO would
be sold on the basis of its own scenario, using central assumptions about
the future of interest rates and defaults to “demonstrate” the payouts over,
say, the next 30 years. This central scenario would then be “stress-tested”
to show that the CDO was robust—though oddly the tests did not include a 20%
fall in house prices.
This was modelling at its most feeble.
Derivatives model an unknown price from today’s known market prices. By
contrast, modelling from history is dangerous. There was no guarantee that
the future would be like the past, if only because the American housing
market had never before been buoyed up by a frenzy of CDOs. In any case,
there are not enough past housing data to form a rich statistical picture of
the market—especially if you decide not to include the 1930s nationwide fall
in house prices in your sample.
Neither could the models take account of
falling mortgage-underwriting standards. Mr Rajan of the University of
Chicago says academic research suggests mortgage originators, keen to
automate their procedures, stopped giving potential borrowers lengthy
interviews because they could not easily quantify the firmness of someone’s
handshake or the fixity of their gaze. Such things turned out to be better
predictors of default than credit scores or loan-to-value ratios, but the
investors at the end of a long chain of securities could not monitor lending
decisions.
The issuers of CDOs asked rating agencies
to assess their quality. Although the agencies insist that they did a
thorough job, a senior quant at a large bank says that the agencies’ models
were even less sophisticated than the issuers’. For instance, a BBB tranche
in a CDO might pay out in full if the defaults remained below 6%, and not at
all once they went above 6.5%. That is an all-or-nothing sort of return,
quite different from a BBB corporate bond, say. And yet, because both shared
the same BBB rating, they would be modelled in the same way.
Issuers like to have an edge over the
rating agencies. By paying one for rating the CDOs, some may have laid
themselves open to a conflict of interest. With help from companies like
Codefarm, an outfit from Brighton in Britain that knew the agencies’ models
for corporate CDOs, issuers could build securities with any risk profile
they chose, including those made up from lower-quality ingredients that
would nevertheless win AAA ratings. Codefarm has recently applied for
administration.
There is a saying on Wall Street that the
test of a product is whether clients will buy it. Would they have bought
into CDOs had it not been for the dazzling performance of the quants in
foreign-exchange, interest-rate and equity derivatives? There is every sign
that the issuing banks believed their own sales patter. The banks so liked
CDOs that they held on to a lot of their own issues, even when the idea
behind the business had been to sell them on. They also lent buyers much of
the money to bid for CDOs, certain that the securities were a sound
investment. With CDOs in deep trouble, the lenders are now suffering.
Modern finance is supposed to be all about
measuring risks, yet corporate and mortgage-backed CDOs were a leap in the
dark. According to Mr Derman, with Black-Scholes “you know what you are
assuming when you use the model, and you know exactly what has been swept
out of view, and hence you can think clearly about what you may have
overlooked.” By contrast, with CDOs “you don’t quite know what you are
ignoring, so you don’t know how to adjust for its inadequacies.”
Now that the world has moved far beyond
any of the scenarios that the CDO issuers modelled, investors’ quantitative
grasp of the payouts has fizzled into blank uncertainty. That makes it hard
to put any value on them, driving away possible buyers. The trillion-dollar
bet on mortgages has gone disastrously wrong. The hope is that the
trillion-dollar bet on companies does not end up that way too.
Continued in article
Closing Jensen Comment
So is portfolio diversification theory dead? I hardly think so. But if any
lesson is to be learned is that we should question those critical underlying
assumptions in Plato's Cave before worldwide strategies are implemented that
overlook the Achilles' heel of those critical underlying assumptions.
Way out there on (or beyond) the leading edge "Caltech Scientists Develop Novel Use of Neurotechnology to Solve Classic
Social Problem, September 10, 2009 ---
http://media.caltech.edu/press_releases/13288 Jim Mahar clued me into this link
Economists and neuroscientists from
the California Institute of Technology (Caltech) have shown that they
can use information obtained through functional magnetic resonance
imaging (fMRI) measurements of whole-brain activity to create feasible,
efficient, and fair solutions to one of the stickiest dilemmas in
economics, the public goods free-rider problem—long thought to be
unsolvable.
This is one of the first-ever
applications of neurotechnology to real-life economic problems, the
researchers note. "We have shown that by applying tools from
neuroscience to the public-goods problem, we can get solutions that are
significantly better than those that can be obtained without brain
data," says Antonio Rangel, associate professor of economics at Caltech
and the paper's principal investigator.
The paper describing their work was
published today in the online edition of the journal Science, called
Science Express.
Examples of public goods range from
healthcare, education, and national defense to the weight room or heated
pool that your condominium board decides to purchase. But how does the
government or your condo board decide which public goods to spend its
limited resources on? And how do these powers decide the best way to
share the costs?
"In order to make the decision
optimally and fairly," says Rangel, "a group needs to know how much
everybody is willing to pay for the public good. This information is
needed to know if the public good should be purchased and, in an ideal
arrangement, how to split the costs in a fair way."
In such an ideal arrangement, someone
who swims every day should be willing to pay more for a pool than
someone who hardly ever swims. Likewise, someone who has kids in public
school should have more of her taxes put toward education.
But providing public goods optimally
and fairly is difficult, Rangel notes, because the group leadership
doesn't have the necessary information. And when people are asked how
much they value a particular public good—with that value measured in
terms of how many of their own tax dollars, for instance, they’d be
willing to put into it—their tendency is to lowball.
Why? “People can enjoy the good even
if they don’t pay for it,” explains Rangel. "Underreporting its value to
you will have a small effect on the final decision by the group on
whether to buy the good, but it can have a large effect on how much you
pay for it."
In other words, he says, “There’s an
incentive for you to lie about how much the good is worth to you.”
That incentive to lie is at the heart
of the free-rider problem, a fundamental quandary in economics,
political science, law, and sociology. It's a problem that professionals
in these fields have long assumed has no solution that is both efficient
and fair.
In fact, for decades it's been assumed
that there is no way to give people an incentive to be honest about the
value they place on public goods while maintaining the fairness of the
arrangement.
“But this result assumed that the
group's leadership does not have direct information about people's
valuations,” says Rangel. “That's something that neurotechnology has now
made feasible.”
And so Rangel, along with Caltech
graduate student Ian Krajbich and their colleagues, set out to apply
neurotechnology to the public-goods problem.
In their series of experiments, the
scientists tried to determine whether functional magnetic resonance
imaging (fMRI) could allow them to construct informative measures of the
value a person assigns to one or another public good. Once they’d
determined that fMRI images—analyzed using pattern-classification
techniques—can confer at least some information (albeit "noisy" and
imprecise) about what a person values, they went on to test whether that
information could help them solve the free-rider problem.
They did this by setting up a classic
economic experiment, in which subjects would be rewarded (paid) based on
the values they were assigned for an abstract public good.
As part of this experiment, volunteers
were divided up into groups. “The entire group had to decide whether or
not to spend their money purchasing a good from us,” Rangel explains.
“The good would cost a fixed amount of money to the group, but everybody
would have a different benefit from it.”
The subjects were asked to reveal how
much they valued the good. The twist? Their brains were being imaged via
fMRI as they made their decision. If there was a match between their
decision and the value detected by the fMRI, they paid a lower tax than
if there was a mismatch. It was, therefore, in all subjects' best
interest to reveal how they truly valued a good; by doing so, they would
on average pay a lower tax than if they lied.
“The rules of the experiment are such
that if you tell the truth,” notes Krajbich, who is the first author on
the Science paper, “your expected tax will never exceed your benefit
from the good.”
In fact, the more cooperative subjects
are when undergoing this entirely voluntary scanning procedure, “the
more accurate the signal is,” Krajbich says. “And that means the less
likely they are to pay an inappropriate tax.”
This changes the whole free-rider
scenario, notes Rangel. “Now, given what we can do with the fMRI,” he
says, “everybody’s best strategy in assigning value to a public good is
to tell the truth, regardless of what you think everyone else in the
group is doing.”
And tell the truth they did—98 percent
of the time, once the rules of the game had been established and
participants realized what would happen if they lied. In this
experiment, there is no free ride, and thus no free-rider problem.
“If I know something about your
values, I can give you an incentive to be truthful by penalizing you
when I think you are lying,” says Rangel.
While the readings do give the
researchers insight into the value subjects might assign to a particular
public good, thus allowing them to know when those subjects are being
dishonest about the amount they'd be willing to pay toward that good,
Krajbich emphasizes that this is not actually a lie-detector test.
“It’s not about detecting lies,” he
says. “It’s about detecting values—and then comparing them to what the
subjects say their values are.”
“It’s a socially desirable
arrangement,” adds Rangel. “No one is hurt by it, and we give people an
incentive to cooperate with it and reveal the truth.”
“There is mind reading going on here
that can be put to good use,” he says. “In the end, you get a good
produced that has a high value for you.”
From a scientific point of view, says
Rangel, these experiments break new ground. “This is a powerful proof of
concept of this technology; it shows that this is feasible and that it
could have significant social gains.”
And this is only the beginning. “The
application of neural technologies to these sorts of problems can
generate a quantum leap improvement in the solutions we can bring to
them,” he says.
Indeed, Rangel says, it is possible to
imagine a future in which, instead of a vote on a proposition to fund a
new highway, this technology is used to scan a random sample of the
people who would benefit from the highway to see whether it's really
worth the investment. "It would be an interesting alternative way to
decide where to spend the government's money," he notes.
In addition to Rangel and Krajbich,
other authors on the Science paper, “Using neural measures of economic
value to solve the public goods free-rider problem,” include Caltech's
Colin Camerer, the Robert Kirby Professor of Behavioral Economics, and
John Ledyard, the Allen and Lenabelle Davis Professor of Economics and
Social Sciences. Their work was funded by grants from the National
Science Foundation, the Gordon and Betty Moore Foundation, and the Human
Frontier Science Program.
It would seem to me that the pattern recognition approach suggested by
Rangel and Kribich is a far out way of overcoming the scaling problem of
utility models.
Question
Is accounting an "academic" discipline?
The (Random House) dictionary defines "academic" as
"pertaining to areas of study that are not primarily vocational or applied , as
the humanities or pure mathematics." Clearly, the short answer to the question
is no, accounting is not an academic discipline. Joel Demski, "Is Accounting an Academic Discipline?" Accounting Horizons,
June 2007, pp. 153-157
Statistically there are a few youngsters who came to
academia for the joy of learning, who are yet relatively untainted by the
vocational virus. I
urge you to nurture your taste for learning, to follow your joy. That is the
path of scholarship, and it is the only one with any possibility of turning us
back toward the academy. Joel Demski, "Is Accounting an Academic Discipline?
American Accounting Association Plenary Session" August 9, 2006 ---
http://faculty.trinity.edu/rjensen//theory/00overview/theory01.htm
Jensen Comment
Joel's lament is a bit confusing since for the past four decades, virtually all
doctoral programs have replaced accounting professional content with
mathematics, statistics, econometrics, psychometrics, and sociometrics content
to a fault and to a point where very few accountants are interested in applying
for accountancy doctoral programs ---
http://faculty.trinity.edu/rjensen//theory/00overview/theory01.htm#DoctoralPrograms
The decline in doctoral program graduates (to less than 100 per year in the
United States) combined with the scientific requirements for publication in
leading academic accounting research journals resulted in the academy serving
the accountancy profession less and less over the past few decades:
It would help if Joel would be more explicit about what types of basic
"academic" research studies qualify as "accounting research" and why there is
virtually none of it being produced according to his paper and his address to
the AAA membership in August 2006. In particular, I would like to know what
types of academic "accounting" publications set academic accounting apart from
mathematical economics and mathematics disciplines such that these basic
research contributions can still be called "accounting" research that is not
applied (in the sense of his definition of "academic" research as not being
applied).
Following Joel's paper is a paper by the same title "is Accounting an
Academic Discipline?" by John C. Fellingham, Accounting Horizons, June
2007, pp. 159-163. John features the following quotation from Henry Rand
Hatfield in 1924:
I am sure that all of us who teach accounting in
the university suffer from the implied contempt of our colleagues, who look
upon accounting as an intruder, a Saul among the prophets, a paria whose
very presence detracts somewhat from the sanctity of the academic halls. Henry Rand Hatfield, "An Historical Defense of Bookkeeping,"
Journal of Accountancy, 1924.
I consider this quotation to be inappropriate in 2007. Professor Hatfield was
referring to the teaching of bookkeeping which is no longer the mundane
vocational subject matter of college accounting in the past fifty or more years.
I consider most of what we now teach in college accountancy to be very
appropriate in service to the accountancy profession. You can read more about
accounting education in Hatfield's time in the following historic papers:
Allen, C. E. (1927), "The growth of accounting instruction since 1900," The
Accounting Review (June): 150-166 ---
http://maaw.info/TheAccountingReview.htm Click on the "Non USF User Link"
Atkins, P. M. (1928), "University instruction in industrial cost
accounting," The Accounting Review," (December): 345-363 ---
http://maaw.info/TheAccountingReview.htm Click on the "Non USF User
Link"
Atkins, P. M. (1929), "University instruction in
industrial cost accounting," The Accounting Review (March):
23-32 ---
http://maaw.info/TheAccountingReview.htm Click on the "Non USF User
Link"
I guess what I'm really trying to say is that accountancy is a profession
like law is a profession, medicine is a profession, architecture is a
profession, engineering is a profession, pharmacy is a profession, etc. Why does
the academy need to apologize for teaching to the profession of accountancy when
in fact the academy is very proud to serve those other highly esteemed
professions. I do not see schools of law and schools of medicine apologizing to
the world for nobly serving those professions.
Both Demski and Fellingham made emotional appeals for academic accounting
researchers to make noteworthy contributions to the "true academic disciplines"
as quoted by Fellingham on Page 163. Not only should this be a goal, but in a
sense they are arguing that this should be a primary goal far above the goal of
serving the accountancy profession. I fail to note similar appeals being made by
professors of law and medicine and engineering. These professions do distinguish
between clinical versus research publications and teaching, but in general they
do not further glorify their research if it cannot conceivably have some
relevance to their professions. Indeed, even the most basic chemical and
physiological research in medicine still takes place with an eye toward eventual
relevance to human health.
I might also note that both law and medicine also publish some academic
research that is not based upon esoteric mathematics and statistics. For
example, historical and philosophical research methodologies are still allowed
in their most prestigious academic law and science journals, which currently is
not the case for leading academic accounting research journals.
By way of example, since Joel Demski took charge of the accounting doctoral
program at the University of Florida, every applicant to that doctoral program
cannot even matriculate into the program before pre-requisites of advanced
mathematics are satisfied.
Students are required to demonstrate math
competency prior to matriculating the doctoral program. Each student's
background will be evaluated individually, and guidance provided on ways a
student can ready themselves prior to beginning the doctoral course work.
There are opportunities to complete preparatory course work at the
University of Florida prior to matriculating our doctoral program.
University of Florida Accounting Concentration
---
http://www.cba.ufl.edu/fsoa/docs/phd_AccConcentration.pdf
Why does every candidate have to qualify in advanced mathematics rather than
allowing substitutes such as advanced philosophy or advanced legal studies?
I might also add that science and medicine academic journals also still place
monumental priorities on replications of research findings. Leading academic
accounting research journals will not even publish replications and mostly as a
result it is very difficult to find replications of most of the top academic
accounting research papers published by so-called leading accounting researchers
---
http://faculty.trinity.edu/rjensen//theory/00overview/theory01.htm#Replication
More of my rants on this can be found in the following links:
Accentuate the Obvious and Avoid the Tough Problems for
Which Data and Models are Lacking
Not everything that can be counted, counts. And not
everything that counts can be counted. Albert Einstein
For a long time, elite accounting
researchers could find no “empirical evidence” of widespread earnings
management. All they had to do was look up from the computers where their heads
were buried. Bob Jensen ---
http://faculty.trinity.edu/rjensen/395wpTAR/Web/TAR395wp.htm
Yes, I have biases, as I freely acknowledge. I like
research that puts the method before the message, meaning that if the conclusion
comes first, as in much of what I perceive under the “critical perspectives”
banner, I view that to be advocacy for a cause, not research.” Steve Kachelmeier,
University of Texas and current Editor of The Accounting Review (in a
letter to Paul Williams)
“Research should be problem driven rather than
methodologically driven," said Lisa Garcia Bedolla, a member of the task force
who teaches at the University of California at Berkeley. Scott Jascik ---
http://www.insidehighered.com/news/2009/09/04/polisci
"I understand your point, Jim." He could not identify one issue that (accountics)
researchers had been able to "put to bed" after
all that effort. P. Kothari, one of the Editors of JAE and a full professor at MIT,
as quoted by Jim Peters below.
Do we forecast? You bet. Do we have
confidence in our forecasts? Never! Confidence about a non-linear chaotic system
can only come in degrees, and even those degrees of confidence are guesses. Not
all hope is lost. There are times when it seems our ability to predict is better
than others. Thus we need to take advantage of it if we see it. Trading ranges,
pivot points, support and resistance, and the like can help, and do help the
trader. Michael Covel, Trading Black Swans,
September 2009 ---
http://www.michaelcovel.com/pdfs/swan.pdf
Research of Dubious Value
Not every scientist can discover the double helix, or
the cellular basis of memory, or the fundamental building blocks of matter. But
fear not. For those who fall short of these lofty goals, another entry in the
"publications" section of the ol' c.v. is within your reach. The proliferation
of scientific journals and meetings makes it possible to publish or present
papers whose conclusion inspires less "Wow! Who would have guessed?" and more
"For this you got a Ph.D.?" In what follows (with thanks to colleagues who
passed along their favorites), names have been withheld to protect the silly.
Sharon Begley, "Scientists Research Questions Few Others Would Bother to Ask,"
The Wall Street Journal, May 27, 2005; Page B1 ---
http://online.wsj.com/article_print/0,,SB111715390781744684,00.html
Jensen Comment: Although some of the studies Begley cites are
well-intended, her article does remind me of some of the more extreme studies
that won Senator Proxmire's Golden Fleece Awards ---
http://www.taxpayer.net/awards/goldenfleece/about.htm
Also see
http://www.encyclopedia.com/html/G/GoldenF1l.asp
Accounting research in top accounting journals seldom is not so much a fleecing
as it is a disappointment in drawing "obvious" conclusions that practicing
accountants "would not bother to ask." Behavioral studies focus on what
can be studied rather than what is interesting to study. Studies based on
analytical mathematics often start with assumptions that guarantee the outcomes.
And capital markets event studies either "discover" the obvious or are
inconclusive.
Rough notes of David Dennis from an informal panel of veteran accounting
researchers at the American Accounting Association annual meetings in 2007 ---
http://faculty.trinity.edu/rjensen/Dennis2007.htm
Financial Theory Errors
Where capital market research in accounting made a huge mistake by relying
on CAPM
The basic problem with most of the research published in leading
academic accounting research journals is that they've been more concerned with
doable methods (using mathematics, statistics, econometrics, and psychometrics)
rather than more important problems that are not amenable to such "accountics"
research methodologies. The message from the editors for the past four decades
is that alternate methods (history, survey methods, and normative reasoning has
no place in top journals where measurement and accountics methodology is the
name of the game. And it has been mostly a game often played by mathematicians
and statisticians who are not well grounded in accounting per se. Certainly some
are good accountants, but accounting knowledge is no longer as important as
mathematics and statistics.
For much of the last 25 years, most of the
investment management world has promoted the idea that individual
investors can't beat the market. To beat the market, stock pickers of
course have to discover mispricings in stocks, but the Nobel-acclaimed
Efficient Market Hypothesis (EMH) claims that
the market is a ruthless mechanism acting instantly to arbitrage away
any such opportunities, claiming that the current price of a stock is
always the most accurate estimate of its value (known as
"informational efficiency"). If this is true, what hope can there be for
motivated stock pickers, no matter how much they sweat and toil, vs.
low-cost index funds that simply mechanically track the market? As it
turns out, there's plenty!
The (absurd) rise of the Efficient
Market Hypothesis
First proposed in University of Chicago
professor Eugene Fama’s 1970 paper
Efficient Capital Markets: A Review of Theory and Empirical Work,
EMH has evolved into a concept that a stock price
reflects all available information in the market, making it impossible
to have an edge. There are no undervalued stocks, it is argued, because
there are smart security analysts who utilize all available information
to ensure unfailingly appropriate prices. Investors who seem to beat the
market year after year are just lucky.
However, despite still being widely taught in
business schools, it is increasingly clear that the efficient market
hypothesis is "one of the most remarkable errors in the history of
economic thought" (Shiller). As Warren Buffett famously quipped, "I'd be
a bum on the street with a tin cup if the market was always efficient."
Similarly, ex-Fidelity fund manager and
investment legend
Peter Lynch said in a 1995 interview with
Fortune magazine: “Efficient markets? That’s a bunch of junk, crazy
stuff.”
So what's so bogus about EMH?
Firstly, EMH is based on a set of absurd
assumptions about the behaviour of market participants that goes
something like this:
Investors can trade stocks freely in any
size, with no transaction costs;
Everyone has access to the same
information;
Investors always behave rationally;
All investors share the same goals and the
same understanding of intrinsic value.
All of these assumptions are clearly
nonsensical the more you think about them but, in particular, studies in
behavioural finance initiated by Kahneman, Tversky and Thaler has shown
that the premise of shared investor rationality is a seriously flawed
and misleading one.
Secondly, EMH makes predictions that do not
accord with the reality. Both the Tech Bubble and the Credit
Bubble/Crunch show that that the market is subject to fads, whims and
periods of irrational exuberance (and despair) which can not be
explained away as rational. Furthermore, contrary to the predictions of
EMH, there have been plenty of individuals who have managed to
outperform the market consistently over the decades.
Question for Fama and French ---
http://www.dimensional.com/famafrench/2009/03/qa-confidence-in-the-bell-curve.html#more
It would be very enlightening if you would comment on the Nassim Nicholas Taleb
("The Black Swan") attack on the use of Gaussian (normal bell curve) mathematics
as the foundation of finance. As you may know, Taleb is a fan of Mandelbrot,
whose mathematics account for fat tails. He argues that the bell curve doesn't
reflect reality. He is also quite critical of academics who teach modern
portfolio theory because it is based on the assumption that returns are normally
distributed. Doesn't all this imply that academics should start doing
reality-based research?
Answer from Gene Fama (Chicago)
EFF: Half of my 1964 Ph.D. thesis is tests of market efficiency, and the
other half is a detailed examination of the distribution of stock returns.
Mandelbrot is right. The distribution is fat-tailed relative to the normal
distribution. In other words, extreme returns occur much more often than
would be expected if returns were normal.
There was lots of interest in this issue for about
ten years. Then academics lost interest. The reason is that most of what we
do in terms of portfolio theory and models of risk and expected return works
for Mandelbrot's stable distribution class, as well as for the normal
distribution (which is in fact a member of the stable class). For passive
investors, none of this matters, beyond being aware that outlier returns are
more common than would be expected if return distributions were normal.
For other applications, however, the difference can
be critical. Risk management by financial institutions is a good example.
For example, portfolio insurance, which was the rage in the early 1980s,
bombed in the crash of October 1987, because this was an event that was
inconceivable in their normality based return model. The normality
assumption is also likely to be a serious problem in various kinds of
derivatives, where lots of the price is due to the probability of extreme
events. For example, news story accounts suggest that AIG blew up because
its risk model for credit default swaps did not properly account for outlier
events.
Answer from Kenneth French (Dartmouth)
KRF: I agree with Gene, but want to make another point that he is
appropriately reluctant to make. Taleb is generally correct about the
importance of outliers, but he gets carried away in his criticism of
academic research. There are lots of academics who are well aware of this
issue and consider it seriously when doing empirical research. Those of us
who used Gene's textbook in our first finance course have been concerned
with this fat-tail problem our whole careers. Most of the empirical studies
in finance use simple and robust techniques that do not make precise
distributional assumptions, and Gene can take much of the credit for this as
well, whether through his feedback in seminars, suggestions on written work,
comments in referee reports, or the advice he has given his many Ph.D.
students over the years.
The possibility of extreme outcomes is certainly
important for things like risk management, option pricing, and many
complicated "arbitrage" strategies. Investors should also recognize the
potential effect of outliers when assessing the distribution of future
returns on their portfolios. None of this implies, however, that the
existence of outliers undermines modern portfolio theory or asset pricing
theory. And the central implications of modern portfolio theory and asset
pricing—the benefits of diversification and the trade-off between risk and
return—remain valid under any reasonable distribution of returns.
"How Dragon Kings Could Trump Black Swans Power laws have a hidden
structure that reveals why extreme events are more common than we'd thought,"
MIT's Technology Review, August 4, 2009 ---
http://www.technologyreview.com/blog/arxiv/
Sornette gives as an example the distribution of
city sizes in France which follows a classic power law, meaning that there
are many small cities and only a few large ones. On a log-log scale, this
distribution gives a straight line. Except for Paris, which is an outlier,
many times larger than it ought to be if it were to follow the power law.
Paris is an outlier because it has been hugely
influential in the history of France and so has benefited from various
positive feedback mechanisms that have ensured its outsize growth.
Apparently London occupies a similarly outlying position in the distribution
of cities in the UK.
Sornette goes on to identify a number of data sets
showing power laws with outliers that he says are the result of positive
feedback mechanisms that make them much larger than their peers. He calls
these events dragon kings. What's interesting about them is that they are
entirely unaccounted for by a current understanding of power laws, from
which Nassim Nicholas Taleb built the idea of black swans.
The special characteristic of dragon kings is that
a positive feedback mechanism creates faster-than-exponential growth making
them larger than expected.
So what to make of this? Sornette makes one
interesting observation. The seemingly ubiquitous existence of these dragon
kings in all kinds of data sets means that extreme events are significantly
more likely than power laws alone suggest.
That's important. If you've ever wondered why we've
experienced not just a single 100-year financial crises in the last couple
of decades but two or three, here's your answer. It also implies that you'll
experience a few more before your time is up.
But Sornette goes further. He argues that dragon
kings may have properties that make them not only identifiable in real time
but also predictable. He puts it like this: "These processes provide clues
that allow us to diagnose the maturation of a system towards a crisis."
That's much more speculative. It's one thing to
identify the feedback mechanisms that cause faster-than-exponential growth
(and it's not clear that Sornette can do even this) but quite another to
spot the event that trigger a crash.
Sornette looks to be onto something interesting
with his notion of dragon kings: outliers that exist beyond the usual realm
of power laws. That could be a hugely infuential. But his contention that
these outliers are in some way more easily predictable than other events
smacks more of wishful thinking than good science.
For example, in the figures below I’ve plotted
the Fama-French 25 (portfolios ranked on size and book-to-market)
against beta.
In the first figure, I plot the average excess
return to the FF 25 against the average excess return one would expect,
given beta.
If you’d like to see how I calculated the
charts above, please reference the excel file
here.
Given such a poor track record, is
anyone still using the CAPM?
Lot’s of people, apparently…
Welch (2008) finds that ~75% of professors
recommend the use of the model when estimating the cost of capital, and
Graham and Harvey (2001) find that ~74% of
CFOs use the CAPM in their work.
A few quotes from Graham and Harvey 2001 sum up
common sentiment regarding the CAPM:
“While the CAPM is popular, we show later
that it is not clear that the model is applied properly in practice.
Of course, even if it is applied properly, it is not clear that the
CAPM is a very good model [see Fama and French (1992)].
“…practitioners might not apply the CAPM or
NPV rule correctly. It is also interesting that CFOs pay very little
attentionto risk factors based on momentum and
book-to-market-value.”
Of course, there are lots of arguments to
consider before throwing out the CAPM. Here are a few:
Everyone learns about it and knows how to
use it (although, Graham and Harvey suggest that many practitioners
don’t even apply the CAPM theory correctly)
Data is easy to obtain on betas.
Roll’s critique–maybe the CAPM isn’t a
junk theory, rather, the empirical tests showing the CAPM doesn’t
work are bogus.
Regardless, being that this blog is dedicated
to empirical data and evidence, and not about ‘mentally masturbating
about theoretical finance models,’ we’ll operate under the assumption
that the CAPM is dead until new data comes available.
The Fama French Alternative?
Given the CAPM doesn’t work that well in
practice, perhaps we should look into the Fama French model (which isn’t
perfect or cutting edge, but a solid workhorse nonetheless). And while
the FF model inputs are highly controversial, one thing is clear: the FF
3-factor model does a great job explaining the variability of returns.
For example, according to
Fama French 1993, the 3-factor model explains
over 90% of the variability in returns, whereas the CAPM can only
explain ~70%!
The 3-factor model is great, but how the
heck does one estimate the FF factors?
Dartmouth Professor Ken French comes in for the
rescue!
Over time, financial statements of public
corporations show more losses, intangibles, and earnings restatements, which
lower their value for predicting corporate bankruptcies.
Corporate bankruptcies, like earthquakes, are rare
events. But when they do occur, says
Maureen
F. McNichols of Stanford's Graduate School of
Business, the results can be financially devastating for investors and other
stakeholders.
An important role of financial statement
information is to permit investors to assess the likely timing and amount of
future cash flows. Recent research by McNichols and coauthors examines the
usefulness of financial statement and market data for investors who want to
ascertain the likelihood of bankruptcy. The results of that research are not
completely reassuring.
The authors — McNichols, Marriner S. Eccles
Professor of Public and Private Management;
William
H. Beaver, Joan E. Horngren Professor of
Accounting, Emeritus, at the Graduate School of Business; and
Maria Correia,
assistant professor of accounting at the London Business School — examined
40 years of financial data garnered from thousands of public corporations.
They analyzed key financial ratios, such as return on assets and leverage,
reported in filings to the
U.S. Securities and Exchange Commission, and market-related data such as
market capitalization and stock returns. Over the period they examined —
1962 to 2002 — the data became significantly less useful in predicting
bankruptcy. "Investors should be concerned and aware of this when they
assess bankruptcy risk," McNichols says.
A professor of accounting, McNichols is quick to add that financial
statement data are still highly relevant. Of the firms she and her
colleagues studied, about 1% fell into bankruptcy, and despite the
deterioration in financial-statement usefulness, financial ratios and market
data are still important tools for predicting insolvency, she says.
Nonetheless, the results are concerning enough that McNichols believes
that regulators and standards setters such as the U.S. Securities and
Exchange Commission and the
Financial Accounting
Standards Board should be aware of this issue.
Three major factors muddy the waters for investors
attempting to predict bankruptcy, the researchers found:
Over the sample period, there is increasing
evidence that management exercises discretion over financial reporting,
and that there have been increasing numbers of restatements because the
financial statements were materially misleading. "Our findings indicate
that the manipulation of reported results gives a misleading impression
of profitability and reduces investors' ability to predict bankruptcy,"
notes Correia. For example, firms recognizing revenue ahead of schedule
or fraudulently may appear profitable. As a result, the bankruptcy
prediction model is much less likely to classify bankrupt firms that
also restated earnings accurately, assigning lower risk due to their
overstated earnings.
Many firms, particularly the technology
companies listed on the
NASDAQ exchange,
are heavy spenders on research and development. R&D in itself is
certainly not a cause for concern, but because this "intangible" is not
recognized on the balance sheet, it makes various financial ratios and
data less useful.
The frequency of firms reporting losses has
increased substantially over the past 40 years. Because predicting
future earnings for firms that suffer losses involves substantially
greater uncertainty than for firms that are profitable, the bankruptcy
prediction model is less likely to accurately classify loss firms that
will go bankrupt.
Consider a firm that suffers a loss. The fact that
it has lost money is obviously not good news, but in and of itself a loss
doesn't mean a company will go bankrupt. Losses complicate the financial
picture, the researchers found, because while firms reporting a loss are
more likely to go bankrupt on average, it is harder to predict which loss
firms will do so relative to firms earning a profit.
Continued in article
Jensen Comment
Until the 1990s net earnings showed a surprising predictive power in empirical
capital market studies. I say "surprising" in the sense that we all knew
historical cost earnings based upon many arbitrary assumptions in accrual
accounting such as depreciation, amortization, and bad debt estimation.
Although net earnings was never defined very well in the old days, the FASB
and IASB pretty well destroyed any remaining definition as fair value
accounting, goodwill impairment, and many other components of earnings took away
any remaining meaning of bottom-line net earnings. The biggest bomb, in my
opinion, was the combining of unrealized fair value changes with realized
revenues on contracts.
Solution 3
Pray hard that the IASB and FASB will one day define "net earnings" in a way
that it will have predictive value. That prayer has about as much hope as
praying for world peace or a balanced Federal Budget in Washington DC.
None of the above approaches necessarily will automatically improve the
predictive value of financial statements. Our hope is that in both solutions
financial analysts will be forced to perform deeper analysis rather than simply
track bottom line net earnings that has little, if any, predictive value after
the FASB and IASB screwed it up.
At the AAA meeting in
DC, I attended a presidential address by Ray Ball and Phil Brown
regarding their seminal research paper (JAR 1968). They described the
motivation for their study as a test of existing scholarly research that
painted a dim picture of reported earnings. The earlier writers noted
that earnings were based on old information (historical cost) or, worse
yet, a mix of old and new information (mixed attributes). The early
articles concluded that earnings could not be informative, and therefore
major changes to accounting practice where necessary to correct the
problem.
Ball and Brown viewed
this literature as providing a testable hypothesis – market participants
should not be able to use earnings in a profitable manner. Stated
another way, knowing the amount of earnings that would be reported at
the end of the year with certainty could not be used to profitably trade
common stocks at the beginning of the year. Evidence to the contrary
would suggest the null that earnings are non-informative does not hold.
While the methods part
of the paper is probably difficult for recent accounting archivalists to
follow, Ball and Brown produce perhaps the single most famous graph in
the accounting literature. It shows stock returns trending up over the
year for companies that ultimately report increases in earnings and
trending down for companies that report decreases in earnings. Thus they
show that accounting numbers can be informative even if the aggregate
number is not computed using a single unified measurement approach
across transactions/events. Subsequent research would show that numbers
from the income statement have predictive ability for future earnings
and cash flows.
As I sat listening to
these two research icons, I could not help but think about some comments
I have heard recently from a few standard setters and practitioners.
Those individuals express contempt for EPS in a mixed attribute world.
They appear to wish they could jump in a time machine and eliminate per
share computations related to income. I readily admit that EPS does not
explain much of the variance in returns over periods of one year or less
( e.g., Lev, JAR 1989). However the link is clearly significant, and
over longer periods, the R2’s are quite high (Easton, Harris, and Ohlson,
JAE 1992). Can the standard setters make incremental improvements to
increase usefulness of EPS? I sure hope so, and maybe the recent paper
posted by Alex Milburn will help. But dismissing a reported number
because it is not derived from a single consistent measurement attribute
– be it fair value or historical cost – seems to revert back to pre-Ball
and Brown views that are rejected by years of research.
Jensen Comment
Given the balance sheet focus of the FASB and the IASB at the expense of the
income statement I don't see how net income or eps could be anything but
misleading to investors and financial analysts. The biggest hit, in my
opinion, is the way the FASB and IASB create earnings volatility not only
unrealized fair value changes but the utter fiction created by posting fair
value changes that will never ever be realized for held-to-maturity
investments and debt. This was not the case at the time of the seminal Ball
and Brown article. Those were olden days before accounting standards
injected huge doses of fair value fiction in eps numbers so beloved by
investors and analysts.
Sydney Finkelstein, the Steven Roth professor of management at the
Tuck School of Business at Dartmouth College, also pointed out that Bank of
America booked a $2.2 billion gain by increasing the value of Merrill
Lynch’s assets it acquired last quarter to prices that were higher than
Merrill kept them. “Although perfectly legal, this move is also perfectly
delusional, because some day soon these assets will be written down to their
fair value, and it won’t be pretty,” he said
"Bank Profits Appear Out of Thin Air ," by Andrew Ross
Sorkin, The New York Times, April 20, 2009 ---
http://www.nytimes.com/2009/04/21/business/21sorkin.html?_r=1&dbk
This is starting to feel
like amateur hour for aspiring magicians.
Another day, another
attempt by a Wall Street bank to pull a bunny out of the hat, showing
off an earnings report that it hopes will elicit oohs and aahs from the
market. Goldman Sachs, JPMorgan Chase, Citigroup and, on Monday, Bank of
America all tried to wow their audiences with what appeared to be —
presto! — better-than-expected numbers.
But in each case,
investors spotted the attempts at sleight of hand, and didn’t buy it for
a second.
With Goldman Sachs, the
disappearing month of December didn’t quite disappear (it changed its
reporting calendar, effectively erasing the impact of a $1.5 billion
loss that month); JPMorgan Chase reported a dazzling profit partly
because the price of its bonds dropped (theoretically, they could retire
them and buy them back at a cheaper price; that’s sort of like saying
you’re richer because the value of your home has dropped); Citigroup
pulled the same trick.
Bank of America sold its
shares in China Construction Bank to book a big one-time profit, but Ken
Lewis heralded the results as “a testament to the value and breadth of
the franchise.”
Sydney
Finkelstein, the Steven Roth professor of management at the Tuck School
of Business at Dartmouth College, also pointed out that Bank of America
booked a $2.2 billion gain by increasing the value of Merrill Lynch’s
assets it acquired last quarter to prices that were higher than Merrill
kept them.
“Although
perfectly legal, this move is also perfectly delusional, because some
day soon these assets will be written down to their fair value, and it
won’t be pretty,” he said.
Investors reacted by
throwing tomatoes. Bank of America’s stock plunged 24 percent, as did
other bank stocks. They’ve had enough.
Why can’t anybody read
the room here? After all the financial wizardry that got the country —
actually, the world — into trouble, why don’t these bankers give their
audience what it seems to crave? Perhaps a bit of simple math that could
fit on the back of an envelope, with no asterisks and no fine print,
might win cheers instead of jeers from the market.
What’s particularly
puzzling is why the banks don’t just try to make some money the
old-fashioned way. After all, earning it, if you could call it that, has
never been easier with a business model sponsored by the federal
government. That’s the one in which Uncle Sam and we taxpayers are
offering the banks dirt-cheap money, which they can turn around and lend
at much higher rates.
“If the federal
government let me borrow money at zero percent interest, and then lend
it out at 4 to 12 percent interest, even I could make a profit,” said
Professor Finkelstein of the Tuck School. “And if a college professor
can make money in banking in 2009, what should we expect from the highly
paid C.E.O.’s that populate corner offices?”
But maybe now the banks
are simply following the lead of Washington, which keeps trotting out
the latest idea for shoring up the financial system.
The latest big idea is
the so-called stress test that is being applied to the banks,
with results expected at the end of this month.
This is playing to a
tough crowd that long ago decided to stop suspending disbelief. If the
stress test is done honestly, it is impossible to believe that some
banks won’t fail. If no bank fails, then what’s the value of the stress
test? To tell us everything is fine, when people know it’s not?
“I can’t think of a
single, positive thing to say about the stress test concept — the
process by which it will be carried out, or outcome it will produce, no
matter what the outcome is,” Thomas K. Brown, an analyst at
Bankstocks.com, wrote. “Nothing good can come of this and, under
certain, non-far-fetched scenarios, it might end up making the banking
system’s problems worse.”
The results of the
stress test could lead to calls for capital for some of the banks. Citi
is mentioned most often as a candidate for more help, but there could be
others.
The expectation, before
Monday at least, was that the government would pump new money into the
banks that needed it most.
But that was before the
government reached into its bag of tricks again. Now Treasury, instead
of putting up new money, is considering swapping its preferred shares in
these banks for common shares.
The benefit to the bank
is that it will have more capital to meet its ratio requirements, and
therefore won’t have to pay a 5 percent dividend to the government. In
the case of Citi, that would save the bank hundreds of millions of
dollars a year.
And — ta da! — it will
miraculously stretch taxpayer dollars without spending a penny more.
Thursday, April 28, 2005 The Chronicle of Higher Education Business Schools' Focus on Research Has
Ensured Their Irrelevance, Says Scathing Article By KATHERINE S. MANGAN
Business schools are
"institutionalizing their own irrelevance" by focusing on scientific
research rather than real-life business practices, according to a blistering
critique of M.B.A. programs that will be published today in the May issue of
the Harvard Business Review.
The article, "How Business Schools Lost Their Way,"
was written by Warren G. Bennis and James O'Toole, both prominent professors
at the University of Southern California's Marshall School of Business. Mr.
Bennis is also the founding chairman of the university's Leadership
Institute, and Mr. O'Toole is a research professor at Southern Cal's Center
for Effective Organizations.
Mr. Bennis and Mr. O'Toole conclude that business
schools are too focused on theory and quantitative approaches, and that, as
a result, they are graduating students who lack useful business skills and
sound ethical judgment. The authors call on business schools to become more
like medical and law schools, which treat their disciplines as professions
rather than academic departments, and to expect faculty members to be
practicing members of their professions.
"We cannot imagine a professor of surgery who has
never seen a patient or a piano teacher who doesn't play the instrument, and
yet today's business schools are packed with intelligent, highly skilled
faculty with little or no managerial experience," the two professors write.
"As a result, they can't identify the most important problems facing
executives and don't know how to analyze the indirect and long-term
implications of complex business decisions."
While business deans pay lip service to making
their courses more relevant, particularly when they are trying to raise
money, their institutions continue to promote and award tenure to faculty
members with narrow, scientific specialties, the authors contend.
"By allowing the scientific-research model to drive
out all others, business schools are institutionalizing their own
irrelevance," the authors write.
Most business problems cannot be solved neatly by
applying hypothetical models or formulas, they say. "When applied to
business -- essentially a human activity in which judgments are made with
messy, incomplete, and incoherent data -- statistical and methodological
wizardry can blind rather than illuminate."
Not surprisingly, the head of the association that
accredits business schools in the United States disagrees with the authors'
assessment. John J. Fernandes, president and chief executive officer of
AACSB International: the Association to Advance Collegiate Schools of
Business, said most business schools today are making an effort to teach
broad skills that are directly applicable to real-world business practices.
He pointed out that in 2003, the association
updated its accreditation standards to emphasize the teaching of "soft
skills" like ethics and communication, and to require that business schools
assess how well students are learning a broad range of managerial skills.
"I think the authors are looking at a very limited
group of business schools that emphasize research," said Mr. Fernandes.
"Most schools have done an excellent job of producing graduates with a broad
range of skills who can hit the ground running when they're hired."
Mr. Bennis and Mr. O'Toole are not convinced. They
say that business schools, which in the early 20th century had the
reputation of being little more than glorified trade schools, have swung too
far in the other direction by focusing too heavily on research. The shift
began in 1959, they say, when the Ford and Carnegie Foundations issued
scathing reports about the state of business-school research.
While the Southern Cal professors say they do not
favor a return to the trade-school days, they think business schools, and
business professors, have grown too comfortable with an approach that serves
their own needs but hurts students.
"This model gives scientific respectability to the
research they enjoy doing and eliminates the vocational stigma that
business-school professors once bore," the article concludes. "In short, the
model advances the careers and satisfies the egos of the professoriate."
The authors point out a few bright spots in their
otherwise gloomy assessment of M.B.A. education. The business schools at the
University of California at Berkeley and the University of Dallas are among
those that emphasize softer, nonquantifiable skills like ethics and
communication, they write. In addition, some business schools operate their
own businesses, such as the student-run investment fund offered by Cornell
University's S.C. Johnson Graduate School of Management.
Bob Jensen wrote:
The troubles with multiple regression and discriminant analysis models
are those nagging assumptions of linearity, predictor variable
independence, homoscedasticity, and independence of error terms. If we
move up to non-linear models, the assumption of robustness is a giant
leap in faith. And superimposed on all of this is the assumption of
stationarity needed to have any confidence in extrapolations from past
experience.
In the end, if gaming is allowed in the future as
it has been allowed by bankers and their auditors for decades, putting
accountics into the standards is not the answer.
Sophisticated accountics is just perfume sprayed on
the manure pile.
Amy Dunbar comment/questions: Oh my, what a
metaphor. ;-)
I continue to struggle with the dismissal of
econometric analysis (accountics?) as an approach to address accounting
issues. Many disciplines use econometric analysis in research, despite the
limitations you point out. What research methods do you think are
appropriate for studying accounting issues? In my opinion, research requires
a disciplined approach that can be replicated, which you argue is crucial.
Can one replicate research using the research methods that you favor? Or
perhaps I am misunderstanding your points.
For example, consider the FIN 48 tax disclosures.
My coauthors and I have collected data from the tax footnotes of300
companies to determine how firms are handling the FIN 48 21d requirement of
forecasting the expected tax reserve change over the next 12 months. We want
to know how accurate forecasts are and if the forecast errors result because
of the inherent difficulty of providing the forecast or if firms do not want
to disclose because they do not want to provide a roadmap for taxing
authorities. We use econometric methods to test our hypotheses. How would
you address this issue? By the way, the Illinois tax conference in October
has a panel session on FIN 48 disclosures, including the forecast
requirement, which suggests others are grappling with the informativeness of
these disclosures.
I ordered the book that Paul Williams suggested:
The Flight from Reality in the Human Sciences. I hope I will have a better
understanding of your position after I read it.
Amy Dunbar
UConn
September 8, 2009 reply from Bob Jensen
Hi Amy,
If you really want to understand the problem you’re
apparently wanting to study, read about how Warren Buffett changed the whole
outlook of a great econometrics/mathematics researcher (Janet Tavkoli). I’ve
mentioned this fantastic book before ---Dear Mr. Buffett. What opened her eyes is how Warren Buffet
built his vast, vast fortune exploiting the errors of the sophisticated
mathematical model builders when valuing derivatives (especially options)
where he became the writer of enormous option contracts (hundreds of
millions of dollars per contract). Warren Buffet dared to go where
mathematical models could not or would not venture when the real world
became too complicated to model. Warren reads financial statements better
than most anybody else in the world and has a fantastic ability to retain
and process what he’s studied. It’s impossible to model his mind.
I finally grasped what Warren
was saying. Warren has such a wide body of knowledge that he does not need
to rely on “systems.” . . . Warren’s vast knowledge of corporations and
their finances helps him identify derivatives opportunities, too. He only
participates in derivatives markets when Wall Street gets it wrong and
prices derivatives (with mathematical models) incorrectly. Warren tells
everyone that he only does certain derivatives transactions when they are
mispriced.
Wall Street derivatives
traders construct trading models with no clear idea of what they are doing.
I know investment bank modelers with advanced math and science degrees who
have never read the financial statements of the corporate credits they
model. This is true of some credit derivatives traders, too. Janet Tavakoli, Dear Mr. Buffett, Page 19
The part of my message
that you quoted was in the context of a bad debt estimation message. I don’t
think multivariate models in general work well in the context of bad debt
estimation because of the restrictive assumptions of the models (except in
some industries where bad debt losses are dominated by one or two really
good predictor variables). There is an exception in the case of the Altman,
Beaver, and Ohlson bankruptcy prediction models, but predicting bankruptcy
is in a different ball park than predicting defaults among 10 million rather
small accounts receivable.
As to multivariate models
as applied in TAR, JAR, and JAE I’ve no objection since the 1970s after
referees became much better at challenging model assumptions (in the 1960s
refereeing of econometrics models in accounting literature was often a
joke). "FANTASYLAND ACCOUNTING RESEARCH: Let's Make Pretend..." by Robert E.
Jensen, The Accounting Review,
Vol. 54, January 1979, 189-196.
The problem, as I see it,
is that there’s nothing wrong with our econometrics tool bag when applied to
problems where the tools fit the problem. The econometrics models (except
for nonlinear models) are relatively robust in most papers that do get
published these days.
An Example of
Challenges of Multivariate Model Assumptions
"Is accruals quality a priced risk factor?" by John E.
Corea, Wayne R. Guaya, and Rodrigo Verdib, Journal of Accounting and
Economics ,Volume 46, Issue 1, September 2008, Pages 2-22
Abstract
In a recent and influential empirical paper, Francis, LaFond, Olsson, and
Schipper (FLOS) [2005. The market pricing of accruals quality. Journal of
Accounting and Economics 39, 295–327] conclude that accruals quality (AQ) is
a priced risk factor. We explain that FLOS’ regressions examining a
contemporaneous relation between excess returns and factor returns do not
test the hypothesis that AQ is a priced risk factor. We conduct appropriate
asset-pricing tests for determining whether a potential risk factor explains
expected returns, and find no evidence that AQ is a priced risk factor.
We need to see the above disputes become the rule
rather than the exception!
Francis, LaFond, Olsson, and Schipper vigorously disagree with criticisms of
their work such that there are some interesting disputes that on occasion
arise in accountics research. For the most part, however, published papers
like this are rarely replicated such that errors and frauds go unchallenged
in most of the thousands of accountics papers that have been published in
the past four decades ---
http://faculty.trinity.edu/rjensen/theory01.htm#Replication
The Corea, Guaya, and Verdib replication is a very,
very, very rare exception. I only wish there were more such disputes over
underlying modeling assumptions --- they should be extended to data quality
as well.
Now let me ask about your
FIN 48 tax disclosure study. Was there any independent replication to verify
that you did not make any significant data collection or modeling analysis
errors (you would be the last person in the world that I would suspect of
research fraud)? Do we accept your harvest as totally edible without a
single taste test by independent replicators?
http://faculty.trinity.edu/rjensen/theory01.htm#Replication
The Bigger Problems
Accountics models seldom
focus on the big problems of the profession, because the econometrics and
mathematical analysis tools just are not suited to our systemic accountancy
problems (such as the vegetable nutrition problem) ---
http://faculty.trinity.edu/rjensen/FraudConclusion.htm#BadNews
The editorial problem in TAR, JAR, and JAE is that they
commenced in the 1980s to ignore problems that could not be attacked with
accountics mathematics and statistical tool bags. This leaves out most
problems faced in the accounting profession since practitioners and standard
setters seldom (almost never) have copies of TAR, JAR, JAE, and even AH on
the table when they are dealing with client issues or standards issues. AH
evolved from its original charge to where articles in AH versus TAR are
virtually interchangeable. I repeat from a message yesterday:
An example is the virtual, albeit not total, neglect of
accounting fraud and ethics in in top academic accounting research journals.
Large databases to mine and model for interesting fraud research are lacking
even as the auditing profession was caught up in every increasing client
bankruptcies involving fraud ---
http://faculty.trinity.edu/rjensen/Fraud001.htm
While Enron and Worldcom burned, academic fiddlers were
fiddling with simplistic behavioral experiments using captive students as
surrogates, students who did no know peanut butter from Shinola on such
matters as SPEs, derivative financial instruments frauds, and structured
financing frauds ---
http://faculty.trinity.edu/rjensen//theory/00overview/speOverview.htm
The huge stimulus for accountics research was rooted in
portfolio theory discovered by Harry Markowitz in1952 that became the core
of his dissertation at Princeton University, which was published in book
form in 1959. This theory eventually gave birth to the Nobel Prize winning
Capital Asset Pricing Model (CAPM) and a new era of capital market research.
Another stimulus was when the CRSP stock price tapes became available from
the University of Chicago. The availability of CRSP led to a high number of
TAR articles on capital market event studies, and academic accounting
researchers quickly began to mimic their brethren in economics and finance,
ignoring the deficiencies of both the CRSP database and the CAPM model.
Topic accountics researchers doing research in
ecnonomics and finance, distanced themselves from problems faced by the
accounting and auditing professions. Joel Demski even referred to applied
research for the profession as a "vocational virus."
Not everything that can be counted,
counts. And not everything that counts can be counted. Albert Einstein
For a long time, elite accounting
researchers could find no “empirical evidence” of widespread earnings
management. All they had to do was look up from the computers where their
heads were buried. Bob Jensen ---
http://faculty.trinity.edu/rjensen/395wpTAR/Web/TAR395wp.htm
“Research should be problem driven rather
than methodologically driven," said Lisa Garcia Bedolla, a member of the
task force who teaches at the University of California at Berkeley. Scott Jascik ---
http://www.insidehighered.com/news/2009/09/04/polisci
"I understand your point,
Jim." He could not identify one issue that (accountics)
researchers had been able to "put to bed" after all that effort. P. Kothari, one of the Editors of JAE and a full professor at
MIT, as quoted by Jim Peters below.
Do we forecast? You bet. Do we have
confidence in our forecasts? Never! Confidence about a non-linear chaotic
system can only come in degrees, and even those degrees of confidence are
guesses. Not all hope is lost. There are times when it seems our ability to
predict is better than others. Thus we need to take advantage of it if we
see it. Trading ranges, pivot points, support and resistance, and the like
can help, and do help the trader. Michael Covel,
Trading Black Swans, September 2009 ---
http://www.michaelcovel.com/pdfs/swan.pdf
Most importantly of all in accountics is that the leading accounting
research journals for tenure, promotion, and performance evaluation in
academe are devoted to accountics paper. Normative methods, case studies,
and interviews are rarely used in studies published in such journals. The
following is a quotation from “An Analysis of the Evolution of Research
Contributions by The Accounting Review (TAR): 1926-2005,” by Jean L. Heck
and Robert E. Jensen, Accounting Historians Journal, Volume 34, No.
2, December 2007, Page 121.
Leading
accounting professors lamented TAR’s preference for rigor over relevancy
[Zeff, 1978; Lee, 1997; and Williams, 1985 and 2003]. Sundem [1987] provides
revealing information about the changed perceptions of authors, almost
entirely from academe, who submitted manuscripts for review between June
1982 and May 1986. Among the 1,148 submissions, only 39 used
archival (history) methods; 34 of those submissions were rejected.
Another
34 submissions used survey methods; 33 of those were rejected.And 100
submissions used traditional normative (deductive) methods with 85 of those
being rejected.
Except for a small set of 28 manuscripts classified as using “other” methods
(mainly descriptive empirical according to Sundem), the remaining larger
subset of submitted manuscripts used methods that Sundem [1987, p. 199]
classified these as follows:
292 General Empirical
172 Behavioral
135 Analytical
modeling
119 Capital Market
97 Economic modeling
40 Statistical
modeling
29 Simulation
It is clear
that by 1982, accounting researchers realized that having mathematical or
statistical analysis in TAR submissions made accountics virtually a
necessary, albeit not sufficient, condition for acceptance for publication.
It became increasingly difficult for a single editor to have expertise in
all of the above methods. In the late 1960s, editorial decisions on
publication shifted from the TAR editor alone to the TAR editor in
conjunction with specialized referees and eventually associate editors
[Flesher, 1991, p. 167]. Fleming et al. [2000, p. 45] wrote the following:
The big change was in research
methods. Modeling and empirical methods became prominent during 1966-1985,
with analytical modeling and general empirical methods leading the way.
Although used to a surprising extent, deductive-type methods declined in
popularity, especially in the second half of the 1966-1985 period.
I think the emphasis highlighted in red
above demonstrates that "Methodological Confusion" reigns supreme in
accounting science as well as political science.
A couple of years
ago, P. Kothari, one of the Editors of JAE and a full professor at MIT,
visited the U. of Maryland to present a paper. In my private discussion with
him, I asked him to identify what he considered to the settled findings
associated with the last 30 years of capital markets research in accounting.
I pointed out that somewhere over half of all accounting research since Ball
and Brown fit into this category and I was curious as to what the effort had
added to Ball and Brown. That is, what conclusions have been drawn that
could be considered settled ground so that researchers could move on to
other topics. His response, and I quote, was "I understand your point, Jim."
He could not identify one issue that researchers had been able to "put to
bed" after all that effort.
P. Kothari's
response is to be expected. I have had similar responses from at least two
ex-editors of TAR; how appropriate a TLA! But who wants to bell the cats (or
call off the naked emperors' bluff)? Accounting academia knows which side of
the bread is buttered.
That you needed to
flaunt Kothari's resume to legitimise his vacuous response shows the
pathetic state of accounting academia.
If accounting
academia is not to be reduced to the laughing stock of accounting practice,
we better start listening to the problems that practice faces. How else can
we understand what we profess to "research"? We accounting academics have
been circling our wagons too long as a ploy to keep our wages arbitrarily
high.
In as much as we
are a profession, any academic on such a committee reduces the whole
exercise to a farce.
Jagdish
September 10, 2009 reply from Bob Jensen
Hi again Amy,
Accountics is the mathematical science of values.
Charles Sprague [1887] as quoted by McMillan [1998, p. 1][NH1]
The history of the accountics takeover of leading academic accounting
research journals around the world as well as the takeover of accountancy
doctoral programs in the U.S. and other nations can be found at
http://faculty.trinity.edu/rjensen/395wpTAR/Web/TAR395wp.htm
The more I read in the book Dear Mr. Buffet by Janet
Tavakoli, the more I see a parallel between investment bankers and
accountics researchers.
After almost 20 years working for Wall
Street firms in New York and London, I made my living running a
Chicago-based consulting business. My clients consider my expertise in
product they consume. I had written books on credit derivatives and
complex structured finance products, and financial institutions, hedge
funds, and sophisticated investors came to identify and solve potential
problems. Janet Tavokoli, Dear
Mr. Buffett (Wiley, 2009, Page 5)
Jensen Comment
Before she wrote Dear Mr. Buffett, her technical book on
Structural Finance & Collateralized Debt Obligations (Wiley) sat on
my desk for constant reference. Janet also runs her own highly
successful hedge fund. She won't disclose how big it is, but certain
clues make me think it is over $100 million with very wealthy clients.
Her professional life changed when she commenced to correspond with what
was the richest man in the world in 2008 (before he gave much of his
wealth to the Gates Charitable Foundation). He's also one of the nicest
and most transparent and most humble men in the world.
Warren Buffett ---
http://en.wikipedia.org/wiki/Warren_Buffett
Warren Buffett disproved theory of
efficient markets that states that prices reflect all known information.
His shareholder letters, readily available (free)
through Berkshire Hathaway's Web site, told
investors everything they needed to know about mortgage loan fraud,
mospriced credit derivatives, and overpriced securitizations, yet this
information hid in plain "site." Janet Tavokoli, Dear
Mr. Buffett (Wiley, 2009, Page 7)
Jensen Comment
Berkshire Hathaway ---
http://en.wikipedia.org/wiki/Berkshire_Hathaway
Jensen Comment
This of course does not mean that on occasion Warren is not fallible.
Sometimes he does not heed his own advice, and rare occasions he loses
billions. But a billion or two to Warren Buffett is pocket change.
I finally grasped what Warren was saying.
Warren has such a wide body of knowledge that he does not need to rely on
“systems.” . . . Warren’s vast knowledge of corporations and their finances
helps him identify derivatives opportunities, too. He only participates in
derivatives markets when Wall Street gets it wrong and prices derivatives
(with mathematical models) incorrectly. Warren tells everyone that he only
does certain derivatives transactions when they are mispriced. Janet Tavokoli,
Dear Mr. Buffett (Wiley, 2009, Page 19)
Why
investment bankers are like many accoutics professors
Wall Street derivatives traders construct trading models with no clear idea
of what they are doing. I know investment bank modelers
with advanced math and science degrees
who have never read the financial statements of the corporate credits they
model. This is true of some credit derivatives traders, too. Janet Tavokoli, Dear Mr. Buffett (Wiley, 2009, Page 19) Jensen Comment
Especially note the above quotation when I refer to Reviewer A below.
Warren is aided by the fact that most
investment banks use sophisticated Monte Carlo models that misprice the
transactions. Some of the models rely on (credit) rating agency inputs,
and the rating agencies do a poor job of rating junk debt. Janet Tavokoli, Dear
Mr. Buffett (Wiley, 2009, Page 21)
Investment banks could put on the
same trades if they did fundamental analysis of the underlying
companies, but they are too busy
playing with correlation models.
Janet Tavokoli, Dear
Mr. Buffett (Wiley, 2009, Page 24)
Warren has another advantage: Wall Street
underestimates him. I mentioned that Warren Buffett and I have similar
views on credit derivatives . . . My former colleague, a Wall Street
structured products "correlation" trader, wrinkled his nose and
sniffed: "That old guy? He hates derivatives." Janet Tavokoli, Dear
Mr. Buffett (Wiley, 2009, Page 24)
Warren Buffett writes billions of dollars worth of put options When Warren sells a put buyer the right to make
him pay a specific price agreed today for the stock index (no matter
what the value 20 years from now), Warren receives a premium. Berkshire
Hathaway gets to invest that money for 20 years. Warren thinks the
buyer, the investment bank, is paying him too much . . . Furthermore,
Berkshire Hataway invests the premiums that will in all likelihood cover
anything he might need to pay out anything at all, since the stock index
is likely to be higher than today's value. Janet Tavokoli, Dear
Mr. Buffett (Wiley, 2009, Page 24)
Before there was a CAPM model there was the seminal portfolio theory
contribution (1952) if Harry Markowitz who later wrote one of the most
remarkable books in the history of economics and finance. Markowitz's
theory was outstanding but the practicality of inverting matrices of the
order of 1,000 or more rows was out of the question, whereupon subsequent
Nobel Prize winners (Treynor, Sharpe, and Lintner) independently developed a
more practical single-index (CAPM) approach for implementing the portfolio
theory of Harry Markowitz. ---
http://en.wikipedia.org/wiki/CAPM
For years (at least since 2001) this idea has been
a mainstay in my classes. The benefits of diversification have been
overstated. Why? The correlations that are used to diversify and get
the so called optimal portfolio change and the change is NOT in a random
format: the correlations go up in bad times.
"Harry Markowitz introduced the idea of
diversification into investing back in the 1950s (at least he
formalized the idea, which was probably around long before). Using
information on the mathematical correlations between the returns of
the different stocks in a portfolio, you can choose a weighted
portfolio to minimize the overall portfolio of volatility for any
expected return. This is maybe the most basic of all results in
mathematical finance.
But it doesn't work; it suffers from the same problem as the
balanced man in the canoe. This is clear from any number of studies
over the past decade which show that the correlations between stocks
change when markets move up or down."
Click through, this will almost assuredly be a
test question for SIMM!
Aside from accountics research on human behavior, I'm not certain that
any other discovery in history has had more impact on accountics research
than the portfolio risk diversification theory of Harry Markowitz that is
the root of the CAPM single-index model of portfolio risk.
For example, in the figures below I’ve plotted
the Fama-French 25 (portfolios ranked on size and book-to-market)
against beta.
In the first figure, I plot the average excess
return to the FF 25 against the average excess return one would expect,
given beta.
If you’d like to see how I calculated the
charts above, please reference the excel file
here.
Given such a poor track record, is
anyone still using the CAPM?
Lot’s of people, apparently…
Welch (2008) finds that ~75% of professors
recommend the use of the model when estimating the cost of capital, and
Graham and Harvey (2001) find that ~74% of
CFOs use the CAPM in their work.
A few quotes from Graham and Harvey 2001 sum up
common sentiment regarding the CAPM:
“While the CAPM is popular, we show later
that it is not clear that the model is applied properly in practice.
Of course, even if it is applied properly, it is not clear that the
CAPM is a very good model [see Fama and French (1992)].
“…practitioners might not apply the CAPM or
NPV rule correctly. It is also interesting that CFOs pay very little
attentionto risk factors based on momentum and
book-to-market-value.”
Of course, there are lots of arguments to
consider before throwing out the CAPM. Here are a few:
Everyone learns about it and knows how to
use it (although, Graham and Harvey suggest that many practitioners
don’t even apply the CAPM theory correctly)
Data is easy to obtain on betas.
Roll’s critique–maybe the CAPM isn’t a
junk theory, rather, the empirical tests showing the CAPM doesn’t
work are bogus.
Regardless, being that this blog is dedicated
to empirical data and evidence, and not about ‘mentally masturbating
about theoretical finance models,’ we’ll operate under the assumption
that the CAPM is dead until new data comes available.
The Fama French Alternative?
Given the CAPM doesn’t work that well in
practice, perhaps we should look into the Fama French model (which isn’t
perfect or cutting edge, but a solid workhorse nonetheless). And while
the FF model inputs are highly controversial, one thing is clear: the FF
3-factor model does a great job explaining the variability of returns.
For example, according to
Fama French 1993, the 3-factor model explains
over 90% of the variability in returns, whereas the CAPM can only
explain ~70%!
The 3-factor model is great, but how the
heck does one estimate the FF factors?
Dartmouth Professor Ken French comes in for the
rescue!
Abstract:
We
investigate the relation between various alternative risk measures and
future daily returns using a sample of firms over the 1988-2009 time
period. Previous research indicates that returns are not normally
distributed and that investors seem to care more about downside risk
than total risk. Motivated by these findings and the lack of research on
upside risk, we model the relation between future returns and risk
measures and investigate the following questions: Are investors
compensated for total risk? Is the compensation for downside risk
different than the compensation for upside risk? and which measure of
risk (i.e., upside, downside, or total) is most important to investors?
We find that, although investors seem to be compensated for total risk,
measures of downside risk, such as the lower partial moment, better
explain future returns. Further, when downside and upside risk are
modeled simultaneously, investors seem to care only about downside risk.
Our findings are robust to the addition of control variables, including
prior returns, size, book-to-market ratio of equity (B/M), and leverage.
We also find evidence of short-run mean reversals in daily returns. Our
findings are important because we document a positive risk-return
relationship, using both total and downside risk measures; however, we
find that investors are concerned more with downside risk than total
risk.
"The
CAPM Debate and the Logic and Philosophy of Finance,"
by David Johnstone, Abacus, Volume 49, Issue Supplement S1, pages
1–6, January 2013 ---
http://onlinelibrary.wiley.com/doi/10.1111/j.1467-6281.2012.00378.x/full
Although most Abacus articles not free, this is a free editorial
download.
Finance, and particularly financial decision
making, has much in common with the discipline of statistics and
statistical decision theory. Both fields involve conceptual models and
related methods by which to make numerical assessments that are meant to
assist users to draw inferences about future states and to make choices
between possible actions. In both fields, inferences and decisions are
reached by implementing quantitative methods, and in both fields those
methods require either empirical or subjective inputs (e.g., sample
estimates of relevant input parameters or human estimates of the same
sorts of variables).1
This is not merely saying that finance theory
makes use of statistical theory. That is incidental, as is the fact that
statistics now adopts the language and ideas of finance in some of its
important applications. Rather, the point is that the two disciplines
are fundamentally analogous in their purposes and construction. They
differ markedly, however, in their states of philosophical
introspection, as is natural given that finance arose as a field only in
the 1960s or later, and has therefore had much less time to mature and
look back at itself and its development in a critical philosophical way.
A stark difference between the two fields is
that in statistics there exists a formalized branch of enquiry called
‘the logic, methodology and philosophy of statistical inference and
decision theory’, whereas in finance there is as yet no equivalent
well-defined or orchestrated subfield. The philosophy of statistics is a
highly developed discipline, built upon hundreds of papers and books,
written by statisticians, logicians, philosophers of science and
practitioners in applied fields (e.g., psychology, medicine, economics)
since the early 1900s. All of the great names in statistical theory,
including Karl Pearson, R. A. Fisher, Neyman, Savage, von Neumann and de
Finetti, have contributed philosophically as well as technically to the
field we know as statistics, and indeed virtually all of the empirical
work that is done in finance today is licensed by one or other of these
philosophers. Similarly, very influential modern statistical theorists
such as Lindley, Kadane, Bernardo, Seidenfeld and Berger have
contributed numerous papers and books to the big-picture philosophical
issues in statistics.
By comparison, the philosophy, logic and
methodology of finance are yet to expressly emerge, or to obtain the
overarching respect and influence that such work has in statistics. This
of itself is something for explanation from positivist and sociological
perspectives. In the early years of finance, there was a great deal of
such work published, but in later years the majority of published
research in finance has been predominantly descriptive or empirical
(data driven) rather than conceptual or philosophical. There are some
obvious practical reasons for this, such as for example the modern
availability of excellent unexplored data bases and fast inexpensive
computing. More fundamentally, however, there has been a cultural shift
away from critical philosophical analysis of financial logic and
financial methods within finance.
As one simple example, early generations of
students in finance spent much time trying to understand the NPV versus
IRR debate, and the mathematical explanations of how these techniques
can coincide or clash. Theoretical papers were written on this topic,
not just in finance but also in economics and engineering. By
comparison, current finance students are not asked to think about the
logical foundations of DCF analysis, and are mostly unaware of the
related debate and mathematical enquiry that once took centre stage. The
most that a modern finance student can be expected to know of the issue
is that undergraduate textbooks list some important problems of IRR and
conclude that NPV does not have the same troubles, and that essentially
the case is closed. Generally this superficial appreciation comes from
pre-scripted lecture slides rather than from any individual research or
thought on the issue. Most textbooks give no academic references to the
related historical literature and no inkling of how subtle matters of
interpretation of NPV and IRR can be.
Research students might once have discovered
such issues for themselves, through curiosity and unstructured
background reading, but the modern way of PhD research is much narrower
and usually involves a substantial commitment of time and thought to
learning statistical techniques, and how to implement them using
different software packages, and to cleaning, merging and reconstructing
large data files. There is obviously less time and appetite for
philosophical critique, out of which potential research outcomes are no
doubt less ‘safe’ than those from a well-conceived empirical
investigation.
. . .
The issue nearly 50 years after its invention
is where finance stands on the CAPM. The papers published in this issue
contain the unedited positions on the CAPM of well-known finance
researchers. They are reactions to the main paper of Dempsey, who adopts
a critical and therefore provocative standpoint. Consistent with the
sentiments expressed above, it is my belief that the free and frank
academic discussion provoked by Dempsey's paper is not only essential to
a mature field but is also of great academic and communal enjoyment.
Those who have provided comments on Dempsey's paper did so willingly and
apparently with the thought that it would be worthwhile to put in print
some ideas and opinions that are usually reserved for informal or
unguarded tearoom conversations.
By chance, this issue of Abacus on the status
of the CAPM coincides with the publication of a wonderful book on the
same subject, written by one of the founders of the field. This book by
Haim Levy (2012) titled The Capital Asset Pricing Model in the 21st
Century covers much of the history and debate over the CAPM and its
theoretical, empirical and practical validity. Readers will likely be
interested in how the arguments advanced by Dempsey and others in this
issue of Abacus compare with the position taken by Levy. There is in
fact a great deal of reinforcement between Levy and some of the
commentators. Levy's essential conclusion is that the CAPM stands, in
his words, ‘alive and well’. This is for philosophical reasons,
including particularly that the CAPM is a model of ex ante decision
making and hence does not need to be, and cannot be expected to be,
mirrored neatly by historical data. Levy's faith in the CAPM is also for
practical reasons, particularly for the close approximation with which
it mimics ex ante optimal investment, and the returns thereof, over a
wide class of utility functions.
I conclude this introduction to Dempsey and
others on the topic of the CAPM in the twenty-first century with the
spur that only when we openly discuss what is inadequate or questionable
with our own theories can we lay claim to scientific ‘objectivity’.
Technical or empirical positions adopted routinely, untempered by
philosophical scepticism or appreciation, can prove greatly inadequate,
misleading and ultimately costly to users and to the scientific
reputation of the field, even when used for strictly practical purposes
(such as choosing investments).
Finance as a field embodies more than
sufficient theoretical substance to warrant its own subfield in
philosophy—the logic and philosophy of finance. By nature, philosophical
critique is normative, so any aversion in principle to normative
research needs to be overcome. I began this introduction with the claim
that finance and statistics are like twins. Note, however, that
published research in statistics is predominantly normative (e.g., Bayes
versus non-Bayes, etc.) whereas most finance research is largely
empirical. If we look more closely, however, empirical finance, which is
sometimes championed as ‘positive’ and ‘anti-normative’, is replete with
normative discussion about matters such as how to construct an
experiment or a statistical test, or how to define a key measure such as
the cost of capital. There should therefore be no in-principle
resistance to the reinvigoration of normative or philosophical thought
concerning finance theory proper.
Footnotes
1 For example, applications in finance of portfolio theory and the CAPM
require an ex ante joint probability distribution of the future returns
on all firms in the market. That distribution is usually estimated
empirically but is in principle a subjective probability distribution.
2 ‘There is no inevitable connection between the
validity of the expected utility maxim and the validity of portfolio
analysis based on, say, expected return and variance’ (Markowitz, 1959,
p. 209).
The model assumes that the variance of returns is an adequate
measurement of risk. This would be implied by the assumption that
returns are normally distributed, or indeed are distributed in any
two-parameter way, but for general return distributions other risk
measures (like
coherent risk measures) will reflect the active and potential
shareholders' preferences more adequately. Indeed risk in financial
investments is not variance in itself, rather it is the probability of
losing: it is asymmetric in nature.
Barclays Wealth have published some research on asset allocation
with non-normal returns which shows that investors with very low risk
tolerances should hold more cash than CAPM suggests.[7]
The model assumes that all active and potential shareholders have
access to the same information and agree about the risk and expected
return of all assets (homogeneous expectations assumption).[citation
needed]
The model assumes that the probability beliefs of active and
potential shareholders match the true distribution of returns. A
different possibility is that active and potential shareholders'
expectations are biased, causing market prices to be informationally
inefficient. This possibility is studied in the field of
behavioral finance, which uses psychological assumptions to provide
alternatives to the CAPM such as the overconfidence-based asset pricing
model of Kent Daniel,
David Hirshleifer, and Avanidhar Subrahmanyam (2001).[8]
The model does not appear to adequately explain the variation in
stock returns. Empirical studies show that low beta stocks may offer
higher returns than the model would predict. Some data to this effect
was presented as early as a 1969 conference in
Buffalo, New York in a paper by
Fischer Black,
Michael Jensen, and
Myron Scholes. Either that fact is itself rational (which saves the
efficient-market hypothesis but makes CAPM wrong), or it is
irrational (which saves CAPM, but makes the EMH wrong – indeed, this
possibility makes
volatility arbitrage a strategy for reliably beating the market).[citation
needed]
The model assumes that given a certain expected return, active and
potential shareholders will prefer lower risk (lower variance) to higher
risk and conversely given a certain level of risk will prefer higher
returns to lower ones. It does not allow for active and potential
shareholders who will accept lower returns for higher risk.
Casino gamblers pay to take on more risk, and it is possible that
some stock traders will pay for risk as well.[citation
needed]
The model assumes that there are no taxes or transaction costs,
although this assumption may be relaxed with more complicated versions
of the model.[citation
needed]
The market portfolio consists of all assets in all markets, where
each asset is weighted by its market capitalization. This assumes no
preference between markets and assets for individual active and
potential shareholders, and that active and potential shareholders
choose assets solely as a function of their risk-return profile. It also
assumes that all assets are infinitely divisible as to the amount which
may be held or transacted.[citation
needed]
The market portfolio should in theory include all types of assets
that are held by anyone as an investment (including works of art, real
estate, human capital...) In practice, such a market portfolio is
unobservable and people usually substitute a stock index as a proxy for
the true market portfolio. Unfortunately, it has been shown that this
substitution is not innocuous and can lead to false inferences as to the
validity of the CAPM, and it has been said that due to the
inobservability of the true market portfolio, the CAPM might not be
empirically testable. This was presented in greater depth in a paper by
Richard Roll in 1977, and is generally referred to as
Roll's critique.[9]
The model assumes economic agents optimise over a short-term
horizon, and in fact investors with longer-term outlooks would optimally
choose long-term inflation-linked bonds instead of short-term rates as
this would be more risk-free asset to such an agent.[10][11]
The model assumes just two dates, so that there is no opportunity to
consume and rebalance portfolios repeatedly over time. The basic
insights of the model are extended and generalized in the
intertemporal CAPM (ICAPM) of Robert Merton,
[12]
and the
consumption CAPM (CCAPM) of Douglas Breeden and Mark Rubinstein.[13]
CAPM assumes that all active and potential shareholders will
consider all of their assets and optimize one portfolio. This is in
sharp contradiction with portfolios that are held by individual
shareholders: humans tend to have fragmented portfolios or, rather,
multiple portfolios: for each goal one portfolio — see
behavioral portfolio theory[14]
and
Maslowian Portfolio Theory.[15]
Empirical tests show market anomalies like the size and value effect
that cannot be explained by the CAPM.[16]
For details see the
Fama–French three-factor model.[17]
Alternative to CAPM: Dual-Beta
Dual-beta model differentiates
downside beta from
upside beta. The difference between CAPM and dual-beta model is that the
CAPM assumes that upside and downside betas are the same while the dual-beta
model does not. Since this assumption is rarely accurate, the dual-beta
model is considered to provide better information for investors.[2]
Jensen Comment
My own threads on how the CAPM has been misleading for much of accountics
research are at
http://faculty.trinity.edu/rjensen/theory01.htm#AccentuateTheObvious
Be patient, this document is very slow to load at the second stage
(#AccentTheObvious)due to the immense size of the document.
You have to scroll down quite a ways for the CAPM tidbits.
Two tidbits of particular interest are as follows:
For example, in the figures below I’ve plotted
the Fama-French 25 (portfolios ranked on size and book-to-market)
against beta.
In the first figure, I plot the average excess
return to the FF 25 against the average excess return one would expect,
given beta.
If you’d like to see how I calculated the
charts above, please reference the excel file
here.
Given such a poor track record, is
anyone still using the CAPM?
Lot’s of people, apparently…
Welch (2008) finds that ~75% of professors
recommend the use of the model when estimating the cost of capital, and
Graham and Harvey (2001) find that ~74% of
CFOs use the CAPM in their work.
A few quotes from Graham and Harvey 2001 sum up
common sentiment regarding the CAPM:
“While the CAPM is popular, we show later
that it is not clear that the model is applied properly in practice.
Of course, even if it is applied properly, it is not clear that the
CAPM is a very good model [see Fama and French (1992)].
“…practitioners might not apply the CAPM or
NPV rule correctly. It is also interesting that CFOs pay very little
attentionto risk factors based on momentum and
book-to-market-value.”
Of course, there are lots of arguments to
consider before throwing out the CAPM. Here are a few:
Everyone learns about it and knows how to
use it (although, Graham and Harvey suggest that many practitioners
don’t even apply the CAPM theory correctly)
Data is easy to obtain on betas.
Roll’s critique–maybe the CAPM isn’t a
junk theory, rather, the empirical tests showing the CAPM doesn’t
work are bogus.
Regardless, being that this blog is dedicated
to empirical data and evidence, and not about ‘mentally masturbating
about theoretical finance models,’ we’ll operate under the assumption
that the CAPM is dead until new data comes available.
The Fama French Alternative?
Given the CAPM doesn’t work that well in
practice, perhaps we should look into the Fama French model (which isn’t
perfect or cutting edge, but a solid workhorse nonetheless). And while
the FF model inputs are highly controversial, one thing is clear: the FF
3-factor model does a great job explaining the variability of returns.
For example, according to
Fama French 1993, the 3-factor model explains
over 90% of the variability in returns, whereas the CAPM can only
explain ~70%!
The 3-factor model is great, but how the
heck does one estimate the FF factors?
Dartmouth Professor Ken French comes in for the
rescue!
Abstract:
We
investigate the relation between various alternative risk measures and
future daily returns using a sample of firms over the 1988-2009 time
period. Previous research indicates that returns are not normally
distributed and that investors seem to care more about downside risk
than total risk. Motivated by these findings and the lack of research on
upside risk, we model the relation between future returns and risk
measures and investigate the following questions: Are investors
compensated for total risk? Is the compensation for downside risk
different than the compensation for upside risk? and which measure of
risk (i.e., upside, downside, or total) is most important to investors?
We find that, although investors seem to be compensated for total risk,
measures of downside risk, such as the lower partial moment, better
explain future returns. Further, when downside and upside risk are
modeled simultaneously, investors seem to care only about downside risk.
Our findings are robust to the addition of control variables, including
prior returns, size, book-to-market ratio of equity (B/M), and leverage.
We also find evidence of short-run mean reversals in daily returns. Our
findings are important because we document a positive risk-return
relationship, using both total and downside risk measures; however, we
find that investors are concerned more with downside risk than total
risk.
An alternative to CAPM theory is Arbitrage Pricing Theory. My long
critique of APT was rejected by the Journal of Finance. The Editor said if
he did not understand it nobody else would probably understand it. In
retrospect is should have been rejected because it was poorly written ---
http://faculty.trinity.edu/rjensen/default4.htm#BigOnes
This illustrates how difficult it is to teach, let alone do
accountics, research given the unknowns about impacts of variations in
methodology. How do professors who teach from a few of their chosen studies
prepare students about the simplifications inherent in any one model?
It would seem that students have to be pretty sophisticated to understand
the limitations of the accountics harvests.
"The Cross-Section of Expected Stock Returns: What Have We Learnt from
the Past Twenty-Five Years of Research," by Avanidhar Subrahmanyam
University of California, Los Angeles - Finance Area, European Financial
Management, Forthcoming
Abstract:
I review the recent literature on cross-sectional predictors of stock
returns. Predictive variables used emanate from informal arguments,
alternative tests of risk-return models, behavioral biases, and
frictions. More than fifty variables have been used to predict returns.
The overall picture, however, remains murky, because more needs to be
done to consider the correlational structure amongst the variables, use
a comprehensive set of controls, and discern whether the results survive
simple variations in methodology.
VERY good review article on the ability of
financial models (CAPM, APT, Fama-French, etc) to predict and explain
cross sectional stock returns).
Super short version: While we have progressed,
we have done so down different paths and there needs to be some
standardization, testing for robustness, and checks for correlations
across the many variables that have been used in past models.
From Introduction:
"The predictive variables are motivated
principally in one of four ways. These are: • Informal Wall Street
wisdom (such as “value-investing”) • Theoretical motivation based on
risk-return (RR) model variants • Behavioral biases or misreaction by
cognitively challenged investors • Frictions such as illiquidity or
arbitrage constraints"
Jensen Comment
I think accountics researchers often use purchased databases (e.g.,
Compustat, AuditAnalytics, and CRSP) without questioning the possibility of
data errors and limitation. For example, we recently took a look at the
accounting litigation database of AuditAnalytics and found many serious
omissions.
These databases are used by multiple accountics researchers, thereby
compounding the felony,.
My Four Telltale Quotations about accoutics professors
Although there are no longer any investment banks in the United States since
early 2009, how were investment bankers much like accountics researchers?
There is of course very little similarity now since investment bankers are
standing in unemployment lines and investment banks are out of business ---
http://faculty.trinity.edu/rjensen/2008Bailout.htm#InvestmentBanking
Accountics professors are still happily in business dancing behind tenure
walls and biased journal editors who still cannot see beyond accountics
research methodology.
I provide three quotations below that, I think, pretty well tell the
story of why many, certainly not all, accountics professors are pretty much
like investment bankers that were superior at mathematics and model building
and lousy at accounting and finance fundamentals. You, Amy, will probably
recall each of these quotations although they may not have sunk in like they
should've sunk in.
Quotation 1
Denny Beresford gave a 2005 luncheon speech at the annual meetings of the
American Accounting Association. Having been both a former executive partner
with E&Y and, for ten years, Chairman of the FASB before becoming an
accounting professor at the University of Georgia, Denny has lived all sides
of accounting --- practice, standard setting, and academe. In his speech
Denny very politely suggested that accountics professors should take and
interest in and learn a bit more about, gasp, accounting.
After he gave his speech, Denny submitted his speech for publication to
Accounting Horizons. Referee A flatly rejected the Denny's submission
for the following reasons:
The paper provides specific recommendations for
things that accounting academics should be doing to make the accounting
profession better. However (unless the author believes that academics'
time is a free good) this would presumably take academics' time away
from what they are currently doing. While following the author's advice
might make the accounting profession better, what is being made worse?
In other words, suppose I stop reading current academic research and
start reading news about current developments in accounting standards.
Who is made better off and who is made worse off by this reallocation of
my time? Presumably my students are marginally better off, because I can
tell them some new stuff in class about current accounting standards,
and this might possibly have some limited benefit on their careers. But
haven't I made my colleagues in my department worse off if they depend
on me for research advice, and haven't I made my university worse off if
its academic reputation suffers because I'm no longer considered a
leading scholar? Why does making the accounting profession better take
precedence over everything else an academic does with their time?
Referee A's rejection letter,
Accounting Horizons, 2005
What riled me the most was the arrogance of Referee A. I read into it
that, whereas mathematicians and econometricians are true "scholars," other
accounting professors are little better than teachers of bookkeeping and
fairy tales. This is the same arrogant attitude held by previous investment
bankers trying to take advantage of Warren Buffet as their counterparties in
derivatives or other financial transactions.
Investment bankers and many accountics professors put on superior airs
because of their backgrounds in mathematics and science. To hell with
knowledge of fundamentals in accounting and finance apart from mathematical
models. To hell with reading and analyzing financial statements in great
depth. Accountics scholars, at least some of them who referee many
submissions to journals, don't waste their time on such mundane things.
Quotation 2
My second quotation laments that accounting education programs now often
have to pay the highest starting salaries for some graduates of accounting
doctoral programs who know very little accounting. Before she moved to
Wyoming, Linda Kidwell wrote a revealing message to the AECM listserv.
I cannot
find the exact quotation in my archives, but some years ago Linda Kidwell
complained that her university had recently hired a newly-minted graduate
from an accounting doctoral program who did not know any accounting. When
assigned to teach accounting courses, this new "accounting" professor was a
disaster since she knew nothing about the subjects she was assigned to
teach.
Quotation 3
In the year following his assignment as President of the American Accounting
Association Joel Demski asserted that research focused on the accounting
profession will become a "vocational virus" leading us away from the joys of
mathematics and the social sciences and the pureness of the scientific
academy:
Statistically there are a few youngsters who came to academia for the joy of
learning, who are yet relatively untainted by the
vocational virus.
I urge you to nurture your taste for learning, to follow your joy. That is
the path of scholarship, and it is the only one with any possibility of
turning us back toward the academy. Joel
Demski,
"Is Accounting an Academic Discipline? American Accounting Association
Plenary Session" August 9, 2006 ---
http://bear.cba.ufl.edu/demski/Is_Accounting_an_Academic_Discipline.pdf
Accounting professors are no longer "leading scholars" if they succumb to a
vocational virus and focus on accounting rather than mathematics,
econometrics, and/or psychometrics ---
http://faculty.trinity.edu/rjensen/395wpTAR/Web/TAR.htm
Quotation 4
One of the very leading accountics professors is employed by the graduate
school at Northwestern University. Ron Dye's academic background is in
mathematics rather than accounting, and he's written some of the most
esoteric accountics research papers ever published in leading accounting
research journals.
Richard Sansing from
Dartmouth, on the AECM, occasionally stresses the importance of a background
in mathematics for students seeking fame and fortune as accounting
professors. Although I agree with Richard because of the dominance of
accountics in the accounting academy over the past four decades, I don't
think Richard anticipated the response he got from Ron Dye when he (Richard
Sansing) asked Ron Dye to comment about accountics research and about the
possible desirability of getting a doctorate in mathematics, econometrics,
psychometrics, statistics, etc. before becoming an accounting assistant
professor.
About the question: by and large, I think it is
a mistake for someone interested in pursuing an academic career in
accounting not to get a phd in accounting. If you look at the
"success" stories, there aren't many: most of the people who make a
post-phd transition fail. I think that happens for a couple reasons.
1. I think some of the people that transfer
late do it for the money, and aren't really all that interested in
accounting. While the $ are nice, it is impossible to think about $
when you are trying to come up with an idea, and anyway, you're
unlikely to come up with an idea unless you're really interested in
the subject.
2. I think, almost independent of the
field, unless you get involved in the field at an early age, for
some reason it becomes very hard to develop good intuition for the
area - which is a second reason good problems are often not
generated by "crossovers."
The bigger thing - not related to the question
you raise - but maybe you could add to the discussion is that there are,
as far as I can tell, not a lot of new ideas being put forth by
anyone in accounting nowadays (with the possible exception of John
Dickhaut's neuro stuff). In most fields, the youngsters are supposed to
come up with the new problems, techniques, etc., but I see a lot more
mimicry than innovation among newly minted phds now.
Anyway, for what it's worth.... Ron Dye, Northwestern
University
I think Ron Dye is being extremely
blunt and extremely honest. What really strikes me is that four decades of
accountics research as pretty much evolved into sterile research where "not
a lot of new ideas are being put forth" by accountics professors.
What the big problem is with
accountics research is that it is too restrictive as to what problems are
taken on by accountics researchers, what papers are written for submission
to the leading academic accounting research journals, and the high level of
mathematics required for admission/progression in an accountancy doctoral
program.
What a boring time it is in accountics
research where virtually nothing comes out that is deemed worth replicating
and verifying.
Accountics researchers, however,
should thank the heavens that they did not become, like those "correlation
investment bankers," counterparties in derivatives with Warren Buffet. It's
far better to be among the highest paid professors in a university while
dancing behind the protective walls of tenure.
I will probably send out a lot more
tidbits from my hero Janet Tavaloli (she became more of a hero after she
delved into the mind of Warren Buffett).
Having been very busy at my "day job" the last few
days, I've missed much of this thread, but I'd like to comment on something
Ron Dye said in the excerpt below about "new ideas." I apologize if my
thoughts are not fully developed, so I'll label them observations or
questions.
How many new PhDs actually have any experience in
accounting or of thinking about accounting issues outside of their
undergraduate degree program?
Although I'm generally on the side of the non-accountics
folks in the debate about relevant research, I also believe it's difficult
for someone to come up with new and interesting questions about which to do
even accountics research if that person hasn't spent time thinking about the
issues of financial reporting (or management decisions-making, etc).
I don't see the problem raised by Ron as one
related to the methodology used for the research. Rather my observation is a
lack of experience about the issues that cause us to want/need some research
in the first place.
Thoughts?
Pat
September 10, 2009 reply from Bob Jensen
Hi Pat,
Gary Sundem,
while editor of TAR and while AAA President, made a major point of saying
that the accounting profession should not look to empirical research for
"new theories."
The following is a quote from the 1993
President’s Message of Gary Sundem, President’s Message. Accounting
Education News 21 (3). 3.
Although empirical scientific
method has made many positive contributions to accounting research, it is
not the method that is likely to generate new theories, though it will be
useful in testing them. For example, Einstein’s theories were not developed
empirically, but they relied on understanding the empirical evidence and
they were tested empirically. Both the development and testing of theories
should be recognized as acceptable accounting research.
If we ever had an accounting Einstein in the past four
decades, that accounting Einstein probably could’ve never published in TAR,
JAR, JAE, CAR, or even AH (in later years). Hence, we do not look to these
“leading” research journals of the accounting academy for the development of
new theories that perhaps cannot be immediately tested.
When I was
Program Director for an AAA annual meeting in NYC, I arranged for Joel
Demski to be on a plenary session (actually a debate with Bob Kaplan). Among
other things I asked Joel to identify at least one seminal and creative idea
from the academy of accountics researchers that impacted on the practitioner
world. In his speech, Joel suggested Dollar-Value Lifo. Later I inspired
accounting historian Dale Flesher investigate the origins of Dollar-Value
Lifo.
-----Original
Message-----
From: Dale Flesher University of Mississippi
[mailto:actonya@HOTMAIL.COM]
Sent: Friday, January 25, 2002 1:35 PM
To:
AECM@LISTSERV.LOYOLA.EDU
Subject: Re: The Only Invention of Academic Accountants
Contrary to a recent
statement in this forum, Dollar-Value Lifo (DVL) was not developed by a
professor. The father of DVL was Herbert T. McAnly, who retired in 1964 as a
partner at Ernst & Ernst after 44 years with the firm. Throughout his
career, McAnly was known as "Mr. LIFO."
Although he did not
develop LIFO, which had been around for decades in the form of the
base-stock method, he did develop DVL after the Internal Revenue began
accepting LIFO from all types of companies. The Treasury would probably
never have agreed to allow all companies to use LIFO (in 1939) had they been
able to prognosticate McAnly's idea. He first described the concept in an
address delivered at the Accounting Clinic and the Central States Accounting
Conference in Chicago in May 1941. His concept was finally accepted by the
IRS following the Hutzler Brothers Co. case in 1947 (8 TC 14 (1947)). He
later worked with the Treasury Department trying to get more practical
regulations relating to LIFO.
Dale L. Flesher
Professor of Accountancy University of Mississippi
I repeat a
few quotations below:
For a long time, elite accounting
researchers could find no “empirical evidence” of widespread earnings
management. All they had to do was look up from the computers where their
heads were buried. Bob Jensen ---
http://faculty.trinity.edu/rjensen/395wpTAR/Web/TAR395wp.htm
If we ever had an accounting Einstein in
the past four decades, that accounting Einstein probably could’ve never
published in TAR, JAR, JAE, CAR, or even AH (in later years). Hence, we do
not look to these “leading” research journals of the accounting academy for
the development of new theories that perhaps cannot be immediately tested.
Bob Jensen
“Research should be problem driven rather
than methodologically driven," said Lisa Garcia Bedolla, a member of the
task force who teaches at the University of California at Berkeley. Scott Jascik ---
http://www.insidehighered.com/news/2009/09/04/polisci
"I understand your point,
Jim." He could not identify one issue that (accountics)
researchers had been able to "put to bed" after all that effort. P. Kothari, one of the Editors of JAE and a full professor at
MIT, as quoted by Jim Peters in an AECM message.
Amy,
Why don't you ask the protagonists what they are doing and why?
Anthropolotgists and sociologists do it all the time. At the AAA meeting in
NYC I used an analogy that Sylvia Earle provided at an Emerging Issues Forum
here at NC State a number of years ago. She is an oceanographer who holds
all the records for time and depth spent under water by a woman. She
described her discipline before and after the invention of SCUBA and other
forms (bathosphere) of deep diving technology. Before the ability to immerse
in the ocean environment she likened her research to being in a balloon over
NYC throwing a basket through the clouds and dragging it along the streets.
From the bits and pieces (much of which was simply
the detritus of life in the city) you had to infer what life was actually
like in a place you couldn't see. What underwater breathing technology did
for her field was absolutely revolutionary because, as she said, you could
actually be in the life of the sea. Obviously what we thought was the case
from the bits of stuff retrieved turned out to be woefully inadequate for
developing a rich understanding of oceanic life.
Accountics research is still little more than
throwing a basket over the side. It is observing at a distance the detritus
(bits of accounting data that float to the surface in the form of public
archives) and inferring what must be happening. This is further limited by
the invariable assumption that whatever is happening must be economic!
Little wonder we have made so little progress.
Ackerloff and Shiller (Animal Spirits) provide an
interesting, two dimensional matrix for understanding human behavior (they
are still economists, but at least Shiller's wife is a social psychologist
who has had a very positive influence on his thinking): One dimension is
Motives -- economic and non-economic (people are likely more non-economic
than economic) and Responses -- rational and irrational. Of the four boxes,
accountics research has confined itself to just one: motives must be
economic and responses must be rational. Seventy five percent of the terrain
of human social behavior is completely ignored.
Added to Bob's shortcomings to accountics research
I would add one more. Sue Ravenscroft and I have a working paper trying to
sort out the inadequacies of "decsion usefulness" as both a policy criterion
and a research objective. One problem with accounting research is that the
accountics approach privileges exclusively algorithmic knowledge -- behavior
that can be modeled (so Wayne Gretzky's famous observation, "I skate to
where the puck is going to be" is beyond understanding). Much of this
research utilizes accounting data as a principal source of measurement. The
problem is that though accountants produce numbers, they don't produce
Quantities, which is essential for performing mathematical operations.
Brian West discusses this extensively in his
Notable Contribution Award winner Professionalism and Accounting Rules. To
perform even the simplest arithmetic operation of addition the numbers you
add must represent quantities of a like type. I can add a coffee cup to a
Volkswagon and claim I have two, but two of what?
Accounting numbers are what Gillies describes as
operational numbers, i.e., numbers obtained by performing operations,
analogous to grading an exam. As West points out financial statements today
consist of numbers developed by performing operations that require cost,
unamortized cost, lower-of-cost or market (with floor and ceiling rules),
exit market values, present values, and, now, "fair" value. When you add all
of these up what do you have? Good question. You have a number, but you most
certainly do not have a quantity. So when an accountics researcher develops
a 20 variable regression model where the dependent variable and at least
half of the independent variables are the operational numbers produced by
accountants (numbers, not quantities), what could the results possibly MEAN.
It is a false precision of the most egregious kind
(GIGO?). In your study you will use operational numbers and assert this is
what my measures mean, but you have no way of knowing if this describes the
actual context in which the decisions were actually made (you are looking at
the stuff from the basket). What it means to you isn't necessarily what it
meant to the actual people who made these decisions.
My issue with so much accountics research is that
it means what the researcher chooses to have it mean; the researcher assigns
the meaning, but to understand what is going on with human beings it is
important to know what their behavior means to them.
And in accountics research this remains a mystery.
A couple of other books (once you finish Shapiro"s) are by Bent Flyvbjerg:
Rationality and Power and Making Social Science Matter. In the latter he
discusses the work of Dreyfus and Dreyfus on what they call "a-rational"
behavior (what Gretzsky is doing when he skates to where the puck is going
to be). See also Gerd Gigerenzer, Gut Feelings: The Intelligence of the
Unconscious..
Statistical methods are not inherently faulty. But they can be, and far too
frequently are, misused. So, to turn your metaphor on its head, much accountics
econometrics work is more like spraying manure in a perfumed room, or more like
a skunk spraying in a perfumed room.
Statistical methods are used for classifying, associating, predicting,
inferring (causally as well as associatively), organising, and learning. It is
important to always keep in mind in which context you are using statistics.
1.
In the accountics stuff I am familiar with, determining association is the
avowed objective, but the language subtly takes a predictive turn in
discussions. The reason usually is the positivist dogma having to do with
absence of causation in a naive positivist's lexicon.
I have been stunned by well known accounticians professing that we do not study
causes because there are no statistical methods for causal inference. And to the
last person, these folks have not heard of modern statistical tools for the
study of causation in statistics.
Ignorance is bliss in this wonderland. Social scientists, however, have used
them for a long time. Theological commitments are dangerous for ANY "science".
2.
Classification is the first step in learning. It is only VERY recently that
accounting folks have started talking about the use of classification by use of
clustering, support vector machines, neural nets, etc., but most of these
discussions take place in non-mainstream contexts.
3.
Many of the techniques in 2 are nowadays considered part of the field of machine
learning, a hybrid between statistics and computing. I am sure one of these
days, when they have become stale elsewhere,They’ll be used in accounting.
Mainstream accountics academics are far too conservative to accept any
statistical method unless they have been certified stale.
4.
Often, in conversations, accountics folks revert to counterfactual
statements.That is natural in the sciences. Underlying such statements are
usually causal inferences. It is in this context that I had made observation 1
above. Building a better mousetrap is a legitimate objective of sciences, and
therefore predictive models are essential component of any science. Accountics'
theological commitment to positivist dogma makes them schizophrenic in that they
cannot admit causality without jeopardising their philosophical suppositions and
yet cannot ignore it if they are to maintain their credibility as scientists.
As to some work in these areas of statistics, any list I prepare would include
the following books.
As David Bartholomae observes, “We make a huge
mistake if we don’t try to articulate more publicly what it is we value in
intellectual work. We do this routinely for our students — so it should not be
difficult to find the language we need to speak to parents and legislators.” If
we do not try to find that public language but argue instead that we are not
accountable to those parents and legislators, we will only confirm what our
cynical detractors say about us, that our real aim is to keep the secrets of our
intellectual club to ourselves. By asking us to spell out those secrets and
measuring our success in opening them to all, outcomes assessment helps make
democratic education a reality. Gerald Graff, "Assessment Changes
Everything," Inside Higher Ed, February 21, 2008 ---
http://www.insidehighered.com/views/2008/02/21/graff
Gerald Graff is professor of English at the University of Illinois at Chicago
and president of the Modern Language Association. This essay is adapted from a
paper he delivered in December at the MLA annual meeting, a version of which
appears on the MLA’s Web site and is reproduced here with the association’s
permission. Among Graff’s books are Professing Literature, Beyond the
Culture Wars and Clueless in Academe: How School Obscures the Life of the Mind.
The consensus report, which was approved by the
group’s international board of directors, asserts that it is vital when
accrediting institutions to assess the “impact” of faculty members’ research on
actual practices in the business world.
Ask anyone with an M.B.A.: Business school provides
an ideal environment to network, learn management principles and gain access
to jobs. Professors there use a mix of scholarly expertise and business
experience to teach theory and practice, while students prepare for the life
of industry: A simple formula that serves the school, the students and the
corporations that recruit them.
Yet like
any other academic enterprise, business schools expect their
faculty to produce peer-reviewed research. The relevance,
purpose and merit of that research has been debated almost
since the institutions started appearing, and now a new
report promises to add to the discussion — and possibly stir
more debate. The Association to Advance Collegiate Schools
of Business on Thursday released the final report of its
Impact of Research Task Force, the
result of feedback from almost 1,000 deans, directors and
professors to a preliminary draft circulated in August.
The
consensus report, which was approved by the group’s
international board of directors, asserts that it is vital
when accrediting institutions to assess the “impact” of
faculty members’ research on actual practices in the
business world. But it does not settle on concrete metrics
for impact, leaving that discussion to a future
implementation task force, and emphasizes that a “one size
fits all” approach will not work in measuring the value of
scholars’ work.
The report
does offer suggestions for potential measures of impact. For
a researcher studying how to improve manufacturing
practices, impact could be measured by counting the number
of firms adopting the new approach. For a professor who
writes a book about finance for a popular audience, one
measure could be the number of copies sold or the quality of
reviews in newspapers and magazines.
“In the
past, there was a tendency I think to look at the
[traditional academic] model as kind of the desired
situation for all business schools, and what we’re saying
here in this report is that there is not a one-size-fits-all
model in this business; you should have impact and
expectations dependent on the mission of the business school
and the university,” said Richard Cosier, the dean of the
Krannert School of Management at Purdue University and vice
chair and chair-elect of AACSB’s board. “It’s a pretty
radical position, if you know this business we’re in.”
That
position worried some respondents to the initial draft, who
feared an undue emphasis on immediate, visible impact of
research on business practices — essentially, clear
utilitarian value — over basic research. The final report
takes pains to alleviate those concerns, reassuring deans
and scholars that it wasn’t minimizing the contributions of
theoretical work or requiring that all professors at a
particular school demonstrate “impact” for the institution
to be accredited.
“Many
readers, for instance, inferred that the Task Force believes
that ALL intellectual contributions must be relevant to and
impact practice to be valued. The position of the Task Force
is that intellectual contributions in the form of basic
theoretical research can and have been extremely valuable
even if not intended to directly impact practice,” the
report states.
“It also is
important to clarify that the recommendations would not
require every faculty member to demonstrate impact from
research in order to be academically qualified for AACSB
accreditation review. While Recommendation #1 suggests that
AACSB examine a school’s portfolio of intellectual
contributions based on impact measures, it does not specify
minimum requirements for the maintenance of individual
academic qualification. In fact, the Task Force reminds us
that to demonstrate faculty currency, the current standards
allow for a breadth of other scholarly activities, many of
which may not result in intellectual contributions.”
Cosier, who
was on the task force that produced the report, noted that
business schools with different missions might require
differing definitions of impact. For example, a traditional
Ph.D.-granting institution would focus on peer-reviewed
research in academic journals that explores theoretical
questions and management concepts. An undergraduate
institution more geared toward classroom teaching, on the
other hand, might be better served by a definition of impact
that evaluated research on pedagogical concerns and learning
methods, he suggested.
A further
concern, he added, is that there simply aren’t enough
Ph.D.-trained junior faculty coming down the pipeline, let
alone resources to support them, to justify a single
research-oriented model across the board. “Theoretically,
I’d say there’s probably not a limit” to the amount of
academic business research that could be produced, “but
practically there is a limit,” Cosier said.
But
some critics have worried that the
report could encourage a focus on the immediate impact of
research at the expense of theoretical work that could
potentially have an unexpected payoff in the future.
Historically, as the report notes, business scholarship was
viewed as inferior to that in other fields, but it has
gained esteem among colleagues over the past 50 or so years.
In that context, the AACSB has pursued a concerted effort to
define and promote the role of research in business schools.
The report’s concrete recommendations also include an awards
program for “high-impact” research and the promotion of
links between faculty members and managers who put some of
their research to use in practice.
The
recommendations still have a ways to go before they become
policy, however. An implementation task force is planned to
look at how to turn the report into a set of workable
policies, with some especially worried about how the
“impact” measures would be codified. The idea, Cosier said,
was to pilot some of the ideas in limited contexts before
rolling them out on a wider basis.
Jensen Comment
It will almost be a joke to watch leading accountics researchers trying of show
how their esoteric findings have impacted the practice world when the professors
themselves cannot to point to any independent replications of their own work ---
http://faculty.trinity.edu/rjensen/Theory01.htm#Replication
Is the practice world so naive as to rely upon findings of scientific research
that has not been replicated?
I’d surprised to see much reaction from
“accountics” researchers as they are pretty secure, especially since the
report takes pains not to antagonize them. Anyway, in the words of Corporal
Klinger of the 4077th MASH Unit, “It takes a lot of manure to produce one
perfect rose.”
> On one hand there is
no respect for accounting research in B-schools. On the other
> hand, publishing
accounting research in peer-reviewed pubs is a requirement for AQ
> status in B-schools.
>
> More and more I am
attracted to Ernest Boyer's description of multiple forms of
> scholarships and
multiple outlets of scholarship.
Re: this conversation.
Ian Shapiro, professor of
Political Science at Yale, has recently published a book "The Flight
from Reality in the Human Sciences" (Princeton U. Press, 2005) that
assures that the problem is not confined to accounting (though it is
more ludicrous a place for a discipline that is actually a practice).
All of the social sciences have succumbed to rational decision theory
and methodological purity to the point that academe now largely deals
with understanding human behavior only within a mathematically tractible
unreality made real in the academy essentially because of its
mathematical tractibility. Jagdish recent post is insightful (and
inciteful to the winners of this game in our academy). The problem the
US academy has defined for itself is not solvable. Optimal information
systems? Information useful for decision making (without any
consideration of the intervening "motives" (potentially infinite in
number) that convert assessments into actions)?
As Bob has so frequently
reminded us replication is the lifeblood of science, yet we never
replicate. But we couldn't replicate if we wanted to because
replication is not the point. Anyone with a passing familiarity with
laboratory sciences knows that a fundamental ethic of those sciences is
the laboratory journal. The purpose of the journal is to provide the
precise recipe of the experiments so that other scientists can
replicate. All research in accounting (that is published in the "top"
journals, at least) is "laboratory research." But do capital market or
principal/agent researchers maintain a log that decribes in minute
detail the innumerable decisions that they made along the way in
assembling and manipulating their data (as chemists and biologists are
bound to do by virtue of the research ethics of their disciplines) ?
No way. From any published article, it is nearly impossible to actually
replicate one of their experiments because the article is never
sufficient documentation. But, of course, that isn't the point.
Producing politically correct academic reputations is what our
enterprise is about. Ideology trumps science every time. We don't want
to know the "truth." Sadly, this suits the profession just fine. (It's
this dream world that permits such nonsensical statements like trading
off relevance for reliability -- how can I know how relevant a datum is
unless I know something about its reliability? Isn't the whole idea of
science to increase the relevance of data by increasing their
reliability?)
A huge problem in the past several decades of capital markets research is
that many (most?) have relied upon the flawed CAPM model. After the flaws became
known, accounting journal editors and referees more often than not ignored the
CAPM flaws knowing full well that the published articles most likely would not
be authenticated with alternative methodologies.
History of the Capital Asset Pricing Model ---
http://en.wikipedia.org/wiki/CAPM
Accounting researchers have tended to ignore tCAPM's unrealistic assumptions and
flaws.
Assumptions of CAPM
All investors:
Aim to maximize economic utility.
Are rational and risk-averse.
Are price takers, i.e., they cannot influence
prices.
Can lend and borrow unlimited under the risk
free rate of interest.
Trade without transaction or taxation costs.
Deal with securities that are all highly
divisible into small parcels.
Assume all information is at the same time
available to all investors.
Shortcomings of CAPM
The model assumes that asset returns are
(jointly)
normally distributed
random variables. It is however frequently
observed that returns in equity and other markets are not normally
distributed. As a result, large swings (3 to 6 standard deviations from
the mean) occur in the market more frequently than the normal
distribution assumption would expect.
The model assumes that the variance of returns
is an adequate measurement of risk. This might be justified under the
assumption of normally distributed returns, but for general return
distributions other risk measures (like
coherent risk measures) will likely reflect
the investors' preferences more adequately. Indeed risk in financial
investments is not variance in itself, rather it is the probability of
losing: it is asymmetric in nature.
The model assumes that all investors have
access to the same information and agree about the risk and expected
return of all assets (homogeneous expectations assumption).
The model assumes that the probability beliefs
of investors match the true distribution of returns. A different
possibility is that investors' expectations are biased, causing market
prices to be informationally inefficient. This possibility is studied in
the field of
behavioral finance, which uses psychological
assumptions to provide alternatives to the CAPM such as the
overconfidence-based asset pricing model of Kent Daniel,
David Hirshleifer, and Avanidhar Subrahmanyam
(2001).
The model does not appear to adequately
explain the variation in stock returns. Empirical studies show that low
beta stocks may offer higher returns than the model would predict. Some
data to this effect was presented as early as a 1969 conference in
Buffalo, New York in a paper by
Fischer Black,
Michael Jensen, and
Myron Scholes. Either that fact is itself
rational (which saves the
efficient-market hypothesis
but makes CAPM wrong), or it is irrational (which saves CAPM, but makes
the EMH wrong – indeed, this possibility makes
volatility arbitrage a strategy for reliably
beating the market).
The model assumes that given a certain
expected return investors will prefer lower risk (lower variance) to
higher risk and conversely given a certain level of risk will prefer
higher returns to lower ones. It does not allow for investors who will
accept lower returns for higher risk.
Casino gamblers clearly pay for risk, and it
is possible that some stock traders will pay for risk as well.
The model assumes that there are no taxes or
transaction costs, although this assumption may be relaxed with more
complicated versions of the model.
The market portfolio consists of all assets in
all markets, where each asset is weighted by its market capitalization.
This assumes no preference between markets and assets for individual
investors, and that investors choose assets solely as a function of
their risk-return profile. It also assumes that all assets are
infinitely divisible as to the amount which may be held or transacted.
The market portfolio should in theory include
all types of assets that are held by anyone as an investment (including
works of art, real estate, human capital...) In practice, such a market
portfolio is unobservable and people usually substitute a stock index as
a proxy for the true market portfolio. Unfortunately, it has been shown
that this substitution is not innocuous and can lead to false inferences
as to the validity of the CAPM, and it has been said that due to the
inobservability of the true market portfolio, the CAPM might not be
empirically testable. This was presented in greater depth in a paper by
Richard Roll in 1977, and is generally
referred to as
Roll's critique.
The model assumes just two dates, so that
there is no opportunity to consume and rebalance portfolios repeatedly
over time. The basic insights of the model are extended and generalized
in the intertemporal CAPM (ICAPM) of Robert Merton, and the consumption
CAPM (CCAPM) of Douglas Breeden and Mark Rubinstein
CAPM assumes that all investors will consider
all of their assets and optimize one portfolio. This is in sharp
contradiction with portfolios that are held by investors: humans tend to
have fragmented portfolios (or rather multiple portfolios: for each goal
one portfolio - see
behavioural portfolio theory and
Maslowian Portfolio Theory
Question for Fama and French ---
http://www.dimensional.com/famafrench/2009/03/qa-confidence-in-the-bell-curve.html#more
It would be very enlightening if you would comment on the Nassim Nicholas Taleb
("The Black Swan") attack on the use of Gaussian (normal bell curve) mathematics
as the foundation of finance. As you may know, Taleb is a fan of Mandelbrot,
whose mathematics account for fat tails. He argues that the bell curve doesn't
reflect reality. He is also quite critical of academics who teach modern
portfolio theory because it is based on the assumption that returns are normally
distributed. Doesn't all this imply that academics should start doing
reality-based research?
Answer from Gene Fama (Chicago)
EFF: Half of my 1964 Ph.D. thesis is tests of market efficiency, and the
other half is a detailed examination of the distribution of stock returns.
Mandelbrot is right. The distribution is fat-tailed relative to the normal
distribution. In other words, extreme returns occur much more often than
would be expected if returns were normal.
There was lots of interest in this issue for about
ten years. Then academics lost interest. The reason is that most of what we
do in terms of portfolio theory and models of risk and expected return works
for Mandelbrot's stable distribution class, as well as for the normal
distribution (which is in fact a member of the stable class). For passive
investors, none of this matters, beyond being aware that outlier returns are
more common than would be expected if return distributions were normal.
For other applications, however, the difference can
be critical. Risk management by financial institutions is a good example.
For example, portfolio insurance, which was the rage in the early 1980s,
bombed in the crash of October 1987, because this was an event that was
inconceivable in their normality based return model. The normality
assumption is also likely to be a serious problem in various kinds of
derivatives, where lots of the price is due to the probability of extreme
events. For example, news story accounts suggest that AIG blew up because
its risk model for credit default swaps did not properly account for outlier
events.
Answer from Kenneth French (Dartmouth)
KRF: I agree with Gene, but want to make another point that he is
appropriately reluctant to make. Taleb is generally correct about the
importance of outliers, but he gets carried away in his criticism of
academic research. There are lots of academics who are well aware of this
issue and consider it seriously when doing empirical research. Those of us
who used Gene's textbook in our first finance course have been concerned
with this fat-tail problem our whole careers. Most of the empirical studies
in finance use simple and robust techniques that do not make precise
distributional assumptions, and Gene can take much of the credit for this as
well, whether through his feedback in seminars, suggestions on written work,
comments in referee reports, or the advice he has given his many Ph.D.
students over the years.
The possibility of extreme outcomes is certainly
important for things like risk management, option pricing, and many
complicated "arbitrage" strategies. Investors should also recognize the
potential effect of outliers when assessing the distribution of future
returns on their portfolios. None of this implies, however, that the
existence of outliers undermines modern portfolio theory or asset pricing
theory. And the central implications of modern portfolio theory and asset
pricing—the benefits of diversification and the trade-off between risk and
return—remain valid under any reasonable distribution of returns.
"How Dragon Kings Could Trump Black Swans Power laws have a hidden
structure that reveals why extreme events are more common than we'd thought,"
MIT's Technology Review, August 4, 2009 ---
http://www.technologyreview.com/blog/arxiv/
Sornette gives as an example the distribution of
city sizes in France which follows a classic power law, meaning that there
are many small cities and only a few large ones. On a log-log scale, this
distribution gives a straight line. Except for Paris, which is an outlier,
many times larger than it ought to be if it were to follow the power law.
Paris is an outlier because it has been hugely
influential in the history of France and so has benefited from various
positive feedback mechanisms that have ensured its outsize growth.
Apparently London occupies a similarly outlying position in the distribution
of cities in the UK.
Sornette goes on to identify a number of data sets
showing power laws with outliers that he says are the result of positive
feedback mechanisms that make them much larger than their peers. He calls
these events dragon kings. What's interesting about them is that they are
entirely unaccounted for by a current understanding of power laws, from
which Nassim Nicholas Taleb built the idea of black swans.
The special characteristic of dragon kings is that
a positive feedback mechanism creates faster-than-exponential growth making
them larger than expected.
So what to make of this? Sornette makes one
interesting observation. The seemingly ubiquitous existence of these dragon
kings in all kinds of data sets means that extreme events are significantly
more likely than power laws alone suggest.
That's important. If you've ever wondered why we've
experienced not just a single 100-year financial crises in the last couple
of decades but two or three, here's your answer. It also implies that you'll
experience a few more before your time is up.
But Sornette goes further. He argues that dragon
kings may have properties that make them not only identifiable in real time
but also predictable. He puts it like this: "These processes provide clues
that allow us to diagnose the maturation of a system towards a crisis."
That's much more speculative. It's one thing to
identify the feedback mechanisms that cause faster-than-exponential growth
(and it's not clear that Sornette can do even this) but quite another to
spot the event that trigger a crash.
Sornette looks to be onto something interesting
with his notion of dragon kings: outliers that exist beyond the usual realm
of power laws. That could be a hugely infuential. But his contention that
these outliers are in some way more easily predictable than other events
smacks more of wishful thinking than good science.
Garbage Research in Stock Pricing Correlations and Equity Premiums
Seriously that smelly kind of garbage you pay to have hauled away A new measure of consumption -- garbage -- is more
volatile and more correlated with stocks than the standard measure, NIPA
consumption expenditure. A garbage-based CCAPM matches the U.S. equity premium
with relative risk aversion of 17 versus 81 and evades the joint equity
premium-risk-free rate puzzle. These results carry through to European data. In
a cross section of size, value, and industry portfolios, garbage growth is
priced and drives out NIPA expenditure growth. Alexi Savov, University of Chicago Booth School of Business. "Asset
Pricing with Garbage, SSRN, February 17, 2009 ---
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1345470
The philosophy of science is a dying discipline
The philosophy of science is a dying discipline in part because it added
philosophical terminology and discourse that did not have enough value added to
scientists themselves as they got on with the work at hand, particularly social
scientists.
Social scientists have moved on from debates over the scientific paradigm. I
highly recommend examining how sociologists now proceed without getting all hung
up on positivist or anti-positivist dogma ---
http://www.trinity.edu/mkearl/methods.html#ms
I particularly like the following quotation from the above document:
Methodology
entails the procedures by which social research, whether quantitative and
qualitative, are conducted and ultimately evaluated--in other words, how
one's hypotheses are tested. Getting more specific, researchers'
methodologies guide them in defining, collecting, organizing, and
interpreting their data. Often the major breakthroughs in our understanding
of social processes occur because of the novelty of the data used, the
techniques by which it is gathered, or by the model or question directing
its acquisition and/or interpretation. And let's hear it for the findings
that don't support the hypotheses at the Journal of Articles in
Support of the Null Hypothesisand in the
Index of Null Effects and
Replication Failures.
Defining one's
data: Precisely how does one go about and measure such theoretical
concepts as altruistic behavior, esprit de corps, or anomie? Even such
apparent "no brainers" as religiosity, happiness, or social class reveal how
methodological adequacy and validity are a function of the clarity of one's
theory and its part. Further, theory tends to be built into our measurement
tools. When, for instance, one measures temperature with a thermometer it
is not the temperature per se that one sees but rather a phenomenon
(mercury rising within a column) theoretically related to it.
For
strategies for data collection see Bill Trochim's Research
Methods Tutorials, including material on:
August 22, 2005 reply from Paul
Williams at North Carolina State University
To add a bit more
to Michael, Ron, and Bob's comments: Even Popper, by the time he died wasn't
a Popperian, but an evolutionary epistimologist. Even he had to recognize
the implications of the linguistic turn and, particularly, Paul Feyerabend's
(a student of Popper) destruction of the pretenses of method. Bob is right
that philosophy of science is a dead horse replaced by a sociology and
history of science. Even scientists don't follow the scientific method.
Underlying every theory are propositions that don't enter into the specific
experiment or hypothesis being tested. I am with Ron, and many others, that
rigor is not obtained by running experiments within the context of a theory
that has absolutely pernicious underlying presuppostions.
Capital market theory and principal/agent theory are such theories.
The pernicious underlying proposition that is both empirically false (as
evolutionary biologists and anthropologists have provided ample evidence of
the kind you would consider rigorous) and morally repugnant is that of
humans' nature. What we in accounting seem never to consider is what
ramifications such presuppositions have for the very culture in which we
live. As Ed Arrington labeled it, Watts and Zimmerman are merely Hobbes in
drag. Hobbesian human nature was constructed to argue for Leviathan -- self-
government is beyond the ken of humans engaged in a war of all against all.
Certainly a libertarian philosophy is untenable in a Hobbesian world.
Solipsistic, vicious self-maximizers. The
project of the Scottish Enlightenment (of which Thomas Jefferson was a
diligent student) was to produce a human being who was capable of being free
of the rule of Kings or absolute sovereigns.
Jagdish provided
us a reference to Sumantra Ghoshal's article "Bad Management Theories Are
Destroying Good Management Practices." The bad management theories he speaks
of are those of agency theory. Why accounting should have been preoccupied
for the last 35 years in substance testing a theory of human nature is one
of the great mysteries. Principal/agent theory is a bad theory based on its
own empirical pretensions. What kind of Rsquares have we produced? Most of
human behavior is left unexplained by theory. And after this last stock
market bubble, does anyone seriously believe in capital market efficiency?
How good a
"scientific" theory do you have when after 40 years of testing you are still
back at square one? And if capital markets aren't efficient, what does that
do to the 30 years of "information content" studies predicated on the
assumption that markets were at least semi-strong efficient? Let me ask this
question, of you and everyone else: How much of what you believe do you
believe on the basis of the "empirical evidence?" Very little. Indeed,
believing you are a Popperian is a belief not based on empirical evidence.
No one did an experiment and proved that Popper was
right.
But what makes capital market theory and principal agent theory bad is what
it forces me to believe about myself and Michael and Ron and You, which I
will not, nor do I have to, accept. To quote from Michael Shermer's The
Science of Good and Evil: "Still, something profound happened in the last
100,000 years that made us -- and no other species -- moral animals to a
degree unprecedented in nature (p. 31)." Accounting is a human practice.
It's objects are not atoms, or quarks, or stars, or planets. It's objects
are also its subjects (the double hermeneutic that our physicists friends
don't have to deal with). A human practice that investigates itself as if
human capacities are as impoverished as neo-classicists would have us
believe they are (both in terms of doing good and evil) might be missing
something exceedingly important to it.
Most published scientific research papers are
wrong, according to a new analysis. Assuming that the new paper is itself
correct, problems with experimental and statistical methods mean that there
is less than a 50% chance that the results of any randomly chosen scientific
paper are true.
John Ioannidis, an epidemiologist at the University
of Ioannina School of Medicine in Greece, says that small sample sizes, poor
study design, researcher bias, and selective reporting and other problems
combine to make most research findings false. But even large, well-designed
studies are not always right, meaning that scientists and the public have to
be wary of reported findings.
"We should accept that most research findings will
be refuted. Some will be replicated and validated. The replication process
is more important than the first discovery," Ioannidis says.
In the paper, Ioannidis does not show that any
particular findings are false. Instead, he shows statistically how the many
obstacles to getting research findings right combine to make most published
research wrong.
Massaged conclusions Traditionally a study is said
to be "statistically significant" if the odds are only 1 in 20 that the
result could be pure chance. But in a complicated field where there are many
potential hypotheses to sift through - such as whether a particular gene
influences a particular disease - it is easy to reach false conclusions
using this standard. If you test 20 false hypotheses, one of them is likely
to show up as true, on average.
Odds get even worse for studies that are too small,
studies that find small effects (for example, a drug that works for only 10%
of patients), or studies where the protocol and endpoints are poorly
defined, allowing researchers to massage their conclusions after the fact.
Surprisingly, Ioannidis says another predictor of
false findings is if a field is "hot", with many teams feeling pressure to
beat the others to statistically significant findings.
But Solomon Snyder, senior editor at the
Proceedings of the National Academy of Sciences, and a neuroscientist at
Johns Hopkins Medical School in Baltimore, US, says most working scientists
understand the limitations of published research.
"When I read the literature, I'm not reading it to
find proof like a textbook. I'm reading to get ideas. So even if something
is wrong with the paper, if they have the kernel of a novel idea, that's
something to think about," he says.
Journal reference: Public Library of Science
Medicine (DOI: 10.1371/journal.pmed.0020124)
Jensen Comment: By analogy, this is a black eye against top accounting
research journals that refuse to publish replication studies. It is a special
problem for accounting behavior studies where sample sizes and validity are
enormous problems. It may be less of a problem in capital market studies where
sample sizes are often huge. But problems of poor study design and missing
variables in models are an enormous in accounting research that tries to be
scientific.
Always subject a research conclusion to the so-what
test! Even without technical skills you often can question that which your
common sense tells you is not correct, although you may have to endure slings
and arrows of paranoids in doing so. Sometimes a child's question is the best
kind of question ---
http://imagine.gsfc.nasa.gov/docs/ask_astro/answers/011021a.html
Learning at Research Schools
Versus "Teaching Schools"
Versus "Happiness"
With a Side Track into Substance Abuse
Shortly after R. Glenn Hubbard took over as dean of
Columbia Business School in 2004, he began hearing rumblings from executives
about the quality of MBA graduates. They were undoubtedly smart but often
unprepared to handle the most crucial of managerial responsibilities:
quickly solving problems with less than perfect information. Among those
wanting more from new hires is Henry Kravis, co-founder of the private
equity firm Kohlberg Kravis Roberts. "I want to see MBAs who can jump in and
make decisions, not jump in and learn to make decisions," he says.
Hubbard made his own executive decision. He devised
a new twist on the case study—the teaching format invented by Harvard
Business School almost a century ago and used by most B-schools. Hubbard's
so-called decision brief offers less information about a situation than the
case study, and it doesn't present the solution until students have grappled
with the issues on their own. "We want our students to be used to dealing
with incomplete data," Hubbard says. "They should be able to make decisions
out of uncertainty."
Even Michael J. Roberts, the executive director of
the Arthur Rock Center for Entrepreneurship at Harvard and author of more
than 100 HBS case studies, acknowledges the potential benefits of Hubbard's
approach, which was introduced to Columbia students last fall. "Framing
problems and finding the data to analyze those problems is a skill that MBAs
need and that the classic case doesn't fully exploit," Roberts says. Hubbard
expects such endorsements, as well as those of companies, will encourage
other business schools to make room one day for Columbia's decision briefs
in their curriculums. Hubbard, at least initially, doesn't plan to sell the
decision briefs but to use them to tap into faculty research.
Hubbard isn't giving up on the traditional case
study altogether. As part of an initiative called CaseWorks, Columbia will
produce cases designed to reflect contemporary issues (which other schools
do already), while also creating decision briefs that do away with the
Harvard formula (which no one else has done). To help guide the program,
Hubbard has turned to two people familiar with the deficits of the old
methods: Stephen P. Zeldes, who has been at Columbia for more than a decade
and is now chairman of the economics department at the B-school, and former
Harvard case writer Elizabeth Gordon.
TOO MUCH INFORMATION The stock case study presents
a tidy narrative arc, with a protagonist and a clear story line. One of the
more widely used HBS cases focuses on Intel's (INTC) former marketing
vice-president, Pamela Pollace, as she decides whether Intel should extend
the "Intel Inside" branding campaign to products other than computers. In 24
pages, students are provided with information on Intel and the history of
microprocessors, as well as details about market share and segmentation.
Pollace's major concern, they learn, is brand dilution; the potential reward
is likely worth the risk. In effect, the students are guided along the
decision-making process.
If this case were a Columbia decision brief,
students might see a video interview in which Pollace describes the
challenge. They would also be given a few documents on the background of the
campaign itself—the same data a manager at the company would have, but no
more. Then, students would discuss possible solutions. Afterward, the group
would see a second video of Pollace explaining how she handled the issue
before debating whether or not she made the right decision.
So far, Columbia has produced six briefs that take
on of-the-moment business challenges: Among them is one that focuses on
General Electric's (GE) business-process-outsourcing division in India.
Given increased competition, the company needed to consider a bigger
investment, as well as the possibility of serving non-GE customers. With
just a little more information than that, students are asked to come up with
various strategies. "The idea is to try to simulate what it will be like in
a real workplace," says Gordon. "There is uncertainty, things aren't
predigested, all the information won't be there."
The first field test for the new teaching technique
will be this summer, when the MBAs head out to their internships. At Goldman
Sachs (GS), which hires more Columbia interns than any other company, the
co-head of campus recruiting, Janet Raiffa, hopes to encounter students who
are more independent thinkers. As for Kravis, his firm doesn't employ summer
interns.
In some ways the pedagogy proposed by Columbia is a shorter and cheaper
version of the BAM approach first proposed by Catanach, Croll, and Grinacker.
The BAM approach uses a year-long case and students can seek out data in
virtually every way they will do it later on while on the job (including paying
for data if necessary) ---
http://faculty.trinity.edu/rjensen/265wp.htm
Law students —
and the lawyers they become — are notoriously unhappy, but
the interests of their professors could make all the
difference in helping them through law school and in
preparing them to be good lawyers.
A study
published this month in the
Personality and Social Psychology Bulletin
compared recent classes at two law
schools with almost identical average undergraduate
grade-point averages and LSAT scores and found that students
at the school that encouraged its professors to be good
teachers rather than good scholars reported higher levels of
well-being and competence, and scored higher on bar exams.
Students at
both law schools entered with similar statistics: average
undergraduate GPAs around 3.4 and LSAT averages near 156.
The schools differed significantly, however, in overall
ranking. Law School 1 (LS1), with a good reputation and an
emphasis on faculty scholarship, ranked in the second tier
(as defined by the study) while Law School 2 (LS2), with an
emphasis on hiring and training faculty to be good teachers,
ranked in the fourth tier.
Twenty-four
percent of the Law School 2 graduates who took the bar exam
in the summer of 2005 had “high” scores above 150, compared
to 14 percent of Law School 1 graduates. Nearly half of Law
School 1’s graduates, meanwhile, had “low” scores – below
130 – on the bar exam, compared with 22 percent of Law
School 2’s graduates. Though the scoring statistics are
representative of each law school overall, rather than just
those students who participated in the study, they are
“strongly suggestive that the teaching and learning at LS2
may be more effective,” the authors wrote.
Krieger, one
of the authors, said in an interview that it was “almost
shocking” to see “how significantly the fourth tier students
outperformed the second tier law students on the bar.” But,
he added, “it makes sense psychologically – the students at
the fourth tier school were happier – and it makes sense
that they would have learned more from better teachers.”
By the third
year of law school, students at Law School 2 reported
significantly higher levels of “subjective well-being,”
autonomy and competence than students at Law School 1.
But
Ann Althouse, a professor at the University of Wisconsin Law
School in Madison said that though it is “intuitively right
that the school that emphasizes teaching is the one with
students who are happier and score better,” those students
may not be better off in the long run.
She said
that if all a law school expects of its faculty is to teach,
then they can “put more time into teaching students to be
lawyers, but not necessarily how to think like lawyers.”
In
February, Althouse, a blogger on law and current events, was
a month-long guest columnist for The New York Times.
In
one column, she wrote that while “law
should connect to the real world … that doesn’t mean we
ought to devote our classes to the personal expression of
law students.”
Rather, she said, law professors should “deny ourselves the
comfort of trying to make [law students] happy and teach
them what they came to learn: how to think like lawyers.”
Continued in article
June 23, 2007 reply from Dan Stone, Univ. of Kentucky
[dstone@UKY.EDU]
Hi all,
Regarding Ken Sheldon
& Lawrence Krieger's law school study
(actually, they have published two studies on this topic: the one that Bob
cites is their second published study.)
Professor Althouse's
assertion that the students at the teaching school may not be learning "how
to think like lawyers" suggests that she has not read this study carefully.
The students at the teaching school were not only happier they also scored
HIGHER on the bar exam. Therefore, unless Professor Althouse argues that the
bar exam doesn't test critical thinking skills her argument doesn't accord
to the data.
So, perhaps one need not be unhappy to be a
competent professional? Perhaps at least some professor-induced suffering
merely creates unhappiness and doesn't improve the quality of the "product"?
Ok, now I am overstepping the data.....
FYI, I saw Ken present this paper a few weeks ago
at the self-determination theory conference and was left wondering if
similar results hold for professional accountancy programs. I chatted with
Ken about this and he is also interested this topic.
Relatedly, there is some evidence that lawyers have
higher alcohol and drug use rates than do some other professionals (though I
can't recall the cites just now).
Best,
Dan Stone
Reply from Bob Jensen
Thank you Dan for that helpful and somewhat personalized reply. Here
are a couple of citations of possible interest with respect to lawyer
substance abuse:
Title: Substance Abuse in Law Schools: A Tool Kit for Law School
Administrators
Authors: Orgena Lewis Singleton JD, Alfred "Cal" Baker L.C.D.C., more...
Publication Date: December 2005, American Bar Association
ISBN: 1-59031-628-2
Topics: Law School, Law Students, Lawyer Assistance Programs, Legal
Education & Admissions to the Bar
URL:
Click Here
Also see "Torts, Trials and ... Treatments," by Elia Powers, Issues in
Higher Ed, January 4, 2007 ---
http://www.insidehighered.com/news/2007/01/04/lawschool
The ABA report argues that the quality of the
legal profession is affected by lawyers who “are impaired as a result of
abuse of alcohol and drugs.” One of the co-authors who spoke at
Wednesday’s meeting in Washington, Cal Baker, is a recent law school
graduate and director of a company that provides chemical dependency
treatments.
Baker, a recovering alcoholic, said alcohol and
drug abuse are the two top problems he sees among law students. (Other
panelists said students often report depression and extreme anxiety, as
well as substance abuse issues. ) He said he would have been unable to
recover from his condition while in school, because nearly all the
planned social activities were centered around bar nights.
One of the largest hurdles, Baker said, is
convincing students that admitting their drinking problems won’t lead to
disciplinary action. Many who have previous alcohol-related citations
are concerned about their professional futures.
Continued in article
I do not know of comparable studies in the accounting profession. I do know
that substance abuse is a problem on two levels for accountants, particularly
auditors who are away from home a lot of the time. At level one is the
professional away from home more than many other professionals. At level two is
the family of a professional who is absent from home much of the time.
Some large CPA firms have hot lines where professionals and their family
members can seek counseling with complete confidentiality and possible
anonymity. These hot lines link directly with medical and family counseling
professionals who are outside the firm itself but are paid by the firm. I'm told
that an overwhelming proportion of the problems dealt with are substance abuse
and troubled family members.
I suspect that these are problems that are not dealt with at all well in our
schools of accountancy. One problem is that we want to attract students to this
profession and do not like to dwell on the dark side of this profession's
troubles. There are substance abuse problems in all professions. It would be
interesting to study whether some professions tend to keep substance abuse
problems in dark closets more than other professions. For example, perhaps there
is more perceived sensitivity among clients/patients who are more afraid of
substance abusers in accounting and medicine relative to law. That is only a
personal observation and not something that I've studied. My guess is that
substance abuse is highest among physicians and highest in terms of keeping
their dependencies secret.
I don’t know about other states, but the Texas
State Board of Public Accountancy acknowledges the problem as evidenced by
the following link on their website:
In some ways, the situation in accounting is
similar to that in law. In others, there is substantial difference.
In law there are essentially two tiers in law
schools: those that are quite bar exam oriented, and those that emphasize
legal theory and philosophy. The kinds of placements they have are also very
different. The students at second sort of schools do clerkships with well
known or almost-well known judges, while those at the first sort of schools
do not. The students at the second sort of schools get hired by the large
well known law firms (for example, on the Wall Street) doing structured
finance and M&A work, whereas the first kind often may do work that could be
considered menial (uncontested divorces, fixing speeding tickets/DUI, etc.).
Of course there are crossovers.
Often, students at the second sort of schools do
not practice at all, but have a profound impact on the profession, and there
are some who practice only occasionally (Tribe, Dershowitz,...).
I agree with Ann Althouse that the second sort of
schools teach students to think like lawyers whereas the first kind teach
them to be lawyers.
In accounting, on the other hand, I think we have
only one kind of schools (the equivalent of second sort have no professional
accounting programs), and they teach students to BE accountants rather) than
to think like accountants.
This situation is convenient for many. It is much
easier to teach one to be like someone than to teach one to think like some
one.
I am not familiar with the Sheldon/Krieger studies,
but will read them soon.
However, I interact with law school faculty often,
and ask them questions just to find out how we in accounting can learn from
them. I also have an abiding interest in the relationship between
jurisprudence and accounting, and it is one of the few psychic benefits I
have enjoyed being an accounting academic.
The law school market is pretty much a
differentiated market. I think the missions of the top tier schools and
others are very different, and both conform to their missions well; there
are no pretensions as we have among the accounting schools where there is a
race to reach the greasy pole no matter what one's comparative advantages
are.
It is difficult to find students from non-top
schools doing clerkships with supreme court justices, or the top law firms
recruiting from such schools.
* The top tier schools emphasise law as an
interdisciplinary field rather than a field confined to narrowly defined
learning of existing laws.
* The top tier schools emphasise more critical
analyses of certain aspects of law such as constitutional law,
international law, jurisprudence... and de-emphasise other aspects such
as administrative law, criminal procedure,... as the other schools do.
* Many students graduating from top schools do
not enter law practice, and even when they do, they enter very different
practices where critical thinking, interdisciplinary, and liberal arts
type skills predominate. Many enter government and public service. Many
also enter the academia. Over my career I have had dozens of friends and
colleagues who went Go top law schools (Harvard, Stanford, Cambridge,
...), and they have established their presence as scholars even outside
their narrow domain. On the other hand, most law academics that I have
known from non-top schools, on the other hand, have been in areas such
as tax law, business law,..., generally not considerer the intellectual
centers of gravity of law.
I do not mean to be an elitist when I make the
above observations. In fact, one of my heroes in law, the late Don Berman, a
Harvard educated lawyer at Northeastern, specialised in tax law. If I dig
deep, I am sure I can find some law academics from non-top schools who were
brilliant scholars in areas of law that are considered scholarly. The point
I make is that the two types of schools are just different.
About a dozen years ago, I was trying to establish
relationships with a local (non-top) law school to introduce our students in
accounting Go topics such as the relationship between constitutional law and
accounting, and the role of jurisprudence in accounting. I got no where, and
we were in fact on different wavelengths. On the other hand, more recently
we did try to establish relationships for tax students and it has worked out
very well. Our graduate tax students take some tax courses at the law school
and it has helped them tremendously.
I attend law sort of conferences (usually at the
intersection of law and computer science), and almost all participants are
from the top tier law schools. Some from other law schools too attend, but
usually to meet CPE requirements to keep their licenses current. I also am
an avid reader of law literature (specially in constitutional law and
jurisprudence) and there too just about every author is from a top tier law
school.
There is nothing wrong in this dichotomy. Those
from non-top law schools have performed brilliantly in the corporate world,
and once in a while they do spectacular jobs for their clients (see OJ
Simpson's dream team)Sometimes they also excel as legal scholars
Another difference I find between the alums at the
two types of schools is that the contribution to legal literature from the
top law schools is disproportionately large. Ronald Dworkin, Lawrence Tribe,
and Richard Posner in the US, or Joseph Raz and HLA Hart in Britain,... one
has to stretch one's imagination to come up with those from non-top tier law
schools who come close.
And there is no cartel in law as we have in
accounting. Good scholarship gets recognised no matter where it originates,
and gatekeepers are generally powerless; quite unlike in accounting.
There is learning at both kinds of schools, they
are just different. Trying to compare them is like comparing apples and
oranges, or worse, like comparing apple to an ape.
I'll try to collect my thoughts on what we in
accounting can learn from legal education at both levels and post them to
AECM one of these days.
Regards,
Jagdish
Why accountancy doctoral programs are drying up
and
why accountancy is no longer required for admission or
graduation in an accountancy doctoral program
Mathematics
for Accounting
Research (Tom Lehrer) ---
http://www.youtube.com/watch?v=gfZWyUXn3So (Watch until you are at or near the end of the video since it sort
of has a false ending.)
David Johnstone from Australia gave me permission to
broadcast his reply to the AECM with respect to the attached paper from the
American Statistical Association.
The ground is shaking beneath the accountics science
foundations upon which all accounting doctoral programs and the prestigious
accounting research journals are built. My guess is, however, that the
accountics scientists are sleeping through the tremors or feigning sleep
because, if they admit to waking up, their nightmares will become real!
"A Scrapbook on What's Wrong with the Past, Present and Future of
Accountics Science"
by Bob Jensen
http://faculty.trinity.edu/rjensen/AccounticsWorkingPaper450.pdf
Dear Sudipta and Bob, thanks for
sending this Sudipta, it was actually written up in the local newspaper
(Sydney Morning Herald) the other day. There has also been a series of
articles on economic modelling that starts with the conclusion and works
back to the argument. People are waking up to rorts slowly but
inevitably, it seems.
There are multi-million dollar
industries (e.g. “accounting research”) that depend on p-levels and
would need a big clean out and recanting/retraining if the tide were to
turn. I think that the funding bodies (e.g. taxpayers) are starting to
smell rats, so life is going to be different for younger researchers in
10 years I suspect. Much more scepticism about supposed “research”.
I have been toying with writing a
book on the P-level problem. I used to be excited about this stuff, I
thought it was deeply interesting and other people would also find it
interesting. I didn’t realize that most researchers are not
intrinsically interested in the techniques they use, and I also didn’t
realize that most will resist bitterly anything that makes their lives
less glamorous and their self-image less wonderful. This is what I see
as the “positive theory of accounting researchers”.
Great to have a couple of old
fashioned academics to talk to on this.
By the way, all the young
statisticians schooled in Bayesian theory know about the issues with
P-levels, and they are breeding up in computer science and elsewhere.
Tom Dyckman’s paper on P-levels is
coming out in Abacus 2nd issue 2016. In that same issue is an excellent
survey paper by Jeremy Bertomeu on cost of capital etc, which will give
that issue further credibility and hopefully prompt some extra readers
to see Tom’s paper.
How can this be fixed? It's becoming
increasingly obvious that our accounting systems need to be modified.
After all, many of today's current companies have 75 percent of their
value stemming from intangible assets. These assets may not appear on
the company's balance sheet, but doesn't it seem grossly negligent to
completely ignore them during the company's valuation process? If we can
somehow effectuate a major change in our present accounting systems so
that they more accurately track the value or inventions and other
intangible assets like patents or other forms of intellectual property,
companies would hopefully become less wasteful and make more educated
decisions about whether to keep or sell their inventions and licenses.
This ideally would encourage a surge of inventions and innovations in
businesses that enrich our lives in both monetary and non-monetary ways.
Jensen Comment
Where do accounting innovations come from? These days they typically come
from standard setters such as when the FASB invented accounting for
derivative financial instruments in SFAS 133.
The last place to look for accounting innovations is our academy of
accounting educators and researchers. The academy divorced its research from
the practicing profession in the 1950s and never looked back until now when
the American Accounting Associate Pathways Commission in the past three
years has attempted to restore interest among accounting professors in doing
research of interest to the accounting profession ---
http://faculty.trinity.edu/rjensen/Theory01.htm#DoctoralPrograms
If you know of any significant innovation or invention by an accounting
professor we would all like to hear from you.
A few years back I conducted a survey among accounting professors on this
issue. Some attributed ABC costing to Harvard's Bob Kaplan, but Kaplan
admitted early on that ABC Costing was developed by accountants in Deere
Corporation. Some also suggested Kaplan's Balanced Scorecard, but once again
Kaplan attributes much of the innovation to practitioners.
Some suggested Dollar-Value Lifo, but Dale Fleisher pointed out
that
Dollazr-Value Lifo was invented by Herbert T. McAnly, who retired in 1964 as
a partner at Ernst & Ernst after 44 years with the firm.
As
far as I can tell the only innovation for accountants came in the AIS field
when Bill McCarthy invented REA ---
https://en.wikipedia.org/wiki/Resources,_events,_agents_(accounting_model)
Has there been any other invention
by accounting professors that excited practitioners?
The Sad State of Accounting Doctoral Programs in North America
"Accounting Doctoral Programs: A Multidimensional Description,"
by Amelia A. Baldwin, Carol E. Brown and BradS. Trinkle.
http://www.academia.edu/532495/Accounting_Doctoral_Programs_A_Multidimensional_Description Advances in Accounting Education: Teaching and Curriculum Innovations,
Volume 11, 101–128Copyright r 2010 by Emerald Group Publishing Limited
ISSN: 1085-4622/doi:10.1108/S1085-4622(2010)000001100
Accounting doctoral programs have been ranked in
the past based on publishing productivity and graduate placement. This
chapter provides descriptions of accounting doctoral programs on a wider
range of characteristics. These results may be particularly useful to
doctoral applicants as well as to doctoral program directors, accreditation
bodies, and search committees looking to differentiate or benchmark
programs. They also provide insight into the current shortage of accounting
doctoral graduates and future areas of research. Doctoral programs can be
differentiated on more variables than just research productivity and initial
placement. Doctoral programs vary widely with respect to the following
characteristics: the rate at which doctorate sare conferred on women and
minorities, the placement of graduates according to Carnegie classification,
AACSB accreditation, the highest degree awarded by employing institution
(bachelors, masters, doctorate),
Continued in article
Table 1. Accounting Doctoral Graduates by Program,
1987–2006(Size; 3,213 Graduates).
http://www.academia.edu/532495/Accounting_Doctoral_Programs_A_Multidimensional_Description
Note that I corrected the ranking for North Texas State from the original
table
The average of 161 per year has been declining. In 2013 there were only 136
new accounting doctorates in the USA.
Rank
Program
#
Rank
Program
#
Rank
Program
#
Rank
Program
#
01
Texas A&M
87
25
Arkansas
46
49
Columbia
31
73
MASS
17
02
Texas
78
26
Florida State
45
50
Drexel
31
74
Syracuse
16
03
Illinois
72
27
Indiana
45
51
Northwester
31
74
Wash St. Louis
15
04
Mississippi
70
28
Tennessee
44
52
Cornell
30
75
Central Florida
14
05
Va. Tech
70
29
Texas Tech
44
53
Purdue
29
76
Cincinnati
14
06
Kentucky
69
30
Georgia St.
43
54
Minnesota
28
77
Cleveland St
14
07
Wisconsin
69
31
Colorado
42
55
Oklahoma
28
78
MIT
13
08
North Texas
65
32
NYU
42
56
Penn
28
79
Fla Atlantic
12
09
Arizona
64
33
Oklahoma St
42
57
Rochester
28
80
UCLA
12
10
Georgia
64
34
Rutgers
42
58
So. Illinois
28
81
Union NY
10
11
Penn State
63
35
Alabama
41
59
Oregon
27
82
Texas Dallas
09
12
Nebraska
61
36
Va. Common
40
60
Texas Arling.
27
83
Tulane
08
13
Arizona St.
60
37
Memphis
38
61
Utah
27
84
Duke
6
14
Houston
60
38
Stanford
37
62
Baruch
25
85
Jackson St.
6
15
Michigan St.
60
39
Chicago
36
63
Connecticut
24
86
Fla. Internat.
4
16
Washington U
55
40
Missouri
36
64
Carnegie M.
23
87
SUNY Bing.
4
17
So. Carolina
54
41
No. Carolina
36
65
Geo. Wash
23
88
Yale
4
18
Michigan
52
42
So. Calif.
36
66
Wash. State
23
89
Ga. Tech
3
19
La. Tech
51
43
UC Berkeley
35
67
Kansas
22
90
Rice
3
20
Ohio State U
50
44
Boston Univ
35
68
SUNY Buffalo
21
91
Tx. San Anton.
3
21
Kent State
49
45
Maryland
35
69
St. Louis
21
93
Miami
2
22
LSU
49
46
Pittsburg
35
70
CWRU
19
94
Cal. Irvine
1
23
Florida
47
47
Iowa
34
71
Harvard
19
95
Hawaii
1
24
Mississippi St
47
48
Temple
34
72
South Fla.
19
96
Vanderbilt
1
Jensen Comment
For years prior to 1987 and years subsequent to 2006 you can see the data by
years in a sequence of the Accounting Faculty Directories by James
Hasselback. For example, for years 1995-current go to
http://www.jrhasselback.com/AtgDoct/XDocChrt.pdf
For years prior to 1995 you have to go to earlier editions of Jim's directories.
There are some minor discrepancies. For example, the above table shows 3
graduates for Rice after 1987 whereas Jim Hasselback shows no graduates at Rice
after 1995. I did not check for all the discrepancies between the two data
sources. Rice no longer has a doctoral program in accountancy. There are several
newer (small) programs such as the one at the University of Texas at San
Antonio.
Nearly all of the long-time programs declined dramatically in output from
their pre-1995 years, especially the University of Illinois, the University
of Washington. the University of Georgia, the University of Arkansas,
Indiana University, and Michigan State University.
In past few years since 2010 Arizona, Arizona State, Rutgers, Penn State,
Texas, Texas A&M, Stanford, and Mississippi maintained an average of three
or more per year. Chicago in recent years has quite a few in the program but
has an average of less than two graduates per year. This suggests to me that
there might be more ABDs dammed up at the University of Chicago than in most
other doctoral programs. UT Dallas and Illinois are also suspect in this
regard ---
http://www.jrhasselback.com/AtgDoct/XDocChrt.pdf
The Baldwin, Brown, and Trinkle paper goes on to discuss trends over time in
the leading programs and much much more. I did not quote data from their paper
that was not previously provided by Jim Hasselback at
http://www.jrhasselback.com/AtgDoct/XDocChrt.pdf
A few of the many important revelations in the BBT study that might be noted
for 1987-2006:
The proportion of female accounting doctorates was 38% of the 3,213
graduates over 20 years.
The proportion of minority accounting doctorates was 4.6% of the
3,213 graduates over 20 years.
Foreign placement of accounting doctoral graduates whose location is
known is about 14% (including those going back to Canada)
Non-academic placement of accounting doctoral graduates whose
employment is know is about 3%. There are very few career advantages of
having an accounting Ph. D. in industry. This is not the case in most
other academic disciplines.
The number of earned doctorates awarded by
American universities increased 3.5 percent in 2013, to 52,760,
according to data
from the National Science Foundation.
However, the snapshot of new Ph.D.’s, which
comes from an
annual report on doctoral-degree attainment
known as the "Survey of Earned Doctorates," highlights a bleak part of
post-Ph.D. life. For new doctoral recipients, starting a postgraduate
career is still an uphill struggle and appears to be getting tougher.
Jensen Comment
Business administration doctorates (including accounting doctoral degrees)
still comprise less that three percent of all doctoral degrees granted in
the USA. But number of graduates increased from 750 graduates in 1983 to
1,545 in 2013. In comparison there were 2,781 engineering new doctorates in
1983 versus 8,963 graduates in 2013.
The tables above do not drill down to accounting doctorates, but those
have actually declined from 212 accountancy doctoral graduates 1989 to 136
graduates in 2013. At the same time, demand for accounting doctorates in
2014 is well in excess of 10 openings for every new accountancy Ph.D.
awarded in 2014.
http://www.jrhasselback.com/AtgDoct/XDocChrt.pdf
Question
Where are the shortages of PhDs in academe more severe than the shortage of
accounting PhDs?
Since there are so few Ph.D.’s in criminal
justice, the degree nearly guarantees an offer for a tenure-track
position, probably several offers, said Craig T. Hemmens, professor and
chair of the department of criminal justice and criminology at
Washington State University.
"There’s job after job posted throughout the
year," he said. "There are more jobs out there than there are people
graduating with Ph.D.’s." A 3-Year Search
Competition for faculty members is also tough
in professionally oriented fields, such as physical therapy. It took
three years for the University of Central Arkansas to hire an instructor
in that field. The small number of qualified applicants, coupled with
the college’s rural location, made for a tough search, said Nancy Reese,
professor and chair of the department of physical therapy at Central
Arkansas and a member of the Board of Directors of the American Council
of Academic Physical Therapy. In Arkansas, Ms. Reese said, the number of
applicants in the health-science field can average in the single digits.
During the search, Ms. Reese said, only about
two or three people applied per year—and not all of them met even the
basic job requirements. Eventually her department decided it had to be
more proactive. Faculty members brainstormed to come up with a list of
people they knew in the industry who might make a good fit and contacted
them, ultimately offering the job to someone who was suggested to Ms.
Reese by a colleague at another institution.
Job advertisements don’t often work for filling
these kind of jobs, she said. "You know someone who knows someone," she
said. "It’s that network that actually gets someone there."
One reason colleges struggle to hire professors
in some fields might be the careers implied by the discipline. Most
students going into social work, for example, don’t envision themselves
leading a classroom, said Tory Cox, assistant director of field
education at the University of Southern California’s School of Social
Work.
Among the hundreds of master’s-degree students
at USC who interact with Mr. Cox, about 15 or 20 will pursue a Ph.D. in
social work, and only four or five of those will even consider teaching.
Teaching isn’t necessarily compatible with the
goals students often have of working directly with people who are poor
and disenfranchised, Mr. Cox said.
In nursing, meanwhile, higher paychecks in the
professional sector often draw qualified candidates away from faculty
positions. Someone with a Ph.D. in nursing, or a
doctor-of-nursing-practice degree (a doctoral degree that emphasizes
practice rather than research), can earn, as a conservative estimate, 15
to 20 percent more in a "practice setting" than in higher education,
said Robert Rosseter, chief communications officer for the American
Association of Colleges of Nursing.
The median salary of an associate professor
with a doctoral degree is $92,736, according to the association’s data.
But the median salary for a nursing director, who typically holds a
doctoral degree, is $125,073. Likewise, the median salary for a chief
nurse anesthetist is $179,552.
There is little comprehensive data to show
where Ph.D.’s across many fields end up working. But the American
Association of Colleges of Nursing tries to track where Ph.D.’s in the
field are employed and began to notice a faculty shortage a decade ago.
The association also keeps track of how many
students are entering nursing Ph.D. programs. So many nursing students
want the credential that there aren’t always enough qualified
instructors to teach them. Over the past decide, the number of students
enrolled in nursing Ph.D. programs increased by 49 percent. And lack of
staffing was cited as a reason almost 280 applicants were turned away
from those programs last year. Nearly 1,500 applicants were turned away
from doctor-of-nursing-practice programs, according to the nursing
association’s data.
On top of that, a wave of nursing professors
are either retiring or nearing retirement age, Mr. Rosseter said.
"It’s a perfect storm, really," said Linda K.
Young, dean of the College of Nursing and Health Sciences at the
University of Wisconsin at Eau Claire. Incentives to Teach
Ms. Young helped get a state grant, worth
$3.2-million, to ease faculty shortages in Wisconsin. The money was
awarded to four nursing programs in the University of Wisconsin system,
which turned away between 50 and 80 percent of qualified applicants last
year.
Continued in article
"Lessons Not Learned: Why is There Still a Crisis-Level Shortage of
Accounting Ph.D.s?" by R. David Plumlee and Philip M. J. Reckers,
Accounting Horizons, June 2014, Vol. 28, No. 2, pp. 313-330.
http://aaajournals.org/doi/full/10.2308/acch-50703 (not free)
SYNOPSIS:
In 2005, an ad hoc committee appointed by the
American Accounting Association (AAA) documented a crisis-level shortage
of accounting Ph.D.s and recommended significant structural changes to
doctoral programs (Kachelmeier, Madeo, Plumlee, Pratt, and Krull 2005).
However, subsequent studies show that the shortage continues and the
cumulative costs grow (e.g., Fogarty and Holder 2012; Brink, Glasscock,
and Wier 2012). The Association to Advance Collegiate Schools of
Business (AACSB) recently called for renewed attention to the problem (AACSB
2013b). We contribute to the literature by providing updated information
regarding responses by doctoral programs and, from the eyes of potential
candidates, of continuing impediments to solving the doctoral shortage.
In this paper, we present information gathered through surveys of
program administrators and master's and Accounting Doctoral Scholars
Program (ADS) students. We explore (1) the cumulative impact of the
Ph.D. shortage as of 2013, including its impact on accounting faculty
composition, across different types of institutions, (2) negative
student perceptions of Ph.D. programs and academic accounting careers,
which discourage applicants from pursuing Ph.D. programs, and (3)
impediments facing institutions in expanding doctoral programs.
Received: December 2013; Accepted: December
2013 ;Published Online: January 2014
R. David Plumlee is a Professor at The
University of Utah, and Philip M. J. Reckers is a Professor at Arizona
State University. Corresponding author: R. David Plumlee. Email:
david.plumlee@business.utah.edu
INTRODUCTION
Despite recognition of a critical shortage in
accounting Ph.D.s and recommendations for structural changes to doctoral
programs (Kachelmeier et al. 2005), there is evidence that the shortage
continues (e.g., Fogarty and Holder 2012; Brink et al. 2012). The
objective of this commentary is to provide contemporaneous information
from administrators of doctoral programs, and the perceptions of
potential candidates on the major impediments to addressing the doctoral
shortage.
We were mindful in the design of our study
that, potentially, two factors contribute to the current dilemma:
Insufficient numbers of qualified individuals
are applying for admission to doctoral programs, and The capacity of
doctoral programs has declined; thus, even if sufficient numbers of
qualified individuals are applying, schools are failing to admit enough
candidates to address the shortage.
In this paper, we present information gathered
through surveys of program administrators and master's and Accounting
Doctoral Scholars Program (ADS) students. We explore (1) the cumulative
impact of the Ph.D. shortage as of 2013, including its impact on
accounting faculty composition, across different types of institutions,
(2) negative student perceptions of Ph.D. programs and academic
accounting careers, which discourage applicants from pursuing Ph.D.
programs, and (3) impediments to growth in doctoral programs faced by
institutions. While many authors (e.g., Gary, Dennison, and Bouillon
2011; Fogarty and Holder 2012) have examined various causal elements for
the shortage over the years, our purpose is to provide a more
comprehensive and up-to-date picture of the environment.
Prior research and commentary have addressed
many of the unintended negative consequences associated with the
accounting doctoral shortage. Exacerbating the problem is the growing
demand for collegiate accounting education. Leslie (2008) and Baysden
(2013) report a surge in undergraduate and graduate accounting
enrollments in recent years In 2011–2012, undergraduate accounting
enrollments exceeded 240,000 students (up another 6 percent from the
2009–2010 figures), with 61,334 B.S. accounting degrees conferred and
20,843 master's accounting degrees conferred—both record highs.
Some prior initiatives regarding the shortage
of Ph.D.-qualified accounting faculty have failed to sustain. The 2005
ad hoc AAA committee recommended greater financial support for doctoral
students. The profession responded. The ADS program was kicked off in
2008 with funding by CPA firms and state societies; it provided four
years of financial support each year for 30 doctoral students
specializing in auditing or tax. Unfortunately, the ADS program has
expired, and its success is hard to evaluate. Despite the initiative,
Fogarty and Holder (2012, 374) conclude that “(e)xtrapolating from the
current population of doctoral programs fails to support the prospects
for a recovery over the near future.”
Alternative means of supplying accounting
faculty have also been suggested. For example, Trapnell, Mero, Williams,
and Krull (2009) propose structural changes to reduce the time frame for
the degree to four years. Additionally, they suggest an executive-type
program where students do not leave their employment to pursue a Ph.D.
In this model, students would draw on their experience, supplemented by
coursework in research methods, to develop a research project. Few
schools have responded and adopted this model, and acceptance of their
graduates has yet to be tested. Another proposed alternative is to take
advantage of international accounting doctoral scholars willing to
relocate to the United States, who would participate in a ten-week
postdoctoral program and thereby become eligible to serve as accounting
faculty in the United States (HassabElnaby, Dobrzykowski, and Tran
2012). Our survey addresses whether schools have actually substantially
changed their doctoral programs along these lines or the composition of
their student bodies.
In the remainder of this paper, we report on
surveys conducted to address these and other relevant issues. First, we
focus on costs of the shortage and, specifically, the changes in hiring
that have been made, in part because of the Ph.D. shortage. Then we
spotlight structural changes in accounting Ph.D. programs. Finally, we
consider what might be discouraging more student applications; to
address these issues, we surveyed 388 M.Acc. students from various
programs across the country, requesting their perceptions of accounting
Ph.D. programs and the academic accounting profession. We also surveyed
84 current Ph.D. students in the ADS program to compare the perceptions
of a group who have chosen to get a Ph.D. with those of potential
applicants. In the final section, we discuss our findings and offer
recommendations for recruiting qualified students to accounting Ph.D.
programs.
SURVEY OF ADMINISTRATORS OF ACCOUNTING
PROGRAMS
Changes in Faculty Composition
Since the AAA ad hoc committee's report on the
accounting Ph.D. shortage in 2005, studies have documented various
aspects of the shortage, using data sources such as Hasselback's
Accounting Directory (Brink et al. 2012; Fogarty and Holder 2012),
surveys of accounting faculty (Hunt, Eaton, and Reinstein 2009), and
surveys of accounting Ph.D. students (Deloitte 2007), but none have
asked accounting program administrators directly about the impact of the
shortage on their programs. To examine how accounting departments have
responded to the Ph.D. shortage, we surveyed 754 accounting program
administrators listed in the Hasselback directory and received 204
completed responses (a 27 percent response rate). The schools in the
sample included 73 percent that had separate AACSB accounting
accreditation. Of responding schools, 69 percent graduated fewer than
100 undergraduate accounting majors each year, and 69 percent of schools
with Master's of Accounting programs graduated 50 or fewer each year.
When asked about their teaching mission, 20 percent responded that they
had only an undergraduate accounting program, 61 percent had both
accounting undergraduate and master's programs, and the remaining 19
percent had a Ph.D. program in accounting, in addition to bachelor's and
master's programs.
. . .
CONCLUSIONS AND RECOMMENDATIONS
Over 70 percent of responding accounting
program administrators believe that their programs have been harmed by
the accounting Ph.D. shortage. While the impact of broader economic
factors is undeniable, the shortage is certainly contributing to larger
class sizes, reduced elective offerings, and a significant change in the
composition of accounting faculties. Nearly every category of school
reports an increasing number of classes taught by clinical faculty,
lecturers, and part-time instructors. It is also clear from our data
that accounting Ph.D. programs have not been responsive to the calls of
the AAA (Kachelmeier et al. 2005), AACSB (2013b), and others for
significant structural change.
Whether the change in faculty composition is
seen as a serious problem depends on one's perspective regarding the
learning goals and objectives of collegiate accounting education. Some
opine (e.g., AACSB 2003, 2013b) that less exposure of accounting
students to doctorally qualified faculty will result in reduced
attention to the economic and social roles of accounting in society, and
less exposure to the rigorous forms of inquiry and analysis associated
with the scientific method (and its attendant skepticism). On the other
hand, the shortage is less troubling if the role of accounting faculty
is perceived to be primarily to instruct and train students in technical
accounting, auditing, and tax topics, and thereby instill those skills
demanded to enter the accounting profession. There is a continuing
controversy about when and where students are best “educated,” in the
classroom or on the job, with clearly different traditions in different
parts of the world.
There is also the issue of the value of
accounting research, as well as the quantity of research needed. A root
issue is the value one places on the role of accounting faculty in
contributing to questions fundamental to accounting as a discipline.
Advocates for a greater research role might ask questions such as,
“Would the propriety of fair value as a measure of asset values or the
option value of stock as a measure of compensation be as thoroughly
embedded in the accounting discipline today without the contribution of
rigorously trained accounting scholars?” The relative contribution of
scholars both in the classroom, as well as through their contribution to
fundamental knowledge and timely analyses of societal issues of
importance, is a value of doctoral education that must be recognized and
appreciated. Certainly, the AACSB (2013b) Report of the International
Doctoral Education Task Force: The Promise of Business Doctoral
Education foresees a much-expanded role for doctorally qualified
faculty.
That AACSB (2013b) report also argues the time
is now for business schools to embrace innovation, experimentation, and
opportunity, and come to grips with economic realities by exploring
innovations in doctoral education to enhance values and constrain costs
to the individual and the institution. While M.Acc. students represent a
large potential population of Ph.D. students, converting that
opportunity into reality has been and will continue to be a challenge.
Dogmatic intransience to change has not served our community well, any
more than it has served politicians in Washington well. Honest, serious
discourse is crucial if a way forward is to emerge. Financial
constraints, including the length of programs, must not only be
acknowledged, they must be solved. Our data are clear. Current
accounting Ph.D. program models are not attractive to domestic doctoral
program candidates.
The authors' personal beliefs represent two
voices out of many. We do not purport to have the solutions. Certainly,
we believe that a critical mass of accounting scholars is necessary for
accounting to continue to serve its crucial role in society.
Nonetheless, we are concerned that little appears to be happening to
address our current dilemma. We are certainly mindful of the
recommendations made nine years ago by the AAA's ad hoc committee (Kachelmeier
et al. 2005), but that is nearly a decade past. Sustainable solutions
have yet to manifest, and few signs of active commitment to find
solutions appear on the horizon. Can we continue to wait on individual
schools to change, or must a major collective initiative be forthcoming?
Foremost, our results suggest that active recruiting of potential
accounting Ph.D. students is critical, but unlikely to be successful
without significant institutional changes.
Our survey of M.Acc. students also finds that
there is a significant knowledge gap. Overcoming this knowledge gap
requires a collective effort. This may be within the purview of the AAA
or the AACSB or both. And this initiative, in our judgment, needs to
rise above the level of a one-year plan.
The group of M.Acc. students who expressed the
highest likelihood of applying to Ph.D. programs is those who see value
in and express an affinity for teaching and research. In professions
such as engineering and medicine, the leap from the academic content
found in master's programs and those found in doctoral programs is not
huge. However, in accounting, the disparity between the content of
master's programs and Ph.D. programs is enormous. As a result, Master's
of Accounting students are not acquainted with accounting research. Can
this condition be remediated? How do we go about this? While cost
constraints are important to everyone, it is well known that accounting
academics are not motivated solely by money matters. Arguably, one way
is to incorporate academic research that addresses issues of
professional and/or societal importance into master's, if not
undergraduate, courses. This is something individual accounting
academics can do. This end might also be achieved through focused
undergraduate honors theses, or by embedding distinct research courses
into master's programs. While incentives for schools to adopt these
strategies and Ph.D. programs to accept the academic credit do not
appear to exist at present, such an approach might serve to reduce the
length of Ph.D. programs.
The ad hoc committee of 2005 also urged leaders
of accounting programs to consider “Ph.D. tracks” in their master's
programs. These tracks should not be thought of narrowly. Courses in the
track could be fashioned to allow students to get a head start on a
Ph.D. program by including foundational topics such as economics,
mathematics, or statistical methods.2 Accounting programs without a
Ph.D. program might develop some sort of articulation agreement, where
certain courses in their “Ph.D. track” would count toward the Ph.D. at
the doctoral granting school. Our M.Acc. survey finds that even those
inclined to apply to an accounting Ph.D. program see five years or more
in a Ph.D. program as too much to sacrifice for an academic career. Any
method of shortening the process without diluting the quality would be a
welcome innovation.
A prior positive teaching experience also
appears to be related to pursuit of an academic career. We cannot
definitively resolve, based on our findings, whether those interested in
Ph.D. programs seek teaching opportunities or whether teaching sparks
interest in Ph.D. programs. Nonetheless, opportunities exist for more
accounting students to teach in some manner, or tutor. Whatever the
venue, teaching opportunities for students could be the catalyst for
pursuit of an academic accounting career.
In summary, the shortage of accounting Ph.D.
graduates continues, with several clearly identifiable negative
consequences. Many recommendations have been forthcoming in the past
with the goal of remediating the problem, but few recommendations have
been adopted. Champions of sustained new initiatives have not stepped
forward, with the exception of the ADS program, and the output of Ph.D.
programs continues to be inadequate.
M.Acc. students offer a large potential
recruiting pool, and a significant number of master's students show
early interest in academic careers. Unfortunately, a host of impediments
thwart our progress toward a robust Ph.D. pool. We identify and discuss
the major impediments. We observe that significant M.Acc. student
recruitment efforts are needed, where there are virtually none today. We
suggest that waiting for this problem to solve itself is folly; that
well-considered, significant, and sustained initiatives are required;
and that there exists an opportunity for the AAA, and its sections, to
take the lead. Individual accounting departments and schools can also
make a difference. Waiting for others to solve the problem has not led
to a solution to date. Continuing on our same path and expecting
different outcomes is likely unrealistic.
Jensen Comment
This is an important update to an ever-increasing problem in our Academy. It
surveys students, doctoral program coordinators, and accounting department
heads with outcomes that provide some detailed insights into large and small
issues.
One enormous issue is the decline in capacity for admission of applicants
into accounitng doctoral programs in North America. That is best reflected
in the well-known table generated by Jim Hasselback each year for many years
showing the number of graduating doctoral students in each doctoral program
over time ---
http://www.jrhasselback.com/AtgDoct/XDocChrt.pdf
At the moment the table shown in the above link only goes back to 1995.
However, I've saved copies of this table from earlier years Consider the
University of Illinois for example. Between 1939 and 1995 the University of
Illinois graduated an average of six accounting PhDs per year. The data are
skewed. There were only a few graduates in the early years of the program
whereas during the1960-1980 period Illinois was graduating 10-20 accounting
PhDs per year.
Between 1996 and 2013 Illinois only graduated an average of two
accounitng PhDs per year. Similar outcomes happened in the other accounting
doctoral mills of Texas and Arkansas where there were similarly severe
declines in the number of annual graduates since 1995. There have been some
new doctoral programs such as the newer program at the University of Texas
in San Antonio, but the numbers graduated each year from those programs are
small.
My poi9nt is that the decline in output in the larger mills since 1995
has not been offset by increased output in other programs. Hence in North
America we see a decline in the annual output from nearly 300 accounting
PhD graduates per year to 140.4 per yer between 1996 and2013.
Plumly and Reckers avoided some of the most controversial questions in
their surveys. Before 1985 accounting doctoral programs admitted accountants
without mathematical and statistical backgrounds and permitted accounting
dissertations without equations such as accounting history disserations
without equations. Now having equations in dissertations is required even in
accounting history dissertations.
In virtually all accounting doctoral programs in North America, new
doctoral students cannot matriculate without meeting advanced mathematics
and statistics prerequisites. Most of the accounting courses have been taken
out of the curricula and are replaced by econometrics and psychometrics
courses. The programs are essentially sophisticated programs on how to mine
data.
Most accounting faculty in an accounting program do not have the
quantitative skill sets to teach in the accounting doctoral programs or if
they have some quantitative skills they do not want to teach ecnonometrics
and psychometrics and data mining course or supervise accountics science
dissertations.. This is a major reason why the number of doctoral
students that can be handled in most accounting doctoral programs have
declined so dramatically.
Also accountants who have been practicing accounting for 5-10 years wound
prefer accounting doctoral programs rather than accountics science doctoral
programs. One reason the number of foreign students has been increasing in
North American Accounting Doctoral Programs is that students are admitted on
the basis of their mathematics and statistics skills rather than accounting
knowledge (and even interest in accounting).
This is why so many of the graduates from our
accounting doctoral programs in the 21st Century are not prepared to teach
accounting courses in the undergraduate and masters programs. All
they can teach are the doctoral program courses. The teaching of accounting
is being shifted to adjunct professors who are better prepared to teach
accounting, auditing, and taxation.
Plumlee and Reckers indirectly recognize this problem and suggest that
there be more curriculum tracks in accounting doctoral programs. The
Pathways Commission is even more blunt. It recommends that doctoral programs
allow doctoral dissertations without equations --- like in the good old days
when we had more accounting doctoral program graduates.
The (Pathways Commission) report includes seven
recommendations. Three are shown below:
Integrate accounting research,
education and practice for students, practitioners and educators by
bringing professionally oriented faculty more fully into education
programs.
Promote accessibility of doctoral
education by allowing for flexible content and structure in doctoral
programs and developing multiple pathways for degrees. The
current path to an accounting Ph.D. includes lengthy, full-time
residential programs and research training that is for the most part
confined to quantitative rather than qualitative methods. More
flexible programs -- that might be part-time, focus on applied
research and emphasize training in teaching methods and curriculum
development -- would appeal to graduate students with professional
experience and candidates with families, according to the report.
Increase recognition and support for
high-quality teaching and connect faculty review, promotion and
tenure processes with teaching quality so that teaching is respected
as a critical component in achieving each institution's mission.
According to the report, accounting programs must balance
recognition for work and accomplishments -- fed by increasing
competition among institutions and programs -- along with
recognition for teaching excellence.
The growing concern for the under-representation of
women in science and engineering has prompted an interest in the mechanisms
driving the share of women in these fields, and in the effect that the
gender diversity of the faculty has on the share of female students.
Interestingly, some universities are more successful than others in
recruiting and retaining women, and in particular female graduate students.
Why is this the case? This paper explores the uneven distribution of female
faculty and graduate students across ten of the top U.S. PhD programs in
economics. We find that the share of female faculty is correlated with the
share of female graduate students and show that this correlation is causal.
We instrument for the share of female faculty by using the number of male
faculty leaving the department as well as the simulated number of leavings.
We find that a higher share of female faculty has a positive effect on the
share of female graduate students graduating 6 years later.
Women are under represented in science and
engineering. In 2010, Men outnumbered women in nearly every science and
engineering field in college, and in some fields, women earned only 20
percent of bachelor’s degrees, with representation declining further at the
graduate level (Hill et al., 2010). In
economics, women constituted 33 percent of the graduating PhD students, and
only 20 percent of faculty at PhD granting institutions
(Fraumeni, 2011).
Women in economics have been shown to have different
career paths than men and to be promoted less (Kahn, 1993; Dynan and Rouse,
1997; McDowell et al., 1999; Ginther and Kahn, 2004). Focusing on the
progression of women through the academic ladder, most research has failed
to fully account for the effect that successful women in the field have had
on the entrance and success of other women. More specifically, the gross
effect that women faculty have on the share of female students have not been
fully explored. In this study we address this gap in the literature and
focus on the causal relationship between the share of female faculty in top
economics departments and the share of graduating female PhD students.
Continued in article
Jensen Comment
Women seem to be making greater strides in Ph.D. achievements in economics that
in many other science fields. It would seem that they could make greater strides
in fields like computer science where males dominate to a much higher degree.
In economics at the undergraduate and
masters levels in North America there are significantly more male graduates than
female graduates. Having more female teachers tends to increase the number of
undergraduate majors according to the above study.
In accounting at the undergraduate and
masters levels in North America there are significantly
more women graduates than men, and the large CPA firms hire more women
than men. There is a possible glass ceiling, however, in terms of newly-hired
CPA-firm women who eventually become partners. That is a very complicated story
for another time other than to note that the overwhelming majority of
newly-hired males and females in large CPA firms willingly leave those firms
after gaining experience and very extensive training.
Many of those departures go to clients of CPA firms where the work tends to
have less travel and less night/weekend duties as well as less stress. In my
opinion most accounting graduates who go to work for CPA firms did not ever
intend to stay with those CPA firms after gaining experience and training. This
accounts for much of the turnover, especially in large CPA firms.
Turnover has an advantage in that it creates more
entry-level jobs for new graduates seeking experience and extensive training.
Question 1
How should accountancy doctoral programs in the USA change where there is
general shortage of supply of graduates relative to tenure-track
positions available?
Question 2
How should doctoral change in humanities and sciences where there is general
overage of supply of graduates relative to tenure-track positions
available?
The report includes seven recommendations.
Three are shown below:
Integrate accounting research,
education and practice for students, practitioners and educators by
bringing professionally oriented faculty more fully into education
programs.
Promote accessibility of doctoral
education by allowing for flexible content and structure in doctoral
programs and developing multiple pathways for degrees. The
current path to an accounting Ph.D. includes lengthy, full-time
residential programs and research training that is for the most part
confined to quantitative rather than qualitative methods. More
flexible programs -- that might be part-time, focus on applied
research and emphasize training in teaching methods and curriculum
development -- would appeal to graduate students with professional
experience and candidates with families, according to the report.
Increase recognition and support for
high-quality teaching and connect faculty review, promotion and
tenure processes with teaching quality so that teaching is respected
as a critical component in achieving each institution's mission.
According to the report, accounting programs must balance
recognition for work and accomplishments -- fed by increasing
competition among institutions and programs -- along with
recognition for teaching excellence.
Question 2
How should doctoral change in humanities and sciences where there is general
overage of supply of graduates relative to tenure track positions
available?
What sorts of changes would you like to
see in American graduate study?
The biggest one is that our doctoral curricula
need to be changed to acknowledge what has been true for a long time,
which is that most of our Ph.D. students do not end up in tenure-track
(or even full-time faculty) positions—and that many of those who do will
be at institutions that are very, very different from the places where
these Ph.D.'s are trained.
The changes will differ from program to program
but might include different kinds of coursework, exams, and even
dissertation structures. Right now we train students for the
professoriate, and if something else works out, that's fine. We can
serve our students and our society better by realizing their diverse
futures and changing the training we offer accordingly.
The other necessary change: We need to think
seriously about the cost of graduate education. There is a perception
that graduate students are simply a cheap labor force for the
university, and that universities are interested in graduate students
only because they perform work as teachers and laboratory assistants
cheaper than any one else.
At elite universities—or at least at elite
private ones—that is simply not true, and I am glad that it is not. It
is absolutely true that graduate students perform labor necessary for
the university in a number of ways, but it is not cheap labor, nor
should it be.
The cost of graduate education has
repercussions for the humanities and social sciences, which is one
reason you are seeing smaller admissions numbers and some program
closings. It also has repercussions for the laboratory sciences, where I
am seeing too many faculty members shift from taking on graduate
students to hiring postdocs. Unfortunately, they regard postdocs as a
less expensive and more stable alternative to graduate students, and
postdocs come without the same burdens of education or job placement
that otherwise fall on the faculty member who hires doctoral students.
I want to underline that I don't think that
graduate programs should be cheaper, but we can't have an honest
conversation about their future unless we acknowledge their cost.
What might those changes look like at
your medium-size private university?
I am not sure. If I were, I'd be writing a
white paper for the dean of our graduate school rather than talking with
you. They would probably include coursework designed to prepare doctoral
students for nonacademic careers, internship options, and even multiple
dissertation options.
I have a sense of what this could look like in
my own discipline, but this needs to be a collective conversation.
Anyone can chart out a "vision" and write it up for The Chronicle.
It's another thing altogether to make it work, starting from the ground
up, at one's own university with the enthusiastic support of everyone
involved. For that to happen, there needs to be sustained, open dialogue
about the real challenges. And most administrators and faculty are
unwilling to engage in that work in a serious way until they see
examples of similar changes in the very top programs in their fields.
Why does this kind of change have to
start from the top?
Both faculty and administrators are extremely
sensitive to the hierarchies of prestige that drive the academy. In most
fields, the majority of faculty members who populate research
universities have graduated from a handful of top programs—and they
spend the rest of their careers trying to replicate those programs, get
back to them, or both. They are worried about doing anything that
diverges from what those top programs do, and will argue strongly that
divergences place them at a competitive disadvantage in both recruiting
and placing graduate students.
Administrators are just as much to blame as
faculty for that state of collective anxiety. No matter what deans,
provosts, and presidents say, we all rely too heavily on rankings and
other comparative metrics that play directly into these conservative
dynamics.
Is this a version of the "mini-me
syndrome," in which advisers try to mold their graduate students in
their own image, writ large?
That is certainly part of it. The desire to see
your own scholarly passions continue through students you have trained
is truly powerful,and administrators underestimate that desire at their
peril. Of course we all want our faculty members to be passionate about
their research, and graduate training is one way that faculty research
makes an impact on the profession. But there are moments when the desire
for scholarly replication can be troubling. The training of graduate
students should fill a greater need than our personal desire for a
legacy.
Graduate school is where we all become
socialized into the academic profession. It sets the template for our
expectations of what it means to be an academic. No matter how many
years go by, most of us hold certain ideals in our mind and think
graduate training should be based on those experiences.
And we build and run our programs
accordingly?
Right. Faculty members often try to either
recreate a graduate program that they attended or carve out their own
institutional training ground by creating a new center. Even as the
number of academic positions has receded over the past five years, the
administration here has been bombarded with requests for new graduate
programs.
Administrators, again, are not blameless in
that dynamic. We overvalue new programs, centers, and so on, as a way of
being able to tell a progressive story of institutional growth. Every
research university trumpets "the new" loudly. No press release ever
comes out and says, "We're doing things the same way as last year,
because it is all working so well!"
The focus on vaguely defined "excellence"
contributes to that behavior, because there is nothing to define
"excellence" beyond the hierarchies that are already in place.
Administrators are worried about lookingtoo
different from their peers or from the institutions with which they
would like to compare themselves. As much as they might talk about
innovation or disruption, they are worried that if they look too
different, they won't be playing the right game. Of course, that also
means that they will never actually leapfrog into the top, because we
are all trying to do the same thing.
That makes you more conservative in
your own job?
Let's just say I wish I were more creative and
ambitious. On the other hand, I share my faculty's skepticism of
wide-eyed visionaries who don't appreciate the real complexities and
challenges that we are facing.
You say that professors are too
defensive and afraid of innovation. What do you mean? Can you give an
example or two?
Faculty members are too quick to experience any
proposed change as a loss. That is especially true in humanities fields,
where the "crisis of the humanities" has made faculty nervous and
defensive. This temperament has made it difficult to take seriously
proposals that could actually help sustain the programs they care about.
For instance, as cohorts get smaller in certain
doctoral programs, it makes sense to think about combining them—to
create both a broader intellectual community and better administrative
support. But most faculty fear that kind of move—even if it could result
in a newly defined and exciting intellectual community. They think it
would erode the particular discipline to which they have devoted
themselves.
Two other examples: First, nearly every
private-university administrator I talk with says that the current state
of language instruction is not sustainable. Most campuses think that
they cannot continue to teach the languages they are teaching at their
current levels while meeting expanding student demands in new fields
(including languages that are more recently arrived in the curriculum).
This is going to require some innovative and integrative solutions if we
are going to provide graduate training in many fields, but the same
administrators will tell you that it is hard to work with professors to
resolve those problems, because they are so afraid of losing what they
have now.
Second, we all know that we should change our
graduate curricula across the board—from the laboratory sciences to the
humanities—to reflect the fact that a diminishing number of our Ph.D.'s
will work in tenure-track jobs. But how many departments have changed
their requirements, introduced new classes, or rethought the structure
of their dissertations?
Everyone is afraid that they will lose
something by doing so, either because it will mean less time for their
students in the lab or library, or because it will make their students
less competitive, or because it will be interpreted by prospective
recruits as an admission of weakness.
The long and short of what you say is
that the conservatism of tenured faculty—which they learn from their
tenured advisers before them—is hurting graduate students badly. It
locks them into curricula and expectations that ill suit their prospects
in today's world. How can we break out of this cycle?
It's not a cycle that we can break, but a
structure that has limitations. We certainly can serve both our graduate
students and our society better. Experimentation and innovation could
have a significant effect, and small groups of tenured faculty members
and administrators have the power to make these changes. The biggest
barrier is our own collective fears and self-imposed conservatism.
But I see reasons for optimism. For example,
the discussion of tracking Ph.D. placement in The Chronicle
(and elsewhere) will have very healthy effects, and I think it is
possible that we can, and should, create a future with a greater
diversity of graduate programs, even if there are slightly fewer of
them.
I also believe that the majority of faculty
members who received their Ph.D.'s in the past 10 years are likely to
take for granted that these changes are inevitable, and even desirable.
For all of the challenges we've discussed, graduate education will be a
necessary and vital component of the research university for at least,
say, the next half-century. And I'm stopping there only because to go
farther out than that is science fiction.
As we focus on the challenges, let's not forget
that our current model of graduate training has been the source of
tremendous creativity and innovation. For all the pessimism running
through our conversation, the research university is still the most
interesting, productive institution in American contemporary life—and
what we have built in the American academy is truly remarkable. There's
no other place I'd rather be.
The limits of mathematical and statistical analysis of big data
From the CFO Journal's Morning Ledger on April 18, 2014
The limits of social engineering Writing in MIT
Technology Review, tech reporter Nicholas
Carr pulls from a new
book by one of MIT’s noted data scientists to explain why he thinks Big Data
has its limits, especially when applied to understanding society. Alex
‘Sandy’ Pentland, in his book “Social Physics: How Good Ideas Spread – The
Lessons from a New Science,” sees a mathematical modeling of society made
possible by new technologies and sensors and Big Data processing power. Once
data measurement confirms “the innate tractability of human beings,”
scientists may be able to develop models to predict a person’s behavior. Mr.
Carr sees overreach on the part of Mr. Pentland. “Politics is messy because
society is messy, not the other way around,” Mr. Carr writes, and any
statistical model likely to come from such research would ignore the
history, politics, class and messy parts associated with humanity. “What big
data can’t account for is what’s most unpredictable, and most interesting,
about us,” he concludes.
Jensen Comment
The sad state of accountancy and many doctoral programs in the 21st Century is
that virtually all of them in North America only teach the methodology and
technique of analyzing big data with statistical tools or the analytical
modeling of artificial worlds based on dubious assumptions to simplify reality
---
http://faculty.trinity.edu/rjensen/Theory01.htm#DoctoralPrograms
The Pathways Commission sponsored by the American Accounting Association
strongly proposes adding non-quantitative alternatives to doctoral programs but
I see zero evidence of any progress in that direction.
The main problem is that it's just much easier to avoid
having to collect data by beating purchased databases with econometric sticks
until something, usually an irrelevant something, falls out of the big data
piñata.
Author
Characteristics for Major Accounting Journals: Differences among
Similarities 1989–2009,"
by Timothy J. Fogarty and Gregory A. Jonas, Issues in Accounting
Education, November 2013 --- http://aaajournals.org/doi/full/10.2308/iace-50520
(Not free)
Abstract Many academic accountants have explicit or
implicit motivations to publish their research in the best journals in the
discipline. However, whether the chances of success are better at some of
these journals is unknown. This paper examines the archival record to find
differences within the authorship of three such publications (The Accounting
Review, Journal of Accounting Research, Journal of Accounting and Economics)
over a recently completed 20-year period. The journals do not differentiate
according to the authors' doctoral training, but are differently sensitive
to place of faculty employment. The journals are equally receptive to non-U.S.
authors, but different in their receptivity to recently graduated and
frequently appearing authors. Although areas of change over time are noted,
both among journals and within each journal itself, the record also shows a
good deal of consistency in other relationships over the 20-year period.
. . .
As expected, the average institutional prestige scores for all of the
journals are concentrated at the low (high-prestige) end of the metric. With
a higher average of slightly over 19 and a larger standard deviation, TAR
appears to present a more diverse set of schools where its authors received
their terminal degrees. The other two journals are less distinguishable
on this dimension. Both exhibit author pools that average below 16 on a
scale that has much more range on the high side (max = 98.5).
Jensen
Comment
One confounding factor not mentioned by the authors is number of articles
published per year. In 2001 and earlier JAR only published two or three
issues per year. Soon afterwards this became five per year. In 2001 and
earlier JAE published only two issues per year and later three issues per
year.
In
contrast, in 2005 TAR increased the number of issues from the traditional
four per year to five per year. In 2008 this increased to six issues per
year More importantly by 2010 the number of articles increased to 12 per
issue thereby resulting in 72 publlished TAR artiocles per hear. TAR may,
therefore, "present a more diverse set of schools where the authors received
their terminal degrees" partly because TAR publishes more articles per year.
Also
TAR has a higher number of co-authors on average as pointed out in this
article. This increases the odds, for example, that one of three co-authors
will received a doctorate from a slightly less prestigious university.
This
increases the odds, for example, that one of three co-authors is employed in
a slightly less prestigious university.
. . .
Statistical tests demonstrate that the distribution of authors based on the
prestige of the authors' employing institution shows much more patterning by
journal. Significant pairwise differences exist between TAR and JAR (p <
0.01) and between TAR and JAE (p < 0.05). The difference between JAR and JAE
is not significant (p > 0.10). TAR authors tend to be employed at less
prestigious schools than the authors in JAR and those in JAE. The change in
the odds of an author's manuscript appearing in TAR, as opposed to JAR or
JAE, increases as the quartile of the employing institution's prestige score
increases by 37.0 percent and 27.6 percent, respectively. No such statements
about relative prestige of employing institution can be said about JAR and
JAE. On balance, the evidence suggests that journal differences do exist.
Therefore, the null H1b should be rejected.
Panel C of Table 2 also reports on whether the interaction between the two
institutional prestige variables varies by journal. Albeit not the subject
of a hypothesized relationship, the interaction effect recognizes the
tendency of graduates from high-prestige doctoral programs to take positions
at other high-prestige programs. These interactions did not vary between any
of the pairs of journals. The consequence of people from prestigious
doctoral programs taking positions at other prestigious schools appears to
be consistent across the author pools at the three journals.
Jensen
Comment
I don't get too excited about prestige schools hiring their own since so
many of these new hires do not stick around long in a high prestige
university. Some never intended to stick around long but did so to coauthor
for a short time with prestigious researchers. This often pays dividends in
getting TAR, JAR, and JAE hits as coauthors and when milking a fresh thesis.
But
for many reasons these newly hired move on from prestigious universities
before they get tenure. Some move on because of real estate costs that are
often out of sight in such places as NYU, Columbia, Harvard, MIT, Stanford,
etc. Some move after frustration with commute times such as the time more or
less wasted commuting long distances into NYC or Stanford. Some move on
because they find prestigious campuses are surrounded by horrid public
schools and the costs and logistics of private schooling are very
troublesome.
And
some new hires in prestigious universities have very low chances of getting
tenure even when they are doing quite well in publishing in JAR, TAR, and
JAE.
Some are getting brutilized in teaching evaluations for various reasons,
including poor English language and teaching skills. Some have little or no
real-world experience to draw upon for teaching, and this is often very
important in prestigious universities that require business experience when
admitting students. Experienced students tend to raise questions about
business and practice that an econometrician that has never had a real job
can answer.
And
most prestigious accounting programs won't admit to it, but there probably
is a quota constraint on the number of tenured faculty. Even Harvard cannot
absorb many of its new hires simply because there aren't enough courses to
keep giving tenure to all the new hires.
. . .
Utilizing the frequency of author appearance in each journal (a variable
called “Publication Count”), Panel C of Table 3 summarizes the statistical
comparisons for H2a. All pairwise comparisons are significant at the p <
0.01 level. JAE tends to publish more work by frequently appearing authors
than either JAR or TAR. Moreover, JAR publishes more work from repeat
authors than does TAR. Of particular note is that as an author's publication
count increases within JAE, the odds of that author's manuscript again
appearing in JAE increases by 19.8 percent relative to TAR. With journal
differences pervasive, the null H2a should be rejected.
Jensen
Comment
In JAE and to a certain extent JAR, the implication that the referees do not
know who write most of the submissions is highly questionable. Firstly,
there are many fewer submissions to JAE and JAR and it seems likely that
referees get clues from topic and/or the mathematics to know the identities
of those "unknown" authors. Similarly, the authors are likely self-selecting
to appeal to the long-time (decades) editors and referees of JAE and JAR.
The editors and associate editors of TAR change much more often and new
referees are added more frequently to TAR since referees are not paid and
tend to grow weary of providing time-consuming refereeing services year
after year.
The next research expectation concerns possible journal differences in the
tendency of the journals to publish the work of relatively new academics.
Leveraging the idea that early scholarly recognition contributes importantly
to the establishment of a successful academic career, H2b seeks to identify
the degree of relative journal support. As shown by Table 3, Panel B, both
TAR and JAR seem to be slightly more predisposed than JAE toward the early
career work of accounting scholars. The difference between each of these two
pairs of journals is statistically significant at the p < 0.01 level.
However, regarding publishing the work of new authors, TAR and JAR cannot be
distinguished (p > 0.10). Differences between the journals based on
descriptive statistics appear quite small (less than one percentage point or
one author-manuscript per year between any journal pair comparison of
non-senior authors). However, the more proper interpretation is that, after
controlling for author publication frequency and interaction between
frequency and being a new scholar, the odds of a new scholar's work
appearing in JAE, as opposed to TAR or JAR, are 42.9 percent and 34.3
percent greater, respectively. On balance, the evidence is not consistent
with the null H2b that expressed the expectation of no journal differences
in the mix of less experienced faculty within the successful author pools.
. . .
H3 posited the lack of difference between the journals on the relative
presence of non-U.S. authors. The results of multinomial tests, found in
Panel B of Table 4, indicate that even the greatest of these differences is
not statistically significant (p > 0.10). The odds of a non-U.S. author
achieving a publication in any of these three journals are not significantly
different. Two of the three odds comparisons are less than 10 percent.
. . .
In total, five null hypotheses evaluate possible ways in which the three
major journals in accounting could vary, supplemented by the prospects of
change over time. At the highest level of abstraction, two of these produced
evidence of similarity and three showed mostly differences. In seven of the
15 pairwise comparisons, a statistically significant variation was noted.
The bulk of the evidence suggests that these three outlets should not be
grouped together in the minds of interested parties. However, the ways that
one journal is different from the others is not permanent, but subject to
moderate levels of change over relatively lengthy periods of time.
How journals become what they are is a product of a self-sustaining cycle of
purposeful gatekeeping, and the selective response of authors to the
resultant perceived odds of success. Studies of the editorial boards of the
major accounting journals reveal enduring concentrations of individuals
trained and employed at the same prestigious schools that dominate the ranks
of the authorship (Lee 2001; Urbanic 1989). Perhaps more consequential is
the considerable degree of overlap in the composition of the editorial
boards of the major journals in accounting (Lee 1997). Concentration,
whether or not it reflects the differential abilities of some to work at the
levels demanded by the major journals, operates to benefit some people and
to hinder others. If publication chances are predictably concentrated, the
statistically derived odds of publishing (e.g., Hasselback et al. 1995) tend
to understate the chances for some and overstate the odds for others.
Previous studies have implied that the three major journals in accounting
move in similar ways and, therefore, can be understood to form a unified
aspiration level for authors. This conclusion may have been strengthened by
empirical observations of the editorial board interlock (e.g., Lee and
Williams 1999) and strong intra-network citation patterns (e.g., Brown
1996). This paper asserted that an untested empirical issue existed in the
actual similarity of the major journals in the accounting discipline. For
these purposes, the historical distribution of author characteristics was
examined.
Perhaps the most important finding from this research is how authors'
institutional prestige credentials are differentiated by journal. Previous
research has shown the independent influence of the prestige of authors'
doctoral degrees, and that of their employing institutions, on their
publishing success (Fogarty and Ruhl 1997; Maranto and Streuly 1994). This
paper shows that the influence of the employing institution also patterns
where in the top-tier level of journals such scholarship might appear.
Specifically, TAR has had a less exclusive appetite for the work done by
scholars employed by the most prestigious schools. However, the prestige of
doctoral programs has not been a differentiating feature of authors'
backgrounds vis-à-vis the likelihood of publishing in one, as opposed to
another, of the three major journals.
That doctoral training does not matter for this purpose suggests that
accounting is a field in which there are at least three journals in which
everyone wants to publish. A super-elite has not selected one of these
publications as an outlet valued over the others, and has not built such a
preference into doctoral training. Likewise, those trained at good schools
(but not the best) do not feel consigned to that which is left over.
The results show that the institutional prestige of employing schools is a
discriminating attribute for publishing within the three major accounting
journals. Those employed by the most prestigious schools show a stronger
tendency to publish in JAR and JAE, relative to TAR. That this institutional
prestige difference exists, apart from doctoral origins, suggests the
possible influence of divergent reward structures put into place by some
employing institutions.
The results pertaining to institutional prestige bear out the
distinctiveness of TAR. As the only association-managed journal, and the
only one not strongly associated with a particular university, TAR might
have been expected to be the outlier relative to the other journals. The
results prove consistent with this expectation. TAR shows a distinctive
willingness to publish the work of faculty employed at schools from a wider
cross-section of the academy than either JAR or JAE. If alternative
traditions (e.g., behavioral, psychological, sociological) are more likely
to be advocated at less prestigious schools, the distinctiveness of TAR
could be based on its relative willingness to range further from the
economics paradigm that more clearly marks JAE and JAR.
Jensen
Comment About the Chicken Versus the Egg
All three journals are significantly impacted by North American accounting
doctoral programs. This is a chicken and egg issue. Did those doctoral
programs stop accepting dissertations without equations because the top
journals only accept articles with equations or did those journals stop
publishing articles without equations because the doctoral students found it
easier to used purchased databases like CRSP, Compustat, AuditAnalytics,
etc. that relieve the drudgery of having to collect data and be responsible
for data errors.
Once
again I remind readers of the following Pathways Commission recommendation.
Recommendation 2 of the American Accounting
Association Pathways Commission (emphasis added)
Promote
accessibility of doctoral education by allowing for flexible
content and structure in doctoral programs and developing
multiple pathways for degrees. The current path to an accounting
Ph.D. includes lengthy, full-time residential programs and
research training that is for the most part confined to
quantitative rather than qualitative methods. More flexible
programs -- that might be part-time, focus on applied research
and emphasize training in teaching methods and curriculum
development -- would appeal to graduate students with
professional experience and candidates with families, according
to the report. http://commons.aaahq.org/groups/2d690969a3/summary
Most
doctoral students accounting doctoral students want to milk their
dissertations for one or several articles that pave their tenure tracks. Why
would they want to collect data when they can use purchased public databases
and stir the data with regression equations? Why would they want to use
qualitative methods if these methods are rejected by the top three academic
accounting research journals?
Jensen Comment
Some of these tips are out of the hands of the doctoral candidate --- like
beating the competition to be sent to a doctoral consortium. I would
recommend some other things such as those shown below:
Study as many Khan Academy modules in math and statistics that
appear to be relevant to your current and future studies. Especially go
for the modules in statistics and probability ---
https://www.khanacademy.org/math/probability
From Day 1 in the program study (not just read) the more recent
doctoral dissertations from you program as well as some of those that
look relevant from other universities. American Doctoral Dissertations
from ProQuest ---
http://www.umi.com/en-US/catalogs/databases/detail/add.shtml
Follow the AECM for ideas on term papers ---
http://pacioli.loyola.edu/aecm/
Note that you can scan the message titles without having to receive each
message in your email box.
Carefully psych out your doctoral program --- probably by getting
advice from recent graduates and students well along in the program.
Every program unique in important ways even though all of them are
social science programs with very little accounting content ---
http://faculty.trinity.edu/rjensen/Theory01.htm#DoctoralPrograms
Late in the program begin to study about how to game for tenure as
an accounting professor ---
http://faculty.trinity.edu/rjensen/TheoryTenure.htm
(with a reply about tenure publication point systems from Linda Kidwell)
Other tips from my AECM friends, many of whom advise doctoral students in
accountancy:
Jensen Comment
The daughter of one of my close friends is now trying to write up a
dissertation proposal in a major USA university. For a time she was dubious
about applying for an accounting doctoral program because of all the math,
statistics, and econometrics. Now at the dissertation proposal she's decided
to beat Compustat data with an econometrics stick because that's easier than
trying to collect an original data set.
The irony is that the econometrics turns away many potential applicants
to accounting doctoral programs becomes their salvation when they want the
easiest kind of dissertations as they near graduation from accountancy
doctoral programs. Go figure!
A recent accountics science study
suggests that audit firm scandal with respect to someone else's audit
may be a reason for changing auditors.
"Audit Quality and Auditor Reputation: Evidence from Japan," by Douglas
J. Skinner and Suraj Srinivasan, The Accounting Review, September
2012, Vol. 87, No. 5, pp. 1737-1765.
Our conclusions are
subject to two caveats. First, we find that clients switched away from
ChuoAoyama in large numbers in Spring 2006, just after Japanese
regulators announced the two-month suspension and PwC formed Aarata.
While we interpret these events as being a clear and undeniable signal
of audit-quality problems at ChuoAoyama, we cannot know for sure
what drove these switches(emphasis added).
It is possible that the suspension caused firms to switch auditors for
reasons unrelated to audit quality. Second, our analysis presumes that
audit quality is important to Japanese companies. While we believe this
to be the case, especially over the past two decades as Japanese capital
markets have evolved to be more like their Western counterparts,
it is possible that audit quality is, in general, less important in
Japan
(emphasis added) .
"Exploring Accounting Doctoral Program Decline: Variation and the
Search for Antecedents," by Timothy J. Fogarty and Anthony D. Holder,
Issues in Accounting Education, May 2012 ---
Not yet posted on June 18, 2012
ABSTRACT
The inadequate supply of new terminally qualified accounting faculty
poses a great concern for many accounting faculty and administrators.
Although the general downward trajectory has been well observed, more
specific information would offer potential insights about causes and
continuation. This paper examines change in accounting doctoral student
production in the U.S. since 1989 through the use of five-year moving
verges. Aggregated on this basis, the downward movement predominates,
notwithstanding the schools that began new programs or increased
doctoral student production during this time. The results show that
larger declines occurred for middle prestige schools, for larger
universities, and for public schools. Schools that periodically
successfully compete in M.B.A.. program rankings also more likely have
diminished in size. of their accounting Ph.D. programs. Despite a recent
increase in graduations, data on the population of current doctoral
students suggest the continuation of the problems associated with the
supply and demand imbalance that exists in this sector of the U.S.
academy.
September 5, 2012 reply from Dan Stone
This is very sad and very true.
Tim Fogarthy talks about the "ghettoization" of
accounting education in some of his work and talks. The message that
faculty get, and give, is that if a project has no chance for
publication in a top X journal, then it is a waste of time. Not many
schools are able to stand their ground, and value accounting education,
in the face of its absence in any of the "top" accounting journals.
The paradox and irony is that accounting
faculty devalue and degrade the very thing that most of them spend the
most time doing. We seem to follow a variant of Woody Allen's maxim, "I
would never join a club that would have me as a member." Here, it is, "I
would never accept a paper for publication that concerns what I do with
most of my time."
As Pogo said, "we have met the enemy and they
is us."
Dan Stone
Jensen Comment
This is a useful update on the doctoral program shortages relative to demand
for new tenure-track faculty in North American universities. However, it
does not suggest any reasons or remedies for this phenomenon. The
accounting doctoral program in many ways defies laws of supply and demand.
Accounting faculty are the among the highest paid faculty in rank (except
possibly in unionized colleges and universities that are not wage
competitive). For suggested causes and remedies of this problem see --- See
Below!
Especially note the table of the entire history of accounting doctoral
graduates for all AACSB universities in the U.S. ---
http://www.jrhasselback.com/AtgDoct/XDocChrt.pdf
In that table you can note the rise or decline (almost all declines) for
each university.
The AAA's Pathways Commission Accounting Education Initiatives Make
National News
Accountics Scientists Should Especially Note the First Recommendation
Year 2013: Asian-Named Authors in The Accounting Review
Previously on the AECM I noted that an increasing number of attendees at
the American Accounting Association (an international organization) Annual
meeting have Asian names in the directories of meeting registrants. Chuck
Pier replied by noting an an increasing proportion of Asian names in the
Directory of Accounting Faculty edited by Jim Hasselback.
In connection with something else I am doing, I noted the following 63
Asian-named authors in the six volumes of the 2013 Accounting Review
(TAR). The number is 61 if you adjust for two authors appearing
twice.
Chen Chen
Chen Chen
Chongyang Chen
Feng Chen
Zhihong Chen
Zhihong Chen
Lin Cheng
Qiang Cheng
Peng-Chia Chiu
Lawrence Chui
Zhonglan Dai
Mai Dao
Kai Du
Yiwei Dou
Yuyan Guan
Chun Keung Hoi
Hyun A. Hong
Pinghsun Huang
Shawn X. Huang
Bin Ke
Bin Ke
Yongtae Kim,
Lian Fen Lee
Chan Li
Edward Xuejun Li
Siqi Li
Yue Li
Scott Liao
Philip P. M. Joos Edith Leung
Hai Lu
Ting Luo
Xiumin Martin
Jeffrey Ng
Carrie Pan
Rui Shen
Tao Shu
Siew Hong Teoh
Feng Tian
Yao Tian
Donghui Wu
Qiang Wu
Chuan-San Wang
Xin Wang
Zhifeng Yang
Zhifeng Yang
Kun Yu
Yong Yu
Heng Yue
Danqing Young
Andrew (Jianzhong) Zhang
Guochang Zhang
Haiwen Zhang
Hao Zhang
Harold H. Zhang
Yan Zhang
Yue (May) Zhang
X. Frank Zhang
X. Frank Zhang
Xiao-Jun Zhang
Yuping Zhao
Zili Zhuang
Luo Zuo
It should be noted that having an Asian name does not mean the author
is necessarily Asian.
For example, the author may simply have assumed the last name of an
Asian-named spouse. I could have also made a mistake in picking out
only "Asian" names. In some instances where I had questions I found the
resumes of the authors. I could also have made a mistake in attributing a
name to be non-Asian. However, I don't think the error rate is high in the
above listing.
It should be noted that all of the 72 TAR articles in 2013 are accountics
science articles in that they feature equations. I've not found a TAR
article in years and years that did not feature equations.
For the 72 articles in TAR I counted 184 authors including a few authors
I counted twice because they were included among the authors of two papers.
There were not many such authors appearing more than once.
By my calculations about 34% of 184 authors appearing in TAR in 2013
had Asian names.
My intent is not to be racist in pointing out the above outcome. I am,
however, always interested in learning more about accountics scientists.
This suggests two hypotheses that could be texted more formally:
Hypothesis 1: The proportion of Asian-named authors in TAR has
increased greatly in the 21st Century relative to the 20th Century.
Hypothesis 2: Asian-named authors are more apt to author
research papers featuring equations than papers that do not feature
equations.
Of course this is probably true fon non-Asian authors as well.
I have not tested either hypothesis. I think that Asian-named authors who
submitted papers to TAR and reside outside the USA are especially more apt
to submit articles to TAR that feature equations. This in great measure is
due to the emphasis placed upon mathematics and statistics in Asian
preparatory schools and universities. Many of the Asian authors who now
reside in the USA had much of their schooling in Asia or grew up in the USA
with parents who placed high priority on excelling in mathematics and
statistics.
I did not determine what proportion of the above authors received their
accounting doctoral degrees in North America, but I think it's a bunch. If
they have a propensity to become accountics scientists it could be that
their only option, even at Harvard University, in North America is to become
an accountics scientist! ---
http://faculty.trinity.edu/rjensen/Theory01.htm#DoctoralPrograms
This is the second post from Dr. Emelee, a former
Big 4 employee who is in process of obtaining his PhD. Read his
first post
here.
Now for the second statement,
“The PhD is not really about
teaching.”
You know how you thought those
professors you only saw two days a week were chilling out the rest
of the week? Well, some are. Especially if they have tenure. Being a
professor can be a cake job, but to get to the gravy you still have
to grind out around five brutal years after getting the doctorate.
Many of the professors you only see two days a week are not chilling
out. They are working somewhere else where students and bored
colleagues can’t come by to bother them every half hour. They are at
home working on research papers. And
you now know that means they are reading up on psychology theory
and thinking about how to design an experiment
to see if financial compensation alters people’s risk tolerances. Or
they are out teaching CPE to professionals hoping that some of these
same professionals will allow the researcher to administer
experiments to their employees. Or they are working with a dataset
with millions of observations and spending weeks cleaning it up just
to get it ready for some brutal statistical analysis. Or they are
using multivariate calculus, sometimes with just a pencil and lots
of scratch paper, to make sure they understand the behind-the-scenes
workings of an econometric technique they are applying.
You’ll notice that teaching isn’t
connected to any of that. Universities vary, but professors
typically teach between one and three classes during a given
semester. If profs only teach two or three classes each semester,
you can do the math and see that the majority of their time is, in
fact, not spent teaching. That’s why publications are the backbone
of getting tenure at a university- because research truly is the
main part of being a professor.
It makes perfect sense that the
average person’s preconceived notions of the PhD are off the
mark. Think about why people go to college. People go to college
to learn to do something they don’t know how to do. For
accounting, people learn the accounting rules as undergrads.
They then go on for master’s degrees to hone their skills even
more. So, if the undergrad and masters were about becoming
better accountants, doesn’t it make sense that the PhD teaches
you even more about accounting and… you become…. a Super
Accountant!?!? Or even a Super Accountant that’s also a Super
Teacher?!?!
This line of reasoning may make
sense, but that’s not at all what happens in a PhD program. Your
first classes as a PhD student will teach you about experimental
design, threats to validity, the scientific method applied to social
phenomenon, measurement theory, and statistics.
What about taking classes on how to
teach? Do PhD programs at least train PhD students to be effective
in the classroom? The answer ranges from not at all to not really.
Some doctoral programs require PhD students to teach and some do
not. The programs that require teaching may just make the PhD
student teach without first taking any formal classes about how to
teach. There are programs that require PhD students to do teaching
mentorships or even take classes on teaching, but this is still
rare. When classes about effective teaching are required, they are
still a small fraction of what the PhD student focuses on.
Jensen Comment
Some of these tips are out of the hands of the doctoral candidate --- like
beating the competition to be sent to a doctoral consortium. I would
recommend some other things such as those shown below:
Study as many Khan Academy modules in math and statistics that
appear to be relevant to your current and future studies. Especially go
for the modules in statistics and probability ---
https://www.khanacademy.org/math/probability
From Day 1 in the program study (not just read) the more recent
doctoral dissertations from you program as well as some of those that
look relevant from other universities. American Doctoral Dissertations
from ProQuest ---
http://www.umi.com/en-US/catalogs/databases/detail/add.shtml
Follow the AECM for ideas on term papers ---
http://pacioli.loyola.edu/aecm/
Note that you can scan the message titles without having to receive each
message in your email box.
Carefully psych out your doctoral program --- probably by getting
advice from recent graduates and students well along in the program.
Every program unique in important ways even though all of them are
social science programs with very little accounting content ---
http://faculty.trinity.edu/rjensen/Theory01.htm#DoctoralPrograms
Late in the program begin to study about how to game for tenure as
an accounting professor ---
http://faculty.trinity.edu/rjensen/TheoryTenure.htm
(with a reply about tenure publication point systems from Linda Kidwell)
Other tips from my AECM friends, many of whom advise doctoral students in
accountancy:
The reason for the disdain in which classical
financial accounting research has come to held by many in the scholarly
community is its allegedly insufficiently scientific nature. While many
have defended classical research or provided critiques of post-classical
paradigms, the motivation for this paper is different. It offers an
epistemologically robust underpinning for the approaches and methods of
classical financial accounting research that restores its claim to
legitimacy as a rigorous, systematic and empirically grounded means of
acquiring knowledge. This underpinning is derived from classical
philosophical pragmatism and, principally, from the writings of John
Dewey. The objective is to show that classical approaches are capable of
yielding serviceable, theoretically based solutions to problems in
accounting practice.
Jensen Comment
When it comes to "insufficient scientific nature" of classical accounting
research I should note yet once again that accountics science never attained
the status of real science where the main criteria are scientific searches
for causes and an obsession with replication (reproducibility) of findings.
The limits of mathematical and statistical analysis of big data
From the CFO Journal's Morning Ledger on April 18, 2014
The limits of social engineering Writing in MIT
Technology Review, tech reporter Nicholas
Carr pulls from a new
book by one of MIT’s noted data scientists to explain why he thinks Big Data
has its limits, especially when applied to understanding society. Alex
‘Sandy’ Pentland, in his book “Social Physics: How Good Ideas Spread – The
Lessons from a New Science,” sees a mathematical modeling of society made
possible by new technologies and sensors and Big Data processing power. Once
data measurement confirms “the innate tractability of human beings,”
scientists may be able to develop models to predict a person’s behavior. Mr.
Carr sees overreach on the part of Mr. Pentland. “Politics is messy because
society is messy, not the other way around,” Mr. Carr writes, and any
statistical model likely to come from such research would ignore the
history, politics, class and messy parts associated with humanity. “What big
data can’t account for is what’s most unpredictable, and most interesting,
about us,” he concludes.
Jensen Comment
The sad state of accountancy and many doctoral programs in the 21st Century is
that virtually all of them in North America only teach the methodology and
technique of analyzing big data with statistical tools or the analytical
modeling of artificial worlds based on dubious assumptions to simplify reality
---
http://faculty.trinity.edu/rjensen/Theory01.htm#DoctoralPrograms
The Pathways Commission sponsored by the American Accounting Association
strongly proposes adding non-quantitative alternatives to doctoral programs but
I see zero evidence of any progress in that direction.
The main problem is that it's just much easier to avoid
having to collect data by beating purchased databases with econometric sticks
until something, usually an irrelevant something, falls out of the big data
piñata.
"Research
on Accounting Should Learn From the Past" by Michael H. Granof and
Stephen A. Zeff, Chronicle of HigherEducation, March 21, 2008
The unintended consequence has been that interesting and researchable
questions in accounting are essentially being ignored.
By confining the major thrust in research to phenomena that can be
mathematically modeled or derived from electronic databases, academic
accountants have failed to advance the profession in ways that are expected
of them and of which they are capable.
Academic research has unquestionably broadened the views of standards
setters as to the role of accounting information and how it affects the
decisions of individual investors as well as the capital markets.
Nevertheless, it has had scant influence on the standards themselves.
Continued in article
"Research on Accounting Should Learn From the Past,"
by Michael H. Granof and
Stephen A. Zeff, Chronicle of Higher Education, March 21, 2008
. . .
The narrow focus of today's research has also resulted in a disconnect
between research and teaching. Because of the difficulty of conducting
publishable research in certain areas — such as taxation, managerial
accounting, government accounting, and auditing — Ph.D. candidates avoid
choosing them as specialties. Thus, even though those areas are central to
any degree program in accounting, there is a shortage of faculty members
sufficiently knowledgeable to teach them.
To be sure, some accounting research, particularly that pertaining to the
efficiency of capital markets, has found its way into both the classroom and
textbooks — but mainly in select M.B.A. programs and the textbooks used in
those courses. There is little evidence that the research has had more than
a marginal influence on what is taught in mainstream accounting courses.
What needs to be done? First, and most significantly, journal editors,
department chairs, business-school deans, and promotion-and-tenure
committees need to rethink the criteria for what constitutes appropriate
accounting research. That is not to suggest that they should diminish the
importance of the currently accepted modes or that they should lower their
standards. But they need to expand the set of research methods to encompass
those that, in other disciplines, are respected for their scientific
standing. The methods include historical and field studies, policy analysis,
surveys, and international comparisons when, as with empirical and
analytical research, they otherwise meet the tests of sound scholarship.
Second, chairmen, deans, and promotion and merit-review committees must
expand the criteria they use in assessing the research component of faculty
performance. They must have the courage to establish criteria for what
constitutes meritorious research that are consistent with their own
institutions' unique characters and comparative advantages, rather than
imitating the norms believed to be used in schools ranked higher in magazine
and newspaper polls. In this regard, they must acknowledge that accounting
departments, unlike other business disciplines such as finance and
marketing, are associated with a well-defined and recognized profession.
Accounting faculties, therefore, have a special obligation to conduct
research that is of interest and relevance to the profession. The current
accounting model was designed mainly for the industrial era, when property,
plant, and equipment were companies' major assets. Today, intangibles such
as brand values and intellectual capital are of overwhelming importance as
assets, yet they are largely absent from company balance sheets. Academics
must play a role in reforming the accounting model to fit the new
postindustrial environment.
Third, Ph.D. programs must ensure that young accounting researchers are
conversant with the fundamental issues that have arisen in the accounting
discipline and with a broad range of research methodologies. The accounting
literature did not begin in the second half of the 1960s. The books and
articles written by accounting scholars from the 1920s through the 1960s can
help to frame and put into perspective the questions that researchers are
now studying.
"The Current State of Accounting Ph.D. Programs in the United States,"
by Alisa G. Brink, Robson Glasscock and Benson Wier, Issues in Accounting
Education, Vol. 27, No. 4, November 2012 ---
Not Free
http://aaajournals.org/doi/full/10.2308/iace-50254
The primary purpose of this study is to provide
evidence about current practices in accounting Ph.D. programs in the
United States. Plumlee et al. (2006) investigated the shortage of Ph.D.
qualified accounting faculty and made recommendations toward addressing
this shortage. We assess the extent to which these recommendations have
been followed and areas where additional progress might be needed. We
gather data from Ph.D. program websites, a survey of doctoral students
in accounting Ph.D. programs in the United States, and interviews with
Ph.D. program coordinators. Key findings, following Plumlee et al.
(2006) indicate: (1) on average, university Ph.D. program websites do
not provide all of the specific information about admission and program
requirements that would be useful for potential students; (2) increases
in the level of financial support for Ph.D. students; (3) considerable
variability with respect to reduction in costs to Ph.D. students; (4)
Ph.D. programs may reduce the number of students accepted in response to
constrained resources; and (5) increases in students pursuing audit and
tax specialties that are attributable, at least in part, to the
Accounting Doctoral Scholars program. Based on our data, we also
identify a number of additional findings, and then discuss the larger
context within which this complex problem (the supply of Ph.D. students)
is situated. Our findings and discussion should be of interest to
potential Ph.D. candidates, Ph.D. program directors/advisors, business
school deans, and accounting department chairs, as well as the larger
accounting-professional community.
. . .
Our findings indicate several areas where
changes have occurred. For example, websites and survey respondents
indicate an average of ten students per program, which is an increase
from the average of eight students per program reported by Behn et al.
(2008). In addition, websites and survey respondents indicate that mean
Ph.D. student stipends exceed $20,000, which is a significant increase
over the mean stipend of $16,000 reported by the Committee based on the
2005 survey (Plumlee et al. 2006). Further, survey respondents and Ph.D.
coordinators indicate that it has become common practice for Ph.D.
programs to provide research-related travel support for students. We
also find evidence indicating that the number of students pursuing audit
and tax specialties has increased. Specifically, 26 and 11 percent of
our respondents indicate an interest in audit and tax research,
respectively. This is a substantial increase from the results of the
2007 survey reported by Behn et al. (2008), which indicated that 12 and
9 percent of students were interested in audit and tax research,
respectively. However, we also find that there are several areas where
practices across doctoral programs vary widely and improvement could be
made. For example, the information about Ph.D. programs on university
websites, on average, lacks much of the specific information that
prospective students might find useful when evaluating Ph.D. programs.
Further, there is significant variation in doctoral student teaching
responsibilities with some programs giving students large teaching loads
and multiple preparations. Specifically, survey respondents indicate
teaching a mean of 4.69 courses over the course of their programs, and
individual responses range from 0 to 28 courses. In addition, the
average number of course preparations is 2.08 with a range of 0 to 8
preparations.
Interviews with Ph.D. program coordinators
indicate a desire for additional information so that they can benchmark
best practices. These coordinators indicate that recent changes in Ph.D.
programs are not driven by the shortage of academically qualified
faculty. Rather, such changes are motivated by a trade-off between
constrained resources and the desire to admit high-quality students.
Our findings are useful for several reasons.
First, we assess the progress being made toward addressing the
recommendations made by the Committee. We identify current trends and
changes occurring in accounting Ph.D. programs in the United States and
identify areas where improvement is still needed if we are to address
the shortage of Ph.D. graduates. Second, the data presented in this
study will enable potential doctoral students to have more realistic and
informed expectations regarding Ph.D. programs and the requirements of
these programs. Third, the information presented in this study is a
valuable resource for Ph.D. program coordinators and advisors, as well
as deans and department chairs who must deal with funding issues and
accreditation requirements in the future.
METHODOLOGY
We gather data from three sources. First, we
perform an analysis of the websites of doctoral granting accounting
programs to gather data on program requirements and the ease of
accessing this information from these websites. Second, we survey
current doctoral students to obtain information about their demographic
characteristics, doctoral program characteristics, and their interests
and expectations regarding their research, teaching, and future careers.
Third, we interview a sample of Ph.D. program coordinators to obtain
information on trends and challenges in accounting Ph.D. programs. Table
1 lists the Ph.D. programs whose websites are included in our analyses
and the number of survey respondents from each university.
. . .
Continued in article
Jensen Comment
The study provides some useful information about demographics of current
students (gender, age, nationality, etc.). Half of the students in these
doctoral students are CPAs and nearly half (43%) have some prior teaching
experience. The percentage of international students is 27.8%. It also
provides information about each university's number of accounting doctoral
students and funding of those doctoral students and average GMAT scores.
Although the study hints at causes for the dramatic decline in
enrollments in accounting doctoral programs it says nothing about what I
view as the primary reason why practicing accountants are shunning away from
accounting doctoral programs due to the 5-6 years required onsite beyond a
masters degree and the lack of accounting in the curriculum relative to the
heavy dosage of mathematics, statistics, econometrics, and psychometrics
requirements ---
http://faculty.trinity.edu/rjensen/Theory01.htm#DoctoralPrograms
The study also provides no information about why doctoral students leave
the program prior to graduation.
Accounting programs should promote curricular
flexibility to capture a new generation of students who are more
technologically savvy, less patient with traditional teaching methods,
and more wary of the career opportunities in accounting, according to a
report released today by the
Pathways Commission, which studies the future
of higher education for accounting.
In 2008, the U.S. Treasury Department's
Advisory Committee on the Auditing Profession recommended that the
American Accounting Association and the American Institute of Certified
Public Accountants form a commission to study the future structure and
content of accounting education, and the Pathways Commission was formed
to fulfill this recommendation and establish a national higher education
strategy for accounting.
In the report, the commission acknowledges that
some sporadic changes have been adopted, but it seeks to put in place a
structure for much more regular and ambitious changes.
The report includes seven recommendations:
Integrate accounting research,
education and practice for students, practitioners and educators by
bringing professionally oriented faculty more fully into education
programs.
Promote accessibility of doctoral
education by allowing for flexible content and structure in doctoral
programs and developing multiple pathways for degrees. The current
path to an accounting Ph.D. includes lengthy, full-time residential
programs and research training that is for the most part confined to
quantitative rather than qualitative methods. More flexible programs
-- that might be part-time, focus on applied research and emphasize
training in teaching methods and curriculum development -- would
appeal to graduate students with professional experience and
candidates with families, according to the report.
Increase recognition and support for
high-quality teaching and connect faculty review, promotion and
tenure processes with teaching quality so that teaching is respected
as a critical component in achieving each institution's mission.
According to the report, accounting programs must balance
recognition for work and accomplishments -- fed by increasing
competition among institutions and programs -- along with
recognition for teaching excellence.
Develop curriculum models, engaging
learning resources and mechanisms to easily share them, as well as
enhancing faculty development opportunities to sustain a robust
curriculum that addresses a new generation of students who are more
at home with technology and less patient with traditional teaching
methods.
Improve the ability to attract
high-potential, diverse entrants into the profession.
Create mechanisms for collecting,
analyzing and disseminating information about the market needs by
establishing a national committee on information needs, projecting
future supply and demand for accounting professionals and faculty,
and enhancing the benefits of a high school accounting educatio
Establish an implementation process to
address these and future recommendations by creating structures and
mechanisms to support a continuous, sustainable change process.
According to the report, its two sponsoring
organizations -- the American Accounting Association and the American
Institute of Certified Public Accountants -- will support the effort to
carry out the report's recommendations, and they are finalizing a
strategy for conducting this effort.
Hsihui Chang, a professor and head of Drexel
University’s accounting department, said colleges must prepare students
for the accounting field by encouraging three qualities: integrity,
analytical skills and a global viewpoint.
“You need to look at things in a global scope,”
he said. “One thing we’re always thinking about is how can we attract
students from diverse groups?” Chang said the department’s faculty
comprises members from several different countries, and the university
also has four student organizations dedicated to accounting -- including
one for Asian students and one for Hispanic students.
He said the university hosts guest speakers and
accounting career days to provide information to prospective accounting
students about career options: “They find out, ‘Hey, this seems to be
quite exciting.’ ”
Jimmy Ye, a professor and chair of the
accounting department at Baruch College of the City University of New
York, wrote in an email to Inside Higher Ed that his department
is already fulfilling some of the report’s recommendations by inviting
professionals from accounting firms into classrooms and bringing in
research staff from accounting firms to interact with faculty members
and Ph.D. students.
Ye also said the AICPA should collect and
analyze supply and demand trends in the accounting profession -- but not
just in the short term. “Higher education does not just train students
for getting their first jobs,” he wrote. “I would like to see some study
on the career tracks of college accounting graduates.”
Mohamed Hussein, a professor and head of the
accounting department at the University of Connecticut, also offered
ways for the commission to expand its recommendations. He said the
recommendations can’t be fully put into practice with the current
structure of accounting education.
“There are two parts to this: one part is being
able to have an innovative curriculum that will include changes in
technology, changes in the economics of the firm, including risk,
international issues and regulation,” he said. “And the other part is
making sure that the students will take advantage of all this
innovation.”
The university offers courses on some of these
issues as electives, but it can’t fit all of the information in those
courses into the major’s required courses, he said.
Dear all, it always seemed to me that
statistics in medicine had a level of earnestness and expert input that
you would expect in a field where results cost so much to produce and
often hugely matter, both in human welfare and potential
income/litigation. Many professional statisticians work in medicine and
biology generally, and the journal Biometrika is extremely high
standard. There are many cases of applied medical statisticians
publishing major pure theory papers in stats theory journals, and also
textbooks that become standard references in statistics departments. In
econometrics there are a few such people (e.g. Zellner). Some techniques
apply really well to an applied field and get developed there rather
than in their "home" field. I think discrete choice models were very
largely developed in econometrics (and their software was written there
too).
As a strategy for empirical researchers in accounting, it seems to me
that enlisting help from pure statisticians is a clever way to do new or
better work. If you glance at medical journals you often see joint
papers written by a medico and a statistician from different departments
and buildings on the campus. R.A. Fisher developed much of modern
statistical theory because he was an agricultural scientist who needed
to design and interpret experiments. Gosset of "Student's t-test" was a
brewery researcher, who wanted valid interpretations of his sample
observations.
There are suggestions these days that drug companies have got influence
over some medical research programs but the basic laws of nature, and
the fact that a really bad drug will tend to be be found out in a
"natural experiment" once it's on the market, must be in medical
researchers minds constantly. Publication in these circumstances is only
the start of the story.
September 7, 2012 reply from Bob Jensen
Hi David,
I agree fully with everything you said, although outsourcing accountics
science research to non-accounting quants is not likely to happen since
there are virtually no research grants from government or industry for
accountics science research.
And we must face up to the fact that statistical research in medicine
(e.g., in epidemiology and drug testing) is only part of all of medical
research. In addition there is a tremendous proportion of implementation
research in medicine intended to improve diagnosis (e.g.,
artificial intelligence and virus discovery in biology and genetics) and
treatment (e.g., new surgical techniques and prostheses)
What is lacking in accountics science are the components of diagnosis
and treatment of benefit to practicing accountants. This of
course was the main point of Harvard's Bob Kaplan in his fabulous 2010
AAA plenary session presentation when he implied that accountics
scientists only focused on narrow research akin to epidemiology research
in medicine.
In any case, until accountics scientists have access to serious research
grant money (including contributions to university overhead), I don't
think there will be much accountics scientist research outsourcing to
statistical experts.
It is also interesting how anthropology took much of the statistical
research out of the academic side of their discipline.
I'm not proposing that academic accountants go to the extremes of having
accounting research without science. What I am proposing is that we have
some alternate tracks in accountancy doctoral programs and leading
accounting research journals. This is also what the Pathways Commission
is seeking.
The dissertation is broken, many scholars
agree. So now what?
Rethinking the academic centerpiece of a
graduate education is an obvious place to start if, as many people
believe, Ph.D. programs are in a state of crisis. Universities face
urgent calls to reduce the time it takes to complete degrees, reduce
attrition, and do more to prepare doctoral candidates for nonacademic
careers, as students face rising debt and increased competition for a
shrinking number of tenure-track jobs.
As a result, many faculty and administrators
wonder if now may finally be the time for graduate programs to begin to
modernize on a large scale and move beyond the traditional, book-length
dissertation.
That scholarly opus, some say, lingers on as a
stubborn relic that has limited value to many scholars' careers and,
ultimately, might just be a big waste of time.
"It takes too long. It's too isolating," says
William Pannapacker, an associate professor of English at Hope College
and a critic of graduate education who writes frequently for The
Chronicle. Producing a dissertation is particularly poor
preparation, he adds, for graduates whose first jobs are outside of
academe—now roughly half of new Ph.D.'s with postgraduation employment
commitments. "It's a hazing ritual passed down from another era,
retained because the Ph.D.'s before us had to do it."
Scholars cite numerous reasons for why the
dissertation is outdated and should no longer be a one-size-fits-all
model for Ph.D. students.
Completing a dissertation can take four to
seven years because students are typically required by their advisers to
pore over minutiae and learn the ins and outs of preceding scholarly
debates before turning to the specific topic of their own work.
Dissertations are often so specialized and burdened with jargon that
they are incomprehensible to scholars from other disciplines, much less
applicable to the broader public.
The majority of dissertations, produced in
paper and ink, ignore the interactive possibilities of a new-media
culture. And book-length monographs don't always reflect students'
career goals or let them demonstrate skills transferable beyond the
borders of academe.
Nontraditional Approaches
Some universities have started to make changes.
Graduate programs in history, literature, philosophy, anthropology, and
sociology the City University of New York, Michigan State University,
and the University of Virginia, among other campuses, have put
significant amounts of money into digital-humanities centers and
new-media and collaborative research programs that can support students
who want to work on nontraditional dissertations. They hold digital boot
camps and have hired faculty with the expertise to train graduate
students who want to do digital work.
Others allow students to write three or four
publishable articles instead of one book-length text. Or they encourage
students to shape their dissertations for public consumption. History
students at Texas State University and Washington State University, for
example, work on projects that can be useful to museums, historical
societies, and preservation agencies.
Some graduate programs allow students to work
collaboratively. Doctoral students in history at Emory University and
Stanford University, among others, work together on projects with help
from faculty, lab assistants, computer technicians, and geographers, who
use digital techniques like infrared scans and geolocation mapping to
build interactive maps that, for example, tell the history of cities and
important events in visually creative ways.
These programs seek not only to move students
beyond the single-author monograph but also to improve upon the
isolating dissertation experience and to replace the hierarchical
committee structure with the project-management style of collaboration
that is required by many employers.
"The economic realities of academic publishing,
coupled with exciting interpretive and methodological possibilities
inherent in new media and digital humanities, mean that the day of the
dissertation as a narrowly focused proto-book are nearly over," Bethany
Nowviskie, director of digital research and scholarship at the
University of Virginia Library, said in an e-mail.
While such efforts to modernize and digitize
the dissertation are good, they do not go far enough to revamp doctoral
education, many scholars say. To reduce time to degree and make other
key improvements, they argue, broader changes in need to be considered.
"You can't separate the dissertation from its
context," says William Kelly, president of CUNY's Graduate Center. "We
need to look at the degree as a whole and be student-centered."
Faculty and administrators, he says, should
find ways to help students move more efficiently through graduate school
from Day 1. Changes in the dissertation process are key, including
focusing course requirements and exams more squarely on preparing
students to write those dissertations, as long as that task remains
necessary.
To help more students complete their Ph.D.
programs, and to do so more quickly, CUNY has unveiled a five-year
fellowship program that will aid 200 new doctoral students. Participants
will have their teaching obligations reduced from two courses to one
course per semester during their second, third, and fourth years. Their
annual stipends will be increased to $25,000 from $18,000, in the hope
that they will spend less time on teaching, grading papers, and outside
work, and more on their own research.
The graduate center will also reduce enrollment
across its graduate programs by one-fourth by 2015, to put more
resources toward helping students succeed. CUNY now enrolls 4,200
doctoral students.
At the University of Washington, starting this
fall, students in a doctoral program in Hispanic studies will be
required to enroll in a new course that will help guide them in
beginning preliminary work on their dissertation prospectus. They will
also be trained in public forms of scholarship, so that their work will
be more attractive to employers outside higher education.
The program will also alter exams, to make them
directly relevant to students' dissertations. The tests will comprise
three elements: an annotated bibliography of the books that are relevant
to student's research projects, a 10- to 15-page dissertation
prospectus, and a 90-minute oral exam.
Stanford has recently proposed changes in its
dissertation requirements, in an effort to reduce the time that students
spend in Ph.D. programs to five years, from an average of nine years
now. The plans include adopting a four-quarter system and providing
students with financial support during the summer, so they can use that
time to make progress on their dissertations.
Departments would be required to provide
clearer guidelines about writing dissertations and to offer students
alternatives to the traditional format, so that their academic work will
match up with their career goals. Advisers would be called on to do a
better job of providing students with timely and effective feedback.
A
21st-Century Dissertation
To the extent that dissertations have changed
already, technological advances have been largely responsible. The rise
of the digital humanities has opened up new interpretive and
methodological possibilities for scholars and has challenged
conventional understandings of the dissertation. Graduate students
looking to take advantage of the interactivity of online platforms are
doing digital dissertations that integrate film clips, three-dimensional
animation, sound, and interactive maps.
One of those students is Sarita I. Alami, a
fifth-year doctoral student in the history department at Emory. She is
looking at the rise and fall of American prison newspapers from 1912 to
1980 and how prisoners used journalism to shape their experiences behind
bars. Many novels and memoirs about prison life have been written for
people outside prison. But Ms. Alami wants to provide a lens into prison
culture through the words of inmates themselves, particularly how they
discussed prison conditions and national and international politics.
She has done the usual work of reading
scholarly articles and books. She's spent time in prison archives
analyzing thousands of newspapers to see how their coverage changed over
time. But she is also taking advantage of a digital microfiche scanner
that Emory recently acquired. Its algorithmic software processes large
amounts of text and returns useful keywords, allowing her to better
analyze prisoners' use of language over time.
For example, at the height of the black-power
era, she saw the use of words like "pig," "whitey," and "solidarity."
"That was black-power rhetoric centered around prison activism," she
says, "and it captures the anger, prison revolts, and rashes of violence
discussed by outside media."
Much of her work, while taking advantage of new
methods of analysis, will still result in a text-heavy, book-length
document. But a big component of her dissertation, she says, will be a
searchable online repository of prison periodicals, graphs, online
exhibits, and explanatory text. On a
Web site,
she is documenting her research experience and introducing others to new
digital tools.
Amanda Visconti, a doctoral student in her
third year at the University of Maryland at College Park, entered the
graduate program in English with a background in Web development,
information studies, and user testing. She hasn't yet started on her
dissertation—which will be digital—but has experimented with a prototype
digital edition of Ulysses, which allows users to read the
novel's first two episodes with explanatory annotations and images that
appear when the reader moves his or her mouse over words that might be
confusing.
"Digital editions do a lot of things, but I'm
interested in making them more participatory, meaning that readers get
an interactive, engaged experience instead of a passive reading
experience," Ms. Visconti says. "Producing a traditional, book-style
dissertation wouldn't help me do the scholarly work I need to do. And it
wouldn't present that work to others in a way they could test, use, and
benefit from."
Alex Galarza, a fourth-year Ph.D. student in
history at Michigan State, is working on a digital dissertation on
soccer clubs of the 1950s and 60s in Buenos Aires, examining how they
were connected to political, economic, and social changes in the city.
Rather than produce a written text that readers would engage with only
passively, he wants people to be able to interact with his work, to dig
behind his documents to see the sources he's using and draw their own
conclusions.
A more traditional approach to his
dissertation, he says, wouldn't provide an experience nearly as
collaborative. He and a faculty mentor created the
Football
Scholars Forum, an online "scholarly
think tank" that includes a group library, film database, audio archive,
academic directory, syllabus repository, and online forum where
researchers discuss monographs, articles, films, and pedagogy.
Mr. Galarza is a graduate fellow at Michigan
State's digital-humanities center, which has 15 full-time employees, and
he has received $2,000 in travel grants to attend digital-humanities
workshops. Other than the scholars he meets at digital-humanities
conference circuits and institutes, though, he doesn't hear many
graduate students talk about incorporating digital methods into their
dissertations. Most of his peers, he says, are neither exposed to those
methods nor encouraged to try them.
Had he not received encouragement from faculty
mentors at Michigan State, he says, he, too, probably would be writing a
traditional dissertation. "If you don't have a program, mentor, and
peers that are demonstrating that these are real possibilities," he
says, "then it's hard to part from what everyone else around you and
what your adviser tells you to do."
Barriers to
Change
If most people agree that, after decades of
debate, it's time to finally do more to revamp the dissertation, then
why isn't such change widespread? The majority of graduate students are
still sticking to the monograph version of the dissertation, producing
static texts that are hundreds of pages in length and take roughly five
or six years to complete.
The barriers to change are many, faculty
members say. Graduate students themselves are part of the time-to-degree
problem. More and more Ph.D. candidates intentionally linger in
departments, in order to write exquisite theses, which they hope will
help them stand out in a brutal job market.
What's more, many programs are behind the curve
on technology, and many do not have professors with the skills to train
students to do digital dissertations. On more than a few campuses,
little, if any, technical support or clear guidelines exist for students
doing digital dissertations. Nor do the usual dissertation books and
workshops provide much help to those students.
Meanwhile, some scholars say the traditional
approaches to the dissertation aren't necessarily in need of overhaul at
all, even if digital and other nontraditional formats may be preferable
for some projects. Anthony T. Grafton, a historian at Princeton
University, argues that some of the proposals for changing the
dissertation and reducing time to degree could affect the quality of
students' projects.
"For me, the dissertation makes intellectual
sense only as a historian's quest to work out the problem that matters
most to him or her, an intellectual adventure whose limits no one can
predict," he says. "There's no way to know in advance how long that will
take. Cut down the ambition and scale, and much of the power of the
exercise is lost."
Many other professors say that until the tenure
process no longer requires the publication of book-length works,
scholars in the pipeline will continue to follow the traditional formula
for writing dissertations. Some students complain that when they create
a digital dissertation, they must also produce a text version. Many
campus libraries have not ironed out the wrinkles in terms of
submission, guidelines, and repositories. And the extra work, of course,
doesn't tend to lessen the time to degree.
Ms. Visconti, the Maryland student, says she
has had to defend her decision to do a nontraditional dissertation to
academics who don't seem to think that digital projects on their own are
scholarly enough. Some people assume, she says, that projects like hers
are just Web sites where scholarship get published electronically; those
professors don't seem to understand how digital work can produce new
tools for analysis that allow researchers to ask new questions.
Continued in article
Jensen Comment
Much of this article is not relevant for science, engineering, accounting,
finance and other disciplines. What makes more sense in those disciplines is
to distinguish between dissertation research that is aimed at an
academic audience versus research that is aimed at a clinical audience such
as practitioners. Presently, doctoral students pretty much have to write a
dissertation for an academic audience. Accordingly, the practitioners in
those professions get shorted.
For example in accountancy a doctoral student might focus redesigning
internal controls for a particular in a company where auditors identified
some weaknesses in such controls in recent audits. This might be more of a
case method research study that currently is unacceptable in most accountics
science dominated accounting doctoral programs. There would still be a
"dissertation" write up, but it could be quite non-traditional with heavy
modules of multimedia such as security videos and their analysis along with
writing of security software code.
"The Accounting Doctoral Shortage: Time for a New Model," by Jerry
E. Trapnell, Neal Mero, Jan R. Williams and George W. Krull, Issues in
Accounting Education, November 2009 ---
http://aaajournals.org/doi/abs/10.2308/iace.2009.24.4.427
ABSTRACT:
The crisis in supply versus demand for doctorally qualified faculty
members in accounting is well documented (Association to Advance
Collegiate Schools of Business [AACSB] 2003a, 2003b; Plumlee et al.
2005; Leslie 2008). Little progress has been made in addressing this
serious challenge facing the accounting academic community and the
accounting profession. Faculty time, institutional incentives, the
doctoral model itself, and research diversity are noted as major
challenges to making progress on this issue. The authors propose six
recommendations, including a new, extramurally funded research program
aimed at supporting doctoral students that functions similar to research
programs supported by such organizations as the National Science
Foundation and other science‐based funding sources. The goal is to
create capacity, improve structures for doctoral programs, and provide
incentives to enhance doctoral enrollments. This should lead to an
increased supply of graduates while also enhancing and supporting
broad‐based research outcomes across the accounting landscape, including
auditing and tax.
Accounting Doctoral Programs
PQ = Professionally Qualified under AACSB standards
AQ = Academically Qualified under AACSB standards
May 3, 2011 message to Barry Rice from Bob Jensen
Hi Barry,
Faculty without doctoral degrees who meet the AACSB PQ standards are
still pretty much second class citizens and will find the tenure track
hurdles to eventual full professorship very difficult except in colleges
that pay poorly at all levels.
There are a number of alternatives for a CPA/CMA looking into AACSB
AQ alternatives in in accounting in North American universities:
The best alternative is to enter into a traditional accounting
doctoral program at an AACSB university. Virtually all of these in North
America are accountics doctoral programs requiring 4-6 years of full
time onsite study and research beyond the masters degree. The good news
is that these programs generally have free tuition, room, and board
allowances. The bad news is that students who have little interest in
becoming mathematicians and statisticians and social scientists need not
apply ---
http://faculty.trinity.edu/rjensen/Theory01.htm#DoctoralPrograms
As a second alternative Central Florida University has an onsite
doctoral program that is stronger in the accounting and lighter in the
accountics. Kennesaw State University has a three-year executive DBA
program that has quant-lite alternatives, but this is only available in
accounting to older executives who enter with PQ-accounting
qualifications. It also costs nearly $100,000 plus room and board even
for Georgia residents. The DBA is also not likely to get the graduate
into a R1 research university tenure track.
As a third alternative there are now some online accounting doctoral
programs that are quant-lite and only take three years, but these
diplomas aren't worth the paper they're written on ---
http://faculty.trinity.edu/rjensen/Crossborder.htm#CommercialPrograms
Cappella University is a very good online university, but its online
accounting doctoral program is nothing more than a glorified online MBA
degree that has, to my knowledge, no known accounting researchers
teaching in the program. Capella will not reveal its doctoral program
faculty to prospective students. I don't think the North American
academic job market yet recognizes Capella-type and Nova-type doctorates
except in universities that would probably accept the graduates as PQ
faculty without a doctorate.
As a fourth alternative there are some of the executive accounting
doctoral programs in Europe, especially England, that really don't count
for much in the North American job market.
As a fifth alternative, a student can get a three-year non-accounting
PhD degree from a quality doctoral program such as an economics or
computer science PhD from any of the 100+ top flagship state/provincial
universities in North America. Then if the student also has PQ
credentials to teach in an accounting program, the PhD graduate can
enroll in an accounting part-time "Bridge Program" anointed by the AACSB
---
http://www.aacsb.edu/conferences_seminars/seminars/bp.asp
As a sixth alternative, a student can get a three-year law degree in
addition to getting PQ credentials in some areas where lawyers often get
into accounting program tenure tracks. The most common specialty for
lawyers is tax accounting. Some accounting departments also teach
business law and ethics using lawyers.
Hope this helps.
Bob Jensen
PS
Case Western has a very respected accounting history track in its PhD
program, but I'm not certain how many of the accountics hurdles are
relaxed except at the dissertation stage.
Why must all accounting doctoral programs be social science
(particularly econometrics) "accountics" doctoral programs? (See below)
Why can't professional schools of business and political science consider
new innovative types of doctoral programs rather than the non-creative
(quantitative social science) doctoral programs that dominate the landscape?
Why can't students who aspire to become leaders of schools of business and
political science find more relevancy in their doctoral studies and research?
Reflections on the 2012 AAA
Annual Meetings: Diversity
I did not make a recent study of AAA Membership, but the last time I did
study the membership the practitioner membership declined dramatically from the
1950s when there were more practitioner members than academic members. The few
practitioner members who remain in the AAA are mostly recruiters for large CPA
firms and PR personnel.
My anecdotal experience from the 2012 AAA Annual Meetings suggests that the
international membership is continuing to explode. This is a very good thing
suggesting that perhaps we should even have a name change similar to the name
change of the AACSB.
My anecdotal experience in the past few AAA Annual Meetings that I've attended
is that the number of Asian-background registrants keeps rising dramatically.
This is most certainly a good thing from a globalization and diversity
standpoint, but the increased number of Asians relative to blacks and Hispanics
seems to be very dramatic and makes me pause to reflect on the 2012 Pathways
Report..
This also begs the question in terms of how many Asian-background registrants
were from Asian universities versus how many are now affiliated with North
American Universities.
Here's my quick and dirty non-random sampling this morning from the 2012 "List
of Participants" at the 2012 Annual Meetings:
16 Registrants named Smith
10 Registrants named Jones
37 Registrants named Chen
Among the 37 registrants named Chen, 18 are affiliated with North American
Universities, and most of those universities are R1 research universities. This
seems to also be the case for other Asian names such as Chang, Cheng, Chiu, Cho,
Choi, Chou, Chua, Chui, Chung, Dong, Dow, etc. in the 2012 List of Participants.
The increasing proportion of Asians affiliated with North American Universities,
in my viewpoint, is largely due to the emphasis of mathematics and statistics in
our accountics-science-only accounting doctoral programs in North America.
Knowledge of mathematics and statistics is much more of a prerequisite for our
doctoral programs than knowledge of accounting, auditing, and tax ---
http://www.trinity.edu/rjensen/Theory01.htm#DoctoralPrograms
I wonder how many African Americans and Hispanics who run the formidable
gauntlet to become CPAs are later discouraged by the maximal mathematics focus
of accounting doctoral programs and minimal focus on accountancy? This has to
be, in my viewpoint, an enormous reason why we do not have a dramatic rise in
African Americans and Hispanics to accompany the dramatic rise in Asians in
North American accounting education programs.
This in turn leads me to support the proposed initiatives in the 2012 Pathways
Report.
The AAA's Pathways Commission Accounting Education Initiatives Make
National News
Accountics Scientists Should Especially Note the First Recommendation
Accounting programs should promote curricular
flexibility to capture a new generation of students who are more
technologically savvy, less patient with traditional teaching methods, and
more wary of the career opportunities in accounting, according to a report
released today by the
Pathways Commission, which studies the future of
higher education for accounting.
In 2008, the U.S. Treasury Department's Advisory
Committee on the Auditing Profession recommended that the American
Accounting Association and the American Institute of Certified Public
Accountants form a commission to study the future structure and content of
accounting education, and the Pathways Commission was formed to fulfill this
recommendation and establish a national higher education strategy for
accounting.
In the report, the commission acknowledges that
some sporadic changes have been adopted, but it seeks to put in place a
structure for much more regular and ambitious changes.
The report includes seven recommendations:
Integrate accounting research, education
and practice for students, practitioners and educators by bringing
professionally oriented faculty more fully into education programs.
Promote accessibility of doctoral
education by allowing for flexible content and structure in doctoral
programs and developing multiple pathways for degrees. The current path
to an accounting Ph.D. includes lengthy, full-time residential programs
and research training that is for the most part confined to quantitative
rather than qualitative methods. More flexible programs -- that might be
part-time, focus on applied research and emphasize training in teaching
methods and curriculum development -- would appeal to graduate students
with professional experience and candidates with families, according to
the report.
Increase recognition and support for
high-quality teaching and connect faculty review, promotion and tenure
processes with teaching quality so that teaching is respected as a
critical component in achieving each institution's mission. According to
the report, accounting programs must balance recognition for work and
accomplishments -- fed by increasing competition among institutions and
programs -- along with recognition for teaching excellence.
Develop curriculum models, engaging learning
resources and mechanisms to easily share them, as well as enhancing
faculty development opportunities to sustain a robust curriculum that
addresses a new generation of students who are more at home with
technology and less patient with traditional teaching methods.
Improve the ability to attract high-potential,
diverse entrants into the profession.
Create mechanisms for collecting, analyzing
and disseminating information about the market needs by establishing a
national committee on information needs, projecting future supply and
demand for accounting professionals and faculty, and enhancing the
benefits of a high school accounting educatio
Establish an implementation process to address
these and future recommendations by creating structures and mechanisms
to support a continuous, sustainable change process.
According to the report, its two sponsoring
organizations -- the American Accounting Association and the American
Institute of Certified Public Accountants -- will support the effort to
carry out the report's recommendations, and they are finalizing a strategy
for conducting this effort.
Hsihui Chang, a professor and head of Drexel
University’s accounting department, said colleges must prepare students for
the accounting field by encouraging three qualities: integrity, analytical
skills and a global viewpoint.
“You need to look at things in a global scope,” he
said. “One thing we’re always thinking about is how can we attract students
from diverse groups?” Chang said the department’s faculty comprises members
from several different countries, and the university also has four student
organizations dedicated to accounting -- including one for Asian students
and one for Hispanic students.
He said the university hosts guest speakers and
accounting career days to provide information to prospective accounting
students about career options: “They find out, ‘Hey, this seems to be quite
exciting.’ ”
Jimmy Ye, a professor and chair of the accounting
department at Baruch College of the City University of New York, wrote in an
email to Inside Higher Ed that his department is already fulfilling
some of the report’s recommendations by inviting professionals from
accounting firms into classrooms and bringing in research staff from
accounting firms to interact with faculty members and Ph.D. students.
Ye also said the AICPA should collect and analyze
supply and demand trends in the accounting profession -- but not just in the
short term. “Higher education does not just train students for getting their
first jobs,” he wrote. “I would like to see some study on the career tracks
of college accounting graduates.”
Mohamed Hussein, a professor and head of the
accounting department at the University of Connecticut, also offered ways
for the commission to expand its recommendations. He said the
recommendations can’t be fully put into practice with the current structure
of accounting education.
“There are two parts to this: one part is being
able to have an innovative curriculum that will include changes in
technology, changes in the economics of the firm, including risk,
international issues and regulation,” he said. “And the other part is making
sure that the students will take advantage of all this innovation.”
The university offers courses on some of these
issues as electives, but it can’t fit all of the information in those
courses into the major’s required courses, he said.
Continued in article
Jensen Conclusion
The last thing I want to recommend is slowing down the flow of Asians into the
accountics science tracks of our North American accounting doctoral programs.
But I do recommend that we stop making accountics science the only track in our
doctoral programs. Therefore, I strongly support the Pathways Commission's
recommendations to create more diversity in terms of research methods and
curricula in our doctoral programs.
August 11, 2012 reply from Chuck Pier
HI Bob.
I didn't get the chance to attend the AAA meeting
this year, but what you noticed corresponds to something that I noticed just
last week.
I ordered a new edition of Hasselback's Accounting
Faculty Directory. When it came last week I spent the better part of an
evening "browsing" through it. (An aside: For those of you old enough and
nerdish enough to relate, when the new Hasselback comes out I become
somewhat giddy and excited to look through it. Everytime I do it reminds me
of how excited I was as a kid when the new telephone books came out. The
loss of excitement of the new phone book is another thing the digital age
has robbed me of since we rarely get new phone books anymore.)
As I was browsing, (flipping the pages from the
back), page 416 jumped out at me. On that page were the alphabetical
listings for "Zhang" among others. What struck me however, was not the name,
but the "Rank" column. Almost all of the Zhang's are listed as "Asst" which
would indicate younger and newer faculty. Not that this is surprising given
the growth of the international, particularly Asian, students in doctoral
programs. I looked further and found the same occurrence(a greater
preponderance of Asst), sometimes to a greater and sometimes to a lesser
extent with the following names:
Chen (page 245) Huang (page 296) Li (pages 321-322)
Liu (page 324) Wang (pages 403-404) Xie and Xi (page 413) Yu (page 415)
I did not notice the same preponderance of Asst in
the following large groups of Asian names: Kim (page 309) Lee (page 319) Lin
(page 323) Park (page 352) Wong (page 411)
This preponderance of Asst was also not noted in
the groupings of the more common traditional American surnames: Anderson
(page 220) Brown (page 236) Jones (pages 303-304) Smith (pages 382-383)
Thomas/Thompson (page 394) Williams (pages 408-409)
What I notice in the difference between the two
Asian groups is that the one where there are more Asst's listed is that the
names are more generally Chinese; while the other Asian group has Korean
names. I can only surmise this is because there is a more recent influx of
Chinese students in recent years.
There is obviously some kind of paper in this
information waiting to be written. If I could only find what it is!
Chuck Pier, Ph.D.
Associate Professor
Department of Accounting, Economics and Finance
Angelo State University
ASU Station #10908
San Angelo, Texas 76909
Bob, A good place to start is to jettison
pretenses of accounting being a science. As Anthony Hopwood noted in his
presidential address, accounting is a practice. The tools of science are
certainly useful, but using those tools to investigate accounting
problems is quite a different matter than claiming that accounting is a
science. Teleology doesn't enter the picture in the sciences -- nature
is governed by laws, not purposes. Accounting is nothing but a
purposeful activity and must (as Jagdish has eloquently noted here and
in his Critical Perspectives on Accounting article) deal with values,
law and ethics. As Einstein said, "In nature there are no rewards or
punishments, only consequences." For a social practice like accounting
to pretend there are only consequences (as if economics was a science
that deals only with "natural kinds) has been a major failing of the
academy in fulfilling its responsibilities to a discipline that also
claims to be a profession. In spite of a "professional economist's"
claims made here that economics is a science, there is quite some
controversy over that even within the economic community. Ha-Joon Chang,
another professional economist at Cambridge U. had this to say about the
economics discipline: "Recognizing that the boundaries of the market are
ambiguous and cannot be determined in an objective way lets us realize
that economics is not a science like physics or chemistry, but a
political exercise. Free-market economists may want you to believe that
the correct boundaries of the market can be scientifically determined,
but this is incorrect. If the boundaries of what you are studying cannot
be scientifically determined what you are doing is not a science (23
Things They Don't Tell You About Capitalism, p. 10)." The silly
persistence of professional accountants in asserting that accounting is
apolitical and aethical may be a rationalization they require, but for
academics to harbor the same beliefs seems to be a decidedly
unscientific posture to take. In one of Ed Arrington's articles
published some time ago, he argued that accounting's pretenses of being
scientific are risible. As he said (as near as I can recall): "Watching
the positive accounting show, Einstein's gods must be rolling in the
aisles."
Never assume that the elite, Ivy League
departments are the highest-ranked or have the best placement rates. Some of
the worst-prepared job candidates with whom I've worked have been from
humanities departments at Yale, Harvard, and Princeton. Do not be dazzled by
abstract institutional reputations. Ask steely-eyed questions about
individual advisers and their actual (not illusory) placement rates in
recent years.
Karen Kelsky (See article below)
Jensen Comment
I think the above quotation is more wishful thinking than fact. In my
opinion the prestige of the overall university is still one of the most
important factors to tenure track appointments except in disciplines have a
few stars that are so respected that their doctoral students jump to the
front of the placement line. More likely than not these stars are in
prestigious universities even if they jumped from the Ivy League ship.
My advice is to enroll in the most prestigious university you can get
into. In doctoral programs, at least in accounting, the programs are
virtually free in most cases, although living costs in some locales may be
problematic if the university does not provide reasonably-priced housing for
doctoral students.
In accounting it's more important to match your aptitude to the doctoral
program. For example, if you really want to focus on accounting history and
avoid much of the advanced mathematics, two programs have accounting history
tracks (Case Western and Ole Miss.). In most other AACSB-accredited
universities having accounting doctoral programs be prepared for advanced
mathematics, statistics, and econometrics ---
http://faculty.trinity.edu/rjensen/Theory01.htm#DoctoralPrograms
One of the most common questions I hear from
graduate students, whether they are in their first or their final year,
is what they can do now to prepare for the academic job market.
Excellent question. As a graduate student, your
fate is in your own hands, and every decision you make—including whether
to go to graduate school at all, which program to go to, which adviser
to choose, and how to conduct yourself while there—can and should be
made with an eye to the job you wish to have at the end.
To do otherwise is pure madness. I
have no patience whatsoever with the "love" narrative (we do what we do
because we love it and money/jobs play no role) that prevails among some
advisers, departments, and profoundly mystified graduate students. But
for those graduate students and Ph.D.'s who actually want a paying
tenure-track job and the things that go with it—health insurance,
benefits, and financial security—here is my list of graduate-school
rules, forged after years of working in academe as a former tenured
professor and now running my own career-advising business for doctoral
students.
Before Graduate School
Ask yourself what job you want and whether an
advanced degree is actually necessary for it.
Choose your graduate program based both on its
focus on your scholarly interests and its tenure-track placement rate.
If it doesn't keep careful records of its placement rate, or does not
have an impressive record of placing its Ph.D.'s in tenure-track
positions, do not consider attending that program.
Choose your adviser the same way. Before
committing to an adviser, find out how many Ph.D.'s that potential
mentor has placed in tenure-track positions in recent years.
Go to the highest-ranked graduate department
you can get into—so long as it funds you fully. That is not actually
because of the "snob factor" of the name itself, but rather because of
the ethos of the best departments. They typically are the best financed,
which means they have more scholars with national reputations to serve
as your mentors and letter writers, and they maintain lively brown-bag
and seminar series that bring in major visiting scholars with whom you
can network. The placement history of a top program tends to produce its
own momentum, so that departments around the country with faculty
members from that program will then look kindly on new applications from
its latest Ph.D.'s. That, my friends, is how privilege reproduces
itself. It may be distasteful, but you deny or ignore it at your peril.
Never assume that the elite, Ivy League
departments are the highest-ranked or have the best placement rates.
Some of the worst-prepared job candidates with whom I've worked have
been from humanities departments at Yale, Harvard, and Princeton. Do not
be dazzled by abstract institutional reputations. Ask steely-eyed
questions about individual advisers and their actual (not illusory)
placement rates in recent years.
Meet, or at least correspond, with your
potential adviser ahead of time so that you understand whether he or she
has a hands-on approach to professionalization training and will be
personally invested in your success.
Do not attend graduate school unless you are
fully supported by—at minimum—a multiyear teaching assistantship that
provides a tuition waiver, a stipend, and health insurance that covers
most of the years of your program. The stipend needs to be generous
enough to support your actual living expenses for the location. Do not
take out new debt to attend graduate school. Because the tenure-track
job market is so bleak, graduate school in the humanities and social
sciences is, in most cases, not worth going into debt for.
Apply to 6 to 10 graduate programs. If you are
admitted with funding to more than one, negotiate to get the best
possible package at your top choice.
Be entrepreneurial before even entering
graduate school to locate and apply for multiple sources of financial
support. Do not forget the law of increasing returns: Success breeds
success and large follows small. A $500 book scholarship makes you more
competitive for a $1,000 conference grant, which situates you for a
$3,000 summer-research fellowship, which puts you in the running for a
$10,000 fieldwork grant, which then makes you competitive for a $30,000
dissertation writing grant.
Early in Graduate School
Never forget this primary rule: Graduate school
is not your job; graduate school is a means to the job you want. Do not
settle in to your graduate department like a little hamster burrowing in
the wood shavings. Stay alert with your eye always on a national stage,
poised for the next opportunity, whatever it is: to present a paper,
attend a conference, meet a scholar in your field, forge a connection,
gain a professional skill.
In year one and every year thereafter, read the
job ads in your field, and track the predominant and emerging emphases
of the listed jobs. Ask yourself how you can incorporate those into your
own project, directly or indirectly. You don't have to slavishly follow
trends, but you have to be familiar with them and be prepared to relate
your own work to them in some way.
Have a beautifully organized and professional
CV starting in your first year and in every subsequent year. When I was
a young assistant professor, a senior colleague told me that her
philosophy was to add one line a month to her CV. Set that same goal for
yourself. As a junior graduate student, you may or may not be able to
maintain that pace, but keep it in the back of your mind, and keep your
eye out for opportunities that add lines to your CV at a brisk pace.
Make strong connections with your adviser and
other faculty members in your department, and in affiliated departments.
Interact with them as a young professional, respectfully but
confidently. Eschew excessive humility; it inspires contempt. Do not
forget the letters of recommendation that you will one day need them to
write.
Minimize your work as a TA. Your first year
will be grueling, but learn the efficiency techniques of teaching as
fast as you can, and make absolutely, categorically, sure that you do
not volunteer your labor beyond the hours paid. Believe me, resisting
will take vigilance. But do it. You are not a volunteer and the
university is not a charity. You are paid for hours of work; do not
exceed them. Teach well, but do not make teaching the core of your
identity.
Continued in article
Jensen Comment
I also don't necessarily advise minimizing experience as a teaching
assistant and/or a research assistant. These experiences can be crucial to
your later quest for tenure. Firstly, there's the value of TA and RA
experience in and of itself. Secondly, there's the importance of those
all-important letters of recommendations from professors that you served
under as a doctoral student.
Warning:
It's often misleading to look at percentages of small numbers. For example,
25% of Brown University history PhD graduates are reported as being employed
in tenure-track jobs, but this is only two of the eight graduates in 2010.
Where Recent History Ph.D.'s Are Working
History departments are facing increased pressure
to track where their Ph.D. recipients end up. Here are
employment data for students who received Ph.D.'s in 2010 from
17 of the top-20 history programs, as ranked by U.S. News &
World Report. Officials at history departments at Cornell
and Stanford Universities and at the University of California at
Berkeley said they could not provide data because they were too
busy.
University
Total No. of Ph.D.'s
Percent in tenure-track jobs
Percent in postdocs
Percent lecturers, sdjuncts, or
visiting professors
Percent in nonteaching academic jobs
Percent high-school teachers
Percent in nonacademic jobs
Percent independent scholars
Percent unemployed/unknown
Brown U.
8
25%
13%
25%
38%
Columbia U.
21
28%
19%
14%
10%
5%
10%
14%
Duke U.
2
50%
50%
Harvard U.
13
46%
31%
15%
8%
Johns Hopkins U.
7
43%
28%
14%
14%
New York U.
18
56%
22%
6%
6%
11%
Northwestern U.
9
33%
22%
11%
11%
22%
Princeton U.
20
55%
15%
5%
25%
Rutgers U.
7
43%
29%
29%
U. of California
at Los Angeles*
21
38%
5%
33%
5%
14%
U. of Chicago
25
18%
14%
55%
5%
6%
U. of Michigan
20
40%
25%
20%
10%
5%
U. of North
Carolina at Chapel Hill
15
40%
7%
20%
7%
27%
U. of Pennsylvania
10
30%
10%
50%
10%
U. of Texas at
Austin
10
60%
30%
10%
U. of Wisconsin at
Madison
15
30%
10%
20%
10%
Yale U.
20
55%
5%
25%
15%
*Total includes 1 student who passed away.
Note: Some percentages do not add to 100% due to rounding.
Source: Chronicle reporting
Correction, 2/14/12 at 2:57 p.m.:
Numbers for the University of Wisconsin at Madison have been
corrected. The program had 15 Ph.D. graduates, not 10, and
the proportion of Madison's Ph.D.'s who were lecturers,
adjuncts, or visiting professors was 20 percent, not 50
percent.
In accountancy there are generally fewer PhD graduates than history PhD
graduates in any of the above universities. The large accountancy PhD
accounting mills decades ago, such as the University of Illinois and the
University of Texas, that each produced 10-20 accounting PhD graduates per
year have shrunk down to producing 1-5 graduates per year. Reasons for this
are complicated, but I don't hesitate to give my alleged reasons at (See
below)
For comparative purposes compare the above table for History PhD
graduates in 2010 with the 2010 column in the table of Accountancy PhD
graduates table at ---
http://faculty.trinity.edu/rjensen/Theory01.htm#DoctoralPrograms
The largest numbers of accountancy PhD graduates from a single university
were the five graduates at Virginia Tech in 2010. But this may be a 2010
anomaly year for Virginia Tech that normally produces two or fewer
accounting PhD graduates per year.
It takes a bit of work, but the employment status of 2010 Accountancy PhD
graduates can be determined from the table at
http://www.jrhasselback.com/AtgDoct/XSchDoct.pdf
Most 2010 accounting PhD graduates had multiple high-paying tenure track
offers (well over $100,000 for nine-month contracts) and are now in the
tenure-track positions of their first choices in 2010. Many in R1 research
universities, however, will move to tenure track positions in other
universities after a few years on the job. More often than not the
first-time moves to other universities is not due to tenure rejections per
se. Sometimes new PhD graduates want to start out at major R1 research
universities to build research publications into their resumes. But many of
these graduates never intended to spend the rest of their careers in R1
universities that highly pressure faculty year-after-year to conduct
research and publish in top research journals.
Unlike in engineering where most PhD graduates track into private sector
industries, most accounting PhD graduates settle into careers in tenure
track in academe. There are generally no comparative advantages of having a
PhD for job applicants in accounting firms, government, or business
corporations. Hence it's not surprising that most accountancy PhD graduates
are in the Academy.
Closing Comment
Of course there are many other things to consider such as the fact that most
accountancy PhD programs admit only students with prior professional
experience in accounting. Accounting PhD programs may also take twice as
long to complete and are replete with courses in mathematics, statistics,
econometrics, psychometrics, and technical data mining. On the other hand,
most accountancy PhD programs offer free tuition and relatively handsome
living allowances in return for some teaching and research assistance.
Usually at least one year is also covered with a full-ride fellowship in an
accountancy PhD program.
The KPMG Foundation is now providing great supplemental financial and
other support for minority students interested in accountancy PhD programs.
This has been a very successful program considering how difficult it is to
lure minority students back to the campus when they're successfully employed
as CPAs, Treasury Agents, and other accounting professionals with young
families to support ---
http://www.kpmgfoundation.org/foundinit.asp
As a doctoral student at Yale University's
psychology department, George E. Newman became increasingly interested
in applying theories he studied to people's business decisions.
He began exploring, for instance, why people
prefer buying original pieces of artwork over perfect duplicates and why
they're willing to pay a lot for celebrity possessions.
"What we found is that a lot of those decisions
have to do, importantly, with psychological essentialism," he said.
"People believe the objects contain some essence of their previous
owners or manufacturers."
Wanting to further pursue such application of
his psychology training, Mr. Newman accepted a postdoctoral appointment
at Yale's School of Management, and last year became an assistant
professor there.
The career path he has followed, as a social
scientist moving to a top-tier business school, is becoming relatively
common, particularly for Ph.D.'s in psychology, economics, and
sociology. As those institutions have sought to bolster and broaden
their research, they've been looking to hire faculty with strong
scholarship in disciplines outside of business. The prospect of teaching
and researching at a business school can be alluring to scholars, too.
And a rough academic job market in the social sciences has also helped
push people with Ph.D.'s in that direction.
Focus on
Research
Adam D. Galinsky, professor of ethics and
decision in management at the Kellogg School of Management at
Northwestern University, was trained as a social psychologist. Mr.
Galinsky, who was hired by Kellogg more than a decade ago, says he was
among the first wave of social scientists to join the faculties of
top-tier business schools. The push to hire more psychologists and
sociologists, he says, was motivated by the institutions' desire to
improve the research they produced.
"There was a sense that the quality of research
in business schools was inadequate," he says. "The idea was to hire
strong discipline-based people and bring them into the business schools
with their strong foundation of research skills."
That trend may have started to slow recently,
Mr. Galinsky says, in part because of the improved training that
business schools can now offer because they have hired social
scientists. As a result, business-school graduates are more competitive
when they apply for faculty positions at business-schools that trained
psychologists and other social scientists are also seeking.
Many social scientists are attracted to
business schools because they provide an opportunity to approach fields
of study from more applied and interdisciplinary perspectives.
Victoria L. Brescoll, who completed her Ph.D.
and held a postdoctoral appointment at Yale's psychology department, is
an assistant professor of organizational behavior at Yale's School of
Management. She says that moving from a psychology department to a
business school was something she had always thought of doing, because
her research on how people are perceived at work is at the intersection
of various disciplines, including social psychology, women studies,
communications, and organizational studies.
"The distinctions between disciplines can be
somewhat artificial," she says. "Part of why I like being in the
business school is that I can do that kind of interdisciplinary work."
Ms. Brescoll says she enjoys the challenge of
considering an economic or business perspective to her work.
"You have to rethink what high-quality evidence
is because you have to think about it from the perspective of someone
from a totally different discipline," she says. "Things you might have
taken for granted, you just can't."
Job-Market
Pressures
For some Ph.D. candidates, the tight academic
job market can be an incentive to explore faculty positions at a
business school.
After completing his doctoral degree in social
psychology at Princeton University in 1999, Mr. Galinsky says he applied
to 50 psychology departments and three business schools. He barely
received any responses from the psychology departments but heard back
from two of the business schools. He accepted a postdoctoral appointment
at Kellogg. "It was a path that was chosen for me," he says.
"For a lot of people interested in social
psychology, there are just not a lot of jobs in that field in general,"
says Mr. Newman, the Yale professor who studies decision-making.
Moving from psychology to business is "not an
expected path at this point, but it is a common path," says Elanor F.
Williams, who completed her Ph.D. in social psychology at Cornell
University in 2008 and then accepted a postdoctoral appointment at the
University of Florida's Warrington College of Business. Her research
focuses on how people think in a social or realized context.
Though she applied to some psychology
departments, Ms. Williams says she focused her job search heavily on
postdoctoral positions at business schools because of the transition
they can offer. In her case, her postdoctoral appointment at Florida
even paid for her to participate in an eight-week program to train
nonbusiness Ph.D.'s to teach in business schools. The Post-Doctoral
Bridge to Business Program was started in 2007 by the Association to
Advance Collegiate Schools of Business, an accrediting agency, as
business schools faced a shortage of qualified professors to teach
growing numbers of students.
If you’re a psychologist, the news has to make
you a little nervous—particularly if you’re a psychologist who published
an article in 2008 in any of these three journals: Psychological
Science, the Journal of Personality and Social Psychology,
or the Journal of Experimental Psychology: Learning, Memory, and
Cognition.
Because, if you did, someone is going to check
your work. A group of researchers have already begun what they’ve dubbed
the Reproducibility Project, which aims to
replicate every study from those three journals for that one year. The
project is part of Open Science Framework, a group interested in
scientific values, and its stated mission is to “estimate the
reproducibility of a sample of studies from the scientific literature.”
This is a more polite way of saying “We want to see how much of what
gets published turns out to be bunk.”
For decades, literally, there has been talk
about whether what makes it into the pages of psychology journals—or the
journals of other disciplines, for that matter—is actually, you know,
true. Researchers anxious for novel, significant, career-making findings
have an incentive to publish their successes while neglecting to mention
their failures. It’s what the psychologist Robert Rosenthal named “the
file drawer effect.” So if an experiment is run ten times but pans out
only once you trumpet the exception rather than the rule. Or perhaps a
researcher is unconsciously biasing a study somehow. Or maybe he or she
is flat-out faking results, which is not unheard of.
Diederik Stapel, we’re looking at you.
So why not check? Well, for a lot of reasons.
It’s time-consuming and doesn’t do much for your career to replicate
other researchers’ findings. Journal editors aren’t exactly jazzed about
publishing replications. And potentially undermining someone else’s
research is not a good way to make friends.
Brian
Nosek knows all that and he’s doing it anyway.
Nosek, a professor of psychology at the University of Virginia, is one
of the coordinators of the project. He’s careful not to make it sound as
if he’s attacking his own field. “The project does not aim to single out
anybody,” he says. He notes that being unable to replicate a finding is
not the same as discovering that the finding is false. It’s not always
possible to match research methods precisely, and researchers performing
replications can make mistakes, too.
But still. If it turns out that a sizable
percentage (a quarter? half?) of the results published in these three
top psychology journals can’t be replicated, it’s not going to reflect
well on the field or on the researchers whose papers didn’t pass the
test. In the long run, coming to grips with the scope of the problem is
almost certainly beneficial for everyone. In the short run, it might get
ugly.
Nosek told Science that a senior
colleague warned him not to take this on “because psychology is under
threat and this could make us look bad.” In a Google discussion group,
one of the researchers involved in the project wrote that it was
important to stay “on message” and portray the effort to the news media
as “protecting our science, not tearing it down.”
The researchers point out, fairly, that it’s
not just social psychology that has to deal with this issue. Recently, a
scientist named C. Glenn Begley attempted to replicate 53 cancer studies
he deemed landmark publications. He could only replicate six. Six! Last
December
I interviewed Christopher Chabris about his
paper titled “Most Reported Genetic Associations with General
Intelligence Are Probably False Positives.” Most!
A related new endeavour called
Psych File Drawer
allows psychologists to upload their attempts to
replicate studies. So far nine studies have been uploaded and only three
of them were successes.
Both Psych File Drawer and the Reproducibility
Project were started in part because it’s hard to get a replication
published even when a study cries out for one. For instance, Daryl J.
Bem’s 2011 study that seemed to prove that extra-sensory perception is
real — that subjects could, in a limited sense, predict the future —
got no shortage of attention and seemed to
turn everything we know about the world upside-down.
Yet when Stuart Ritchie, a doctoral student in
psychology at the University of Edinburgh, and two colleagues failed to
replicate his findings, they had
a heck of a time
getting the results into print (they finally did, just recently, after
months of trying). It may not be a coincidence that the journal that
published Bem’s findings, the Journal of Personality and Social
Psychology, is one of the three selected for scrutiny.
Continued in article
Jensen Comment
Scale Risk
In accountics science such a "Reproducibility Project" would be much more
problematic except in behavioral accounting research. This is because
accountics scientists generally buy rather than generate their own data
(Zoe-Vonna Palmrose is an exception). The problem with purchased data from
such as CRSP data, Compustat data, and AuditAnalytics data is that it's
virtually impossible to generate alternate data sets, and if there are
hidden serious errors in the data it can unknowingly wipe out thousands of
accountics science publications all at one --- what we might call a "scale
risk."
Assumptions Risk
A second problem in accounting and finance research is that researchers tend
to rely upon the same models over and over again. And when serious
flaws were discovered in a model like CAPM it not only raised doubts about
thousands of past studies, it made accountics and finance researchers make
choices about whether or not to change their CAPM habits in the future.
Accountics researchers that generally look for an easy way out blindly
continued to use CAPM in conspiracy with journal referees and editors who
silently agreed to ignore CAPM problems and limitations of assumptions about
efficiency in capital markets---
http://faculty.trinity.edu/rjensen/Theory01.htm#EMH
We might call this an "assumptions risk."
Hence I do not anticipate that there will ever be a Reproducibility
Project in accountics science. Horrors. Accountics scientists might not
continue to be the highest paid faculty on their respected campuses and
accounting doctoral programs would not know how to proceed if they had to
start focusing on accounting rather than econometrics.
Your question is really not clear, because there are core courses in
statistics, econometrics, and probability theory in virtually all accounting
doctoral programs in AACSB accredited universities. In other words, it is
not usually possible to avoid studying econometrics by choosing a behavioral
track or non-quantitative beyond the core requirements. Michigan State many
years ago had no required core courses, but I'd bet my shirt that MSU now
has some core courses that require econometrics, statistics, and probability
theory.
Various programs have archival versus behavioral tracks versus other tracts
(e.g., accounting history at Ole Miss. and Case Western) beyond the core
requirements. For example, look at Question 14 about Cornell University that
is made public on a BYU site ---
http://aaahq.org/temp/phd/StudyMaterials/Questions/CornellUniv.pdf
Related to this are issues of why most accounting doctoral students these
days prefer archival research to other types of research, which accounts
somewhat for the domination of archival research professors and courses and
databases in accounting doctoral programs.
Some of the reasons are given below:
The top accounting research journals in which publishing has become
a necessary condition in top universities publish more archival research
articles than any other kind. Steve Kachelmeir argues that there is a
"denominator effect" making competition for publication in that category
difficult, but at least there is more of a chance of publishing in TAR,
JAR, and JAE than if you do accounting history research without
equations, field research without equations, or case method research
without equations.
Archival research in many respects is easier. Archival researchers
have their databases delivered free to their office computers (no need
to collect data off campus or roam the campus library stacks and
reference collections). There is an exception in the case of a Bloomberg
or Reuters terminal for which researchers may actually have to walk to
the campus library to obtain access.
Skills for archival research are part of the doctoral program core
such that no added specialties are required such as specialties needed
for most types of AIS research, accounting history research, field
research, etc.
We often blame journal editors and professors trained more in
econometrics than accountancy for the archival bias of accounting
research journals and doctoral programs. Perhaps part of the blame is
really due to the easier data collection tasks of archival research,
particularly events studies in capital market research. The data is
literally handed to archival researchers on a silver platter for free in
their offices (although their universities are paying the database
access fees to such services as CRSP, Compustat, West Tax, and
AuditAnalytics).
Harvard University today announced a new doctoral
program in educational leadership that, in partnership with prominent
organizations pushing for change in elementary and secondary schools, will
seek to train people capable of bringing about major school reform.
Harvard's new Doctor of Education Leadership
Program will be based at its Graduate School of Education and will involve
faculty members of that school as well as Harvard's business school and John
F. Kennedy School of Government. In their third and final year in the
program, students will enter a yearlong residency with a partner
organization such as Teach for America, the National Center on Education and
the Economy, or one of the nation's largest urban school districts.
The program's mission will be to train top
officials of school districts, government agencies, nonprofit groups, and
private organizations who will be equipped to shake up the status quo in
elementary and secondary education.
"Our goal is not to develop leaders for the system
as it currently exists; rather, we aim to develop people who will lead
system transformation," Kathleen McCartney, dean of the Graduate School of
Education, said in written statement.
The Wallace Foundation has provided Harvard a
$10-million grant for the program, enabling the university to operate it
tuition-free and to offer its students a cost-of-living stipend. An initial
cohort of 25 students is expected to enroll in the program in the fall of
2010.
Thank you so much for providing such a detailed and permanent 2011 TAR
fiscal year annual report ended May 31, 2011 --- http://aaajournals.org/
You are commended during your service as TAR Senior Editor fpr having to
deal with greatly increased numbers of submissions. This must've kept you up
late many nights in faithful service to the AAA. And writing letters of
rejections to friends and colleagues must've been a very painful chore at
times. And having to communicate repeatedly with so many associate editors
and referees must've been tough for so many years. I can understand why some
TAR editors acquired health problems. I'm grateful that you seem to still be
healthy and vigorous.
I'm also grateful that you communicate with us on the AECM. This is more
than I can say for other former TAR editors and most AAA Executive Committee
members who not only ignore us on the AECM, but they also do not communicate
very much at all on the AAA Commons.
I'm really not replying to start another round of debate on the AECM
using your fine annual report. But I can't resist noting that I just do not
see the trend increasing for acceptance of papers that are not accountics
science papers appearing in TAR.
One of the tables of greatest interest to me is Panel D of Table 3 which
is shown below:
What you define as "All Other Methods" comprises 7% leaving 93% for
Analytical, Empirical Archival, and Experimental. However, this does not
necessarily mean that 7% of the acceptances did not contain mathematical
equations and statistical testing such that what I would define as
accountics science acceptances for 2011 constitute something far greater
than 93%. For example, you've already pointed out to us that case method and
field study papers published in TAR during 2011 contain statistical
inference testing and equations. They just do not meet the formal tests as
having random samples.
Presidential scholar papers are published automatically (e.g., Kaplan's
March 2011) paper, such that perhaps only 15 accepted Other Methods papers
passed through the refereeing process. Your July 2011 Editorial was possibly
included in the Other Methods such that possibly only 13 Other Methods
papers passed through the refereeing process. And over half of these were
"Managerial" and most of those contain equations such that 2011 was a
typical year in which nearly all the published TAR papers in 2011 meet my
definition of accountics science (some of which do not have scientific
samples) ---
http://faculty.trinity.edu/rjensen/395wpTAR/Web/TAR395wp.htm
We can conclude that in 2011 that having equations in papers accepted by
referees was virtually a necessary condition for acceptance by referees in
2011 as has been the case for decades.
Whatever happened to accounting history publications in TAR? Did
accounting historians simply give up on getting a TAR hit?
Whatever happened to normative method papers if they do not meet the
mathematical tests of being Analytical?
Whatever happened to scholarly commentary?
An Appeal for Replication and Other Commentaries/Dialogs in an
Electronic Journal Supplemental Commentaries and Replication Abstracts With a Rejoinder from the Current Senior Editor of The Accounting
Review (TAR), Steven J. Kachelmeier
http://faculty.trinity.edu/rjensen/TheoryTA
Accounting Doctoral Programs
PQ = Professionally Qualified under AACSB standards
AQ = Academically Qualified under AACSB standards
May 3, 2011 message to Barry Rice from Bob Jensen
Hi Barry,
Faculty without doctoral degrees who meet the AACSB PQ standards are
still pretty much second class citizens and will find the tenure track
hurdles to eventual full professorship very difficult except in colleges
that pay poorly at all levels.
There are a number of alternatives for a CPA/CMA looking into AACSB
AQ alternatives in in accounting in North American universities:
The best alternative is to enter into a traditional accounting
doctoral program at an AACSB university. Virtually all of these in North
America are accountics doctoral programs requiring 4-6 years of full
time onsite study and research beyond the masters degree. The good news
is that these programs generally have free tuition, room, and board
allowances. The bad news is that students who have little interest in
becoming mathematicians and statisticians and social scientists need not
apply ---
http://faculty.trinity.edu/rjensen/Theory01.htm#DoctoralPrograms
As a second alternative Central Florida University has an onsite
doctoral program that is stronger in the accounting and lighter in the
accountics. Kennesaw State University has a three-year executive DBA
program that has quant-lite alternatives, but this is only available in
accounting to older executives who enter with PQ-accounting
qualifications. It also costs nearly $100,000 plus room and board even
for Georgia residents. The DBA is also not likely to get the graduate
into a R1 research university tenure track.
As a third alternative there are now some online accounting doctoral
programs that are quant-lite and only take three years, but these
diplomas aren't worth the paper they're written on ---
http://faculty.trinity.edu/rjensen/Crossborder.htm#CommercialPrograms
Cappella University is a very good online university, but its online
accounting doctoral program is nothing more than a glorified online MBA
degree that has, to my knowledge, no known accounting researchers
teaching in the program. Capella will not reveal its doctoral program
faculty to prospective students. I don't think the North American
academic job market yet recognizes Capella-type and Nova-type doctorates
except in universities that would probably accept the graduates as PQ
faculty without a doctorate.
As a fourth alternative there are some of the executive accounting
doctoral programs in Europe, especially England, that really don't count
for much in the North American job market.
As a fifth alternative, a student can get a three-year non-accounting
PhD degree from a quality doctoral program such as an economics or
computer science PhD from any of the 100+ top flagship state/provincial
universities in North America. Then if the student also has PQ
credentials to teach in an accounting program, the PhD graduate can
enroll in an accounting part-time "Bridge Program" anointed by the AACSB
---
http://www.aacsb.edu/conferences_seminars/seminars/bp.asp
As a sixth alternative, a student can get a three-year law degree in
addition to getting PQ credentials in some areas where lawyers often get
into accounting program tenure tracks. The most common specialty for
lawyers is tax accounting. Some accounting departments also teach
business law and ethics using lawyers.
Hope this helps.
Bob Jensen
PS
Case Western has a very respected accounting history track in its PhD
program, but I'm not certain how many of the accountics hurdles are
relaxed except at the dissertation stage.
The complete ranking of 66 executive MBA programs, with details
on each program’s class profile and student evaluations of teaching
quality, curriculum, and support services
More than 1,000 in-depth statistical profiles on full-time,
part-time, executive, and distance MBA programs, non-degree
executive education programs, and undergraduate business programs
In a recent online chat, <em>Bloomberg Businessweek</em> editors
Louis Lavelle and Geoff Gloeckler fielded questions from readers on
trends, methodology, and more
Jensen Comment
Media rankings of colleges, universities, and degree programs (like
accounting) are heavily influenced by both attributes selected as important
for the rankings, the weightings of those attributes, and the people
themselves who do the rankings. The above Bloomberg Business Week
rankings are based heavily upon opinions of alumni.
The US News rankings are based upon responses presidents, deans,
or other administrators on selected criteria. The US New Rankings
probably the rankings influenced based heavily upon research reputations of
universities and programs within universities. The non-media rankings of
university programs and faculty based upon academic studies of journal hits
such as the BYU (David Wood) studies are even more heavily based upon
research publications.
The Wall Street Journal Rankings of business and accounting
programs are based upon opinions of recruiters.
The Economist rankings are based upon opinions of student
applicants based upon why they chose to apply to particular programs.
The
rankings presented via the links . .
. are based on the research
paper Accounting Program Research
Rankings By Topic and Methodology,
forthcoming in Issues In Accounting
Education . These rankings are based
on classifications of peer reviewed
articles in 11 accounting journals
since 1990. To see the set of
rankings that are of interest to
you, click on the appropriate title.
Each
cell contains the ranking and the
(number of graduates) participating
in that ranking. The colors
correspond to a heat map (see legend
at bottom of table) showing the
research areas in which a program
excels. Move your mouse over the
cell to see the names of the
graduates that participated in that
ranking
Jensen
Comment
I'm impressed by the level of detail,
I repeat
my cautions about rankings that I
mentioned previously about the earlier
study. Researchers sometimes change
affiliations two, three, or even more
times over the course of their careers.
Joel Demski is now at Florida. Should
Florida get credit for research
published by Joel when he was a tenured
professor at Stanford and at Yale before
moving to Florida?
There is
also a lot of subjectivity in the choice
of research journals and methods. Even
though the last cell in the table is
entitled "Other Topic, Other Material,"
there seems to me to be a bias against
historical research and philosophical
research and a bias for accountics
research. This of course always stirs me
up ---
http://faculty.trinity.edu/rjensen/Theory01.htm#WhatWentWrong
In
future updates I would like to see more
on accounting history and applied
accounting research. For example, I
would like to see more coverage of the
Journal of Accountancy. An example
article that gets overlooked research on
why the lattice model for valuing
employee stock options has key
advantages over the Black-Scholes Model:
The
Journal of Accountancy and many
other applied research/professional
journals are not included in this BYU
study. Hence professors who publish
research studies in those excluded
journals are not given credit for their
research, and their home universities
are not given credit for their research.
Having
said all this, the BYU study is the best
effort to date in terms of accounting
research rankings of international
universities, accounting researchers,
and doctoral student research.
574 Shields Against
Validity Challenges in Plato's Cave
An Appeal for Replication and Other
Commentaries/Dialogs in an Electronic
Journal Supplemental Commentaries and
Replication Abstracts
http://faculty.trinity.edu/rjensen/TheoryTAR.htm
It's also relatively uncommon for accountics scientists to criticize each
others' published works. A notable exception is as follows:
"Selection Models in Accounting Research," by Clive S. Lennox, Jere
R. Francis, and Zitian Wang, The Accounting Review, March 2012,
Vol. 87, No. 2, pp. 589-616.
This study explains the challenges associated
with the Heckman (1979) procedure to control for selection bias,
assesses the quality of its application in accounting research, and
offers guidance for better implementation of selection models. A survey
of 75 recent accounting articles in leading journals reveals that many
researchers implement the technique in a mechanical way with relatively
little appreciation of important econometric issues and problems
surrounding its use. Using empirical examples motivated by prior
research, we illustrate that selection models are fragile and can yield
quite literally any possible outcome in response to fairly minor changes
in model specification. We conclude with guidance on how researchers can
better implement selection models that will provide more convincing
evidence on potential selection bias, including the need to justify
model specifications and careful sensitivity analyses with respect to
robustness and multicollinearity.
. . .
In addition this paper has presents a replication of a previously
published study --- pp. 603-609
. . .
CONCLUSIONS
Our review of the accounting literature
indicates that some studies have implemented the selection model in a
questionable manner. Accounting researchers often impose ad hoc
exclusion restrictions or no exclusion restrictions whatsoever. Using
empirical examples and a replication of a published study, we
demonstrate that such practices can yield results that are too fragile
to be considered reliable. In our empirical examples, a researcher could
obtain quite literally any outcome by making relatively minor and
apparently innocuous changes to the set of exclusionary variables,
including choosing a null set. One set of exclusion restrictions would
lead the researcher to conclude that selection bias is a significant
problem, while an alternative set involving rather minor changes would
give the opposite conclusion. Thus, claims about the existence and
direction of selection bias can be sensitive to the researcher's set of
exclusion restrictions.
Our examples also illustrate that the selection
model is vulnerable to high levels of multicollinearity, which can
exacerbate the bias that arises when a model is misspecified (Thursby
1988). Moreover, the potential for misspecification is high in the
selection model because inferences about the existence and direction of
selection bias depend entirely on the researcher's assumptions about the
appropriate functional form and exclusion restrictions. In addition,
high multicollinearity means that the statistical insignificance of the
inverse Mills' ratio is not a reliable guide as to the absence of
selection bias. Even when the inverse Mills' ratio is statistically
insignificant, inferences from the selection model can be different from
those obtained without the inverse Mills' ratio. In this situation, the
selection model indicates that it is legitimate to omit the inverse
Mills' ratio, and yet, omitting the inverse Mills' ratio gives different
inferences for the treatment variable because multicollinearity is then
much lower.
In short, researchers are faced with the
following trade-off. On the one hand, selection models can be fragile
and suffer from multicollinearity problems, which hinder their
reliability. On the other hand, the selection model potentially provides
more reliable inferences by controlling for endogeneity bias if the
researcher can find good exclusion restrictions, and if the models are
found to be robust to minor specification changes. The importance of
these advantages and disadvantages depends on the specific empirical
setting, so it would be inappropriate for us to make a general statement
about when the selection model should be used. Instead, researchers need
to critically appraise the quality of their exclusion restrictions and
assess whether there are problems of fragility and multicollinearity in
their specific empirical setting that might limit the effectiveness of
selection models relative to OLS.
Another way to control for unobservable factors
that are correlated with the endogenous regressor (D) is to use panel
data. Though it may be true that many unobservable factors impact the
choice of D, as long as those unobservable characteristics remain
constant during the period of study, they can be controlled for using a
fixed effects research design. In this case, panel data tests that
control for unobserved differences between the treatment group (D = 1)
and the control group (D = 0) will eliminate the potential bias caused
by endogeneity as long as the unobserved source of the endogeneity is
time-invariant (e.g., Baltagi 1995; Meyer 1995; Bertrand et al. 2004).
The advantages of such a difference-in-differences research design are
well recognized by accounting researchers (e.g., Altamuro et al. 2005;
Desai et al. 2006; Hail and Leuz 2009; Hanlon et al. 2008). As a caveat,
however, we note that the time-invariance of unobservables is a strong
assumption that cannot be empirically validated. Moreover, the standard
errors in such panel data tests need to be corrected for serial
correlation because otherwise there is a danger of over-rejecting the
null hypothesis that D has no effect on Y (Bertrand et al. 2004).10
Finally, we note that there is a recent trend
in the accounting literature to use samples that are matched based on
their propensity scores (e.g., Armstrong et al. 2010; Lawrence et al.
2011). An advantage of propensity score matching (PSM) is that there is
no MILLS variable and so the researcher is not required to find valid Z
variables (Heckman et al. 1997; Heckman and Navarro-Lozano 2004).
However, such matching has two important limitations. First, selection
is assumed to occur only on observable characteristics. That is, the
error term in the first stage model is correlated with the independent
variables in the second stage (i.e., u is correlated with X and/or Z),
but there is no selection on unobservables (i.e., u and υ are
uncorrelated). In contrast, the purpose of the selection model is to
control for endogeneity that arises from unobservables (i.e., the
correlation between u and υ). Therefore, propensity score matching
should not be viewed as a replacement for the selection model (Tucker
2010).
A second limitation arises if the treatment
variable affects the company's matching attributes. For example, suppose
that a company's choice of auditor affects its subsequent ability to
raise external capital. This would mean that companies with higher
quality auditors would grow faster. Suppose also that the company's
characteristics at the time the auditor is first chosen cannot be
observed. Instead, we match at some stacked calendar time where some
companies have been using the same auditor for 20 years and others for
not very long. Then, if we matched on company size, we would be throwing
out the companies that have become large because they have benefited
from high-quality audits. Such companies do not look like suitable
“matches,” insofar as they are much larger than the companies in the
control group that have low-quality auditors. In this situation,
propensity matching could bias toward a non-result because the treatment
variable (auditor choice) affects the company's matching attributes
(e.g., its size). It is beyond the scope of this study to provide a more
thorough assessment of the advantages and disadvantages of propensity
score matching in accounting applications, so we leave this important
issue to future research.
Rankings of Accountics Science Researchers
It's only slightly misleading to call the Pickerd (2011) et al. accountics
science researcher rankings (see below). There are a small percentage of
non-accountics research articles included in the thousands of articles in
the 11 journals in this study's database, but these these were apparently
insignificant since Table 2 of the study is limited to three accountics
science research methods. In Table 2 only three
research methods are recognized in the study --- Analytical, Archival, and
Experimental. Accounting Information Systems (AIS) does not fit
neatly into the realm of accountics science. The authors mention that there
are "Other" occasional non-accountics and non-AIS articles published in the
11 journals of the database, but these are totally ignored as "research
methods" in Table 2 of the study.
The top-ranked academic accounting researchers listed in the tables of
this study are all noted for their mathematics and statistical writings.
The articles in the rankings database were published over two recent
decades in 11 leading academic accounting research journals.
The "Top Six" Journals
The Accounting Review (TAR),
Journal of Accounting Research (JAR),
Journal of Accounting and Economics (JAE),
Contemporary Accounting Research (CAR),
Review of Accounting Studies (RAST),
Accounting, Organizations and Society (AOS).
Other Journals in the
Rankings Database Auditing: A Journal of Practice & Theory (Auditing),
Journal of the American Taxation Association (JATA),
Journal of Management Accounting Research (JMAR),
Journal of Information Systems (JIS),
Behavioral Research in Accounting (BRIA).
Probably the most telling bias of the study is the
bias against normative, case method, and field study accountancy research.
In fact only three methods are recognized as "research methods" in Table 2
--- Analytical, Archival, and Experimental. For example, the best known and
most widely published accounting case method researcher is arguably Robert
Kaplan of Harvard University. Kaplan is not even listed among the hundreds
of accountics scientists ranked in Table 1 (Topical Areas) of this this
study although he was, before 1990, a very noted accountics researcher who
shifted more into case and field research. Nor is the famous accounting case
researcher Robin Cooper mentioned in the study. For years both Kaplan and
Cooper have complained about how the top accountics science journals like
TAR discourage non-accountics science submissions
"Accounting Scholarship that Advances Professional Knowledge and Practice,"
The Accounting Review, March 2011, Volume 86, Issue 2,
Also see
http://www.trinity.edu/rjensen/TheoryTAR.htm
What is not clear is what the Pickerd (2011) et al. authors did
with non-accountics articles in Table 1 (Topics) versus Table 2 (Methods).
These articles were obviously not included in Table
2 (Methods) . But were their non-accountics study authors included in Table
1 (Topics)? My guess is that they were included in Table 1. Other
than for AIS, I could be wrong on this with respect to Table 1. In any case,
the number of non-accountics articles available for the database is
extremely small relative to the thousands of accountics science articles in
the database. Except in the area of AIS in Table 1, this is an accountics
scientist set of rankings.
ABSTRACT: This paper ranks individual accounting researchers based on their research productivity in the most recent six, 12, and 20 years. We extend
prior individual faculty rankings by providing separate individual faculty research rankings for each topical area commonly published in accounting journals
(accounting information systems [AIS], audit, financial, managerial, and tax). In addition, we provide individual faculty research rankings for each research
methodology commonly used by accounting researchers (analytical, archival, and experimental). These findings will be of interest to potential doctoral students
and current faculty, as well as accounting department, business school, and university administrators as they make decisions based on individual faculty members’ research productivity.
When reading the rankings the following coding is used in the cells:
Table 1 presents the top 100-ranked accounting
researchers by topical area based on publication counts in the selected
accounting journals. In the tables, the first number reported is the
ranking that does not take into account coauthorship; the second
reported number (after the *) is the ranking if authors receive only
partial credit for coauthored work. The table shows the author rank
based on article counts over the entire sample period of the study (20
years), as well as ranks based on the number of articles published in
selected journals over the past 12-year and six-year windows. Even
though specialization is common in accounting research, it is
interesting to note that some professors publish widely in a variety of
topical areas.
In other words, Jane Doe (3*32) means that Jane ranks 3 in terms of
authorship of articles in a category but has a lower rank of 32 if the
rankings are adjusted for joint authorship partial credit.
It should also be noted that authors are listed on the basis of the
20-year window.
One of the most noteworthy findings in this study, in my viewpoint, is
the tendency for most (certainly not all) leading academic researchers to
publish research more frequently in the earliest years of their careers
(especially before earning tenure) relative to later years in their careers.
Here are the top two winners in each category:
Table 1, Panel A: AIS
Author
6-Year (2004–2009) 12-Year (1998–2009) 20-Year (1990–2009)
Hunton, James E., Bentley University 1
*1 1 *1
1 *1
Murthy, Uday S., University of South Florida 10
*35 8 *4
2 *3
Table 1, Panel B: Audit
Author
6-Year (2004–2009) 12-Year (1998–2009) 20-Year (1990–2009)
Raghunandan, K., Florida International U. 1
*4 1 *2
1 *3
Wright, Arnold M., Northeastern University 7
*9 5 *5
1 *2
Table 1, Panel C: Financial
Author
6-Year (2004–2009) 12-Year (1998–2009) 20-Year (1990–2009)
Barth, Mary E., Stanford University 60
*159 2 *8
1 *2
Francis, Jennifer, Duke University 6
*26 3 *13
2 *5
What is interesting is to note how poorly some of these universities do
in the Pickerd (2011) rankings of their individual faculty members. Some
like Stanford and Duke do quite well in the Pickerd rankings, but many other
highly ranked accountics science programs in the above the list do much
worse than I would've expected. This suggests that some programs are ranked
high on the basis of numbers of accountics scientists more than the
publishing frequency of any one resident scientist. For example, the
individual faculty members at Chicago, the University of Illinois, Wharton
(Pennsylvania), and Harvard don't tend to rank highly in the Pickerd
rankings.
Ignoring the Accountics Science Controversies
Pickerd (2011) et al. make no mention of the limitations and heated
controversies concerning accountics science and the fact that one of the
journals (AOS) among the 11 in the database (as well as AOS's founder and
long-time editor) is largely devoted to criticism of accountics science.
"Whither Accounting Research?" by Anthony G. Hopwood The
Accounting Review 82(5), 2007, pp.1365-1374
Organizations like the American Accounting
Association also have a role to play, not least with respect to their
presence in the field of scholarly publication. For the American
Accounting Association, I would say that now is the time for it to adopt
a leadership role in the publication of accounting research. Not only
should every effort be made to encourage The Accounting Review to
embrace the new, the innovative, what accounting research might be in
the process of becoming, and new interdisciplinary perspectives, but
this should also be done in a way that provides both a catalyst and a
model for other journals of influence. For they need encouragement, too.
While the Association has done much to embrace the need for a diversity
of gender and race, so far it has done relatively little to invest in
intellectual diversity, even though this is not only of value in its own
terms, but also an important generator of innovation and intellectual
progress. I, at least, would see this as appropriate for a learned
society in the modern era. The American Accounting Association should
set itself the objective of becoming an exemplar of intellectual
openness and thereby innovation.
"The Absence of Dissent," by Joni J.
Young, Accounting and the Public Interest 9 (1), 2009 ---
Click Here
"UNDERGRADUATE PREPARATION AND DISSERTATION METHODOLOGIES OF
ACCOUNTING PHDS OVER THE PAST 40 YEARS." by Marvin Bouillon, College of
Business Central Washington University Ellensburg and Sue Ravenscroft
College of Business Iowa State University, Global Perspectives on
Accounting Education, Volume 7, 2010, pp. 19-29 ---
http://gpae.bryant.edu/~gpae/Vol7/Academic Background of PhDs.pdf
There is a shortage of accounting faculty and
this shortage is predicted to worsen in the future. The number of new
PhDs in accounting has declined from approximately 200 per year in the
late 1980’s and early 1990’s to just over 100 per year in recent years.
Currently, we expect approximately 400 to 500 new accounting faculty
positions to open up annually over the next to five to ten years. We
believe that there has been a narrowing of the number of PhD candidates
coming from fields other than accounting and other business related
fields. If this is true, we believe that the number of accounting PhDs
could be increased and the shortage could be reduced by increasing the
number of nonaccounting/nonbusiness bachelor degree holders in
accounting PhD programs. In this study, we examined patterns in the
undergraduate majors of accounting doctorates over a forty-year time
period to determine whether there was such a narrowing and how it
related to the total number of accounting doctorates issued. We find
that the percentage of non-accounting undergraduates was highest when
the number of accounting PhDs granted annually was the highest. We also
analyze the frequency of topics and research methods used in accounting
dissertations to determine whether shifts in topics and research methods
are related to changes in the total number of accounting doctorates.
Results indicate that topics addressed and methodologies used in
dissertations have become less diverse. Thus, we could perhaps increase
the supply of accounting PhDs by expanding the applicant pool to include
undergraduates with nonaccounting/business degrees.
Jensen Comment
I think there are several major causes for the decline in doctoral graduates
in accounting. First and foremost is that accounting doctoral programs in
North America take 150% to 200% longer than doctoral degrees in the social
sciences, including economics. Second, applicants to accounting programs are
expected in most instances to have 1-5 years of accounting experience in
industry, which also adds to the time commitment relative to social science
doctorates that can more often be commenced immediately following a
baccalaureate degree.
One of the reasons accounting doctoral degrees take so long is that
they've virtually all become "accountics" doctoral programs that require
prerequisites in mathematics and statistics not typically studied in
five-year accounting programs preparing students for careers in public and
corporate accounting. More importantly many, probably most, potential
candidates for accountancy doctoral programs would like most of their
doctoral studies to be in accountancy. Instead most accountancy doctoral
courses are virtually no different than econometrics and psychometrics
doctoral programs with very little added accountancy study beyond what
students knew about accountancy when they started the long and grueling
doctoral programs.
The Alternative Model: Partnerships Between Not-for-Profit and
For-Profit Education Distance Education Ventures
The model is not new but it may become much more common as for-profit
stand-alones become more stressed by regulations and drying up markets
With budgets tight and
the commercial market flush with companies willing to take on various
tasks that come with running a university, it has become relatively
common for institutions to outsource parts of their operations to
outside companies.
It is less common for
a public university to entrust an outsider with such a wide swath of
duties that it calls that private company an equal partner in online
education. But Arizona State University
announced on Monday that it is doing just that
with Pearson, the education and media company.
Under the agreement,
the Arizona State faculty will teach online courses through Pearson’s
learning management platform, LearningStudio, using the tools embedded
in that platform to collect and analyze data in hopes of improving
student performance and retention. Pearson will also help with
enrollment management and “prospect generation," while providing more
"customer-friendly" support services for students, the university says.
Arizona State,
meanwhile, says it will retain control over all things academic,
including instruction and curriculum development.
Universities often
strike deals with private companies to manage parts of their online
operations, particularly when they are trying to quickly
grow their online enrollments, which is
Arizona State’s stated goal in this case (now serving 3,000 online
students, it hopes to grow to somewhere between 17,000 and 30,000 within
five years). Companies such as Embanet, 2Tor, SunGard Higher Education,
Bisk Education, Colloquy, and Compass Knowledge Group have, to varying
degrees, taken over online program management at other name-brand
universities in exchange for a cut of the tuition revenue.
Jensen Comment
There is obviously a spectrum of partnerships that will probably emerge. At
one end the courses are totally managed by a not-for-profit university that
only uses the for-profit partner's media delivery services. Then there might
be a move up where selected for-profit's courses are selectively brought
into the curriculum. Then there might be entire specialized programs that
are brought into the curriculum such as executive programs (non-degree) or
undergraduate pharmacy or even accounting degree programs.
The next move up the ladder would be for-profit graduate degree programs
where assessment is controlled by the not-for-profit partner. For example,
Western Governor's University now has over 10,000 students in
competency-based programs. One might imagine partnering of WGU with a
for-profit distance education MBA program where the competency assessments
and degrees are administered by WGU.
Lastly, one might envision doctoral programs, although these might come
last because they are typically money losers if they have respectability in
the market such as AACSB respectability. For example, Capella now has an
online accounting doctoral program that I view as a fraud ---
http://faculty.trinity.edu/rjensen/Crossborder.htm#CommercialPrograms
One might envision a partnering with some respected state university, such
as ASU, that greatly alters the curriculum and the assessment process and
the dissertation advising to bring Cpaella's accounting doctoral program
more in line with ASU's onsite accounting doctoral program. This off course
is probably way, way down the road.
The University of Iowa has increased its adjunct workforce (to 2,308)
by nearly10 percent this year to accommodate an influx of freshmen
Alison Sullivan, "UI increases temporary workforce, Chronicle of Higher
Education, September 8, 2010 ---
http://www.dailyiowan.com/2010/09/08/Metro/18634.html
One question is whether adjuncts are in fact
temporary. Yes, they are on a course by course contract and may not be
rehired or may choose not to teach a particular semester, but many adjuncts
teach year after year, especially those are are good teachers and are
teaching because they love it, rather than as their primary source of
income.
Given the shortage of new PhDs in accounting, what
is a school to do? We have just gone from a 3-3 to a 3-2 teaching load for
tenured faculty. Tenure track faculty generally have at least an additional
course reduction for some of the years until tenure. Yet, there are courses
that much have faculty to teach them. One action is to increase the class
size of those courses with multiple sections. But that strategy doesn't work
with courses that have only one section and are only offered once a year.
Either a full-time faculty teaches an overload course (at additional $), the
school hires an adjunct or the course isn't offered.
What other options do members of this list believe
could be done?
Pat
September 9, 2010 reply from Bob Jensen
Hi Pat,
I can’t offer any magical solutions, but it would seem that potential
adjuncts and PQ accounting faculty in NYC are much more plentiful than in
Iowa City.
In between the part-time adjunct and the tenure-track alternatives are
full-time hires under the AACSB’s PQ standards in place of AQ standards. Use
of full-time PQ faculty is becoming very popular in accounting programs. PQ
faculty are often retired technical partners from CPA firms.
http://www.aacsb.edu/publications/papers/accreditation/aq-pq-status.pdf
This is also an outlet for technically-qualified CPA firm managers that did
not make the cut for partnership status.
We may even see more and more colleges setting PQ scholarship publication
standards in place of AQ research publication standards. I think the AAA
might begin to think of more ways to serve PQ accounting faculty, including
electronic publishing outlets for scholarly papers that do not technically
qualify as research papers.
In some disciplines like nursing it is virtually impossible to hire PhDs.
Many of these disciplines have been thriving nicely with professionally
qualified scholars.
Abstract: Educating Nurses: A Call for Radical
Transformation explores the strengths and weaknesses in nursing education
and the external challenges the profession faces. It identifies the most
effective practices for teaching nursing and persuasively argues that
nursing education must be remade. Indeed, the authors call for radical
advances in the pathways to nursing licensure and a radical new
understanding of the curriculum.
Based on extensive field research conducted at a
wide variety of nursing schools, and a national survey of teachers and
students administered in cooperation with the National League for Nursing (NLN),
the American Association of Colleges of Nursing (AACN) and the National
Student Nurses’ Association (NSNA), Educating Nurses offers recommendations
to realign and transform nursing education.
The AAA's Pathways Commission Accounting Education Initiatives Make
National News
Accountics Scientists Should Especially Note the First Recommendation
Accounting programs should promote curricular
flexibility to capture a new generation of students who are more
technologically savvy, less patient with traditional teaching methods, and
more wary of the career opportunities in accounting, according to a report
released today by the
Pathways Commission, which studies the future of
higher education for accounting.
In 2008, the U.S. Treasury Department's Advisory
Committee on the Auditing Profession recommended that the American
Accounting Association and the American Institute of Certified Public
Accountants form a commission to study the future structure and content of
accounting education, and the Pathways Commission was formed to fulfill this
recommendation and establish a national higher education strategy for
accounting.
In the report, the commission acknowledges that
some sporadic changes have been adopted, but it seeks to put in place a
structure for much more regular and ambitious changes.
The report includes seven recommendations:
Integrate accounting research, education
and practice for students, practitioners and educators by bringing
professionally oriented faculty more fully into education programs.
Promote accessibility of doctoral
education by allowing for flexible content and structure in doctoral
programs and developing multiple pathways for degrees. The current path
to an accounting Ph.D. includes lengthy, full-time residential programs
and research training that is for the most part confined to quantitative
rather than qualitative methods. More flexible programs -- that might be
part-time, focus on applied research and emphasize training in teaching
methods and curriculum development -- would appeal to graduate students
with professional experience and candidates with families, according to
the report.
Increase recognition and support for
high-quality teaching and connect faculty review, promotion and tenure
processes with teaching quality so that teaching is respected as a
critical component in achieving each institution's mission. According to
the report, accounting programs must balance recognition for work and
accomplishments -- fed by increasing competition among institutions and
programs -- along with recognition for teaching excellence.
Develop curriculum models, engaging learning
resources and mechanisms to easily share them, as well as enhancing
faculty development opportunities to sustain a robust curriculum that
addresses a new generation of students who are more at home with
technology and less patient with traditional teaching methods.
Improve the ability to attract high-potential,
diverse entrants into the profession.
Create mechanisms for collecting, analyzing
and disseminating information about the market needs by establishing a
national committee on information needs, projecting future supply and
demand for accounting professionals and faculty, and enhancing the
benefits of a high school accounting education.
Establish an implementation process to address
these and future recommendations by creating structures and mechanisms
to support a continuous, sustainable change process.
According to the report, its two sponsoring
organizations -- the American Accounting Association and the American
Institute of Certified Public Accountants -- will support the effort to
carry out the report's recommendations, and they are finalizing a strategy
for conducting this effort.
Hsihui Chang, a professor and head of Drexel
University’s accounting department, said colleges must prepare students for
the accounting field by encouraging three qualities: integrity, analytical
skills and a global viewpoint.
“You need to look at things in a global scope,” he
said. “One thing we’re always thinking about is how can we attract students
from diverse groups?” Chang said the department’s faculty comprises members
from several different countries, and the university also has four student
organizations dedicated to accounting -- including one for Asian students
and one for Hispanic students.
He said the university hosts guest speakers and
accounting career days to provide information to prospective accounting
students about career options: “They find out, ‘Hey, this seems to be quite
exciting.’ ”
Jimmy Ye, a professor and chair of the accounting
department at Baruch College of the City University of New York, wrote in an
email to Inside Higher Ed that his department is already fulfilling
some of the report’s recommendations by inviting professionals from
accounting firms into classrooms and bringing in research staff from
accounting firms to interact with faculty members and Ph.D. students.
Ye also said the AICPA should collect and analyze
supply and demand trends in the accounting profession -- but not just in the
short term. “Higher education does not just train students for getting their
first jobs,” he wrote. “I would like to see some study on the career tracks
of college accounting graduates.”
Mohamed Hussein, a professor and head of the
accounting department at the University of Connecticut, also offered ways
for the commission to expand its recommendations. He said the
recommendations can’t be fully put into practice with the current structure
of accounting education.
“There are two parts to this: one part is being
able to have an innovative curriculum that will include changes in
technology, changes in the economics of the firm, including risk,
international issues and regulation,” he said. “And the other part is making
sure that the students will take advantage of all this innovation.”
The university offers courses on some of these
issues as electives, but it can’t fit all of the information in those
courses into the major’s required courses, he said.
Bob, A good place to start is to jettison
pretenses of accounting being a science. As Anthony Hopwood noted in his
presidential address, accounting is a practice. The tools of science are
certainly useful, but using those tools to investigate accounting
problems is quite a different matter than claiming that accounting is a
science. Teleology doesn't enter the picture in the sciences -- nature
is governed by laws, not purposes. Accounting is nothing but a
purposeful activity and must (as Jagdish has eloquently noted here and
in his Critical Perspectives on Accounting article) deal with values,
law and ethics. As Einstein said, "In nature there are no rewards or
punishments, only consequences." For a social practice like accounting
to pretend there are only consequences (as if economics was a science
that deals only with "natural kinds) has been a major failing of the
academy in fulfilling its responsibilities to a discipline that also
claims to be a profession. In spite of a "professional economist's"
claims made here that economics is a science, there is quite some
controversy over that even within the economic community. Ha-Joon Chang,
another professional economist at Cambridge U. had this to say about the
economics discipline: "Recognizing that the boundaries of the market are
ambiguous and cannot be determined in an objective way lets us realize
that economics is not a science like physics or chemistry, but a
political exercise. Free-market economists may want you to believe that
the correct boundaries of the market can be scientifically determined,
but this is incorrect. If the boundaries of what you are studying cannot
be scientifically determined what you are doing is not a science (23
Things They Don't Tell You About Capitalism, p. 10)." The silly
persistence of professional accountants in asserting that accounting is
apolitical and aethical may be a rationalization they require, but for
academics to harbor the same beliefs seems to be a decidedly
unscientific posture to take. In one of Ed Arrington's articles
published some time ago, he argued that accounting's pretenses of being
scientific are risible. As he said (as near as I can recall): "Watching
the positive accounting show, Einstein's gods must be rolling in the
aisles."
For example, one module you might want to add in such a syllabus is "Lean
Accounting" ---
http://maaw.info/JITMain.htm
Personally, I would probably play down 80% learning curves since the
early work on learning curves in airplane manufacturing really don't
extrapolate well to most other industries ---
http://faculty.trinity.edu/rjensen/theorylearningcurves.htm
You can, however, bring in more recent evidence on learning curves.
"Ethanol learning Curve—the Brazilian experience," by José
Goldemberga, Suani Teixeira Coelhob, Plinio Mário Nastaric, Oswaldo Lucond,
Biomass and Bioenergy, Volume 26, Issue 3, March 2004, Pages 301–304
Abstract
Economic competitiveness is a very frequent
argument against renewable energy (RE). This paper demonstrates, through
the Brazilian experience with ethanol, that economies of scale and
technological advances lead to increased competitiveness of this
renewable alternative, reducing the gap with conventional fossil fuels.
Jensen Comment
Unlike corn ethanol, sugar cane ethanol is a viable renewable energy
alternative. Corn ethanol, however, just does not get enough energy out for
the energy going into its refining. Corn ethanol can only survive on the
basis of government subsidies and tariff. If we want ethanol in our fuel, we
should shift to cane sugar ethanol production and importing rather than
raise tariff barriers against cane sugar ethanol imports.
The extent and timing of cost-reducing
improvements in low-carbon energy systems are important sources of
uncertainty in future levels of greenhouse-gas emissions. Models that
assess the costs of climate change mitigation policy, and energy policy
in general, rely heavily on learningcurves to include technology
dynamics. Historically, no energy technology has changed more
dramatically than photovoltaics (PV), the cost of which has declined by
a factor of nearly 100 since the 1950s. Which changes were most
important in accounting for the cost reductions that have occurred over
the past three decades? Are these results consistent with the notion
that learning from experience drove technical change? In this paper,
empirical data are assembled to populate a simple model identifying the
most important factors affecting the cost of PV. The results indicate
that learning from experience, theoretical mechanism used to explain
learning curves, only weakly explains change in the most important
factors—plant size, module efficiency, and the cost of silicon. Ways in
which the consideration of a broader set of influences, such as
technical barriers, industry structure, and characteristics of demand,
might be used to inform energy technology policy are discussed.
Evolution from Education to Training and Back to Education
"As Doctoral Education in Europe Evolves, Educators Meet to Chart Its
Progress," by Aisha Labi, Chronicle of Higher Education, June 6, 2010
---
http://chronicle.com/article/As-Doctoral-Education-in/65799/
Doctoral education across Europe is evolving
quickly and, even as universities shift their focus from traditional
training based largely on individual relationships to structured
programs, in-depth research must remain at the core of Ph.D. work,
educators from across Europe agreed at a two-day conference here on the
future of doctoral education in Europe.
The conference, the third annual meeting of the
European University Association's Council for Doctoral Education, came
five years after European educators, meeting in Salzburg, Austria,
agreed to a set of
10 core principles for for doctoral
education.
European higher education has undergone
profound changes since the Salzburg meeting, with nearly 50 countries
across Europe making huge strides in the past decade toward harmonizing
their university systems as part of the Bologna Process, which
culminated earlier this year in the official creation of the European
Higher Education Area.
The initial focus of many of the Bologna
reforms was on what are referred to as the first- and second-degree
cycles, resulting in bachelor's and master's degrees. Unlike the first
two cycles, the doctoral cycle is not tied to earning a set number of
credits, nor should it be, participants at the Berlin meeting agreed,
although a working declaration agreed to at the meeting's conclusion
noted that "thinking in credits could be a useful common ground for
joint programs or moving between programs."
In a period of "breathtaking transformation,"
American Ph.D. programs have served as a "loose model" for many of the
new doctoral schools that are quickly becoming the norm in European
doctoral education, noted Giuseppe Silvestri, a former rector of the
University of Palermo and a member of the steering committee of the
Council for Doctoral Education. But the advent of structured programs in
Europe does not mean that doctoral education is becoming uniform, he
emphasized, and indeed the sheer diversity of programs, including those
that span institutions in several countries or pilot programs for a
selected number of candidates at a single institution, is striking.
The American model for graduate education is
also evolving, in many cases as a result of some of the same changes
that are affecting Europe, Karen P. DePauw, a former chair of the
Council of Graduate Schools and vice president and dean for graduate
education at Virginia Tech, told the conference. As in Europe, graduate
education in American universities is taking place in an increasingly
internationalized context, with faculty members and graduate students
collaborating more with international colleagues, and with formal degree
programs involving international partner universities on the rise. The
spread of the Bologna Process has created new challenges as well, she
noted, including increased competition among programs with high numbers
of international students. Research remains at the core of the American
doctorate, but is also increasingly being incorporated much more into
master's and even undergraduate programs, she said.
Internationalization is an essential component
of quality doctoral education, Juan José Moreno Navarro, director
general for university policy at the Spanish Ministry of Education,
emphasized, because "quality research is international." The working
conclusions produced by the conference emphasized the central role of
internationalization as "a means to research capacity," and noted that
institutions need to have in place both top-down strategies to organize
international engagements but also bottom-up support from research
staffs for such collaborations.
In the United States, a Commission on the
Future of Graduate Education in the United States, organized by two
education groups, recently issued a set of recommendations for improving
graduate education, including a call for increased government financing
for graduate studies. Higher education in Europe is still largely paid
for by public subsidies, and European graduates do not struggle with the
same kinds of educational-debt burdens that their American counterparts
often face. But sustained financing for graduate studies also faces
constraints.
Seeking Professional Status Izabela
Stanislawiszyn, president of Eurodoc, an association of European
doctoral students, spoke about concerns of doctoral candidates, who want
to be seen not as students but as early-stage professionals. The
distinction is more than semantic. In most European countries, being an
employee carries benefits, such as access to pensions and career
security, that students do not enjoy. "We prefer to be treated as
professionals, not as students," she said.
Europe's 680,000 doctoral candidates represent
a "real engine of growth," Ms. Stanislawiszyn said, and much of the
conference discussion touched on their future trajectories and how
doctoral education can better prepare them for careers in academe and
beyond.
In Germany, especially, which counts for a
fourth of all European doctorates, many Ph.D. holders end up working in
industry. For many employers, graduates who have shown that they are
capable of doing the kind of intellectual "deep dig" that comes from
doctoral research are especially attractive job candidates, said Wilhelm
Krull, secretary general of Germany's Volkswagen Foundation, Germany's
largest nongovernmental backer of scientific research.
Jean Chambaz, vice president for research at
the University of Paris VI (Pierre et Marie Curie), chairs the steering
committee for the Council for Doctoral Education. He warned against a
"false dichotomy" between careers in academe and industry. "I don't
think that we remain an academic when we go from the Ph.D. to the
postdoc to an academic career," he said. "You enter an academic career,
and the Ph.D. should be considered the first step of a career, when
you're trained through the practice of research, whatever you do later
in your career."
Still, especially in a climate of increased
pressure from the governments that still provide most of the financing
for higher education to demonstrate the relevance and values of the
degrees that are being produced, focusing on the doctorate's essential
academic, research-oriented dimension is crucial, Geoffrey Boulton, a
professor of geosciences at the University of Edinburgh, emphasized.
"The ivory tower is important," he said. "It is where professors and
others are able to patrol the boundaries of what we know with a
microscope. It may seem irrelevant to others, but don't deride the ivory
tower; we have to defend it."
The conference produced a series of draft
recommendations for the progress of doctoral education in Europe that
will be distributed among member institutions for their input.
Since 1994, The PhD
Project has more than tripled the number of minority business school
professors...from 294 to over 960. These individuals are inspiring and
encouraging a new generation of business professionals. Click here to learn
more about our fifteen years of achievements, real insights on the journey
to a PhD degree and the professors who are making a big impact.
Are you ready to be
the next role model? Currently, The PhD Project has 400 minority doctoral
student members pursuing their dream. Like you, they were professionals or
recent grads satisfying their quest for a high level of achievement and
answering the call to mentor. With an expansive network of support, The PhD
Project is now helping them prepare for success in academia.
Whether you become
involved as a doctoral student, professor, participating university, or
supporting organization...just become involved. Learn more by visiting the
links on the left.
Participation in The
PhD Project is available to anyone of African-American, Hispanic American
and Native American descent who is interested in business doctoral studies.
Jensen Comment
The PhD Project commenced in the KPMG Foundation under the guidance of
Executive Partner Bernie Milano who increasingly devoted more time, money,
and sweat to raise money from other accounting firms and from corporations.
It has since expanded beyond accounting doctoral programs into other
business disciplines.
Above and beyond helping minority students get into selected doctoral
programs, Bernie has been dogged about trying every which way to see them to
the graduation day endings when a wide array colleges in literally every
part of the world are eager to hire them. These students have many more
hurdles to cross than most other doctoral students, and Bernie's Dream is to
help them across the biggest hurdles without making it any easier for them
then all other doctoral students.
Most importantly, the salting of these graduates around the world as role
models is increasingly vital to inspiring undergraduate and even K12
minority students to aspire to become practicing professionals and/or
doctoral students themselves. These role models are living proof that
Berne's Dream can become their dream.
Thank you Bernie, KPMG, and the many other accounting firms and
corporations have made Bernie's Dream come true.
Also read about the efforts of the Bill and Melinda Gates Foundation ---
Click Here
Added Jensen Rant
Often potential minority candidates for accounting doctoral programs are
CPAs. They are strong accounting candidates that are attracted to accounting
and turned off by the heavy mathematics, statistics, and econometrics years
of study in accountancy doctoral programs that have almost no accountancy.
It would help greatly if some of our leading doctoral programs would open up
paths of study other than "accountics."
Alternative study and research paths could include paths of case method
and field research. Those graduates may never publish in The Accounting
Review (which now publishes zero case and field research studies
according to the latest report of the TAR Editor), but there are research
journals that will publish case and field research studies.
My rants ad nauseum on the narrow mindedness of present accountics
doctoral programs are shown below.
Question
Will the business school faculty shortage be a thing of the past?
With expenses such as business lunches being
curtailed and a dwindling list of new clients, Wayne Nelms knew it was only
a matter of time before he would be laid off by accounting firm Grant
Thornton.
"The writing was on the wall. I just didn't know
when," says Nelms, 36, who worked as senior internal auditor at the
company's Baltimore office for two-and-a-half-years. "Then I got the
e-mail."
By January he was out of a job and found himself at
a crossroads. Reluctant to jump back into the job market immediately, he
started exploring his options and stumbled upon the PhD Project, a nonprofit
that encourages minority business professionals to earn PhDs and go on to
become professors. He'd heard of the program back when he was an MBA student
at Howard University but had put it on the back burner after graduation.
"When D-day happened, I decided, well I can do one
of two things with my future: Either get a doctorate or look for a good old
dependable job," said Nelms, who got in contact with the PhD Project. A few
weeks later he applied and was accepted to the accounting PhD program at
Morgan State University in Baltimore, Md., where he'll be starting full-time
this fall. Says Nelms: "With a doctorate, I thought my destiny would be a
little more in my control."
Nelms is part of a growing wave of professionals
who are leaving the battered business world behind for a career in the
hallowed halls of academia. Applications are up substantially this year at
many top business PhD programs, with some business schools reporting jumps
in applications as high as 40%. PhD program directors attribute the jump to
professionals fleeing a weak job market, coupled with a surge of interest
from undergraduates bypassing that job market entirely to head straight for
school.
An Encouraging Sign Meanwhile, organizations like
the PhD Project say more people than ever before are expressing interest in
their programs and annual conference, which attracted the largest number of
participants in the organization's 15-year history this fall. It's an
encouraging sign for the world of management education, where a looming
faculty shortage has had B-school deans worried for years.
The surge of interest in becoming a business
professor comes just as a backlash is being felt among those in the business
community who hold MBAs, says Yuval Bar-Or, an adjunct at Johns Hopkins
University's Carey Business School and author of Is a PhD for Me? A
Cautionary Guide for Aspiring Doctoral Students, slated for release on May
19. Many fleeing the business world for academia may view it as a more
venerable profession, he says.
"MBAs are now persona non grata in many places, and
there is a fair amount of animosity being directed at them for living in the
fast lane, spending everyone's money, and not being responsible enough,"
Bar-Or says. "So business leaders, in society's eyes, have been knocked off
a pedestal, and that may be causing a lot of people with an interest in
business to want to go down a path that is more respected in society."
Those who have been thinking about getting a PhD
are not wasting any time exploring their options. Potential PhD students
were out in full force this fall at the PhD Project's annual conference in
Chicago last November, where attendees mingled with professors and deans
from nearly 100 business schools around the country. The conference usually
attracts around 330 people, but this year 832 people applied, about 534 of
whom were invited to attend.
"This was a substantial increase. It was so big
that we were starting to worry from a budgetary standpoint about how we were
going to pay for everything and if the room and hotel was going to be big
enough," said Bernie Milano, president of the PhD Project. He expects that
interest will continue to grow. He's already received 65 applications for
next year's conference, triple the amount he usually receives by this time
of year, he says.
Continued in article
Jensen Comment
There are a number of things working against an explosion of doctoral students
in accountancy. Firstly, the traditionally large accounting doctoral programs (Illinois,
Texas, Michigan, Indiana, Florida, Wisconsin, Ohio State, etc.) have greatly
shrunk in size since their days of glory before the "accountics" revolution
commenced in the 1960s. Shrinking departmental budgets will further dry up
funding going into doctoral programs and accounting research in general.
Generosity of hard-pressed accounting firms and alumni may also shrink private
donations that are often used heavily to fund endowed chair faculty and other
needs of doctoral programs.
Secondly, many jobless accountants with high GMAT scores often have
children and financial responsibilities and will be turned off by the five-year
average time it takes to get an accounting PhD, especially for jobless
applicants who have weak and or maybe forgotten accountics
prerequisites (calculus, advanced calculus, linear algebra, mathematical
statistics, econometrics, data mining, etc.) for which few have interest in
studying for five more years of their lives. Accounting doctoral programs now
have little to do with accounting and everything to do with making graduates
scientists in econometrics, mathematics, and psychometrics --- See below!
Thirdly, virtually all colleges and universities are now being forced
to downsize in some way due to shrinking budget allocations. Recovery of these
budgets will be slow long after the current recession turns around because of
the many demands placed upon states for other priorities such as Medicare and
expanded welfare that was only temporarily shrunk by the Clinton
Administration.. While expanding entitlements for poor people, President Obama
promises to eventually reduce the Federal deficit which means more and more of
the funding burdens will fall upon state taxation. Californians are now showing
the world that taxpayers are not in the mood for higher state taxes. I do not
anticipate that the shrinking doctoral programs in accountancy will get heavy
revival funding for years to come.
Fourthly, due to shrinking budgets and explosive growth in
undergraduate accountancy programs, virtually all colleges and universities,
with blessings from the AACSB, are creating full-time faculty positions for
former practitioners who do not have accounting doctoral degrees (although many
have law degrees or doctorates in other disciplines). These faculty reduce the
demand for more expensive graduates from accountancy doctoral programs. And this
is an outlet for early retirees who are great instructors with specialized
skills (e.g., ERP, auditing, and tax) that are more in line with undergraduate
teaching curricula in accountancy undergraduate and masters programs.
The new AICPA-sponsored fellowship program for doctoral students who elect
auditing and tax will help but the number of students funded in these
professional specialties is too small to have much of an impact on filling empty
tenure track positions. The KMPG Foundation fellowships for minority students
has helped to get more African Americans into accounting doctoral programs, but
I do not anticipate great increases in this funding source. The numerical impact
of both these dedicated programs will be very small among the thousands of
accountancy education programs in the United States.
There will be substantial increases in the doctoral programs in management,
marketing, MIS, and economics. Finance is a question mark since the number of
undergraduate students majoring in finance will greatly decline due to black
hole in job opportunities for graduates in finance. With declines in
undergraduate finance majors there will be less demand for newly-minted
professors of finance. Economics will probably fare better because the fact that
economics doctoral students on average only take three years beyond a bachelors
degree to complete the doctoral program. Three-year doctorates are drawing
cards to many returning jobless graduate students who do not want to spend more
than three years earning a doctorate. And there will probably be increased
opportunities for economists in Obama's exploding Federal government.
Purportedly increasing numbers of doctoral students in economics are looking
forward to civil service careers ---
http://faculty.trinity.edu/rjensen/Bookbob1.htm#careers
I do not even know what a course in accounting
research and analysis means.
David Albrecht
Hi David,
Since you got your doctorate at a very fine university (Virginia
Tech), I assume that you are being modest for purposes of stimulating
discussion on the AECM.
A course in "accounting research" can vary across an extremely wide
range from an undergraduate course that is more like a legal and
archival research course showing students how to locate international
financial data, accounting standards, and literature to advanced accountics doctoral seminars
that typically divide a number of courses on the basis of capital
markets (econometrics) research, behavioral (psychometrics, behavioral
finance/economics), and analytical (economic modeling, game theory,
agency theory, mathematical information economics).
The term “analysis” can also mean different things, but the usual
context is mathematical analytics apart from mathematical statistical
inference and data mining. The common example is economics game theory.
Since Joel Demski became dominant in the doctoral program at the
University of Florida, Florida’s doctoral program has become a model of
an accountics doctoral program heavy on the analytical side of research.
The outline of Florida's "accountics" doctoral program is shown below.
I've highlighted in red those courses that I think fit into what would be
termed "analysis" or "analytics" courses which of course are Joel
Demski's major research interests and contributions to accountics over the
years ---
http://www.cba.ufl.edu/fsoa/docs/phd_AccConcentration.pdf
PREREQUISITES
ACCOUNTING BACKGROUND
The Program assumes that new doctoral students have
a proficiency in accounting and business similar to that of an
undergraduate accounting major. This background does not necessarily
require a formal accounting degree, so long as the student can
establish a reasonable accounting background (such as a graduate
student who has taken several accounting courses in the MBA
program). Successful applicants who do not have a sufficient
accounting background must take the MBA Accounting sequence and
Intermediate Accounting in the coursework phase of the
Ph.D. program.
QUANTITATIVE BACKGROUND
The program assumes that new doctoral students have
taken the equivalent of three semesters of calculus and one semester
of linear algebra as mathematical background. Entering accounting
Ph.D. students who do not have this background can take any
necessary courses among the following University of Florida course
offerings. We encourage students who do not meet this mathematical
background to start taking the needed courses in the summer before
starting the program (or earlier if they can take equivalent courses
before arriving in Gainesville). Students can complete any needed
mathematical courses subsequent to matriculating in the fall.
MAC 2311 (or MAC
3472) Analytic Geometry and Calculus 1 (Honors Calculus 1)
MAC 2313 (or MAC
3473) Analytic Geometry and Calculus 2 (Honors Calculus 2
MAC 2313 (or MAC
3474) Analytic Geometry and Calculus 3 (Honors Calculus 3)
MAS 4105 Linear
Algebra
STA 6329 Matrix Algebra and
Statistical computing (this most likely is partly analytical and
partly inferential)
ECO 7408
Mathematical Methods and Application to Economics
ACCOUNTING SEMINARS
All students must successfully complete the
following courses:
• Overview of
Accounting Research (first semester) 3
• Archival Research
in Accounting 3
•
Analytical
Research in Accounting 3
• Experimental
Research in Accounting 3
BUSINESS CORE COURSES
All students must
successfully complete or demonstrate that they have completed the
equivalent of the
following courses:
•
ECO 7404: Game Theory for Economists 2
• ECO 7115:
Microeconomic Theory 1 3
• ECO 7113: Information
Economics 2
• FIN 7446:
Corporate Finance 4
• FIN 7447: Asset
Pricing 2
RESEARCH METHODS CORE COURSES
All students must
successfully complete or demonstrate that they have completed the
equivalent of the
following courses:
• STA 6326:
Introduction to Theoretical Statistics I 3
• STA 6327:
Introduction to Theoretical Statistics II 3
• ECO 7424:
Econometric Methods I 3
• ECO 7426:
Econometric Methods II or 3
ECO 7415:
Statistical Methods in Economics or MAR 7636: Research Methods
in Marketing can be substituted
12
SUPPORTING FIELD
All students must
take a minimum of four graduate-level courses (12 credits) in a
supporting field, such as finance, economics, decision and
information science, mathematics, political science, psychology or
sociology.
OTHER REQUIREMENTS
1.
First
Year Summer Project – All students are required to execute a
research project in the first summer of matriculation. The first
year summer project requires students to replicate and extend, in a
minor way, a published accounting paper. The intent of this project
is to have the student explore a question, grapple with the data
collection and analysis issues, and present the findings. The
resulting paper is due no later than October 15th in the Fall
semester of the second year. The presentation to the faculty of the
first-year summer project constitutes the first year exam.
2.
Second Year Summer Project – All
students are required to execute a research project in the second
summer of matriculation. The second year project entails completing,
presenting, and submitting a paper that demonstrates original
thinking. The project is an independent scholarly effort with
faculty providing broad, informal guidance. The resulting paper must
be presented at a FSOA workshop no later than the end of the Fall
semester of the third year.
3.
Teaching Requirement – All students
are required to teach a minimum of one semester.
In addition to Joel's extensive bibliography (often in partnership with
Jerry Feltham) on accounting analytics, I'm virtually certain that a key
component in the accountics program at Florida is the "Economics of
Accounting" by Feltham and Christensen that commenced in 2002 with Volume 1
---
Click Here
At sales rank 588,703, Volume 1 was not a major money maker, which is
probably why only Volume 2 is not available from Amazon and Barnes & Noble.
The two volumes are based on lectures notes for two graduate courses on the
economic analysis of accounting information in markets and in organizations.
The first volume, focusing on markets, looks at the basic role of
information in facilitating decisions, public information and private
investor information in equity markets, and the disclosure of private owner
information in equity and product markets.
If we divided the very high cost of of one decade of Florida's
accountancy doctoral program by 11, the cost per graduate is very high
indeed. Of course many of the costs are joint costs among the business
administration doctoral program graduates in the various disciplines in
Florida's School of Business.
I did not so much answer your question David as I did point the way
on where to look.
Although I'm all in favor of having some accountics programs (that
require a high level of mathematics, econometrics/psychometrics, and
mathematical statistics as well as data mining skills), I'm very
disappointed that such programs took over all accountancy doctoral
programs in North America (with the possible exception of the University
of Central Florida and Kennesaw State University).
The accountics monopoly is, in my viewpoint, the major cause of the
extreme shortage of accounting doctoral graduates, because potential
applicants from the accounting profession who would like to teach
accounting are turned off by having to spend five years or more studying
mathematics, econometrics, psychometrics, game theory, agency theory,
mathematical information economics, etc. Sadly there is now almost no
accounting in the accountics doctoral programs, especially accounting
needed to teach professional courses in financial accounting, tax, and
auditing at the undergraduate and masters degree levels. Knowledge
needed for teaching in those areas must be acquired before entering
accounting doctoral programs.
June 21, 2010 message from accounting doctoral student Bergner, Jason M
[jason.bergner@uky.edu]
Bob,
I’ve just been turned on to your web site about
accounting, accountics, and teaching. I will continue to read but am very
interested so far. I recently had a piece published in Journal of
Accountancy on entering Ph.D. programs. I didn’t know if you knew of it
and/or would consider adding it to your site.
I just returned from the Tahoe conference where I
was besieged with “accountics” work and the pressure to get published in the
top journals. I’ve always been curious about the “other side” of this story.
I think your site is beginning to shed some light on this.
Thanks.
Jason
Jason Bergner
Doctoral Candidate
Office 355 MM
Douglas J. Von Allmen School of Accountancy
Gatton School of Business & Economics
University of Kentucky
June 21, 2010 reply from Bob Jensen
Hi Jason,
Since the Journal of Accountancy article is free to the world, I don’t
see a need to copy parts of it into my Website. However, I will publish a
link to your fine work (somewhat of a tribute to Dan Stone as well) and
recommend that they carefully read the article at
http://www.journalofaccountancy.com/Web/PursuingaPhDinAccounting
The fact that you were a mathematics teacher probably gave you a leg up
in an accountics doctoral program.
Students with no business studies background (other than a basic
accounting course) can complete the program in 2.5 years part time or
slightly less than 2 years full-time.
the Capella accounting PhD curriculum is more like an MBA
curriculum and is totally unlike any other accounting PhD program in
North America. There are relatively few accounting courses and much less
focus on research skills.
There are no comprehensive or oral examinations. The only
requirements 120 quarter credits, including credits to be paid for a
dissertation
I'm still trying to learn whether there is access to any kind of
research library or the expensive financial databases that are required
for other North American accounting doctoral programs..
Even in lean times, the $400 billion business
of higher education is booming. Nowhere is this more true than in one of
the fastest-growing -- and most controversial -- sectors of the
industry: for-profit colleges and universities that cater to
non-traditional students, often confer degrees over the Internet, and,
along the way, successfully capture billions of federal financial aid
dollars.
In College, Inc., correspondent
Martin Smith investigates the promise and
explosive growth of the for-profit higher education industry. Through
interviews with school executives, government officials, admissions
counselors, former students and industry observers, this film explores
the tension between the industry --which says it's helping an
underserved student population obtain a quality education and marketable
job skills -- and critics who charge the for-profits with churning out
worthless degrees that leave students with a mountain of debt.
At the center of it all stands a vulnerable
population of potential students, often working adults eager for a
university degree to move up the career ladder. FRONTLINE talks to a
former staffer at a California-based for-profit university who says she
was under pressure to sign up growing numbers of new students. "I didn't
realize just how many students we were expected to recruit," says the
former enrollment counselor. "They used to tell us, you know, 'Dig deep.
Get to their pain. Get to what's bothering them. So, that way, you can
convince them that a college degree is going to solve all their
problems.'"
Graduates of another for-profit school -- a
college nursing program in California -- tell FRONTLINE that they
received their diplomas without ever setting foot in a hospital.
Graduates at other for-profit schools report being unable to find a job,
or make their student loan payments, because their degree was perceived
to be of little worth by prospective employers. One woman who enrolled
in a for-profit doctorate program in Dallas later learned that the
school never acquired the proper accreditation she would need to get the
job she trained for. She is now sinking in over $200,000 in student
debt.
The biggest player in the for-profit sector is
the University of Phoenix -- now the largest college in the US with
total enrollment approaching half a million students. Its revenues of
almost $4 billion last year, up 25 percent from 2008, have made it a
darling of Wall Street. Former top executive of the University of
Phoenix
Mark DeFusco told FRONTLINE how the company's
business-approach to higher education has paid off: "If you think about
any business in America, what business would give up two months of
business -- just essentially close down?" he asks. "[At the University
of Phoenix], people Go to school all year round. We start classes every
five weeks. We built campuses by a freeway because we figured that's
where the people were."
"The education system that was created hundreds
of years ago needs to change," says
Michael Clifford, a major education
entrepreneur who speaks with FRONTLINE. Clifford, a former musician who
never attended college, purchases struggling traditional colleges and
turns them into for-profit companies. "The big opportunity," he says,
"is the inefficiencies of some of the state systems, and the ability to
transform schools and academic programs to better meet the needs of the
people that need jobs."
"From a business perspective, it's a great
story," says
Jeffrey Silber, a senior analyst at BMO
Capital Markets, the investment banking arm of the Bank of Montreal.
"You're serving a market that's been traditionally underserved. ... And
it's a very profitable business -- it generates a lot of free cash
flow."
And the cash cow of the for-profit education
industry is the federal government. Though they enroll 10 percent of all
post-secondary students, for-profit schools receive almost a quarter of
federal financial aid. But Department of Education figures for 2009 show
that 44 percent of the students who defaulted within three years of
graduation were from for-profit schools, leading to serious questions
about one of the key pillars of the profit degree college movement: that
their degrees help students boost their earning power. This is a subject
of increasing concern to the Obama administration, which, last month,
remade the federal student loan program, and is now proposing changes
that may make it harder for the for-profit colleges to qualify.
"One of the ideas the Department of Education
has put out there is that in order for a college to be eligible to
receive money from student loans, it actually has to show that the
education it's providing has enough value in the job market so that
students can pay their loans back," says Kevin Carey of the Washington
think tank Education Sector. "Now, the for-profit colleges, I think this
makes them very nervous," Carey says. "They're worried because they know
that many of their members are charging a lot of money; that many of
their members have students who are defaulting en masse after they
graduate. They're afraid that this rule will cut them out of the
program. But in many ways, that's the point."
FRONTLINE also finds that the regulators that
oversee university accreditation are looking closer at the for-profits
and, in some cases, threatening to withdraw the required accreditation
that keeps them eligible for federal student loans. "We've elevated the
scrutiny tremendously," says Dr. Sylvia Manning, president of the Higher
Learning Commission, which accredits many post-secondary institutions.
"It is really inappropriate for accreditation to be purchased the way a
taxi license can be purchased. ...When we see any problematic
institution being acquired and being changed we put it on a short
leash."
Also note the comments that follow the above text.
Interesting program. I saw the first half of it
and was not surprised by anything, other than the volume of students.
For example, enrollment at University of Phoenix is 500,000. Compare
that to Arizona State's four campuses with maybe 60,000 to 70,000. The
huge computer rooms dedicated to online learning were fascinating too.
We've come a long way from the Oxford don sitting in his wood paneled
office, quoting Aristotle, and dispensing wisdom to students one at a
time. The evolution: From the pursuit of truth to technical training to
cash on the barrelhead. One question about the traditional university
though -- When they eliminate the cash flow from big time football, will
they then be able to criticize the dash for cash by the educational
entrepreneurs?
Paul Bjorklund, CPA
Bjorklund Consulting, Ltd.
Flagstaff, Arizona
I wonder if the Secretary of Education watched the College Inc
Frontline PBS show? I doubt it!
"Duncan Says For-Profit Colleges Are Important to Obama's 2020 Goal,"
By Andrea Fuller," by Andrea Fuller, Chronicle of Higher Education, May 11,
2010 ---
http://chronicle.com/article/Duncan-Says-For-Profit/65477/
Arne Duncan, the secretary of education,
expressed support on Tuesday for the role that for-profit colleges play
in higher education at a policy forum here held by DeVry University.
For-profit institutions have come under fire
recently for their low graduation rates and high levels of student debt.
A Frontline documentary last week focused on the for-profit sector, and
a speech by Robert Shireman, a top Education Department official, was
initially reported as highly critical of for-profit colleges, even
though a transcript of Mr. Shireman's remarks showed that he actually
spoke more temperately.
Mr. Duncan said on Tuesday in a luncheon speech
at the forum that there are a "few bad apples" among actors in the
for-profit college sector, but he emphasized the "vital role" for-profit
institutions play in job training.
Those colleges, he said, are critical to
helping the nation achieve President Obama's goal of making the United
States the nation with the highest portion of college graduates by 2020.
Mr. Duncan also praised a partnership between DeVry and Chicago high
schools that allows students to receive both high-school and college
credit while still in high school.
Mr. Duncan's comments come at a time when
for-profit college officials are anxiously awaiting the release of new
proposed federal rules aimed at them. A proposal that would tie college
borrowing to future earnings has the sector especially concerned.
The rule is not yet final, but the Education
Department is considering putting a cap on loan payments at 8 percent of
graduates' expected earnings based on a 10-year repayment plan and
earnings data from the Bureau of Labor Statistics.
Supporters of for-profit colleges say the rule
would basically force them to shut down educational programs and as a
consequence leave hundreds of thousands of students without classes.
PBS broadcast a
documentary on for-profit higher education
last week, titled College, Inc. It begins with the slightly
ridiculous figure of
Michael Clifford, a former cocaine abuser
turned born-again Christian who never went to college, yet makes a
living padding around the lawn of his oceanside home wearing sandals and
loose-fitting print shirts, buying up distressed non-profit colleges and
turning them into for-profit money machines.
Improbably, Clifford emerges from the
documentary looking OK. When asked what he brings to the deals he
brokers, he cites nothing educational. Instead, it's the "Three M's:
Money, Management, and Marketing." And hey, there's nothing wrong with
that. A college may have deep traditions and dedicated faculty, but if
it's bankrupt, anonymous, and incompetently run, it won't do students
much good. "Nonprofit" colleges that pay their leaders executive
salaries and run
multi-billion dollar sports franchises have
long since ceded the moral high ground when it comes to chasing the
bottom line.
The problem with for-profit higher education,
as the documentary ably shows, is that people like Clifford are applying
private sector principles to an industry with a number of distinct
characteristics. Four stand out. First, it's heavily subsidized.
Corporate giants like the University of Phoenix are now pulling in
hundreds of millions of dollars per year from the taxpayers, through
federal grants and student loans. Second, it's awkwardly regulated.
Regional accreditors may protest that their imprimatur isn't like a
taxicab medallion to be bought and sold on the open market. But as the
documentary makes clear, that's precisely the way it works now.
(Clifford puts the value at $10-million.)
Third, it's hard for consumers to know what
they're getting at the point of purchase. College is an experiential
good; reputations and brochures can only tell you so much. Fourth—and I
don't think this is given proper weight when people think about the
dynamics of the higher-education market—college is generally something
you only buy a couple of times, early in your adult life.
All of which creates the potential—arguably,
the inevitability—for sad situations like the three nursing students in
the documentary who were comprehensively ripped off by a for-profit
school that sent them to a daycare center for their "pediatric rotation"
and left them with no job prospects and tens of thousands of dollars in
debt. The government subsidies create huge incentives for for-profit
colleges to enroll anyone they can find. The awkward regulation offers
little in the way of effective oversight. The opaque nature of the
higher-education experience makes it hard for consumers to sniff out
fraudsters up-front. And the fact that people don't continually purchase
higher education throughout their lives limits the downside for bad
actors. A restaurant or automobile manufacturer that continually screws
its customers will eventually go out of business. For colleges, there's
always another batch of high-school graduates to enroll.
The Obama administration has made waves in
recent months by proposing to tackle some of these problems by
implementing "gainful
employment" rules that would essentially
require for-profits to show that students will be able to make enough
money with their degrees to pay back their loans. It's a good idea, but
it also raises an interesting question: Why apply this policy only to
for-profits? Corporate higher education may be the fastest growing
segment of the market, but it still educates a small minority of
students and will for a long time to come. There are plenty of
traditional colleges out there that are mainly in the business of
preparing students for jobs, and that charge a lot of money for degrees
of questionable value. What would happen if the gainful employment
standard were applied to a mediocre private university that happily
allows undergraduates to take out six-figure loans in exchange for a
plain-vanilla business B.A.?
The gainful employment standard highlights some
of my biggest concerns about the Obama administration's approach to
higher-education policy. To its lasting credit, the administration has
taken on powerful moneyed interests and succeeded. Taking down the FFEL
program was a historic victory for low-income students and reining in
the abuses of for-profit higher education is a needed and important
step.
Continued in article
Jensen Comment
The biggest question remains concerning the value of "education" at the
micro level (the student) and the macro level (society). It would seem that
students in training programs should have prospects of paying back the cost
of the training if "industry" is not willing to fully subsidize that
particular type of training.
Education is another question entirely, and we're still trying to resolve
issues of how education should be financed. I'm not in favor of "gainful
employment rules" for state universities, although I think such rules should
be imposed on for-profit colleges and universities.
What is currently happening is that training and education programs are
in most cases promising more than they can deliver in terms of gainful
employment. Naive students think a certificate or degree is "the" ticket to
career success, and many of them borrow tens of thousands of dollars to a
point where they are in debtor's prisons with their meager laboring wages
garnished (take a debtor's wages on legal orders) to pay for their business,
science, and humanities degrees that did not pay off in terms of career
opportunities.
But that does not mean that their education did not pay off in terms of
life's fuller meaning. The question is who should pay for "life's fuller
meaning?" Among our 50 states, California had the best plan for universal
education. But fiscal mismanagement, especially very generous unfunded
state-worker unfunded pension plans, has now brought California to the brink
of bankruptcy. Increasing taxes in California is difficult because it
already has the highest state taxes in the nation.
Student borrowing to pay for pricey certificates and degrees is not a
good answer in my opinion, but if students borrow I think the best
alternative is to choose a lower-priced accredited state university. It will
be a long, long time before the United States will be able to fund
"universal education" because of existing unfunded entitlements for Social
Security and other pension obligations, Medicare, Medicaid, military
retirements, etc.
I think it's time for our best state universities to reach out with more
distance education and training that prevent many of the rip-offs taking
place in the for-profit training and education sector. The training and
education may not be free, but state universities have the best chance of
keeping costs down and quality up.
I teach a class for our
MAcc program titled Accounting Policy and Research, although it is
mainly the former. With respect to the latter, I introduce the students
to the FASB Codification and they do three major cases that I develop
that involve having to research financial accounting issues and prepare
reports for a CFO or Partner based on the results of their research.
Needless to say, the cases involve issues where there are no clear cut
answers and the students must use the Codification, the concepts
statements, and practical examples of what other companies have done in
somewhat similar situations. I also insist that their reports comment on
related audit, tax, and broader business issues and not be limited to
just what they believe to be the "correct" GAAP answer.
Denny Beresford
October 18, 2009 reply
from Bob Jensen
First I want to point out
that the FASB Codification database is now
included in Comperio such that if your college gets
access to Comperio, you may not need the AAA site license. Also the IASB
library is included in Comperio such that no added purchases in
international licenses is required. Of course Comperio a very
comprehensive research library and costly accounting research library
---
http://www.pwc.com/gx/en/comperio/index.jhtml
Whether your
company reports under US GAAP, IFRS, or both, Comperio's recently
enhanced functionality offers you the ability to navigate both sets of
financial reporting requirements using one accounting research tool.
That tool gives you access to the same PwC interpretive guidance our own
professional audit staff uses.
If you can see
this page, you can use Comperio—there’s no software to install: just Go
to the Comperio Web site and start researching! Content covers the FASB,
EITF, AICPA, IASB, IFAC, PCAOB, SEC, FASAB and GASB, as well as the
requirements of eight key countries from around the world. Plus, we've
added the FASB’s new Accounting Standards Codification, which was
launched in July 2009 as the single source of authoritative US
accounting standards.
If the course on “accounting
research” is to be much like a law school course on “legal research,” it
should focus on where to find answers. Denny suggested, among other
things, teaching students how to use the FASB Codification database.
As an extension, I recommend
teaching students how to use PwC’s Comperio Virtual Library of
Accounting Research ---
http://www.pwc.com/gx/en/comperio/index.jhtml
The biggest problem is the cost of a multi-user site license, although
at Trinity University our program was so small that we could teach some
of the basics with a single-user site license (which is not restricted
to a given user, but does restrict the use to one user at a time).
Such a course could also
include some tax research if the tax courses are finding it cumbersome
to teach both tax and tax research. Your college probably already has at
least one tax research license such as CCH.
Since it is so common in the
profession to use search engines, perhaps some attention could be given
to “how scholars conduct searches” ---
http://faculty.trinity.edu/rjensen/Searchh.htm#Scholars
Most definitely the above link should be studied by doctoral students.
However, undergraduates might also learn some of the basics of scholarly
search.
Three years after World War II drew to a close,
a young professor at MIT published "Foundations of Economic Analysis."
Its mathematical approach to economics would revolutionize the
profession. And its author, Paul Samuelson, would go on to earn many
awards and honors, culminating in 1970, when he won the Nobel Prize in
economics—the second year it was awarded. Samuelson died on Sunday at
the age of 94.
His influence has been profound, but the
mathematization of economics has been a mixed blessing. The downside is
that the math hurdle in leading U.S. economics programs is now so high
that people who grasp the power of economic concepts to explain human
behavior are losing out in the competition to mathematicians.
The upside is that Samuelson sometimes used
math to resolve issues that had not been resolved at a theoretical level
for decades. As fellow Nobel laureate Robert Lucas of the University of
Chicago said in a 1982 interview, "He'll take these incomprehensible
verbal debates that go on and on and just end them; formulate the issue
in such a way that the question is answerable, and then get the answer."
For instance, Swedish economist Bertil Ohlin
had argued that international trade would tend to equalize the prices of
factors of production. Trade between, say, India and the United States
would narrow wage-rate differentials between the two countries.
Samuelson, using mathematical tools, showed the conditions under which
the differentials would be driven to zero: It's called the Factor Price
Equalization Theorem.
He contributed fundamental insights in consumer
theory and welfare economics, international trade, finance theory,
capital theory, general equilibrium and macroeconomics. In finance
theory, which he took up at age 50, Samuelson did some of the initial
work that showed that properly anticipated futures prices should
fluctuate randomly.
Economists had long believed that there were
goods that would be hard for the private sector to provide because of
the difficulty of charging those who benefit from them. National defense
is one of the best examples of such a good. In the 1954 Review of
Economics and Statistics, Samuelson gave a rigorous definition of a
public good that is still standard in the literature.
"Let those who will write the nation's laws if
I can write its textbooks," Samuelson said during a speech at Trinity
University in San Antonio, Texas. He revised his own widely read
textbook, "Economics," about every three years since 1948. One of the
best and punchiest statements in the 1970 edition was his comment about
a proposal to raise the minimum wage from its existing level of $1.45 an
hour to $2.00 an hour: "What good does it do a black youth to know that
an employer must pay him $2.00 an hour if the fact that he must be paid
that amount is what keeps him from getting a job?"
This is the kind of comment that causes many on
the left to grit their teeth; and yet Samuelson was a liberal Keynesian
and the best-known rival of the late libertarian monetarist, Milton
Friedman. The two men respected each other highly, but the intellectual
influence was mainly one way. Over time, Samuelson came more to
Friedman's views, especially on monetary policy.
In the 1948 edition of his textbook, Samuelson
wrote dismissively, "few economists regard Federal Reserve monetary
policy as a panacea for controlling the business cycle.'' But in the
1967 edition, he wrote that monetary policy had "an important
influence'' on total spending. In the 1985 edition, Samuelson and
co-author William Nordaus (of Yale) would write, "Money is the most
powerful and useful tool that macroeconomic policymakers have,'' and the
Fed "is the most important factor'' in making policy.
Paul Samuelson began teaching at the
Massachusetts Institute of Technology in 1940 at the age of 26 and
remained there, publishing on average almost one technical paper a month
for over 50 years. In addition to the Nobel Prize, he also earned the
John Bates Clark Award in 1947, awarded for the most outstanding work by
an economist under age 40. He was president of the American Economic
Association in 1961.
Samuelson, like Milton Friedman, had a regular
column in Newsweek (from 1966 to 1981). Unlike Friedman, he did not have
a passionate belief in free markets—or, for that matter, in government
intervention in markets. His pleasure seemed to come from providing new
proofs, demonstrating technical finesse, turning a clever phrase, and
understanding the world better.
But not always. Samuelson had an amazingly tin
ear about communism. As early as the 1960s, economist G. Warren Nutter
at the University of Virginia had done empirical work showing that the
much-vaunted economic growth in the Soviet Union was a myth. Samuelson
did not pay attention. In the 1989 edition of his textbook, Samuelson
and William Nordhaus wrote, "the Soviet economy is proof that, contrary
to what many skeptics had earlier believed, a socialist command economy
can function and even thrive."
Although I was never a fan of Samuelson's
textbook, an appendix on futures markets in a late 1960s edition laid
out beautifully how the profit motive in futures markets causes
reallocation from times of relative plenty to future times of relative
scarcity. In 1990 I asked him to do an article on futures markets for
"The Fortune (now "Concise") Encyclopedia of Economics." He replied
quickly that he did not have time and ended graciously, "My loss."
Professor Henderson is a research fellow with Stanford
University's Hoover Institution and an economics professor at the Naval
Postgraduate School in Monterey, Calif. He is editor of "The Concise
Encyclopedia of Economics" (Liberty Fund, 2008.)
As Southern Mississippi, having almost no majors in accounting, seriously
contemplates dropping its Economics Department, the following article is
critical of what has happened in economics and in particular doctoral programs
in accounting.
Gone was the accounting history course that exposed
students to market failures and the importance of the evolution of
accounting traditions and standards in the evolution of business and
financial contracting.. In their place: mathematically-oriented courses
devoid of any historical content or context. … In the mid 1980s the
accountics community discovered it could use mathematics to restrict entry
into accounting doctoral programs.
Most US economists believe globalization is good. The
unfettered flow of goods, labor, and intellectual capital across our
international borders reduces costs and improves competitiveness of most sectors
of the economy. … Foreign students increasingly dominate US doctoral programs in
economics. Although the number of doctorates has remained relatively stable ove
the past 35 years, the fraction of these degrees conferred on foreign students
has increased dramatically–from 20.5 percent in 1972 to 72 percent in 2005. …
The best and the brightest? Perhaps. Most PhD candidates in economics are
Asians–from Japan, Korea, India, and China, and Taiwan. … But there is one
problem: while the Asians are whizzes at math, they generally do not speak
English well. Had they been high-schoolers, remedial English classes would have
been mandatory for most of them. … Gone was the history of economic thought.
Gone was the economic history course that exposed students to market failures
and the importance of psychological factors–what Keynes dubbed ‘animal spirits’–
to a prosperous economy. In their place: mathematically-oriented courses devoid
of any historical content or context. … In the mid 1980s the financial community
discovered it could use mathematics to make money
"A Rant On 'Economathematicians," Simoleon Sense, August 17, 2009 ---
http://www.simoleonsense.com/a-rant-on-economathematicians/
“Research should be problem driven rather than methodologically driven," said
Lisa Garcia Bedolla, a member of the task force who teaches at the University of
California at Berkeley. See Below
Assignment
Download the following document into a word processor, click on "Edit, Replace,"
and replace "political science" with "accounting" and see how much of it rings
true.
There will
be differences. Undergraduate accounting courses are not as
statistical/mathematical as many undergraduate political science courses.
Undergraduate accounting courses and textbooks are largely driven by the CPA
examination content. In political science there is no such overriding
certification process. For example, when my daughter took her first political
science course for a general education major at the University of Texas (she was
a biology major), the instructor adopted a game theory textbook that really had
very few political science examples --- it was a game theory book. Turns out
that he was a doctoral student in political science and was studying game theory
himself at the same time.
Consider this story: A political science department has a senior thesis program
and has attracted a group of engaged undergraduates to pursue research projects
that excite them. Then the department's professors have a fight and
traditionalists take over supervision of the senior thesis program and "turn it
into a statistical methods course." Many students, because the projects that
drew them to the program had been wiped out, dropped out. The professor who told
the story didn't name his college, but judging from the reaction here at the
annual meeting of the American Political Science Association, the story rang
true as something that could have taken place at many colleges and universities.
The anecdote came after a presentation Thursday by a special task force of the
association, appointed to consider how the discipline should reshape itself --
in just about everything, including the undergraduate curriculum, the evaluation
of faculty members and the subjects considered for research. The panel is about
halfway through a two-year process to create a report on "political science in the 21st century,"
and used the association's annual meeting to share some of the ideas it is
considering. The ideas include changing the way introductory courses are
generally taught, shifting how graduate students are trained so they aren't
being prepared only for research university jobs that are hard to come by, and
making relevance (in courses and research) a key issue.
“Research should be problem driven rather than methodologically driven," said
Lisa Garcia Bedolla, a member of the task force who teaches at the University of
California at Berkeley.
Calls to make political science more relevant and less methodological are not
new. In 2000, an anonymous e-mail calling the association and its leading
journals out of touch and dominated by methodology set off a "perestroika"
movement within the discipline (so called because of the pen name of the author
of the e-mail and his not-so-subtle comparison of the discipline to the end days
of the Soviet Union). The rallying cry of that movement was "methodological
diversity."
That appears to be a major part of the way the new task force views political
science. But the new reform effort is also very much about diversity in American
society and colleges' student bodies -- which is notably not matched by the
profession -- and how political science should change to reflect that diversity.
And the vision of those on the task force is as much about teaching as it is
about research.
Manuel Avalos of the University of North Carolina at Wilmington said that
introductory courses typically try to cover bits of all of the "subfields" of
political science -- an approach that may make sense for a traditional
undergraduate at an elite college, who wants to Go to graduate school and earn a
doctorate. "But that is not how an undergraduate who is not going to graduate
school views the world," he said. "How are we making this relevant to them?"
Another notable difference between this movement and the one that started the
decade is that this one has backing from association leaders. The task force was
created by Dianne Pinderhughes, the past president and a political scientist at
the University of Notre Dame. The perestroika movement was very much from
outsiders trying to have some influence (many say that they did, although many
also say not enough).
Here are some of the issues raised Thursday -- not as final or even draft
recommendations, but as concepts that the committee is exploring:
·
The real world. A theme of several of the panel members was that students sign
up for political science courses because they want to understand what's going on
around them, not because they want theory. "We have to emphasize the connections
between the real world and the discipline," said Sherri Wallace of the
University of Louisville. Several also noted that by failing to offer such
material, political science risks losing students. Terri Givens, co-chair of the
panel and a professor at the University of Texas at Austin (who does work on
comparative political systems), said she is worried about "the rise of
international studies and international relations" (operating outside of
political science). "Students are looking for what they think is international
relations and they often don't find it in political science," she said.
·
A true commitment to teaching. Members of the task force said that the
discipline is dominated by an ethos that research is the most important thing
and that research universities represent the key model for careers. "We are a
bit elitist," said Wallace. Even if political scientists believe that research
careers are the ultimate goal, several panelists noted that there are not nearly
as many jobs at such institutions as there are at regional state universities or
community colleges, and they suggested graduate programs should change to
prepare people for jobs that they may actually get. "Most people do not get jobs
at Research I institutions. They can't," said Juan Carlos Huerta of Texas A&M
University at Corpus Christi. The contrast between the association's annual
meeting and its annual conference on teaching, they noted, isn't just in the
subject matter, but who attends. At this week's gathering in Toronto, the big
names are from research universities and many teaching oriented professors don't
bother to attend.
·
A broader research agenda. At a time when the student body is increasingly
diverse, and issues of global inequities are front and center, several said that
a much more diverse research agenda is needed -- with more attention to pressing
social and political problems. Bedolla of Berkeley said that the discipline's
focus on the state and state institutions has led the discipline to study those
in power, at the expense of looking at those without power. Further, Givens said
it was important for political scientists to be more willing to embrace other
disciplines. She mentioned as an example an area she follows in European
politics. German politicians, having studied the Internet techniques used by
Barack Obama in his campaign, are now being surprised that they aren't as
effective in Germany. Givens said that to understand why, political scientists
need not just their own ideas, but knowledge about social networks and new
media.
·
Understanding the tradeoffs of reform ideas. Luis R. Fraga of the University of
Washington, co-chair of the task force, stressed that solutions to these issues
are not simple. For example, he said that one idea about reforming graduate
education might be to have doctoral programs create specific programs for those
interested in teaching careers. But if that were take place, Fraga said, "I
wonder which of our graduate students would be quickly tracked into teaching and
teaching institutions, and whether that would exacerbate issues associated with
access and inclusion," leaving a white male cohort to focus on research.
Behind all these and other questions, Fraga said, is a desire by the task force
to promote a more rigorous analysis of many of the assumptions that go into how
political scientists operate. Fraga said that the traditional ways of operating
aren't necessarily wrong, but that adhering to them without evidence is. The
profession, he said, "needs to be more self-reflective."
"We think it is important to ask more of those of us in the profession about
whether we are doing the best job we can," he said. "To often, we just follow
elements of whatever the dominant thinking has been."
All is Not Well in Modern Languages Education
Proposal to integrate languages with literature, history, culture, economics and
linguistics
Proposal to use fewer adjuncts who now teach language courses
The MLA created a special committee in 2004 to study the future of language
education andits report,
being issued today
(May 24, 2007)
is in many ways unprecedented for the association in that it is urging
departments to reorganize how languages are taught and who does the teaching. In
general, the critique of the committee is that the traditional model has started
with basic language training (typically taught by those other than tenure-track
faculty members) and proceeded to literary study (taught by tenure-track faculty
members). The report calls for moving away from this “two tiered” system,
integrating language study with literature, and placing much more emphasis on
history, culture, economics and linguistics — among other topics — of the
societies whose languages are being taught.
Scott Jaschik, Inside Higher Ed, May 24, 2007 ---
http://insidehighered.com/news/2007/05/24/mla
Who Teaches First-Year Language Courses?
Rank
Doctoral-Granting Departments
B.A.-Granting Departments
Tenured or tenure-track professors
7.4%
41.8%
Full-time, non-tenure track
19.6%
21.1%
Part-time instructors
15.7%
34.7%
Graduate students
57.4%
2.4%
All is Not
Well in Programs for Doctoral Students in Departments/Colleges of Education
The education doctorate, attempting to serve dual purposes—to prepare
researchers and to prepare practitioners—is not serving either purpose well. To
address what they have termed this "crippling" problem, Carnegie and the Council
of Academic Deans in Research Education Institutions (CADREI) have launched the
Carnegie Project on the Education Doctorate (CPED), a three-year effort to
reclaim the education doctorate and to transform it into the degree of choice
for the next generation of school and college leaders. The project is
coordinated by David Imig, professor of practice at the University of Maryland.
"Today, the Ed.D. is perceived as 'Ph.D.-lite,'" said Carnegie President Lee S.
Shulman. "More important than the public relations problem, however, is the real
risk that schools of education are becoming impotent in carrying out their
primary missions to prepare leading practitioners as well as leading scholars."
"Institutions Enlisted to Reclaim Education Doctorate," The Carnegie Foundation
for Advancement in Teaching ---
http://www.carnegiefoundation.org/news/sub.asp?key=51&subkey=2266
The EED
does not focus enough on research, and the PhD program has become a social
science doctoral program without enough education content. Middle ground is
being sought.
Partly the
problem is the same as with PhD programs in colleges of education.
The pool of accounting doctoral program applicants is drying up, especially
accounting doctoral program pool that is increasingly trickle-filled with
mathematically-educated foreign students who have virtually no background in
accounting. Twenty years ago, over 200 accounting doctoral students were being
graduated each year in the United States. Now it's less than one hundred
graduates per year, many of whom know very little about accounting, especially
U.S. accounting. This is particularly problematic for financial accounting, tax,
and auditing education requiring knowledge of U.S. standards, regulations, and
laws.
Accounting
doctoral programs are social science research programs that do not appeal to
accountants who are interested in becoming college educators but have no
aptitude for or interest in the five or more years of quantitative methods study
required for current accounting doctoral programs.
There were only 29 doctoral students in auditing and 23 in tax out of the 2004
total of 391 accounting doctoral students enrolled in years 1-5 in the United
States.
The answer here it seems to me is to open doctoral programs to wider humanities
and legal studies research methodologies and to put accounting back into
accounting doctoral programs.
Partly the
problem is the same as with “two-tiered” departments of modern languages
The huge shortage of accounting doctoral graduates has bifurcated the teaching
of accounting. Increasingly, accounting, tax, systems, and auditing courses are
taught by adjunct part-time faculty or full-time adjunct faculty who are not on
a tenure track and often are paid much less than tenure-track faculty who teach
graduate research courses.
The short run answer here is difficult since there are so few doctoral graduates
who know enough accounting to take over for the adjunct faculty. If doctoral
programs open up more to accountants, perhaps more adjunct faculty will enter
the pool of doctoral program prospects. This might help the long run problem.
Meanwhile as former large doctoral programs (e.g., at Illinois, Texas, Florida,
Indiana, Wisconsin, and Michigan) shrink more and more, we’re increasingly
building two-tier accounting education programs due to increasing demand and
shrinking supply of doctoral graduates in accountancy.
We’re becoming more and more like “two-tier” language departments in our large
and small colleges.
Practitioners in education schools generally are K-12 teachers and school
administrators. In the case of accounting doctoral programs, our dual mission is
to prepare college teachers of accountancy as well as leading scholars. Our
accounting doctoral programs are drying up (less than 100 per year now
graduating in the United States, many of whom know virtually no accounting)
primarily because our doctoral programs have become five years of social science
and mathematics concentrations that do not appeal to accountants who might
otherwise enter the pool of doctoral program admission candidates.
Note that
the above Carnegie study also claims that education doctoral programs are also
failing to "prepare researchers." I think the same criticism applies to current
accountancy doctoral programs in the United States. We're failing in our own
dual purpose accountancy doctoral programs and need a concerted effort to become
a "degree of choice" among the accounting professionals who would like to move
into academe in a role other than that of a low-status and low-paid adjunct
professor.
In the
United States, following the Gordon/Howell and Pierson reports, our accounting
doctoral programs and leading academic journals bet the farm on the social
sciences without taking the due cautions of realizing why the social sciences
are called "soft sciences." They're soft because "not everything that can be
counted, counts. And not everything that counts can be counted."
Leading
academic accounting research journals commenced accepting only esoteric papers
with complicated mathematical models and trivial hypotheses of zero interest to
accounting practitioners ---
http://faculty.trinity.edu/rjensen/395wpTAR/Web/TAR395wp.htm
Accounting
doctoral programs made a concerted effort to recruit students with mathematics,
economics, and social science backgrounds even though these doctoral candidates
knew virtually nothing about accountancy. To compound the felony, the doctoral
programs dropped all accounting requirements except for some doctoral seminars
on how to mine accounting data archives with econometric and psychometric models
and advanced statistical inference testing.
I cannot
find the exact quotation in my archives, but some years ago Linda Kidwell
complained that her university had recently hired a newly-minted graduate from
an accounting doctoral program who did not know any accounting. When assigned to
teach accounting courses, this new "accounting" professor was a disaster since
she knew nothing about the subjects she was assigned to teach.
In the
year following his assignment as President of the American Accounting
Association Joel Demski asserted that research focused on the accounting
profession will become a "vocational virus" leading us away from the joys of
mathematics and the social sciences and the pureness of the scientific academy:
Statistically there are a few youngsters who came to academia for the joy of
learning, who are yet relatively untainted by the
vocational virus.
I urge you to nurture your taste for learning, to follow your joy. That is the
path of scholarship, and it is the only one with any possibility of turning us
back toward the academy. Joel
Demski,
"Is Accounting an Academic Discipline? American Accounting Association Plenary
Session" August 9, 2006 ---
http://bear.cba.ufl.edu/demski/Is_Accounting_an_Academic_Discipline.pdf
When Professor Beresford attempted to publish his remarks, an Accounting
Horizons referee’s report to him contained the following revealing reply
about “leading scholars” in accounting research:
1. The paper provides specific recommendations for things that accounting
academics should be doing to make the accounting profession better. However
(unless the author believes that academics' time is a free good) this would
presumably take academics' time away from what they are currently doing. While
following the author's advice might make the accounting profession better, what
is being made worse? In other words, suppose I stop reading current academic
research and start reading news about current developments in accounting
standards. Who is made better off and who is made worse off by this reallocation
of my time? Presumably my students are marginally better off, because I can tell
them some new stuff in class about current accounting standards, and this might
possibly have some limited benefit on their careers. But haven't I made my
colleagues in my department worse off if they depend on me for research advice,
and haven't I made my university worse off if its academic reputation suffers
because I'm no longer considered a leading scholar? Why does making the
accounting profession better take precedence over everything else an academic
does with their time? As
quoted in Jensen (2006a) ---
http://faculty.trinity.edu/rjensen//theory/00overview/theory01.htm#AcademicsVersusProfession
Number of Doctoral Students Graduating Per Year: History Versus
Accounting Disciplines
Since the accounting job market is faring relatively well in the current job
market, we expect an explosion in the number of students seeking to major in
accounting.
Job ads in history during this past school year
were down 30 to 35 percent over the previous year. There were 343 U.S.
history job ads on
H-Net between Aug 15,
2007 to May 15, 2008 and 241 during the 2008-2009 school year. Similarly,
the number of H-Net job ads in European history fell from 226 in 2007-2008
to 150 in 2008-2009. The current recession has apparently returned our
profession to
hiring levels of the 1990s.
My latest tabulations from the
AHA’s dissertation directory indicates that we may
have hit a new record. There are now 4,094 history dissertations in
progress. This represents a
23
percent increase in the last 30 months.
As of two years ago,
about only 800 individuals were graduating annually from history doctoral
programs. If history repeats itself, a large proportion of ABD students
will try to avoid graduating during the recession and
the job market will pick back up about two years
after the recession ends. So if you are planning on graduating next year,
don’t expect to easily find work. Let’s just hope
we don’t have
a repeat of the early 1970s.
I don’t want to end this post on a discouraging
note. I think those of us who are willing to retool, rethink our goals, and
pick up new skill sets will have an advantage in this new landscape.
Federal appropriations, for history
and across the board, are on the rise. This will boost the number of
jobs in public history. The
recommitment to science and research in this country will likely
accelerate the transition to
digital methods in history and
the humanities.
I have decided to explore some of these
non-traditional avenues for historical practice. I hope some of you will
join me. We just might be able to change our profession in the process.
Jensen Comment
The current estimate is that slightly over 100 accountancy doctoral students in
the U.S. per year which compares with about 800 in the discipline of history.
Even in the best of job market years, I suspect a higher proportion (relative to
accountancy) of history doctoral graduates do not seek tenure track college
careers. A significant proportion aspire to be book authors and seek careers
other forms of scholarly authorship.
How many doctoral students are at the dissertation stage in accounting?
I don't know a source for the answer to this question. Jim Hasselback
estimates that 30-35% of accounting doctoral students do not complete the
programs ---
http://www.jrhasselback.com/AtgDoct/FAQs.pdf
Hmm...- wasn't it Yuji Ijiri who was reported as
claiming in a not-too-recent paper in Accounting Horizons that, as a
student, one of his most interesting courses (in Accounting Theory ? I can't
remember exactly) had been devoted entirely to a novel by Thomas Carlyle
entitled Sartor Resartus (The Tailor Retailored) ? And that of all the
courses he had taken, it was this course which he had found most stimulating
and thought-provoking? (The Accounting Horizons paper was a piece on the
thoughts of several high profile accounting academics of which Ijiri was
one).
I think that Denis Rancourt crosses the line
between academic freedom and idiosyncrasy for idiosyncracy's' sake. At the
same time, the case may remind us that academic freedom generally gives us a
fair amount of rope to play with if we so choose.
Thomas Carlyle's major work, Sartor Resartus
(meaning 'The tailor re-tailored'), first published as a serial in
1833-34, purported to be a commentary on the thought and early life of a
German philosopher called Diogenes Teufelsdröckh (which translates as
'god-born devil-dung'), author of a tome entitled "Clothes: their Origin
and Influence." Teufelsdröckh's Transcendentalist musings are mulled
over by a skeptical English editor who also provides fragmentary
biographical material on the philosopher. The work is, in part, a parody
of Hegel, and of German Idealism more generally.
Roger Collins
TRU School of Business
February 10, 2009 reply from Bob Jensen
Hi Roger,
Ijiri brings up Sartor
Resartus (free download) at
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=305904
“I took a
philosophical "accounting seminar" as an undergraduate in Japan, in which we
spent the entire course on Thomas Carlyle's (1896) Sartor Resartus ("Tailor Retailored"). Here, we went
over the philosophy of clothes and the indispensable role that clothes play in
society, treating accounting also as indispensable clothes people wear, change
and discard. Nearly a half-century later, it is still having impact on my
thinking.”
Professor Ijiri served on my doctoral
studies committee when we were both at Stanford years ago. He never mentioned
Sartor Resartus at the time.
Some Thoughts
on the Intellectual Foundations of Accounting
Joel S. Demski
University of Florida - Fisher School of Accounting
Abstract:
We
report on a panel discussion at the 2001 CMU Accounting Mini-conference under
the title "Intellectual Foundations of Accounting." We provide a background and
the motivation for the discussion and present the remarks by the four panelists.
A number of perspectives are taken. Sunder emphasizes dualities in accounting.
Demski stresses the endogeneity of accounting measurement activities. Fellingham
examines the core and superstructure of accounting. Ijiri observes the
microcosmos in accounting and its philosophical connection. We also argue that
accounting's intellectual foundations are far from settled and an on-going
discussion is likely to help reinvigorate accounting scholarship
Many thanks for this. The paper you've so kindly
attached was one that annoyed me somewhat when I first read it, as I thought
that the major contributors (Demski, Sunder, Fellingham and Ijiri) were
taking rather narrowly defined positions and perhaps rather resting on their
laurels. I took the attached paper to a couple of minor conferences but
never seriously thought of having it published. If you - or anyone else on
AECM - feels inclined either to critique it or comment on its suitability
for publication at this distance in time from the original paper, I'd
welcome any responses.
Roger
Roger Collins
TRU School of Business
February 11, 2009 reply from Bob Jensen
Hi Roger,
Your critique is great for openers. It just does not go
far enough with regard to the destructiveness of the search for
"intellectual foundations" in accountancy. Since the "Perfect Storm" of the
late 1950s and 1960s, academic accountants from Mattesich to Demski to
Zimmerman became
prophets of destructive
positivism. The leading academic
accounting research centers literally ignored the warnings of Bob Sterling,
Steve Zeff, and others about the destructive evolution of this so-called
"intellectualism" of academic accounting research. You can read more about
this "Perfect Storm" at ---
http://faculty.trinity.edu/rjensen/395wpTAR/Web/TAR395wp.htm
By "destructive" I mean that the leading academic
accounting research centers, journals, and doctoral programs virtually all
adopted a mathematical model building paradigm without caring that the world
of information, executive decision making, and portfolio investment behavior
within and external to a business organization is far too complex for most
models to have much utility to either decision makers or standard setting
bodies around the world. The result was to divert our best and brightest
accounting academic researchers into superficial worlds where they could get
their intellectual highs while financial and managerial accounting
professions themselves had to carry on without much of any contribution of
merit from the accounting academy. A good example is Ijiri's promising cash
flow equivalency model which on paper looked like it would revolutionize
accounting information systems and financial analysis. But implicit inside
the model is a hypersensitivity to parameter estimation error that washed
out all relevance of the model. This is why very few people on the AECM
listserv even heard about this model. Certainly it was never relevant to the
FASB or General Electric.
About the same time, the same thing commenced to take
place in the search for intellectual foundations of science intended to
raise the world of science to new heights in intellectualism. This so-called
"philosophy of science" intended to bring about intellectual sophistication
in scientific effort. Leading universities commenced to offer philosophy of
science courses and even majors in philosophy of science. Unlike in leading
academic accounting research centers, the science research centers learned
quickly that this intellectualization of science was not adding much if any
value to science. Instead it was sometimes getting in the way of science.
Quietly, these centers dropped most of their philosophy of science courses,
journals, and study itself. Scientists just got on with their work without
allowing themselves to be destroyed by
positivism. This is not to say that
there was not some basic values that evolved in the philosophy of science.
It's constraints on science just should not be taken too far.
Paul Feyerabend argued that no description of
scientific method could possibly be broad enough to encompass all the
approaches and methods used by scientists. Feyerabend objected to
prescriptive scientific method on the grounds that any such method would
stifle and cramp scientific progress. Feyerabend claimed, "the only
principle that does not inhibit progress is: anything goes."[28]
However there have been many opponents to his theory. Alan Sokal and
Jean Bricmont wrote the essay "Feyerabend:
Anything Goes" about his belief that science
is of little use to society.
By way of example, since Joel Demski took charge of the accounting
doctoral program at the University of Florida, every applicant to that
doctoral program cannot even matriculate into the program before
pre-requisites of advanced mathematics are satisfied.
Students are required to demonstrate math
competency prior to matriculating the doctoral program. Each student's
background will be evaluated individually, and guidance provided on ways
a student can ready themselves prior to beginning the doctoral course
work. There are opportunities to complete preparatory course work at the
University of Florida prior to matriculating our doctoral program.
University of Florida Accounting Concentration
---
http://www.cba.ufl.edu/fsoa/docs/phd_AccConcentration.pdf
Accordingly the University of Florida's doctoral
program puts up a wall blocking doctoral program applicants with research
skills other than mathematics. What Florida's biomedical research center put
up the same barriers requiring advanced mathematics to be allowed into any
of its doctoral programs?
Probably the major shortcoming of our model builders in
academic accounting research centers is their indifference to risk and risk
management. What leading accounting research center has experts on
derivative financial instruments and the complex contracting that evolved in
derivative instrument practice and frauds? I would really like to know since
I'm contacted almost weekly by business firms and news reporters seeking
accounting professors who are experts in FAS 133 and its amendments.
When coming to terms with this during the evolution of
FAS 133, what accounting professor in the world made a noteworthy
contribution to the FASB struggling to learn how to report these contracts?
Where are the papers on derivative financial instruments and their massive
frauds when you scour the literature of TAR, JAR, and JAE in the 1960s,
1970s, 1980s, and 1990s when all the derivative financial instruments frauds
were taking place. I provide a timeline of these frauds and the evolution of
FASB and IASB standards without citing a single noteworthy research paper
appearing in our leading academic accounting research journals ---
http://faculty.trinity.edu/rjensen/FraudRotten.htm#DerivativesFrauds
Joel Demski
steers us away from the clinical side of the accountancy profession by
saying we should avoid that pesky “vocational virus.” (See below).
The (Random House) dictionary defines "academic"
as "pertaining to areas of study that are not primarily vocational or
applied , as the humanities or pure mathematics." Clearly, the short answer
to the question is no, accounting is not an academic discipline. Joel Demski, "Is Accounting an Academic Discipline?" Accounting
Horizons, June 2007, pp. 153-157
Statistically there are a few youngsters who
came to academia for the joy of learning, who are yet relatively untainted
by the vocational virus.
I urge you to nurture your taste for learning, to follow your joy. That is
the path of scholarship, and it is the only one with any possibility of
turning us back toward the academy. Joel Demski, "Is Accounting an Academic Discipline? American
Accounting Association Plenary Session" August 9, 2006 ---
http://faculty.trinity.edu/rjensen//theory/00overview/theory01.htm
Too many
accountancy research programs have immunized themselves against the
“vocational virus.” The resulting problem is that
we’ve been neglecting the clinical needs of our profession. Perhaps
the real underlying reason is that our clinical problems are so immense that
academic accountants quake in fear of having to make contributions to the
clinical side of accountancy as opposed to the clinical side of finance,
economics, and psychology.
Demski’s (1973) article, ‘‘The
General Impossibility of Normative Accounting Standards,’’ reinforced
academic reluctance to weigh in on how practice ‘‘ought’’ to proceed. What
quantitative, management accountants read into Demski’s article was that the
accounting standard-setting process was hopelessly and inevitably pointless—
impossible, even—and that it did not deserve any further effort from them.
Academicians began backing off from involvement in standard setting, which
caused further separation of teaching from research, but also exacerbated
the separation of research from practice. In fact, polls revealed that the
most quantitative journals—thus, those least accessible to
practitioners—were perceived to have the highest status in the academy
(Benjamin and Brenner 1974).
Glenn Van Wyhe, "A History of U.S. Higher Education in Accounting, Part II:
Reforming Accounting within the Academy," Issues in Accounting Education,
Vol. 22, No. 3 August 2007, Page 481.
I most certainly did not question Professor Hughes'
standing as an academic. I was just questioning if this sort of research is
really accounting or finance. I am not opposed to this sort of research at
all, and in fact do read it occasionally.
Neither am I saying this line of research should
not be pursued by accountants. As some one from a campus-wide
interdisciplinary PhD program, I view any such strictures as infringing on
academic freedom. Almost all of my own research the past few years has been
very much outside (yet extremely relevant to) accounting, but most
accounting departments in the US thoroughly discourage any sort of research
other than the likes of those in the video.
However, why is it that this sort of research is
glorified (and privileged) in academic accounting AT THE EXPENSE of many
other kinds of research (especially when the space in the so-called quality
journals in accounting is limited)?
Also, since this is really research in finance, do
the academics in finance read it? Does this sort of research in accounting
get any sort of peer review from academic researchers in finance?
Jagdish Gangolly (gangolly@csc.albany.edu)
Department of Informatics,
College of Computing & Information
State University of New York at Albany
1400 Washington Avenue, Albany NY 12222 Phone: 518-442-4949
February 12, 2009 reply from Bob Jensen
Hi Jagdish,
I hate to keep harping on this, but if our
“scientific” capital markets and behavioral studies published in leading
accounting research journals had any genuine relevance, readers would demand
replications. Readers don’t have any interest in replications and the
leading accounting research journals won’t even publish replications ---
http://faculty.trinity.edu/rjensen/theory01.htm#Replication
That’s the main difference between real science and accounting’s so-called
science.
If you read an article in TAR, JAR, JAE, CAR, etc.
you must make a leap of faith that the authors did not make a mistake in
data collection and data analysis. Our leading research studies are assumed
to be error free. It’s either that or the publications have so little
relevance that nobody cares. Imagine that!
You asked whether academics in finance (and
accordingly economics) find much value added in finance/economics studies
published in accounting research journals.
In her Presidential
Message at the AAA annual meeting in San Francisco in August, 2005, Judy
Rayburn addressed the low citation rate of accounting research when
compared to citation rates for research in other fields. Rayburn
concluded that the low citation rate for accounting research was due to
a lack of diversity in topics and research methods:
Accounting research is different from other
business disciplines in the area of citations: Top-tier accounting
journals in total have fewer citations than top-tier journals in
finance, management, and marketing. Our journals are not widely cited
outside our discipline. Our top-tier journals as a group project too
narrow a view of the breadth and diversity of (what should count as)
accounting research.
Rayburn [2006, p. 4] ---
http://faculty.trinity.edu/rjensen/395wpTAR/Web/TAR395wp.htm
Publication in top-tier journals is the primary
criterion for promotion at many business schools and a strong influence on
salary, teaching load, and research support. Business schools evaluate
publication records by comparing the quality and quantity of top-tier
research articles to those of peers within the same discipline (intradisciplinary)
and to those of academics from other business disciplines
(interdisciplinary). An analytical model of the research review process (the
q-r model) predicts that interdisciplinary differences exist in the
standards that top-tier journals use for accepting articles. If true,
decision makers should consider these differences. I examine the period from
1980 to 1999 and, consistent with the model's predictions, find that
significant differences exist in the number of articles and proportion of
faculty who published in the "major" journals in accounting, finance,
management, and marketing. Most notably, top-tier accounting journals
publish substantially fewer major articles than journals in the other three
business disciplines. In addition, I find the proportion of doctoral faculty
publishing a major article has declined in all four disciplines over the
1980 to 1999 period.
I think one key difference between accounting and
the related disciplines of finance, marketing, and management is that
practitioners in those professions (e.g., former investment bankers,
bankers, marketing executives, and some management executives) actually make
use of leading academic journals in their disciplines and cite them in their
own writings in professional non-academic journals. The Journal of
Finance became so esoteric that it was not serving the majority of
instructors of finance. This gave rise to the exceedingly popular Financial
Management Association (FMA) among finance faculty and the generally
readable journals called Financial Management and the Journal of
Applied Finance.
Probably the main difference, however, is that the
majority of instructors in accounting stopped even looking at the leading
accounting research journals like TAR, JAR, and JAE. Once the
practitioner-oriented and teaching-oriented articles were steered from TAR
to AH and IAE, readership in TAR plummeted. You can read the following at
http://faculty.trinity.edu/rjensen/395wpTAR/Web/TAR395wp.htm
Fleming et al. [2000, p. 48]
report that education articles in TAR declined from 21 percent in 1946-1965
to 8 percent in 1966-1985. Issues in Accounting Education began to
publish the education articles in 1983. Garcha, Harwood, and Hermanson
[1983] reported on the readership of TAR before any new specialty journals
commenced in the AAA. They found that among their AAA membership
respondents, only 41.7 percent would subscribe to TAR if it became unbundled
in terms of dollar savings from AAA membership dues. This suggests that TAR
was not meeting the AAA membership’s needs. Based heavily upon the written
comments of respondents, the authors’ conclusions were, in part, as follows
by Garcha, Harwood, and Hermanson [1983, p. 37]:
The findings of
the survey reveal that opinions vary regarding TAR and that emotions run
high. At one extreme some respondents seem to believe that TAR is performing
its intended function very well. Those sharing this view may believe that
its mission is to provide a high-quality outlet for those at the
cutting-edge of accounting research. The pay-off for this approach may be
recognition by peers, achieving tenure and promotion, and gaining mobility
should one care to move. This group may also believe that trying to affect
current practice is futile anyway, so why even try?
At the other extreme are those who believe that TAR is not
serving its intended purpose. This group may believe TAR should serve the
readership interests of the audiences identified by the Moonitz Committee.
Many in the intended audience cannot write for, cannot read, or are not
interested in reading the Main Articles which have been published during
approximately the last decade. As a result there is the suggestion that this
group believes that a change in editorial policy is needed.
We surmise that some
professionals in accounting who have no aptitude or interest in becoming
scientists refrain from enrolling in current accounting doctoral programs
due to the narrowness of most accounting doctoral programs and the lack of
other epistemological and ontological methods more to their liking. New
evidence suggests that this problem also extends Go topical concentrations
of those who do enter doctoral programs. In a study of the critical shortage
of doctoral students in accountancy, Plumlee et al. [2006] discovered that
there were only 29 doctoral students in auditing and 23 in tax out of the
2004 total of 391 accounting doctoral students enrolled in years 1-5 in the
United States. We might add that the authors of the article were all
appointed in 2004 by American Accounting Association President Bill Felix to
an ad hoc Committee to Assess the Supply and Demand for Accounting Ph.D.s.
Plumlee et al. [2006, p. 125] wrote as follows (emphasis added as we think
it relates to accountics):
The Committee believes the dire shortages in tax and audit areas
warrant particular focus. One possible solution to these specific
shortages is for PhD. Programs to create new tracks targeted toward
developing high-quality faculty specifically in these areas. These
tracks should be considered part of a well-rounded Ph.D. program in
which students develop specialized knowledge in one area of accounting,
but gain substantive exposure to other accounting research areas . . .
A possible explanation for the shortages in these areas is that PhD.
Students perceive that publishing audit and tax research in top
accounting journals is more difficult, which might have the unintended
consequence of reducing the supply of PhD.-qualified faculty to teach in
those specialties.Given that promotion and
tenure requirements at major universities require publication in
top-tier journals, students are likely drawn to financial accounting in
hopes of getting the necessary publications for career success. While
the Committee has no evidence that bears directly on this point, it
believes that the possibility deserves further consideration.
A number of AAA presidents have asserted that empirical
research is not always well suited for “discovery research.” These AAA
presidents urged in their messages to the membership and elsewhere that
accounting research become more diverse in terms of topics and methods.
Examples include Bailey [1994], Langenderfer [1987], Rayburn [2006], and
Dyckman and Zeff [1984]. The following is a quote from the President’s
Message of Sundem [1993, p. 3]:
Although empirical scientific method has made many positive
contributions to accounting research, it is not the method that is
likely to generate new theories, though it will be useful in testing
them. For example, Einstein’s theories were not developed empirically,
but they relied on understanding the empirical evidence and they were
tested empirically. Both the development and testing of theories should
be recognized as acceptable accounting research.
In fairness, the new TAR Editor is listening to our
complaints and is inviting the accounting academy to submit more diverse
articles to TAR (including commentaries, survey-based studies, AIS-method
studies, and (gasp) case studies. Thus far, however, the professors in the
leading doctoral programs are not heeding the call. It’s pretty much same old,
same old in all of our leading academic research journals.
I received the following message from a staff member of
the FASB. I altered it slightly to keep it anonymous.
Hi Bob,
As you know, after 16 years in the corporate world,
I spent over (XX) years teaching as a non-tenure track, non PhD in
accounting. Several times during my stay in academia, i investigated PhD
programs in accounting. Each time i found the mathematical requirements to
be distasteful. Precious few programs actually included courses in
accounting or current FASB/IASB practice issues and those who did still did
so sparingly. I could not see myself, at advanced age and experience,
subjecting myself to several year of extremely low pay and distasteful (to
me) study. What joy is there in producing "research" that includes heavy
statistical analysis that nobody outside a very small circle of researchers
looking for citations will ever read? There certainly would have been no
time or encouragement to pursue relevant topics like XBRL.
While I at the FASB, I see first hand the low
esteem members of academia held inside FASB. Not once did I hear a staff
member indicate that they would be calling a professor to ask an opinion on
an accounting issue. I'm sure some did, but they were quiet about it. I also
did not see any academic journals in the bookcases of FASB staff members.
The library held copies of the top level journals but it was as rare
occasion indeed when the library sent a notice to staff alerting them to a
new accounting journal article. In contrast, Accounting Today, CFO magazine,
Wall Street Journal, The Times, New York Times and the news services that
produced digests of current accounting issues were in daily their reads.
XXXXX
A Small But Important Step in Breaking the Accountics
Stranglehold on Accountancy Doctoral Programs
"A Profession's Response to a Looming Storage:
(sic, I think
they meant shortage): Closing
the Gap in the Supply of Accounting Faculty," by Michael Ruff, Jay C. Thibodeau,
and Jean C. Bedard, Journal of Accountancy, March 2009 ---
http://www.journalofaccountancy.com/Issues/2009/Mar/AccountingFaculty.htm
The website for the ADS program is
http://www.adsphd.org/
. The list of participating institutions is at
http://www.adsphd.org/participatingschools.asp
Doyle Williams is chairing this effort. He has been
strong in holding the line, saying, for example, that if a student starts in
auditing and tax and then decides to switch to financial accounting, they
must give up their scholarship. Of course, the reality is that capital
markets research can be applied to many decision frames and the centrifugal
forces are so strong that we will see:
1) Students using capital markets approaches to
study auditing (think audit fees) or tax
2) Switching to largely financial accounting, capital markets research
after graduation
Having said that, I think this will apply to only a
minority (albeit a significant minority) of students. It was a great
experience to interact with other faculty and potential students in December
last year. I think we can see this effort as an important first step in
righting the listing ship of accounting academia.
Quality
remains high in the second batch of future accounting Ph.D.s
participating in the Accounting Doctoral Scholars (ADS) program, say
program officials.
Thirty
applicants for enrollment in fall 2010 were selected to receive the
program’s annual stipend of $30,000 for up to four years while pursuing
a doctorate in accounting with an emphasis in auditing or tax. The
process began with 99 applicants, of whom 60 were invited to meet with
program and university officials Nov. 9, 2009, in Chicago. The group was
then further winnowed to 30. All those interviewed, however, had
attractive credentials, and as a whole, the group seemed well-equipped
for training future generations of accountants, organizers said.
“It was very
strong,” said Steve Matzke, manager of the program for the AICPA, of the
latest crop of scholars. “The university representatives, particularly,
were very pleased with the quality of candidates.”
In addition,
27 participants from the program’s first year are continuing their
studies.
The Institute
co-sponsors the ADS program with more than 70 of the nation’s largest
accounting firms, 41 colleges and universities and 40 state CPA
societies. The program aims to create 120 additional Ph.D.s in
accounting by 2016 and has raised more than $17 million to support that
goal.
“The program
in year one has already exceeded what we expected,” said Denny Reigle,
AICPA director of academic and career development and secretary of the
AICPA Foundation, which administers the program.
Particularly encouraging was the depth of public accounting experience
in tax and auditing among the latest crop of candidates, Reigle said.
Besides having such experience, applicants must be U.S. citizens or
permanent residents committed to a career in teaching and research in
auditing or tax.
The FMA (and its main journals (Financial Management and the
Journal of Applied Finance) was formed at a time when the American
Finance Association (and its Journal of Finance) was deemed too
esoteric in mathematical economics and growing out of touch with the
industry of finance. Some would argue today that the quants are also taking
over the FMA, but that's a topic I will leave to the membership of the FMA.
Finance practitioners have generally been more respectful of their quants
than accounting practitioners are respectful of their quants in academia.
One simple test would be to ask some random practitioners to name ten quants
who have had an impact on industry. Finance practitioners could probably
name ten (e.g., Markowitz, Modigliani, Arrow, Sharp, Lintner, Merton,
Scholes, Fama, French, etc.). Accounting practitioners could probably only
name one or two from their alma maters at best and then not because of
awareness of anything practical that ever came out of accountics.
Note that major research university salaries considerably higher than
average while salaries in many private universities are much lower as are
salaries in state universities that are not flagship research universities. The
results for accounting and taxation new assistant professors primarily reflects
the downward trend of doctoral graduates in accounting, auditing, and taxation
in the past two decades ---
http://faculty.trinity.edu/rjensen/theory01.htm#DoctoralPrograms
The Annual
AACSB salary
survey is the definitive source for business school faculty salaries. Here's
the most important table from the report - it shows the mean salaries for
new doctorates for the major business disciplines
The figures
above are
for 9-month salaries. At research schools, summer research support can add
another 10-20% to that, and there are also opportunities to pick up
additional $$ teaching over the summer. However, at teaching oriented
schools, there typically isn't summer
support,
and summer teaching money is also much lower.
For years, Finance professors got the highest salaries across all business
disciplines. That's changed in the last few years, with accounting salaries
pulling ahead. The increase in accounting new-hire salaries is likely due to
smaller numbers of accounting
PhD's being
graduated and a lot of retirements in their field. But still, $120K isn't
bad.
Click
here for the free executive summary (you can also
get the full report, but it'll cost you).
My ex-President (a brilliant scholar of American
constitutional law, he died in a swimming accident a few years ago) Kermit
Hall once said that if you don't like teaching, you should be a banker or
something else. As our President, he taught an undergraduate course in
history each semester. He insisted that all the Deans teach a course every
semester; didn't make him popular.
We should not forget that, at the well-known
English universities such as Oxford and Cambridge, in the not too distant
past, faculty and dons were not to marry if they wished to retain their
position, lest they acquire acquisitive (or comparative?) instinct.
I would never encourage any student to take to
academics to get rich. In fact, I think business schools have been
thoroughly corrupted because of this constant talk of opportunity costs of
alternative employment. Fortunately this economic virus is not as rampant at
other units at most universities I know.
On the other hand, as a profession, I think one
should not be in teaching unless you also have practiced the profession. Any
day, I would have a mid-career or retired professional teaching me than a
PhD who has never seen real-world accounting and who has learnt the
profession from faculty who have themselves never seen real-world
accounting.
The shortage of accounting faculty is contrived by
us to protect our wages. If opportunity costs are high, why not ask faculty
to produce evidence of such opportunities if they demand higher wages? Or
still better, how about asking tenured faculty to produce evidence of such
alternative practice opportunities to retain their tenure? For most faculty
these days, such opportunities are ethereal more than real.
I gave up a lucrative career in industry when I
took the vow of poverty years ago, and have never regretted it. Early in my
academic career, lack of material possessions irritated me, but have learnt
not to compare me to any others, especially my good old friends in industry
rolling in riches.
Jagdish Gangolly
(gangolly@csc.albany.edu )
Department of Informatics,
College of Computing & Information
State University of New York at Albany
1400 Washington Avenue, Albany NY 12222 Phone: 518-442-4949
February 20, 2009 reply from Bob Jensen
Hi Jagdish,
You wrote:
"The shortage of accounting faculty is contrived by us
to protect our wages."
I agree with most of what you said above. However, I don’t think the
decline in accountancy doctoral graduates over the past two decades was
contrived in any kind of conspiracy to create barriers to entry for purposes
of higher salaries. The causes of accounting PhD shortages are many and
complicated, but none of them were intended to make accounting professors
the highest paid professors in the academy.
Part of the cause of a shortage was the increase in demand for accounting
professors. When the big firms commenced adding internships to senior
accounting majors, accounting became much more popular as an undergraduate
major. The professorial supply just did not increase with this demand.
One of the main causes of a shortage of accountancy PhDs is the
time-to-degree. A top economics undergraduate can get a PhD in economics in
seven years of college. The same is possible in finance, marketing, and
management. Law school typically takes three years after obtaining an
undergraduate degree.
In accounting we now require 150 credits to take the CPA examination, so
most of our graduates now get a masters degree with almost no courses in for
academic research. If a statistics course is required it generally has a
coloring book for a textbook.
In addition our doctoral programs prefer to admit candidates with work
experience in accountancy. So now we’re talking six or more years before
admitting a doctoral student. Then students week in mathematics, statistics,
econometrics, and psychometrics take about two years of such courses.
Students who manage to get admitted without much accounting, often foreign
students, take about two years of undergraduate accounting. Then there’s the
additional time for doctoral seminars in accounting research, financial
research, and behavioral research. All told a doctoral program in
accountancy takes at least five years and often six years. What is six years
plus five years? That is just a minimum. Most of our accounting professors
today probably did not complete their accountancy PhD degrees before they
were almost 30 years old except for the oldsters who did not have to earn
150 credits to sit for the CPA examination along the way.
BYU recognized this problem and created a masters degree program for
students who are pretty certain that they want to eventually be admitted to
a doctoral program. The BYU masters program won an AAA Innovation in
Accounting Education annual award. This masters program is intended to
provide students with the research course prerequisites for doctoral studies
such that the time in a doctoral program should, in theory, be reduced to
three years. You can read about BYU’s award winning PhD Prep Program at
http://phdprep.byu.edu/index.php?title=Main_Page
If students has a sufficient amount of accountancy as undergraduates, that
can also take the CPA examination with this masters degree.
Another barrier to entry in accountancy doctoral programs is that the
accountics research professors hijacked the prestigious doctoral programs
and all the other doctoral programs in North America thought that it was
necessary to clone the accountancy doctoral programs at Chicago, Stanford,
Rochester, Cornell, Northwestern, Illinois, Texas, USC, UCLA, and
Cal-Berkeley. Hence all accountancy programs became highly mathematical
social science programs in mathematics, econometrics, and psychometrics.
Practicing CPAs who contemplate returning to a university for an accountancy
PhD are frequently turned off by having to get a social science PhD in the
name of accountancy/accountics. I’ve already written much about this problem
at
http://faculty.trinity.edu/rjensen/theory01.htm#DoctoralPrograms
The bottom line is that I don’t think that the decline in the number of
accountancy doctoral graduates in North America was contrived for purposes
of keeping accounting professor salaries high. The decline was caused by
lengthening the time to the CPA (150 credits), a desire for work experience
for doctoral program admission, and upping the requirements for mathematics,
statistics, econometrics, and psychometrics if virtually all North American
doctoral programs in accountancy.
There are of course other factors to be considered. Accounting careers in
CPA firms and corporations became increasingly attractive. For example, all
the Big Four accounting firms now place in the top ten organizations as
desirable places to work. CPA firms in particular strived to become more
accommodating to parents who seek more time to care for children. In the age
of networking, more and more clients can be served from work at home. Hence,
many accounting workers are less frustrated on the job and are less inclined
to give up five or more years of their lives in a doctoral program.
Business school graduates in non-accounting specialties often have more
trouble getting jobs. Even in the Wall Street boom times, most graduates in
finance could not get plumb jobs on Wall Street and had to settle for
less-than-exciting local bank jobs or become stock brokers living on
commission income. Those graduates were more inclined to come back to
college for doctorates in economics, finance, marketing, management, and
MIS. Some regretted later on that they had not been accounting majors.
It’s tough late in life to come back and take all those accounting
undergraduate courses to get back on track in accounting. But Finley Graves
did it after becoming a PhD in German Literature. He then took the time and
trouble to earn a second PhD in Accounting and is now a terrific accounting
professor.
The KPMG Foundation is marking the 15th anniversary
of its Minority Accounting Doctoral Scholarship program by announcing today it
has awarded a total of $390,000 in scholarships to 39 minority doctoral scholars
for the 2009 - 2010 academic year.
Of the awards, eight are to new recipients scheduled
to begin their accounting doctoral program this fall, three are to new
recipients who have already begun programs, and 28 are renewals of scholarships
previously awarded.
Each of the scholarships is valued at $10,000 and
renewable annually for a total of five years. The Foundation established the
scholarship program in 1994 as part of its ongoing efforts to increase the
number of minority students and professors in business schools – and has since
awarded $8.7 million to minorities pursuing doctorate degrees.
“We’re proud of the achievements of our program over
the last 15 years, and we have seen a healthy increase in the number of minority
faculty members at our nation’s business schools, although more work needs to be
done,” said Bernard J. Milano, President of the KPMG Foundation and The PhD
Project. “That’s why we continue to award new scholarships each year and we
remain committed to our mission.”
Together with The PhD Project, a related program
whose mission is to increase the diversity of business school faculty, the
Minority Accounting Doctoral Scholarship program has helped to more than triple
the number of minority business professors in the United States since The PhD
Project first began in 1994. Today, there are 985 minority business school
professors teaching in the United States. Nearly 400 minority students are
currently enrolled in business doctoral programs.
The Minority Accounting Doctoral Scholarship
recipients come from a wide variety of cultures and backgrounds. This year’s new
recipients are:
Continued in article
Jensen Comment
Under the guidance of KPMG Executive Partner Bernie Milano this program became
more than a money awards program. KPMG works with some recipients in customized
counseling and assistance when problems arise for certain individuals still
studying for their doctorates. Various types of problems arise, including some
crises within families.
Minority Hiring Success Varies Greatly
by Discipline: Law, Business, and Sciences Have the Worst Records The major cause lies in the supply chain of PhD
graduates
One of the reasons for
the shortage of minority undergraduate students in accounting has been the lack
of role models teaching accounting courses in college.
The black faculty Strategic
Initiative began in 1993, on the heels of the failed effort to add at least
one black professor to every department.
As of the fall of
2007, Duke had 62 tenured or tenure-track black professors, accounting for
4.5 percent of the faculty. But while the raw number is double that of 20
years ago, it masks tremendous variation within the university.
Black professors remain rare in the law school, which
has one black professor, the business school, with two, and the natural
sciences, with three.
Karla FC Holloway, an
English professor who served as dean of humanities and social sciences from
1999 to 2005, says each unit of the university should be held accountable
for its record on diversity. "There has been growth in arts and social
sciences, and medicine, but in some ways that growth has arguably allowed
other schools or divisions not to work as aggressively with this effort,"
she says.
Mr. Lange, the provost,
concedes that some parts of the university have fallen short. He says he is
working closely on the issue with the law school's dean, David F. Levi, and
other officials. "They have made offers and have not been successful at
times," Mr. Lange says. "They're putting in a lot of effort to do better."
Duke makes sure that when
black job applicants visit the campus, they meet other black faculty
members — and not just potential colleagues in the department to which
they're applying. The university also is taking small steps to widen the
pipeline. Duke has financed two postdoctoral positions for minority
candidates each year, with the hope that it will eventually hire some of
them for tenure-track faculty positions.
In 2003, Duke started yet
another faculty initiative related to diversity — but this time the scope
was expanded to include women and all underrepresented minority groups. "We
needed to recognize that diversity had come to include a substantially
broader set of concerns," Mr. Lange says.
Ms. Holloway worries that
the broader focus may give deans and department chairs an out: "People can
say, 'I've hired enough women, and that makes up for the lack of
minorities.'"
Harvard U.: Uneven
progress on racial diversity
Harvard created an office of
faculty development and diversity, to be headed by a senior vice provost, in
2005, shortly after announcing that it would spend $50-million to help
diversify the faculty.
In the more than three years
since that commitment, the university has made modest progress in
diversifying its faculty, and some professors believe that the new office
deserves some of the credit. Kay Kaufman Shelemay, a professor of music and
of African and African-American studies, says the office has done a good job
compiling statistics related to diversity and working with deans and
department chairs to ensure that they cast a wider net in their searches.
"There is no doubt that the office established by former President Summers
both invigorated and centralized our institutional efforts," Ms. Shelemay
says.
Women now make up 16 percent
of tenured and tenure-track faculty members in the natural sciences, up from
12 percent in 2004-5. In the humanities, 32 percent of the professors are
women, up from 30 percent, and in the social sciences, 31 percent are women,
up from 28 percent.
The changes for the
professional schools over that period varied — law, engineering, and
government all saw significant gains for women, while the proportion of
female faculty members actually dropped in the schools of divinity,
dentistry, and education.
The university's progress on
racial diversity, meanwhile, has been uneven. More than 6 percent of the
tenured and tenure-track faculty members in the social sciences are black,
but black professors make up 1 percent or less of faculty members in the
natural sciences and the humanities. Hispanic professors make up no more
than 2 percent of faculty members in each of those three areas.
In 2006, Harvard committed
$7.5-million to improve child care on the campus — a primary concern of
female faculty members. The university also just completed its third year of
a summer program aimed in part at improving the pipeline for female and
minority professors. The program allows undergraduates to spend 10 weeks in
the research laboratories of science and engineering faculty members. More
than half of the 400 participants have been women, and more than 60 percent
have been minority students.
Judith D. Singer, a
professor of education who became senior vice provost for faculty
development and diversity in June, says she was willing to take on the job
because the climate "feels different" under Drew Gilpin Faust, Harvard's
first female president. But Ms. Singer acknowledges that progress has been
uneven among departments and divisions.
"Addressing issues of
diversity remains a challenge throughout higher education," she says. "We at
Harvard, like our peer institutions, must do better."
U. of Wisconsin at
Madison: Progress in fits and starts
The university undertook its
Madison Plan in 1988, vowing to double the number of black, Hispanic, and
American Indian professors by adding 70 new faculty members within three
years.
Progress has come in fits
and starts. A Wisconsin official told The Chronicle in 1995 that the
university hadn't made the progress it had hoped for. The number of tenured
or tenure-track black professors, for example, increased only 61 percent, to
37, in that seven-year span. The total then surged to 60 by 2001, only to
stall. Over the six years ending in 2007, the number of black professors
dropped to 51.
Mr. Farrell, the provost,
argues that part of the challenge is increased competition. While
institutions like Wisconsin were among the first to spell out ambitious
plans to diversify the faculty, now almost every institution has one. "We
compete with everybody else for the pool that exists," he says.
Damon A. Williams, who
became vice provost for diversity and climate in August, says Wisconsin and
other universities must seek out minority job candidates more aggressively.
For example, he wants to see Madison recruit aggressively at the annual
Institute on Teaching and Mentoring, sponsored by the Southern Regional
Educational Board and attended by hundreds of minority Ph.D. candidates.
"We have to be visible and
present at that meeting and be willing to sell ourselves to them," he says.
Wisconsin's record with
Hispanic and American Indian faculty members has been stronger. The
university had 77 Hispanic professors in 2007, up from 53 in 1998, and 13
American Indian professors, up from four in 1998.
The growth of American
Indian studies — in a state that is home to several Indian tribes — has
helped attract new American Indian professors to the campus, Mr. Farrell
says. "Professors who visit say, 'OK, here's a place where people from our
background can thrive, fit in, and have success.'"
Still, Wisconsin and other
universities must persuade more minority undergraduates to pursue academic
careers, the provost says. The engineering school has developed a fellowship
program, aimed primarily at minority graduate students, that encourages them
to pursue research immediately. That program is being copied by the College
of Letters and Science.
"When students spend their
first year or two just on class work," Mr. Farrell says, "they find graduate
school is not nearly as interesting as they thought it would be."
Virginia Tech: A bigger
faculty role in hiring
The university made an
extraordinary effort to diversify its campus starting in the late 1990s, and
it paid off: During the three years ending in 2002, the number of black
tenured and tenure-track professors in the College of Arts and Sciences rose
by more than 50 percent, to 17; the number of Hispanic professors more than
doubled, to seven; and the proportion of female professors rose from 20.6
percent to 23.6 percent.
Myra Gordon, an associate
dean who left Virginia Tech in 2002, was the architect of the plan. At the
time, faculty members complained that she had essentially taken over their
role of hiring new professors.
Mark G. McNamee, the provost
since 2001, says that while the university remains strongly committed to
diversifying the faculty, some of the tactics that were criticized have been
reined in or eliminated. Now he and the deans offer input at beginning of
the process but for the most part let faculty members have the final say in
hiring.
"It was a much more
centrally controlled process at the time," Mr. McNamee says. "The deans are
still engaged and have responsibilities, but they're not perceived as unduly
influencing what the outcome is going to be."
It is difficult to evaluate
progress in the College of Arts and Sciences since then, because it was
divided into smaller colleges several years ago. Over the four years ending
in 2007, the university had a net increase of five black and five Hispanic
professors. Black faculty members make up about 3 percent of the tenured and
tenure-track professoriate, Hispanic faculty members less than 2 percent,
and women 24.3 percent.
In 2006 students protested
the university's decision not to grant tenure to a black professor known for
his activism on affirmative action and other causes. Mr. McNamee promised to
establish a committee to study the role of race at the university. "When
someone doesn't get tenure, that doesn't help us, but that's just the way it
is sometimes," he says now.
In August the committee
released a plan that calls for a cluster of six new hires in Africana
studies and race and social policy.
Virginia Tech also
frequently invites professors from historically black universities to
deliver lectures on the campus, in part to elevate awareness of the
university among those lecturers.
"Once people know Virginia
Tech," says Mr. McNamee, "they really like it a lot better than they think
they're going to like it."
Continued in article
To its credit, the Big Four accounting firm KPMG, inspired heavily by
Bernie Milano at KPMG, years ago created a foundation (with multiple outside
contributors) for virtually five years of funding to minorities to selected for
particular accounting doctoral programs ---
http://www.kpmgfoundation.org/foundinit.asp
Minority Accounting Doctoral Scholarships
The KPMG Foundation Minority Accounting Doctoral
Scholarships aim to further increase the completion rate among
African-American, Hispanic-American and Native American doctoral students.
The scholarships provide the funding for them to see their dreams come to
fruition.
For the 2007-2008 academic year, the Foundation
awarded $10,000 scholarships (annually), for a total of five years, to 9
minority accounting and information systems doctoral students. There are 35
doctoral students who have had their scholarships renewed for 2007-2008,
bringing the total number of scholarships awarded to 44. To date, KPMG
Foundation's total commitment to the scholarship program exceeds $12
million.
Financial support often determines whether a
motivated student can meet the escalating costs of higher education. For
most of those students, a return to school means giving up a lucrative job.
For some, acceptance in a doctoral program means an expensive relocation.
Still others need enough time to study without the burden of numerous
part-time jobs.
Jensen Comment
This is more than just a pot of money. KPMG works with doctoral program
administrators and families of minority candidates to work out case-by-case
solving of special problems such as single parenthood. I think added funding
is provided on an as-needed basis. The effort is designed to help students
not only get into an accounting doctoral program but to follow through to
the very end. It should be noted that although KPMG started this effort,
various competing accounting firms have donated money to this exceptionally
worthy cause. One of the reasons for the shortage
of minority undergraduate students in accounting has been the lack of role
models teaching accounting courses in college.
Universities, if they
are going to encourage the careers of women (and of everyone), she said, need to
be willing to embrace “people with different values” and be sure that they are
fully included. To the extent some men “will compete for anything,” Downey said,
that should not set a standard where only women who share those values can
succeed in academe. The success of women and men, she said, can be judged on
their work and not competitiveness. “It’s no longer useful to have a ’sink or
swim’ mentality,” she said.
"New Questions on Women, Academe and Careers," by Scott Jaschik,
Inside Higher Ed, September 22, 2008 ---
http://www.insidehighered.com/news/2008/09/22/women
Especially note the bottom of the table at
http://www.jrhasselback.com/AtgDoct/XDocChrt.pdf Jim made a concerted effort recently to improve the accuracy of the data
provided in this table. He points out that the Year 2007 data are incomplete
such at the 116 number is understated. However, the 149 number of doctoral
graduates in 2006 can be trusted and compared with the numbers in earlier years.
These numbers are a bit on the rise since the number bottomed out at 105
graduates in 2003. In the 1980s and early 1990s this number hovered around 200
graduates. In a period of exploding salaries since year 2000 coupled with
reductions of teaching loads to about three courses a year or less, something
serious has been contributing to the declining interest in getting a doctoral
degree in accounting in the United States. One reason is the shrinking of
program size in such universities as Texas and Illinois that historically
produced the largest numbers of accounting doctoral graduates. Another reason is
the number of years that it takes (around five to six) of full-time study in an
accounting doctoral program vis-à-vis the three years needed for many other
doctoral degrees such as economics and psychology. But the most serious reason
in Bob Jensen's viewpoint is that accounting doctoral programs are no longer
attractive to accountants who want to study accounting (see below).
At the 2008 AAA annual meetings, Jim made a point of saying that an
increasing proportions of our doctoral graduates are from outside the United
States. The shortage of doctoral graduates to meet the demand in U.S.
universities is affected by this since a significant number of graduates return
to their home countries after graduation. Also, some graduates do not commence
working for colleges and universities. Thus perhaps only 100 (rough guess) of
the 2006 graduating accounting doctoral students were available to colleges and
universities in the U.S. Furthermore, a serious number of those graduates had
prior study in mathematics and science while having little education and
experience in accounting studies. Some still have difficulties with the English
language.
Two important reports on the crisis of meeting the demand for new doctoral
graduates in accounting were published as follows:
Behn (2008) --- (not free)
http://www.atypon-link.com/AAA/doi/pdf/10.2308/iace.2008.23.3.357 Accounting Doctoral Education—2007 A Report of the Joint AAA/APLG/FSA
Doctoral Education Committee Issues in Accounting Education, Vol. 23, No. 3, August 2008,
pp.357-368
Author(s): Bruce K. Behn | Gregory A. Carnes | George W. Krull Jr | Kevin D.
Stocks | Philip M. J. Reckers |
Plumlee (2006) --- (not free)
http://www.atypon-link.com/AAA/doi/pdf/10.2308/iace.2006.21.2.113 Assessing the shortage of accounting faculty,” Issues in Accounting Education, Vol. 21 Number 2, May 2006, pp.
113-126
R. David Plumlee | Steven J. Kachelmeier | Silvia A. Madeo | Jamie H. Pratt
| George Krull
Both the Plumlee (2006) and Behn (2008) reports conclude that shortages are
more severe in some specialties than others. The crisis is critical in
Accounting Information Systems (AIS), Auditing, and Tax. Table 6 of the
Behn (2008) report on Page 360 reads as follows:
TABLE 6
Student Topical Research Areas
(percentage of responses by category)
Area Percentage
Financial 52%
Managerial 12%
Tax 9%
Audit 12%
Information Systems 4%
Unsure /Undecided/Other 11%
AIS shortages are supplemented with MIS and computer science graduates who
have backgrounds in accountancy. Auditing and tax were viewed by the AICPA as
being in really deep trouble, i.e., the heart and core of public accountancy has
the fewest numbers of graduating accountancy doctoral students. For this reason,
the large accounting firms are contributing to a newly-established AICPA
Foundation fund providing $30,000 annual scholarships to selected doctoral
students in auditing and tax ---
http://commons.aaahq.org/files/24e4586780/ADS_Program_Overview.doc
Increased funding to attract doctoral students into accounting is important
and will have an impact, especially on directing study and research into
auditing and taxation. However, what is really necessary is to make accounting
doctoral programs more attractive to real-world accountants who really want to
teach accounting, do research in accounting, and get a doctoral degree in a
reasonable amount of full-time effort for three to maybe four years instead of
five to six years. I think the most important things that will reverse the
decline in the numbers of doctoral students in accounting are as follows:
Doctoral programs should be shortened for experienced accountants who
have credentials like CPA and CMA certificates.
Doctoral programs should offer study and research tracks apart from the
limited econometrics, psychometrics, and analytical mathematics tracks that
all require years of study of mathematics, statistics, and social science
prerequisites. For example, at present there is virtually no university in
the United States that has a doctoral studies track in accounting history.
Few offer tracks in case method research.
Universities in the U.S. need to increase the numbers of doctoral
students in their programs. This, in turn, means adding more incentives for
AIS, auditing, and tax professors to take on responsibilities in the
doctoral programs.
Leading accounting research journals need to invite submissions beyond
the narrow band of mathematics and statistics research method criteria of
the past three decades ---
http://faculty.trinity.edu/rjensen/395wpTAR/03MainDocumentMar2007.htm The Accounting Review has taken the lead in 2008 by inviting
submissions in AIS, field studies, and accounting history.
Accountancy doctoral programs need to be more concerned about pressing
research problems in the practicing profession. Schools of medicine do
research on problems encountered in treating patients. Law schools do
research on problems encountered in the practice of law. Schools of
accountancy elected to rise above issues of accounting practice by focusing
on problems of economic and behavioral theory that have had little or no
impact on the practicing profession.
In the academic year ended in 2006, there were 1,711 doctorates awarded in
business reported in the Chronicle of Higher Education's 2008 Almanac Issue
on Page 20. There's no separate category for accounting. But if Hasselback's
reported 149 accounting graduates are included in the 1,711 number, then 8.7% of
the business doctoral degrees for 2006 were in accounting. The AACSB can provide
some further data about its member schools enrollments and graduations ---
http://www.aacsb.edu/knowledgeservices/datadirect/dd-intro.asp
If the 2,848,440 total earned degrees (Associate+Bachelor's+Master's+Doctoral)
are divided into the 562,435 earned degrees in business, the percentage is about
20%. If the 56,067 earned doctoral degrees in the United States are divided into
the 1,711 business doctoral degrees, the percentage is about 3%. This suggests
that perhaps 3% of the new business doctorates are teaching about 20% of the
students, although there are wide margins for error in these percentages. I
suspect that the situation is much worse in accounting education programs that
are increasingly relying on adjunct faculty without doctoral degrees to teach
the accounting students.
In retrospect, the financial planning by
our most sophisticated financial institution looks incredibly stupid.
Merrill Lynch never included in its plans the risk that its counterparties
could demand more collateral. Citigroup proceeded to dive headlong into the
mortgage market on the assumption that a national housing decline was
impossible. Everyone, it seems, failed to guard against the risk that they
might be forced to sell assets to raise capital during a downturn. So it's
worth asking: how did so many rich guys get so dumb?
If we're really cynical about it we'd say:
they weren't dumb. They took huge risks, got paid immense amounts and the
worst that happened is they lost their job. A few guys with hundreds of
millions now have dozens of millions instead. Give them a few years, or even
a few months, and many of them will be back in the drivers seat again, at a
new bank or a hedge fund. Even the public scorn attached to bank failures is
vague and undirected. Except for a few CEOs, almost no one is living with a
scarlet letter attached to their name.
But a good many of these guys and gals
probably thought they were making the right decisions. One of the reasons
they thought that was because the super-smart math dudes and physicists they
hired told them that they had calculated the risks involved in various
positions and proved that everything would be okay.
Scientific American, in an editorial,
blasts the "quants" and other scientists who helped contribute to this
horrendous financial destruction.
The causes of this fiasco are
multifold—the Federal Reserve’s easy-money policy played a big role—but the
rocket scientists and geeks also bear their share of the blame. After the
crash, the quants and traders they serve need to accept the necessity for a
total makeover. The government bailout has already left the U.S. Treasury
and Federal Reserve with extraordinary powers. The regulators must ensure
that the many lessons of this debacle are not forgotten by the institutions
that trade these securities. One important take-home message: capital safety
nets (now restored) should never be slashed again, even if a crisis is not
looming.
For its part, the quant community needs to
undertake a search for better models—perhaps seeking help from behavioral
economics, which studies irrationality of investors’ decision making, and
from virtual market tools that use “intelligent agents” to mimic more
faithfully the ups and downs of the activities of buyers and sellers. These
number wizards and their superiors need to study lessons that were never
learned during previous market smashups involving intricate financial
engineering: risk management models should serve only as aids not
substitutes for the critical human factor. Like an airplane, financial
models can never be allowed to fly solo.
Melissa Lafsky, who writes the Reality
Based blog for Discover magazine, seconds this condemnation and call for
reform. "In other words, maybe we should start calculating risk using models
that take into account actual human behavior, as opposed to some nebulous
dreamland where markets don’t freeze solid and eras don’t go down in a haze
of napalm," she writes.
The American Accounting Association (AAA) has a new research report
on the future supply and demand for accounting faculty. There's a whole lot of
depressing colored graphics and white-knuckle handwringing about anticipated
shortages of new doctoral graduates and faculty aging, but there's no solution
offered ---
http://aaahq.org/temp/phd/AccountingFacultyUSCollegesUniv.pdf
April 2, 2008 message from David Fordham, James Madison University
[fordhadr@JMU.EDU]
I've been reading the AAA study on accounting
faculty status and trends:
My guess: probably not. I've concluded no one is
listening.
It seems to me that the long-term answer (more
Ph.D. students and expanded Ph.D. programs) will of necessity exacerbate the
short term crisis: shortage of experienced faculty teaching accounting
majors. If more of the experienced professors teach Ph.D. students, that
means even fewer teaching the undergrad accounting majors.
Of course, deans will point out that having more
Ph.D. students means more grad students will be available to teach
accounting majors. So more and more accounting classes will be taught by
grad students rather than experienced professors. Is this a good thing? My
guess: probably not.
And to be more cynical, does it really MATTER
whether or not it's a good thing? My guess: ... probably not.
Having raised four children during the era of
Winnie-the-Pooh, I can't help but see a parallel here with a character named
Eeyore. Poor ol' Eeyore.
I guess you could say we are living in interesting
times. *sigh*
The study is worth perusing. (Are our hands sore
yet?)
David Fordham
James Madison University
April 3, 2008 reply from Bob Jensen
Hi David,
I suspect that the most popular solution in the future to meet the shortage
of doctoral accounting faculty will be an explosion in the use of adjunct
accounting faculty at highly varying ranges of compensation. This will bring
us full circle back to the late 1950s when the scathing Pierson Carnegie
Report [1959] and the Gordon and Howell Ford Foundation Report [1959]
reports dramatically changed accounting doctoral education in the United
States ---
http://faculty.trinity.edu/rjensen/395wpTAR/Web/TAR395wp.htm
There are several remedies to relieve future shortages of accounting
faculty to meet expected continued growth of accounting majors in
undergraduate and masters programs (most states virtually require a fifth
year of advanced study to sit for the CPA examination):
Make it more attractive for aging accounting faculty who are doing a
great job with students to continued beyond retirement age. This is not
a ideal solution in that it possibly blocks the flow of "fresh blood"
and revitalization into accounting departments, but it is more
affordable than paying over $200,000 in salary and fringe benefits for a
new accounting doctoral graduate. Even at higher salaries there are just
not enough new doctoral graduates (less than a hundred per year) to
spread around among a thousand or more colleges. One way to make it more
attractive is to assign aging faculty who want to live elsewhere (on the
beach?) and teach some distance education courses an opportunity
to do so.
Make increasing use of good accounting teachers without doctorates
to teach full time. Most will be assigned adjunct status, but some
colleges may even let them be on a tenure track depending on the
uniqueness of their credentials. This is generally a mixed bag for
students, because adjunct professors are often poorly paid and forced to
moonlight for sometimes more than they are paid from the colleges.
Students generally benefit more from full-time teachers. It is also a
poor solution in that adjunct faculty are generally second-class
employees on a college campus.
Lure increasing numbers of accounting faculty with doctorates who
are now teaching in foreign countries. One problem is that in these
countries their doctoral degrees often are not in accountancy (many
foreign countries do not even have accounting doctoral programs). In
addition there are problems with luring families to leave their home
countries. Plus there are the same problems as those noted below for
many foreign student graduates of U.S. accounting doctoral programs.
Shorten North American accounting doctoral programs by making them
something other than accountics (econometrics, psychometrics, and
advanced mathematics) wolves in sheep clothing. Virtually all accounting
doctoral programs now take nearly five years beyond a masters degree in
large part because candidates with accounting backgrounds must take
years of accountics courses or candidates with mathematics,
econometrics, and psychometrics backgrounds must take years of
undergraduate accounting equivalents.
The essential problem is social science research methodology is now the
only acceptable research methodology in North American accounting
doctoral programs. This is an increasingly negative incentive for
younger practicing accountants to consider entering accounting doctoral
programs. Increasingly the applicants to these programs, especially at
our most prestigious universities, are foreign mathematicians who know
virtually nothing about accountancy but are seeking the salary,
prestige, and citizenship of accounting professors in North America.
The problem here is that our undergraduate and graduate students often
benefit more from taking accounting courses from instructors who have
rich backgrounds in five years of accounting courses and some years of
accounting practice. Foreign graduates of accounting doctoral programs
are often assigned AIS and doctoral research courses to teach since they
have such limited backgrounds in financial, tax, auditing, and
managerial accounting. There are of course noted exceptions and some of
these immigrant professors have become great accounting educators and
friends in the United States. But finding tax and auditing accounting
doctoral graduates is particularly problematic.
There were only 29 doctoral students in
auditing and 23 in tax out of the 2004 total of 391 accounting
doctoral students enrolled in years 1-5 in the United States.
I suspect that the most popular solution in the future to meet the shortage
of doctoral accounting faculty will be an explosion in the use of adjunct
accounting faculty at highly varying ranges of compensation. This will bring
us full circle back to the late 1950s when the scathing Pierson Carnegie
Report [1959] and the Gordon and Howell Ford Foundation Report [1959]
reports dramatically changed accounting doctoral education in the United
States ---
http://faculty.trinity.edu/rjensen/395wpTAR/Web/TAR395wp.htm
David,
Eeyore analogy was spot on. Oh woe, Oh woe. For many reasons, most of which
have been touched upon or beaten to death on this listserv, we have brought
this on ourselves. Frankly, I took the report to be wonderful news! As one
of those folks over 41 (well over 41), I am becoming more valuable to NC
State all of the time. I make less than a new hire and I have so (so, so,
so) much more institutional knowledge and experience. I won't have to retire
until I can't remember how to find my classroom and there will be no real
incentive for the institution to want to get rid of me until then. I suspect
that many of those Plumlee predicts will retire, won't. Some of the supply
problem will be taken up by faculty working well past the retirement age.
Follow-up message from Paul on April 2, 2008
I was being somewhat facetious with my "delighted because they won't be in a
hurry to rush me out the door" comment. I think your observations are
correct. We must ask ourselves how it is that attracting students into PhD
programs where the pay prospects are considerably lower is easier than in
accounting. I am not surprised that bright, imaginative, bold people aren't
attracted to doctoral work in accounting -- it is so mind-numbingly boring.
It is all about technique, nothing about ideas. You and I are testimony to
what was typical of the generation of accounting academics to which we
belong. In my doctoral program, few of the students were undergraduate
accounting majors. In my program we had people with degrees in engineering,
forestry, sociology, education, and history. Now every candidate we
interview from a U.S. doctoral program has the same profile: undergraduate
accounting major, MAC, a few years of practice experience (perhaps to
manager level), then the standardized, universal doctoral education in
"applied" (whatever that could be is a mystery) economics. Based on my
experience with undergraduate accounting curricula, a B.S. in accounting is
about the worst preparation one could have for pursuing a Doctor of
Philosophy degree. Supplication to authority seems to be the thread that
runs through every accounting course. FASB (ooo!, GASBs (ooo!), SASs (ooo!),
PCAOB (ooo!), SEC (ooo!) , BIG 4 (ooo!). I would like to teach a course
(which I am not allowed to do) where we take the GAAP hierarchy and every
acronym that students are taught to be reverential toward and teach them to
be heretics -- a Dead Poets' Society for accounting students. There is
nothing sacred about "official pronouncements" and even less sacred are the
unexamined presumptions that underlay them. Even at the highest level of
education, the PhD. level, accounting has become, in Bourdieu's term, a
doxic society, which is anethema to scholarship.
First, it tells us that we are a geriatric
profession. Lack of new blood will have disastrous consequences.
Second, the study keeps harping on the shortage of
PhDs IN ACCOUNTING. This shortage is contrived. If four years of college and
four or five more years of graduate school is all it takes, the way
accounting is currently taught generally, a PhD IN ACCOUNTING is irrelevant.
AACSB, in my opinion, is ruining what is essentially a professional field by
forcing it with trappings of academic respectability.
If accounting is to succeed as an academic field, I
would strongly suggest that we get rid of this ridiculous idea that a PhD IN
ACCOUNTING is a requirement for college teaching. If AACSB can not relax the
requirement by allowing qualified practitioners to teach accounting, it
should relax the requirement of PhD in accounting.
There is no reason why a PhD in Economics,
Computing, Psychology, Sociology, Engineering, or even classics can not
teach accounting with some minimal retooling.
Third, salary inversion is a consequence of foolish
policies having to do with the second point (above).
Fourth, inspite of monstrous salary differentials,
we are unable to attract doctoral students. It is pathetic that fields with
virtually negligible job markets such as anthropology and classics can
attract good talent while we are languishing is a sign that our field is
intellectually stagnating and unattractive to the bright minds.
Fifth, the exaggerated salaries offered to new
entrants may be getting us the wrong type of people; the type of people
attracted to money rather than intellectual excitement. As department chair,
I have been put in the ridiculous position of recommending a ghigher
starting pay to an ABD than we pay to Guggenheim, McArthur, Fulbright
fellows, and NSF Young Investigator award winners with publications that our
candidates will not equal in several lifetimes.
We have an unsustainable business model for
academic accounting. The earlier the universities realise this the better
for the education of accountants. But that will not happen; we have a moral
hazard problem.
Being a member of the well-over-the-40-hill gang
and having been sidelined as one doing off-the-wall non-mainstream research
most of my academic life, the work I do outside of mainstream accounting
sustains me. The "mainstream" academic accounting "tent" has gotten
considerably smaller since I became an accountant late in life, and I found
myself an outsider almost right from the beginning. What has been
"mainstream" in academic accounting for the past over thirty years was then
the proverbial camel sticking its nose into the tent. The people who have
been pushed out of the tent are the professionals and the non-mainstream
researchers.
This should not be the case. It is not the case
with other fields in which I work.
Jagdish
"Research on Accounting Should Learn From the Past," by
Michael H. Granof and Stephen A. Zeff, Chronicle of Higher Education, March 21,
2008
Starting in the 1960s, academic research on
accounting became methodologically supercharged — far more quantitative and
analytical than in previous decades. The results, however, have been
paradoxical. The new paradigms have greatly increased our understanding of
how financial information affects the decisions of investors as well as
managers. At the same time, those models have crowded out other forms of
investigation. The result is that professors of accounting have contributed
little to the establishment of new practices and standards, have failed to
perform a needed role as a watchdog of the profession, and have created a
disconnect between their teaching and their research.
Before the 1960s, accounting research was primarily
descriptive. Researchers described existing standards and practices and
suggested ways in which they could be improved. Their findings were taken
seriously by standard-setting boards, CPA's, and corporate officers.
A
confluence of developments in the 1960s markedly changed the nature of
research — and, as a consequence, its impact on practice. First,
computers emerged as a means of collecting and analyzing vast amounts of
information, especially stock prices and data drawn from corporate financial
statements. Second, academic accountants themselves recognized the
limitations of their methodologies. Argument, they realized, was no
substitute for empirical evidence. Third, owing to criticism that their
research was decidedly second rate because it was insufficiently analytical,
business faculties sought academic respectability by employing the methods
of disciplines like econometrics, psychology, statistics, and mathematics.
In response to those developments, professors of
accounting not only established new journals that were restricted to
metric-based research, but they limited existing academic publications to
that type of inquiry. The most influential of the new journals was the
Journal of Accounting Research, first published in 1963 and sponsored by the
University of Chicago Graduate School of Business.
Acknowledging the primacy of the journals,
business-school chairmen and deans increasingly confined the rewards of
publication exclusively to those publications' contributors. That policy was
applied initially at the business schools at private colleges that had the
strongest M.B.A. programs. Then ambitious business schools at public
institutions followed the lead of the private schools, even when the public
schools had strong undergraduate and master's programs in accounting with
successful traditions of practice-oriented research.
The unintended consequence has been that
interesting and researchable questions in accounting are essentially being
ignored. By confining the major thrust in research to phenomena that can be
mathematically modeled or derived from electronic databases, academic
accountants have failed to advance the profession in ways that are expected
of them and of which they are capable.
Academic research has unquestionably broadened the
views of standards setters as to the role of accounting information and how
it affects the decisions of individual investors as well as the capital
markets. Nevertheless, it has had scant influence on the standards
themselves.
The research is hamstrung by restrictive and
sometimes artificial assumptions. For example, researchers may construct
mathematical models of optimum compensation contracts between an owner and a
manager. But contrary to all that we know about human behavior, the models
typically posit each of the parties to the arrangement as a "rational"
economic being — one devoid of motivations other than to maximize pecuniary
returns.
Moreover, research is limited to the homogenized
content of electronic databases, which tell us, for example, the prices at
which shares were traded but give no insight into the decision processes of
either the buyers or the sellers. The research is thus unable to capture the
essence of the human behavior that is of interest to accountants and
standard setters.
Further, accounting researchers usually look
backward rather than forward. They examine the impact of a standard only
after it has been issued. And once a rule-making authority issues a
standard, that authority seldom modifies it. Accounting is probably the only
profession in which academic journals will publish empirical studies only if
they have statistical validity. Medical journals, for example, routinely
report on promising new procedures that have not yet withstood rigorous
statistical scrutiny.
Floyd Norris, the chief financial correspondent of
The New York Times, titled a 2006 speech to the American Accounting
Association "Where Is the Next Abe Briloff?" Abe Briloff is a rare academic
accountant. He has devoted his career to examining the financial statements
of publicly traded companies and censuring firms that he believes have
engaged in abusive accounting practices. Most of his work has been published
in Barron's and in several books — almost none in academic journals. An
accounting gadfly in the mold of Ralph Nader, he has criticized existing
accounting practices in a way that has not only embarrassed the miscreants
but has caused the rule-making authorities to issue new and more-rigorous
standards. As Norris correctly suggested in his talk, if the academic
community had produced more Abe Briloffs, there would have been fewer
corporate accounting meltdowns.
The narrow focus of today's research has also
resulted in a disconnect between research and teaching. Because of the
difficulty of conducting publishable research in certain areas — such as
taxation, managerial accounting, government accounting, and auditing — Ph.D.
candidates avoid choosing them as specialties. Thus, even though those areas
are central to any degree program in accounting, there is a shortage of
faculty members sufficiently knowledgeable to teach them.
To be sure, some accounting research, particularly
that pertaining to the efficiency of capital markets, has found its way into
both the classroom and textbooks — but mainly in select M.B.A. programs and
the textbooks used in those courses. There is little evidence that the
research has had more than a marginal influence on what is taught in
mainstream accounting courses.
What needs to be done? First, and most
significantly, journal editors, department chairs, business-school deans,
and promotion-and-tenure committees need to rethink the criteria for what
constitutes appropriate accounting research. That is not to suggest that
they should diminish the importance of the currently accepted modes or that
they should lower their standards. But they need to expand the set of
research methods to encompass those that, in other disciplines, are
respected for their scientific standing. The methods include historical and
field studies, policy analysis, surveys, and international comparisons when,
as with empirical and analytical research, they otherwise meet the tests of
sound scholarship.
Second, chairmen, deans, and promotion and
merit-review committees must expand the criteria they use in assessing the
research component of faculty performance. They must have the courage to
establish criteria for what constitutes meritorious research that are
consistent with their own institutions' unique characters and comparative
advantages, rather than imitating the norms believed to be used in schools
ranked higher in magazine and newspaper polls. In this regard, they must
acknowledge that accounting departments, unlike other business disciplines
such as finance and marketing, are associated with a well-defined and
recognized profession. Accounting faculties, therefore, have a special
obligation to conduct research that is of interest and relevance to the
profession. The current accounting model was designed mainly for the
industrial era, when property, plant, and equipment were companies' major
assets. Today, intangibles such as brand values and intellectual capital are
of overwhelming importance as assets, yet they are largely absent from
company balance sheets. Academics must play a role in reforming the
accounting model to fit the new postindustrial environment.
Third, Ph.D. programs must ensure that young
accounting researchers are conversant with the fundamental issues that have
arisen in the accounting discipline and with a broad range of research
methodologies. The accounting literature did not begin in the second half of
the 1960s. The books and articles written by accounting scholars from the
1920s through the 1960s can help to frame and put into perspective the
questions that researchers are now studying.
For example, W.A. Paton and A.C. Littleton's 1940
monograph, An Introduction to Corporate Accounting Standards, profoundly
shaped the debates of the day and greatly influenced how accounting was
taught at universities. Today, however, many, if not most, accounting
academics are ignorant of that literature. What they know of it is mainly
from textbooks, which themselves evince little knowledge of the
path-breaking work of earlier years. All of that leads to superficiality in
teaching and to research without a connection to the past.
We fervently hope that the research pendulum will
soon swing back from the narrow lines of inquiry that dominate today's
leading journals to a rediscovery of the richness of what accounting
research can be. For that to occur, deans and the current generation of
academic accountants must give it a push.
Michael H. Granof is a professor of accounting at the McCombs School
of Business at the University of Texas at Austin. Stephen A. Zeff is a
professor of accounting at the Jesse H. Jones Graduate School of Management
at Rice University.
Steve Zeff has
been saying this since his stint as editor of The Accounting Review
(TAR); nobody has listened. Zeff famously wrote at least two editorials
published in TAR over 30 years ago that lamented the colonization of the
accounting academy by the intellectually unwashed. He and Bill Cooper wrote
a comment on Kinney's tutorial on how to do accounting research and it was
rudely rejected by TAR. It gained a new life only when Tony Tinker published
it as part of an issue of Critical Perspectives in Accounting devoted
to the problem of dogma in accounting research.
It has only been since
less subdued voices have been raised (outright rudeness has been the
hallmark of those who transformed accounting into the empirical
sub-discipline of a sub-discipline for which empirical work is irrelevant)
that any movement has occurred. Judy Rayburn's diversity initiative and her
invitation for Anthony Hopwood to give the Presidential address at the D.C.
AAA meeting came only after many years of persistent unsubdued pointing out
of things that were uncomfortable for the comfortable to confront.
“An Analysis of the Evolution of Research Contributions by The Accounting
Review: 1926-2005,” by Jean Heck and Robert E. Jensen, Accounting Historians
Journal, Volume 34, No. 2, December 2007, pp. 109-142.
Praxiologies and the Philosophy of Economics, Edited by J. Lee Auspitz et
al. ---
Click Here
To my
knowledge Rashad was the first Accounting Review editor to impose a
requirement that authors place an abstract in front of a paper that explains the
paper and its significance in non-technical terms --- perhaps to the teenage
child of an author. This has been somewhat successful subject to abstract length
restrictions. Probably the biggest drawback has been that abstracts often
suggest quite general findings that, when subjected to tests of model robustness
(often overlooked in the study itself) and limiting assumptions, the findings
are about as narrow as the sharp edge of aSamurai sword.
For
example, log-linear models generally seek a parsimonious model that, when put to
the test, is not especially robust relative to other parsimonious models
vis-a-vis the saturated model ---
http://faculty.chass.ncsu.edu/garson/PA765/logit.htm
Another example of a model that is not robust is Ijiri’s cash flow recovery rate
model that’s great in theory but lacks robustness and is too sensitive to even
the slightest errors in parameter estimation. In theory it sounds like a
tremendous tool for financial analysts. But in practice the model is just not
robust. Have you ever seen robustness mentioned in the abstract of a paper? See
http://en.wikipedia.org/wiki/Robust
One thing
abstracts often reveal is the trivial nature of the findings when they are
explained in plain English rather than statistical significance ---
Click Here
Another problem with very large samples arises when researchers declare
statistical significance to differences that are substantively trivial. When is
that last time you saw such a conclusion in an abstract or even the accounting
research paper itself?
I will
give you an example of the residual-errors test that is seldom mentioned in an
accountics paper abstract or even the paper itself. The example is classic even
though it’s not an accounting research finding. This illustration is from a book
entitled Credit Derivatives & Synthetic Structures by Janet M. Tavakoli
(Wiley, 2001, pp. 2-3),
Many years ago, my advanced statistics
professor, one of the world’s most talented statisticians and statistical
modelers, laughingly admitted to model hubris early in his career. He had been
asked to participate in a study to model tree trunk wood volumes. He diligently
measured the trees and recorded the wood yield data corresponding to the
measured trees. He tabulated and graphed the data. He used a computer program
and regression analysis. He applied modeling theory and came up with a formula
that was closely correlated with tree wood yields. It was magic. Statistics
worked.
The formula looked very much like that for the
volume of a cylinder --- with a small fudge factor thrown in. Fudge factors are
common. They make up for the fact that the world doesn’t always behave the way
we think it should behave. This was in the days before fractal theory. Euclidean
geometry always leaves us with the need for fudge factors; we’re used to it.
We know the world isn’t made up of squares,
triangles, circles, and cylinders. Nonetheless, the model was a nice, neat, and
intuitive little formula. It had a high correlation coefficient. When you
plugged in the trunk width and the height of the tree, the wood volume was
pretty much as predicted by the neat little formula. Statistics showed that the
formula described the data and predicted future events pretty well. That ---
among other things --- is what makes a statistician feel satisfied
The formula was perfect.
We, almost perfect.
Little things about the formula kept bothering
the budding professor. For instance, a plot of the residuals didn’t look random.
The residuals, the unexplained data, appeared to have a pattern. Statisticians
know that isn’t a good thing. That usually means the neat little formula missed
something. But it was so close. The minor error seemed negligible.
The budding professor was tempted to ignore
these pesky residuals and declare the job done. But he kept at it, laboring
away, modifying the formula, trying to make the residuals disappear. The
cylinderlike formula seemed so right. The professor had a problem. He
couldn’t see the formula for the trees.
Trees do indeed look very much like cylinders.
But they look even more like cones.One of the foresters
pointed this out one day to the budding professor. This is a moment
statisticians and mathematicians both love and hate.They hate it because they get the churning feeling in the pit of
their stomachs, which lets them know in their gut that they are wrong. They also
love it because now they’ve hit on a better answer.
In
retrospect between 2001 and the credit derivatives fiasco of 2008 (where Wall
Street had millions of such contracts) is that Janet M. Tavakoli’s credit
derivative models in 2001 looked almost perfect but ignored the Black Swan of
2008 that some might argue helped to bring down the world of finance to the
extent that so many credit derivatives were used, in a failing effort, to insure
against investment failures. This, of course, was a much larger specification
problem than the Euclidean difference between cylinders and cones. I wonder how
Ms. Tavokoli is sleeping these days. See
http://faculty.trinity.edu/rjensen/2008Bailout.htm#Bailout
Question for Fama and French ---
http://www.dimensional.com/famafrench/2009/03/qa-confidence-in-the-bell-curve.html#more
It would be very enlightening if you would comment on the Nassim Nicholas Taleb
("The Black Swan") attack on the use of Gaussian (normal bell curve) mathematics
as the foundation of finance. As you may know, Taleb is a fan of Mandelbrot,
whose mathematics account for fat tails. He argues that the bell curve doesn't
reflect reality. He is also quite critical of academics who teach modern
portfolio theory because it is based on the assumption that returns are normally
distributed. Doesn't all this imply that academics should start doing
reality-based research?
Answer from Gene Fama (Chicago)
EFF: Half of my 1964 Ph.D. thesis is tests of market efficiency, and the
other half is a detailed examination of the distribution of stock returns.
Mandelbrot is right. The distribution is fat-tailed relative to the normal
distribution. In other words, extreme returns occur much more often than
would be expected if returns were normal.
There was lots of interest in this issue for about
ten years. Then academics lost interest. The reason is that most of what we
do in terms of portfolio theory and models of risk and expected return works
for Mandelbrot's stable distribution class, as well as for the normal
distribution (which is in fact a member of the stable class). For passive
investors, none of this matters, beyond being aware that outlier returns are
more common than would be expected if return distributions were normal.
For other applications, however, the difference can
be critical. Risk management by financial institutions is a good example.
For example, portfolio insurance, which was the rage in the early 1980s,
bombed in the crash of October 1987, because this was an event that was
inconceivable in their normality based return model. The normality
assumption is also likely to be a serious problem in various kinds of
derivatives, where lots of the price is due to the probability of extreme
events. For example, news story accounts suggest that AIG blew up because
its risk model for credit default swaps did not properly account for outlier
events.
Answer from Kenneth French (Dartmouth)
KRF: I agree with Gene, but want to make another point that he is
appropriately reluctant to make. Taleb is generally correct about the
importance of outliers, but he gets carried away in his criticism of
academic research. There are lots of academics who are well aware of this
issue and consider it seriously when doing empirical research. Those of us
who used Gene's textbook in our first finance course have been concerned
with this fat-tail problem our whole careers. Most of the empirical studies
in finance use simple and robust techniques that do not make precise
distributional assumptions, and Gene can take much of the credit for this as
well, whether through his feedback in seminars, suggestions on written work,
comments in referee reports, or the advice he has given his many Ph.D.
students over the years.
The possibility of extreme outcomes is certainly
important for things like risk management, option pricing, and many
complicated "arbitrage" strategies. Investors should also recognize the
potential effect of outliers when assessing the distribution of future
returns on their portfolios. None of this implies, however, that the
existence of outliers undermines modern portfolio theory or asset pricing
theory. And the central implications of modern portfolio theory and asset
pricing—the benefits of diversification and the trade-off between risk and
return—remain valid under any reasonable distribution of returns.
"How Dragon Kings Could Trump Black Swans Power laws have a hidden
structure that reveals why extreme events are more common than we'd thought,"
MIT's Technology Review, August 4, 2009 ---
http://www.technologyreview.com/blog/arxiv/
Sornette gives as an example the distribution of
city sizes in France which follows a classic power law, meaning that there
are many small cities and only a few large ones. On a log-log scale, this
distribution gives a straight line. Except for Paris, which is an outlier,
many times larger than it ought to be if it were to follow the power law.
Paris is an outlier because it has been hugely
influential in the history of France and so has benefited from various
positive feedback mechanisms that have ensured its outsize growth.
Apparently London occupies a similarly outlying position in the distribution
of cities in the UK.
Sornette goes on to identify a number of data sets
showing power laws with outliers that he says are the result of positive
feedback mechanisms that make them much larger than their peers. He calls
these events dragon kings. What's interesting about them is that they are
entirely unaccounted for by a current understanding of power laws, from
which Nassim Nicholas Taleb built the idea of black swans.
The special characteristic of dragon kings is that
a positive feedback mechanism creates faster-than-exponential growth making
them larger than expected.
So what to make of this? Sornette makes one
interesting observation. The seemingly ubiquitous existence of these dragon
kings in all kinds of data sets means that extreme events are significantly
more likely than power laws alone suggest.
That's important. If you've ever wondered why we've
experienced not just a single 100-year financial crises in the last couple
of decades but two or three, here's your answer. It also implies that you'll
experience a few more before your time is up.
But Sornette goes further. He argues that dragon
kings may have properties that make them not only identifiable in real time
but also predictable. He puts it like this: "These processes provide clues
that allow us to diagnose the maturation of a system towards a crisis."
That's much more speculative. It's one thing to
identify the feedback mechanisms that cause faster-than-exponential growth
(and it's not clear that Sornette can do even this) but quite another to
spot the event that trigger a crash.
Sornette looks to be onto something interesting
with his notion of dragon kings: outliers that exist beyond the usual realm
of power laws. That could be a hugely infuential. But his contention that
these outliers are in some way more easily predictable than other events
smacks more of wishful thinking than good science.
American Accounting
Association Membership Trends:
Year
Academic
Practitioner
Emeritus
Life
Associate
Total
1998
6,417
1,068
219
102
636
8,442
1999
6,473
965
207
94
610
8,349
2000
6,528
975
207
117
621
8,448
2001
6,643
972
217
130
594
8,556
2002
6,557
897
239
138
688
8,519
2003
6,373
810
238
146
750
8,317
2004
6,026
734
245
151
847
8,003
2005
6,019
676
209
235
918
8,057
2006
5,996
636
198
264
1,001
8,095
2007
5,859
605
213
277
1,155
8,109
10 Year change
-9%
-43%
-3%
172%
82%
-4%
Proportions in 1998
76%
13%
3%
1%
8%
100%
Proportions in 2007
72%
7%
3%
3%
14%
100%
This table (with the three
summary rows I added) shows the 2007 report of AAA KPIs at aaahq.org/about/financials/KeyIndicators8_31_07.pdf
.. there are some interesting patterns here. The number of practitioners
has gone down by more than 40%. This has been a matter of concern for me
for many years. The AAA should be the natural place a well trained,
thoughtful accountant should Go to for a professional experience that is
different than that provided by the AICPA, IIA, ISACA etc. Yet we seem
to be able to attract only 600 professional members – a statistical
blip. I have spoken to several professionals who are involved with the
AAA and even they seem to think that attracting professionals is a lost
cause. I don’t agree and I don’t think we should accept this number.
Other similar organizations such as the AEA and ACM have a much higher
proportion than we do.
New journals such as the
Auditing sections new journal (which is already providing much fodder
for my classes and my own professional improvement) is the way forward
as is a much more targeted approach to marketing to professionals. I
think that the AAA Annual Meeting is without parallel in terms of
receiving an update on current events .. especially if one went only
to the panels and keynotes. And at a price that is just a fraction of
equivalent events for professional organizations. This is something we
should be marketing strongly.
The second interesting
issue is the increase in proportion of associate members. This category
is (I imagine) mostly students. The category has increased by more than
80% and nearly doubled its share to 14%. But I imagine that this hides
considerable churn and losses. If it were not the case, the number of
academic and practitioner members would have increased. What are we
doing to actively convert Associate into Academic and Practitioner
classes, I wonder?
Roger
July 18, 2008 reply from Bob Jensen
Thanks for the
updates Tracey and Roger!
Not to detract
from Tracey’s current optimism, the membership in the AAA has been on a
steady decline for the past four decades (Craig Polhemus vs. Joel Demski)---
http://www.cs.trinity.edu/rjensen/001aaa/atlanta01.htm
The professionalism of Tracey and her staff have contributed greatly to
preventing a membership disaster in recent years.
We lost over 90%
of our practitioner AAA members in the past five decades from a high point
where there were more practitioner members in the AAA than academic members.
Practitioners that remain today are mostly PR and recruiting specialists
from the large firms. I don’t think you will find them sitting in our
concurrent sessions at the annual meetings of the AAA. At the same time,
however, the large firms have greatly increased their financial support of
the AAA and, even more importantly, the private support of our accountancy
programs in colleges and universities throughout the world. As far as the
AAA is concerned, however, the increased financial support from practitioner
donations to the AAA is offset somewhat by the loss of the dues being paid
by almost 6,000 practitioners who abandoned the AAA ship.
FIGURE 2
Non-Academic Authorship in TAR
What is really
sad is the decline in academic members at a time when accounting professors
were becoming the highest paid professors on nearly every college campus
that has an accounting education program. The reason quite simply is the
decline in enrollments in accounting doctoral programs as they became solely
focused on producing accountics social scientists ---
http://faculty.trinity.edu/rjensen/theory01.htm#DoctoralPrograms
FIGURE 3
Numbers of Doctoral Degrees
from 2000-2004
But the saddest
statistic is the longer run decline in the number of accounting doctoral
program graduates in the United States. In 1988 there were over 200
graduates from U.S. doctoral programs in accounting. In two decades this is
down by over 50%.
Doesn’t anybody
else see a correlation between the decline in practitioner membership in the
AAA with the decline in accounting doctoral program graduation rates? The
overwhelming majority of applicants in history have been drawn from the
practicing world of accountants, particularly practitioners from CPA firms.
There is a tremendous and growing pool of applicants who have been working
as practitioners from 1-5 years. Many would love to become accounting
professors but are totally turned off by our social science accounting
doctoral programs. They love accounting and hate accountics! They also
hate to spend five years of their lives earning a PhD in accounting.
Our accounting
doctoral programs were hijacked by mathematicians, economists, and
psychologists in search of higher pay in accounting departments.
Bob Jensen
Question
How long does it take to get an accounting doctorate?
Answer
The answer varies with respect to how long it takes to get both the
undergraduate degree plus the requisite masters degree (or at least 150 credits
required in most states). Assuming the student is full time and on track as an
accounting major this makes it about 5.5 years before entering a doctoral
program, although some masters programs only require one year for the masters
degree for undergraduate accounting majors. To that we must add about four years
of doctoral studies. This adds up to 9.5 years of full time study in college
give or take a year. To this we must add the typical 1-5 years of experience
most doctoral students spend in practice between attainment of a masters degree
and eventual matriculation into a doctoral program.
The good news is that, unlike
masters of accountancy and MBA programs, virtually all accountancy doctoral
programs provide free tuition and rather generous living allowances from start
to finish, although some of the time doctoral students must work as teaching
and/or research assistants. Often fellowships in the fourth year allow students
to devote full time to finishing their doctoral thesis.
Accountancy doctoral programs
take at least four years in most cases for former accounting majors because
entering students typically must take advanced mathematics, statistics,
econometrics, and psychometrics prerequisites for doctoral seminars in
accounting ---
http://faculty.trinity.edu/rjensen/Theory01.htm#DoctoralPrograms
Update on the
AACSB's Bridge Program for Wannabe Accounting Professors I'm sure glad the American Medical
Association does not have a bridging program where accounting PhDs can become
medical doctors by taking only four courses in medicine.
Students who get doctorates in
fields other than accounting can typically get a doctoral degree in less than
9.5 years of full-time college. For example, an economics PhD can realistically
spend only 7.5 years in college. He or she can then enter a
bridge program to
become a business, finance, or even an accounting professor under the AACSB's
Bridge Program, but that program may take two or more years part time. There
just does not appear to be a short track into accounting tenure track positions.
But the added years may be worth it since accounting faculty salaries are
extremely high relative to most other academic disciplines. The high salaries,
in part, are do to the enormous shortage of accounting doctoral graduates
relative to the number of tenure-track openings in major colleges and
universities ---
http://faculty.trinity.edu/rjensen/Theory01.htm#DoctoralPrograms
Only four United States Universities currently
participate in the AACSB's
Bridge program and one European business school whose
doctoral programs I have doubts about because of truly absurd faculty-to-student
ratios in the doctoral program.
Tulane only lists one full professor of accounting in my
Hasselback Directory such that I doubt that Tulane is a major player in an
accounting Bridge Program (Tulane may be more viable in management, marketing,
and finance).
The University of Florida does apparently have an
accounting bridge ---
http://www.cba.ufl.edu/academics/pdbp/
But this strangely does not appear to be affiliated with the well known Fisher
School of Accountancy at the University of Florida.
From what I can tell, Florida is bridging with only four
courses. Can four courses alone turn an economics or history professor into an
accounting professor?
The Bridge Program says yes! I think the Bridge Program has little to do with
it, although a person's prior background such as years of professional work as a
CPA may make all the difference in the world along with the type of doctoral
degree earned outside accounting.
There is a
surprisingly high proportion of the 78 candidates who want to teach
accounting and auditing given than most of the
bridge programs like Virginia
Tech opted out of teaching accounting but do bridge business and finance
studies. However, 20 bridged candidates who want to teach accounting and
auditing will not make a big dent in the market where the number of
accounting faculty openings exceeds the new doctoral graduate supply (less
than 100 graduates) by over 1,000 openings.
The big
question now is whether those bridged candidates can get tenure track
positions and make tenure with sufficient research publications in
accounting. The leading schools willingly hire adjunct, non-tenure-track,
accounting instructors, but they’re pretty snooty when it comes to tenure
tracks.
In my
opinion the bridge program is absurd. Can four-courses in a typical bridge
program is tantamount to a “90-day Wonder Program” for college graduates to
become military officers ---
http://en.wiktionary.org/wiki/90-day_wonder
There were great military officers that
emerged from the 90-Day Wonder officers' candidate programs. There will also
be great accounting, finance, and business professors that emerge from the
AACSB bridging program. However, the programs do not deserve much of the
credit, since the criteria for success are the credentials and personal
qualities of the persons who entered the program. In accounting there's
almost no chance of success unless the candidate was a good accountant
before entering the bridge program. There's just too much to accounting that
cannot be covered in less than about three years of full-time study in
accountancy modules alone. In most states it takes five years of college as
an accounting major just to sit for the CPA examination.
I'm sure glad the American Medical
Association does not have a bridging program where accounting PhDs can
become medical doctors by taking only four courses in medicine.
Many of
us have known this scholar: The hair is
well-streaked with gray, the chin has begun to sag,
but still our tortured friend slaves away at a
masterwork intended to change the course of
civilization that everyone else just hopes will
finally get a career under way.
We even
have a name for this sometimes pitied species — the
A.B.D. — All But Dissertation. But in academia these
days, that person is less a subject of ridicule than
of soul-searching about what can done to shorten the
time, sometimes much of a lifetime, it takes for so
many graduate students to, well, graduate. The
Council of Graduate Schools, representing 480
universities in the United States and Canada, is
halfway through a seven-year project to explore ways
of speeding up the ordeal.
For
those who attempt it, the doctoral dissertation can
loom on the horizon like Everest, gleaming
invitingly as a challenge but often turning into a
masochistic exercise once the ascent is begun. The
average student takes 8.2 years to get a Ph.D.; in
education, that figure surpasses 13 years. Fifty
percent of students drop out along the way, with
dissertations the major stumbling block. At
commencement, the typical doctoral holder is 33, an
age when peers are well along in their professions,
and 12 percent of graduates are saddled with more
than $50,000 in debt.
These statistics, compiled by
the
National Science Foundation
and other government agencies
by studying the 43,354 doctoral recipients of 2005,
were even worse a few years ago. Now, universities
are setting stricter timelines and demanding that
faculty advisers meet regularly with protégés. Most
science programs allow students to submit three
research papers rather than a single grand work.
More universities find ways to ease financial
burdens, providing better paid teaching
assistantships as well as tuition waivers. And more
universities are setting up writing groups so that
students feel less alone cobbling together a thesis.
Fighting these trends, and stretching out the
process, is the increased competition for jobs and
research grants; in fields like English where
faculty vacancies are scarce, students realize they
must come up with original, significant topics.
Nevertheless, education researchers like Barbara E.
Lovitts, who has written a new book urging
professors to clarify what they expect in
dissertations; for example, to point out that
professors “view the dissertation as a training
exercise” and that students should stop trying for
“a degree of perfection that’s unnecessary and
unobtainable.”
There are probably few universities that nudge
students out the door as rapidly as Princeton, where
a humanities student now averages 6.4 years compared
with 7.5 in 2003. That is largely because Princeton
guarantees financial support for its 330 scholars
for five years, including free tuition and stipends
that range up to $30,000 a year. That means students
need teach no more than two courses during their
schooling and can focus on research.
“Princeton since the 1930s has felt that a Ph.D.
should be an education, not a career, and has valued
a tight program,” said William B. Russel, dean of
the graduate school.
And
students are grateful. “Every morning I wake up and
remind myself the university is paying me to do
nothing but write the dissertation,” said Kellam
Conover, 26, a classicist who expects to complete
his course of study in five years next May when he
finishes his dissertation on bribery in Athens.
“It’s a tremendous advantage compared to having to
work during the day and complete the dissertation
part time.”
But fewer than a dozen
universities have endowments or sources of financing
large enough to afford five-year packages. The rest
require students to teach regularly. Compare
Princetonians with Brian Gatten, 28, an English
scholar at the
University of Texas in
Austin. He has either been teaching or assisting in
two courses every semester for five years.
“Universities need us as cheap labor to teach their
undergraduates, and frankly we need to be needed
because there isn’t another way for us to fund our
education,” he said.
That
raises a question that state legislatures and
trustees might ponder: Would it be more cost
effective to provide financing to speed graduate
students into careers rather than having them drag
out their apprenticeships?
But
money is not the only reason Princeton does well. It
has developed a culture where professors keep after
students. Students talk of frequent meetings with
advisers, not a semiannual review. For example, Ning
Wu, 30, a father of two, works in Dr. Russel’s
chemical engineering lab and said Dr. Russel comes
by every Friday to discuss Mr. Wu’s work on polymer
films used in computer chips. He aims to get his
Ph.D. next year, his fifth.
While Dr. Russel values “the
critical thinking and independent digging students
have to do, either in their mind for an original
concept or in the archives,” others question the
necessity of book-length works. Some universities
have established what they call professional
doctorates for students who plan careers more as
practitioners than scholars. Since the 1970s,
Yeshiva University has not
only offered a Ph.D. in psychology but also a
separate doctor of psychology degree, or Psy.D., for
those more interested in clinical work than
research; that program requires a more modest
research paper.
OTHER institutions are reviving master’s degree
programs for, say, aspiring scientists who plan
careers in development of products rather than
research.
Those who insist on
dissertations are aware that they must reduce the
loneliness that defeats so many scholars. Gregory
Nicholson, completing his sixth and final year at
Michigan State, was able
to finish a 270-page dissertation on spatial
environments in novels like Kerouac’s “On the Road”
with relative efficiency because of a writing group
where he thrashed out his work with other thesis
writers.
Continued in article
Bob Jensen's threads on accountancy doctoral programs are at the following three
links:
Question
What is "the" major difference between medical research and accounting research
published in top research journals?
Answer
Medical researchers publish a lot of research that is "misleading, exaggerated,
or flat-out wrong." The difference is that medical research eventually discovers
and corrects most published research errors. Accounting researchers rarely
discover their errors and leave these errors set in stone ad infinitum
because of a combination of factors that discourage replication and retesting of
hypotheses. To compound the problem, accounting researchers commonly purchase
their data from outfits like Audit Analytics and Compustat and make no effort to
check the validity of the data they have purchased. If some type of rare
research finding validation takes place, accounting researchers go on using the
same data. More commonly, once research using this data is initially published
in accounting research journals, independent accounting researchers do not even
replicate the research efforts to discover whether the original researchers made
errors ---
http://faculty.trinity.edu/rjensen/TheoryTAR.htm
Nearly always published accounting research, accounting research findings are
deemed truth as long they are published in top accounting research journals.
Fortunately, this is not the case in medical research even though long delays in
discovering medical research truth may be very harmful and costly.
MUCH OF WHAT MEDICAL RESEARCHERS CONCLUDE IN THEIR
STUDIES IS MISLEADING, EXAGGERATED, OR FLAT-OUT WRONG. SO WHY ARE DOCTORS—TO A
STRIKING EXTENT—STILL DRAWING UPON MISINFORMATION IN THEIR EVERYDAY PRACTICE?
DR. JOHN IOANNIDIS HAS SPENT HIS CAREER CHALLENGING HIS PEERS BY EXPOSING THEIR
BAD SCIENCE.
But beyond the headlines, Ioannidis was shocked at
the range and reach of the reversals he was seeing in everyday medical
research. “Randomized controlled trials,” which compare how one group
responds to a treatment against how an identical group fares without the
treatment, had long been considered nearly unshakable evidence, but they,
too, ended up being wrong some of the time. “I realized even our
gold-standard research had a lot of problems,” he says. Baffled, he started
looking for the specific ways in which studies were going wrong. And before
long he discovered that the range of errors being committed was astonishing:
from what questions researchers posed, to how they set up the studies, to
which patients they recruited for the studies, to which measurements they
took, to how they analyzed the data, to how they presented their results, to
how particular studies came to be published in medical journals.
This array suggested a bigger, underlying
dysfunction, and Ioannidis thought he knew what it was. “The studies were
biased,” he says. “Sometimes they were overtly biased. Sometimes it was
difficult to see the bias, but it was there.” Researchers headed into their
studies wanting certain results—and, lo and behold, they were getting them.
We think of the scientific process as being objective, rigorous, and even
ruthless in separating out what is true from what we merely wish to be true,
but in fact it’s easy to manipulate results, even unintentionally or
unconsciously. “At every step in the process, there is room to distort
results, a way to make a stronger claim or to select what is going to be
concluded,” says Ioannidis. “There is an intellectual conflict of interest
that pressures researchers to find whatever it is that is most likely to get
them funded.”
Arrogant professors often assume that practitioner journals mostly publish
fluff. In reality, practitioner journals often publish technical jargon papers
for which academic experts are nonexistent or very rare finds by journal
editors.
One of the great myths in academe is that academic research journals are more
technical than practitioner journals. In reality sometimes academic journal
editors cannot find a professor to referee a technical paper such as a very
technical paper in insurance accounting, international tax accounting, ERP,
XBRL, or many of the esoteric subtopics in FAS 133.
In reality, practitioner journals sometimes publish articles that are deemed
too technical for academic accounting research journals. I mentioned previously
that I submitted a rejoinder article to Issues in Accounting Education on
accounting for derivative financial instruments for which the Editor could not
find a single professor to referee the article. The IAE Editor then found to
technical practitioners in Big Four firms to referee my paper ---
http://faculty.trinity.edu/rjensen/CaseAmendment.htm
As a second illustration, two of my best technical submissions were turned
back by academic journal editors with comments that they were too narrow and too
technical for their academic readership. I then found a practitioner journal
that had both papers refereed by Wall Street experts --- http://faculty.trinity.edu/rjensen/Resume.htm#Published
I have thought about what practice focused
accounting research would comprise and I have some difficulty seeing what it
might be. For academic research to benefit practice necessitates that there
be some generic problem of interest to practitioners. In civil engineering,
for example, academic research might contribute by looking at the attributes
of some new building material. Medicine benefits by study of new drugs or
surgical techniques and so on. But accounting happens at the level of the
particular. Each accounting problem is unique to itself. Accounting is the
process by which double entry is applied to produce a representation of what
happened (or what might happen I suppose).
Short of the academic actually participating in the
messy practice of accounting I don’t see how they can contribute to the real
business of accounting. But then that might be the answer. In my practice I
have more accounting problems than I can practically deal with … where are
the academics and their students to help me?
June 12, 2011 reply from Bob Jensen
Hi Robert,
Research is defined as a contribution to new knowledge whereas
scholarship is the mastery of existing knowledge.
You raise three questions of interest.
The most important question is whether research on professional
problems is making a valuable contribution to the practice of
accounting? Obviously there have been valuable and monumental changes in
the practice of accounting such that it's obvious that somewhere at some
time new knowledge (research) contributed to those changes in accounting
practice. Otherwise accountants would still be sitting on
three-legged stools making journal entries and postings with quill pens.
The second question is whether academic researchers made the seminal
contributions to valuable contributions to the practice of accounting?
The third question is whether academic accounting researchers made
valuable additions to seminal contributions to of practitioners and
researchers in other academic disciplines?
The most important question is whether research (new
knowledge) on professional problems is making a valuable contribution to
the practice of accounting?
The answer to the first question is a resounding yes, although the "value"
of "new knowledge" contributions varies greatly by topical area. Where would
tax practice be today without research on international and domestic
taxation, including legal and economic research? Where would accounting
information systems (AIS) be today without research on design, software,
security, hardware, etc. be without research? In your specialty, where would
forensic accounting be today without research on how and why frauds and
other types of cheating take place?
The second question is whether academic researchers
made the seminal contributions to valuable contributions to the practice of
accounting?
The second question is difficult and in some cases impossible to answer
unless a "eureka moment" actually transpired that led to improvements in
accounting practice. In most instances those monumental "eureka moments"
just did not happen as research accumulated like bricks being added to a
building. Or the "eureka moments" transpired so far down at the foundation
level that they're sometimes forgotten when adding bricks to the upper
walls. For example, we can trace computer hardware back to the "eureka
moment" of the conception of a transistor (Shockley) and millions of other
Eureka moments in science and engineering technology taking place over the
past 100 years or even further back in time if we want to delve into the
"eureka moments" in electricity.
On occasion we've identified some "eureka moments" to accounting
practices. Bob Kaplan traces ABC costing back to such a moment in a John
Deere factory. Dale Flesher traced dollar-value LIFO back to a practitioner.
But those eureka moments are seldom identified since more often than not
changes in accounting practice are rooted in new knowledge in underlying
disciplines of science and engineering and the social sciences, including
economics. When there've been "eureka moments" leading to changes in
accounting practice, those moments are almost never attributed to
academic researchers. Understandably they arise from practitioners
themselves seeking ways to improve their job functions and contributions.
Many changes in accounting practices are rooted in new knowledge of
financial contracting. Although options contracts can be traced back to the
Roman empire, things like interest rate swaps are rooted in an IBM contract
in the 1980s. And a defeasance contract can be traced back to an Exxon
contract in the 1980s. Major contributions to practice such as the
Black-Scholes Option Pricing Model can be traced to seminal moments of
academic researchers, but these seminal moments more often than not took
place outside the discipline of accounting.
Many "eureka moments" in fraud can be traced back to the perpetrators
themselves who dreamed up frauds that the rest of the world had never
dreamed of before the frauds actually transpired. Sometimes the clever
thinkers had not even finished high school.
The pickings are pretty slim when if we try to award "Walker Prizes" to
accounting professors who made "eureka moment" seminal contributions to
changes in accounting practice. As I stated above, changes in accounting
practice came more from bricks being laid in a building than where one brick
is designated as a cornerstone. The American Accounting Association has made
five "Seminal Contributions to Accounting Literature Awards" over the years,
but I doubt that most practitioners can name even one of the seminal
literature pieces, although some might've expected Bob Kaplan to get an
award for his work in ABC Costing. But Bob will be the first to admit that
the seminal contribution to ABC Costing came from unknown practitioners in a
John Deere plant. The other recipients, including the Ball and Brown
initial award, built upon earlier research with seminal contributions in
economics and finance ---
http://aaahq.org/awards/awrd2win.htm
In any case, the changes in accounting practice that took place due to these
particular seminal contributions are very difficult to link. Practitioners
most likely would not have made any of these seminal research award.
The third question is whether academic accounting
researchers made valuable additions to seminal contributions of
practitioners and academic researchers in other academic disciplines?
If we confine ourselves to those contributions that changed practice, we
must conclude that academic accountants have their names etched into parts
of bricks put into practice buildings. Often the incremental value of
academic accounting research is mixed into the clay and mortar along with
other ingredients such that "Walker Prizes" would be very difficult to award
in terms of a what a particular author contributed to a particular brick in
the wall of practice. Certainly tax professors have added ingredients to
changes in accounting practice. AIS professors like Bill McCarthy have added
ingredients to changes in AIS practice. The academic works of some
professors like Mary Barth have added ingredients to accounting standards
even if we cannot point to a particular contribution that stands out above
all other contributions.
If we examine the American Accounting Association's Notable Contributions
to Accounting Literature Award we find few if any such awards that can be
linked to specific changes in practice ---
http://aaahq.org/awards/awrd3win.htm
Most practitioners (more than 99%) probably cannot name a single winner
of the NCAL Award and randomly picked academic accounting teachers probably
cannot do much better if pressed to name the title and/or author of one of
the literature pieces that won the monetary NCAL Award. Most of these awards
have been accoutics research awards chosen by accountics research
professors. Some NCAL Award winning articles, especially before 1979, were
actually aimed at changing accounting practice but the changes are generally
difficult to trace into practice. There are no Nobel Prize winners here
where practitioners can remember the importance of the literature piece.
Many of the contributions of academic accounting researchers have been
important in theory even if they did not have marked impact on practice. My
best example here is the 1976 NCAL Award to Yuji Ijiri. The contributions of
Yuji to accounting practice in the Year 2080 may be more appreciated by
practitioners than it is in the Year 2011 in part because as of 2011 Yuji's
contributions are just not yet practical for practitioners. The same might
be said for Carl Devine and many of the other recipients of this prize.
Very few NCAL Award recipients had immediate and marked impact on
practice, although the contribution of Eric Lie is an exception. Regulators
pounced upon his findings and changed practice immediately. Sadly he is a
finance professor receiving an accounting prize for an article published in
a non-accounting journal. Such is life on occasion when awarding a Notable
Contribution to Accounting Literature.
In Conclusion
In conclusion Robert, I would have to argue that accounting practice has
changed greatly in the past 700 years due to new knowledge, and new
knowledge was generated mostly by some type of research. More often than not
it was not accounting practitioners or academics who made the seminal
contributions. And more often than not the seminal contributions were
probably made by accounting practitioners vis-à-vis accounting professors,
but it is naive to deny that accounting professors did not make research
contributions that added to the clay and mortar going into the brick walls
of accounting practice.
My best example of changes in accounting practice is XBRL that is now
having and will soon have an even more monumental impact upon accounting
practice. If we try to provide seminal awards to developers of XBRL where do
we start since XBRL builds upon so many research contributions leading up to
XBRL ---
http://faculty.trinity.edu/rjensen/XBRLandOLAP.htm#Timeline
XBRL is but one brick laid upon all the bricks that are laid under this
brick ---
http://faculty.trinity.edu/rjensen/XBRLandOLAP.htm
STATIC WEB TIMELINE
Hypertext--->PC---> GUI,Mouse ---> GML,SGML --->Internet
--->Hypermedia--->HTML, HTTP, WWW ---> DYNAMIC WEB TIMELINE
CGI,Java,JavaScript,DHTML,ActiveX,ASP ---> XML/SMIL --->RDF and
OWL ---> OLAP ---> XBRL -
SEMANTIC WEB
Charles Hoffman, a CPA practitioner, should probably get seminal credit
for making the leap from XML to the XBRL reporting system. But since Charlie
made his seminal contribution, many academic researchers in accounting and
outside accounting have made valuable contributions to this evolving change
in practice in accountancy.
It's new knowledge that leads to change Robert, and new knowledge is
research!
And research contributions are only seldom identified "eureka moments."
Bob Jensen's threads on accounting theory and research are at:
The reason for the disdain in which classical
financial accounting research has come to held by many in the scholarly
community is its allegedly insufficiently scientific nature. While many have
defended classical research or provided critiques of post-classical
paradigms, the motivation for this paper is different. It offers an
epistemologically robust underpinning for the approaches and methods of
classical financial accounting research that restores its claim to
legitimacy as a rigorous, systematic and empirically grounded means of
acquiring knowledge. This underpinning is derived from classical
philosophical pragmatism and, principally, from the writings of John Dewey.
The objective is to show that classical approaches are capable of yielding
serviceable, theoretically based solutions to problems in accounting
practice.
Jensen Comment
When it comes to "insufficient scientific nature" of classical accounting
research I should note yet once again that accountics science never attained the
status of real science where the main criteria are scientific searches for
causes and an obsession with replication (reproducibility) of findings.
"Research
on Accounting Should Learn From the Past" by Michael H. Granof and Stephen
A. Zeff, Chronicle of HigherEducation, March 21, 2008
The unintended consequence has been that interesting and researchable questions
in accounting are essentially being ignored.
By confining the major thrust in research to phenomena that can be
mathematically modeled or derived from electronic databases, academic
accountants have failed to advance the profession in ways that are expected of
them and of which they are capable.
Academic research has unquestionably broadened the views of standards setters as
to the role of accounting information and how it affects the decisions of
individual investors as well as the capital markets. Nevertheless, it has had
scant influence on the standards themselves.
Continued
in article
"Research on Accounting Should Learn From the Past,"
by Michael H. Granof and
Stephen A. Zeff, Chronicle of Higher Education, March 21, 2008
. . .
The narrow focus of today's research has also resulted in a disconnect between
research and teaching. Because of the difficulty of conducting publishable
research in certain areas — such as taxation, managerial accounting, government
accounting, and auditing — Ph.D. candidates avoid choosing them as specialties.
Thus, even though those areas are central to any degree program in accounting,
there is a shortage of faculty members sufficiently knowledgeable to teach them.
To be sure, some accounting research, particularly that pertaining to the
efficiency of capital markets, has found its way into both the classroom and
textbooks — but mainly in select M.B.A. programs and the textbooks used in those
courses. There is little evidence that the research has had more than a marginal
influence on what is taught in mainstream accounting courses.
What needs to be done? First, and most significantly, journal editors,
department chairs, business-school deans, and promotion-and-tenure committees
need to rethink the criteria for what constitutes appropriate accounting
research. That is not to suggest that they should diminish the importance of the
currently accepted modes or that they should lower their standards. But they
need to expand the set of research methods to encompass those that, in other
disciplines, are respected for their scientific standing. The methods include
historical and field studies, policy analysis, surveys, and international
comparisons when, as with empirical and analytical research, they otherwise meet
the tests of sound scholarship.
Second, chairmen, deans, and promotion and merit-review committees must expand
the criteria they use in assessing the research component of faculty
performance. They must have the courage to establish criteria for what
constitutes meritorious research that are consistent with their own
institutions' unique characters and comparative advantages, rather than
imitating the norms believed to be used in schools ranked higher in magazine and
newspaper polls. In this regard, they must acknowledge that accounting
departments, unlike other business disciplines such as finance and marketing,
are associated with a well-defined and recognized profession. Accounting
faculties, therefore, have a special obligation to conduct research that is of
interest and relevance to the profession. The current accounting model was
designed mainly for the industrial era, when property, plant, and equipment were
companies' major assets. Today, intangibles such as brand values and
intellectual capital are of overwhelming importance as assets, yet they are
largely absent from company balance sheets. Academics must play a role in
reforming the accounting model to fit the new postindustrial environment.
Third, Ph.D. programs must ensure that young accounting researchers are
conversant with the fundamental issues that have arisen in the accounting
discipline and with a broad range of research methodologies. The accounting
literature did not begin in the second half of the 1960s. The books and articles
written by accounting scholars from the 1920s through the 1960s can help to
frame and put into perspective the questions that researchers are now studying.
This citation was forwarded by Don Ramsey
"Why business ignores the business schools," by Michael Skapinker,
Financial Times, January 7, 2008
Chief executives, on the other hand, pay little
attention to what business schools do or say. As long ago as 1993, Donald
Hambrick, then president of the US-based Academy of Management, described
the business academics' summer conference as "an incestuous closed loop", at
which professors "come to talk with each other". Not much has changed. In
the current edition of The Academy of Management Journal.
. . .
They have chosen an auspicious occasion on which to
beat themselves up: this year is The Academy of Management Journal's 50th
anniversary. A scroll through the most recent issues demonstrates why
managers may be giving the Journal a miss. "A multi-level investigation of
antecedents and consequences of team member boundary spanning behaviour" is
the title of one article.
Why do business academics write like this? The
academics themselves offer several reasons. First, to win tenure in a US
university, you need to publish in prestigious peer-reviewed journals.
Accessibility is not the key to academic advancement.
Similar pressures apply elsewhere. In France and
Australia, academics receive bonuses for placing articles in the top
academic publications. The UK's Research Assessment Exercise, which
evaluates university research and ties funding to the outcome, encourages
similarly arcane work.
But even without these incentives, many business
school faculty prefer to adorn their work with scholarly tables, statistics
and jargon because it makes them feel like real academics. Within the
university world, business schools suffer from a long-standing inferiority
complex.
The professors offer several remedies. Academic
business journals should accept fact-based articles, without demanding that
they propound a new theory. Professor Hambrick says that academics in other
fields "don't feel the need to sprinkle mentions of theory on every page,
like so much aromatic incense or holy water".
Others talk of the need for academics to spend more
time talking to managers about the kind of research they would find useful.
As well-meaning as these suggestions are, I suspect
the business school academics are missing something. Law, medical and
engineering schools are subject to the same academic pressures as business
schools - to publish in prestigious peer-reviewed journals and to buttress
their work with the expected academic vocabulary.
In his first President's Message, Gary Previts mentions the Plumlee report
on the dire shortage of accountancy doctoral students and provides a link to the
AAA's new site providing resources for research and experimentation on "Future
Accounting Faculty and Programs Projects" ---
http://aaahq.org/temp/phd/index.cfm
Note especially the Accounting PhD Program Info link with a picture) and the PhD
Project link (at the bottom):
Welcome to the
preliminary posting of a new resource for the
community participating in and supporting accounting
programs, students, faculty, and by that connection
practitioners of accounting. We plan to build this
collection of resources for the broad community
committed to a vital future for accounting education.
This page is an initial step to creating a place where
we can come together to gather resources and share data
and ideas.
Making A Difference: Careers in Academia
Powerpoint slides created by Nancy BaGranof and
Stephanie Bryant for the 2007 Beta Alpha Psi
Annual Meeting. Permission granted for use and
adaptation with attribution.
Part I:
Future of Accounting Faculty Project (Report
December, 2007)
Part II: Future of Accounting Programs Project
Part I
will describe today's accounting academic workforce,
via demographics, work patterns, productivity, and
career progression of accounting faculty, as well as
of faculty in selected peer disciplines using data
from the national survey of postsecondary faculty (NSOPF)
to establish trends, and a set of measures will be
combined to benchmark the overall status of
accounting against (approximately) 150 fields. This
project will provide context and data to identify
factors affecting the pipeline and workplace.
Part II
will focus on expanding understanding of the
characteristics of accounting faculty, students, and
accounting programs, and implications of their
evolving environment. The need for the Part I
project illustrates how essential it is for the
discipline and profession of accounting that we
establish a more standard and comprehensive process
for collecting, analyzing, and reporting data about
accounting students, doctoral students, faculty,
curriculum, and programs.
More Resources
on the Changing Environment for Faculty:
Report of the AAA/APLG
Committee to Assess the Supply and Demand of
Accounting PhDs
Link to the
Doctoral Education Resource Center of AACSB
International (Association to Advance Collegiate
Schools of Business)
AICPA's Journal of
Accountancy's article "Teaching for the Love of It"
Deloitte
Foundation Accounting Doctoral Student Survey
Survey Results (Summer, 2007)
Data collected by survey of attendees of the 2007
AAA/Deloitte J. Michael Cook Doctoral Consortium
The PhD Project
and Accounting Doctoral Students Association
The PhD Project is an information clearinghouse
created to increase the diversity of business school
faculty by attracting African Americans, Hispanic
Americans and Native Americans to business doctoral
programs and by providing a network of peer support.
In just 12 short years, the PhD Project has been the
catalyst for a dramatic increase in the number of
minority business school faculty—from 294 to 842,
with approximately 380 more candidates currently
immersed in doctoral studies.
The PhD Project Accounting Doctoral Students
Association is a voluntary association offering
moral support and encouragement to African-American,
Hispanic-American, and Native American Accounting
Doctoral Students as their pursue their degrees and
take their places in the teaching and research
profession, and serve as mentors to new doctoral
students.
Professor Dan Deines at Kansas State University has a handful of
Outstanding Educator Awards, including one from the AICPA. Beginning on Page 5
of the Fall 2007 edition of AEN, Dan discusses the Taylor Research and
Consulting Group study of accounting education commissioned by the AICPA in
2002. The study identifies barriers to students that prevent many top students
from majoring in accounting. Dan then describes a pilot program initiated by KSU
in reaction to the Taylor Report. I think accounting educators outside KSU may
attend some of the pilot program events.
Bob Jensen's threads on the shortage of doctoral students in accountancy are
shown below.
The AAA's Pathways Commission Accounting Education Initiatives Make
National News
Accountics Scientists Should Especially Note the First Recommendation
Accounting programs should promote curricular
flexibility to capture a new generation of students who are more
technologically savvy, less patient with traditional teaching methods, and
more wary of the career opportunities in accounting, according to a report
released today by the
Pathways Commission, which studies the future of
higher education for accounting.
In 2008, the U.S. Treasury Department's Advisory
Committee on the Auditing Profession recommended that the American
Accounting Association and the American Institute of Certified Public
Accountants form a commission to study the future structure and content of
accounting education, and the Pathways Commission was formed to fulfill this
recommendation and establish a national higher education strategy for
accounting.
In the report, the commission acknowledges that
some sporadic changes have been adopted, but it seeks to put in place a
structure for much more regular and ambitious changes.
The report includes seven recommendations:
Integrate accounting research, education
and practice for students, practitioners and educators by bringing
professionally oriented faculty more fully into education programs.
Promote accessibility of doctoral
education by allowing for flexible content and structure in doctoral
programs and developing multiple pathways for degrees. The current path
to an accounting Ph.D. includes lengthy, full-time residential programs
and research training that is for the most part confined to quantitative
rather than qualitative methods. More flexible programs -- that might be
part-time, focus on applied research and emphasize training in teaching
methods and curriculum development -- would appeal to graduate students
with professional experience and candidates with families, according to
the report.
Increase recognition and support for
high-quality teaching and connect faculty review, promotion and tenure
processes with teaching quality so that teaching is respected as a
critical component in achieving each institution's mission. According to
the report, accounting programs must balance recognition for work and
accomplishments -- fed by increasing competition among institutions and
programs -- along with recognition for teaching excellence.
Develop curriculum models, engaging learning
resources and mechanisms to easily share them, as well as enhancing
faculty development opportunities to sustain a robust curriculum that
addresses a new generation of students who are more at home with
technology and less patient with traditional teaching methods.
Improve the ability to attract high-potential,
diverse entrants into the profession.
Create mechanisms for collecting, analyzing
and disseminating information about the market needs by establishing a
national committee on information needs, projecting future supply and
demand for accounting professionals and faculty, and enhancing the
benefits of a high school accounting education.
Establish an implementation process to address
these and future recommendations by creating structures and mechanisms
to support a continuous, sustainable change process.
According to the report, its two sponsoring
organizations -- the American Accounting Association and the American
Institute of Certified Public Accountants -- will support the effort to
carry out the report's recommendations, and they are finalizing a strategy
for conducting this effort.
Hsihui Chang, a professor and head of Drexel
University’s accounting department, said colleges must prepare students for
the accounting field by encouraging three qualities: integrity, analytical
skills and a global viewpoint.
“You need to look at things in a global scope,” he
said. “One thing we’re always thinking about is how can we attract students
from diverse groups?” Chang said the department’s faculty comprises members
from several different countries, and the university also has four student
organizations dedicated to accounting -- including one for Asian students
and one for Hispanic students.
He said the university hosts guest speakers and
accounting career days to provide information to prospective accounting
students about career options: “They find out, ‘Hey, this seems to be quite
exciting.’ ”
Jimmy Ye, a professor and chair of the accounting
department at Baruch College of the City University of New York, wrote in an
email to Inside Higher Ed that his department is already fulfilling
some of the report’s recommendations by inviting professionals from
accounting firms into classrooms and bringing in research staff from
accounting firms to interact with faculty members and Ph.D. students.
Ye also said the AICPA should collect and analyze
supply and demand trends in the accounting profession -- but not just in the
short term. “Higher education does not just train students for getting their
first jobs,” he wrote. “I would like to see some study on the career tracks
of college accounting graduates.”
Mohamed Hussein, a professor and head of the
accounting department at the University of Connecticut, also offered ways
for the commission to expand its recommendations. He said the
recommendations can’t be fully put into practice with the current structure
of accounting education.
“There are two parts to this: one part is being
able to have an innovative curriculum that will include changes in
technology, changes in the economics of the firm, including risk,
international issues and regulation,” he said. “And the other part is making
sure that the students will take advantage of all this innovation.”
The university offers courses on some of these
issues as electives, but it can’t fit all of the information in those
courses into the major’s required courses, he said.
Questions
Why must all accounting doctoral programs be social science (particularly
econometrics) doctoral programs?
What's wrong with humanities research methodologies?
What's wrong about studying accounting in accounting doctoral programs?
Why are we graduating so many new assistant professors of accounting who do not
know any accounting? Hint: Similar problems exist in languages and education school PhD programs
The reason for the disdain in which classical
financial accounting research has come to held by many in the scholarly
community is its allegedly insufficiently scientific nature. While many have
defended classical research or provided critiques of post-classical
paradigms, the motivation for this paper is different. It offers an
epistemologically robust underpinning for the approaches and methods of
classical financial accounting research that restores its claim to
legitimacy as a rigorous, systematic and empirically grounded means of
acquiring knowledge. This underpinning is derived from classical
philosophical pragmatism and, principally, from the writings of John Dewey.
The objective is to show that classical approaches are capable of yielding
serviceable, theoretically based solutions to problems in accounting
practice.
Jensen Comment
When it comes to "insufficient scientific nature" of classical accounting
research I should note yet once again that accountics science never attained the
status of real science where the main criteria are scientific searches for
causes and an obsession with replication (reproducibility) of findings.
"Research
on Accounting Should Learn From the Past" by Michael H. Granof and Stephen
A. Zeff, Chronicle of HigherEducation, March 21, 2008
The unintended consequence has been that interesting and researchable questions
in accounting are essentially being ignored.
By confining the major thrust in research to phenomena that can be
mathematically modeled or derived from electronic databases, academic
accountants have failed to advance the profession in ways that are expected of
them and of which they are capable.
Academic research has unquestionably broadened the views of standards setters as
to the role of accounting information and how it affects the decisions of
individual investors as well as the capital markets. Nevertheless, it has had
scant influence on the standards themselves.
Continued
in article
"Research on Accounting Should Learn From the Past,"
by Michael H. Granof and
Stephen A. Zeff, Chronicle of Higher Education, March 21, 2008
. . .
The narrow focus of today's research has also resulted in a disconnect between
research and teaching. Because of the difficulty of conducting publishable
research in certain areas — such as taxation, managerial accounting, government
accounting, and auditing — Ph.D. candidates avoid choosing them as specialties.
Thus, even though those areas are central to any degree program in accounting,
there is a shortage of faculty members sufficiently knowledgeable to teach them.
To be sure, some accounting research, particularly that pertaining to the
efficiency of capital markets, has found its way into both the classroom and
textbooks — but mainly in select M.B.A. programs and the textbooks used in those
courses. There is little evidence that the research has had more than a marginal
influence on what is taught in mainstream accounting courses.
What needs to be done? First, and most significantly, journal editors,
department chairs, business-school deans, and promotion-and-tenure committees
need to rethink the criteria for what constitutes appropriate accounting
research. That is not to suggest that they should diminish the importance of the
currently accepted modes or that they should lower their standards. But they
need to expand the set of research methods to encompass those that, in other
disciplines, are respected for their scientific standing. The methods include
historical and field studies, policy analysis, surveys, and international
comparisons when, as with empirical and analytical research, they otherwise meet
the tests of sound scholarship.
Second, chairmen, deans, and promotion and merit-review committees must expand
the criteria they use in assessing the research component of faculty
performance. They must have the courage to establish criteria for what
constitutes meritorious research that are consistent with their own
institutions' unique characters and comparative advantages, rather than
imitating the norms believed to be used in schools ranked higher in magazine and
newspaper polls. In this regard, they must acknowledge that accounting
departments, unlike other business disciplines such as finance and marketing,
are associated with a well-defined and recognized profession. Accounting
faculties, therefore, have a special obligation to conduct research that is of
interest and relevance to the profession. The current accounting model was
designed mainly for the industrial era, when property, plant, and equipment were
companies' major assets. Today, intangibles such as brand values and
intellectual capital are of overwhelming importance as assets, yet they are
largely absent from company balance sheets. Academics must play a role in
reforming the accounting model to fit the new postindustrial environment.
Third, Ph.D. programs must ensure that young accounting researchers are
conversant with the fundamental issues that have arisen in the accounting
discipline and with a broad range of research methodologies. The accounting
literature did not begin in the second half of the 1960s. The books and articles
written by accounting scholars from the 1920s through the 1960s can help to
frame and put into perspective the questions that researchers are now studying.
Question
What drastic move is the AACSB
International (accrediting body) taking to deal with the shortage of
graduating students from business doctoral programs (including accountancy
doctoral programs)? Hint:
It's called a “Postdoctoral Bridge to Business”
Answer
With many business schools reporting difficulty attracting
Ph.D. faculty members, the Association to Advance Collegiate Schools of Business
has announced the first participating institutions in new
“Postdoctoral Bridge to Business” programs —
short-term programs that will train new Ph.D.’s in fields outside business for
faculty jobs at business schools. The programs are starting at the Grenoble
Ecole de Management, Tulane University, the University of Florida, the
University of Toledo and Virginia Tech. Inside Higher Ed, September 20, 2007 ---
http://www.insidehighered.com/news/2007/09/20/qt
A cynic might conclude that this
is a correctional option for naive students who earned an economics PhD in an
Economics Department rather than lucky students who earned virtual economics
PhDs in accountancy doctoral programs.
This reminds me of the Harvard
math professor (I can't recall which one at the moment) who said:
"Accounting is a fascinating discipline. I think I might take a couple of hours
to master it."
The AAA's Pathways Commission Accounting Education Initiatives Make
National News
Accountics Scientists Should Especially Note the First Recommendation
Accounting programs should promote curricular
flexibility to capture a new generation of students who are more
technologically savvy, less patient with traditional teaching methods, and
more wary of the career opportunities in accounting, according to a report
released today by the
Pathways Commission, which studies the future of
higher education for accounting.
In 2008, the U.S. Treasury Department's Advisory
Committee on the Auditing Profession recommended that the American
Accounting Association and the American Institute of Certified Public
Accountants form a commission to study the future structure and content of
accounting education, and the Pathways Commission was formed to fulfill this
recommendation and establish a national higher education strategy for
accounting.
In the report, the commission acknowledges that
some sporadic changes have been adopted, but it seeks to put in place a
structure for much more regular and ambitious changes.
The report includes seven recommendations:
Integrate accounting research, education
and practice for students, practitioners and educators by bringing
professionally oriented faculty more fully into education programs.
Promote accessibility of doctoral
education by allowing for flexible content and structure in doctoral
programs and developing multiple pathways for degrees. The current path
to an accounting Ph.D. includes lengthy, full-time residential programs
and research training that is for the most part confined to quantitative
rather than qualitative methods. More flexible programs -- that might be
part-time, focus on applied research and emphasize training in teaching
methods and curriculum development -- would appeal to graduate students
with professional experience and candidates with families, according to
the report.
Increase recognition and support for
high-quality teaching and connect faculty review, promotion and tenure
processes with teaching quality so that teaching is respected as a
critical component in achieving each institution's mission. According to
the report, accounting programs must balance recognition for work and
accomplishments -- fed by increasing competition among institutions and
programs -- along with recognition for teaching excellence.
Develop curriculum models, engaging learning
resources and mechanisms to easily share them, as well as enhancing
faculty development opportunities to sustain a robust curriculum that
addresses a new generation of students who are more at home with
technology and less patient with traditional teaching methods.
Improve the ability to attract high-potential,
diverse entrants into the profession.
Create mechanisms for collecting, analyzing
and disseminating information about the market needs by establishing a
national committee on information needs, projecting future supply and
demand for accounting professionals and faculty, and enhancing the
benefits of a high school accounting education.
Establish an implementation process to address
these and future recommendations by creating structures and mechanisms
to support a continuous, sustainable change process.
According to the report, its two sponsoring
organizations -- the American Accounting Association and the American
Institute of Certified Public Accountants -- will support the effort to
carry out the report's recommendations, and they are finalizing a strategy
for conducting this effort.
Hsihui Chang, a professor and head of Drexel
University’s accounting department, said colleges must prepare students for
the accounting field by encouraging three qualities: integrity, analytical
skills and a global viewpoint.
“You need to look at things in a global scope,” he
said. “One thing we’re always thinking about is how can we attract students
from diverse groups?” Chang said the department’s faculty comprises members
from several different countries, and the university also has four student
organizations dedicated to accounting -- including one for Asian students
and one for Hispanic students.
He said the university hosts guest speakers and
accounting career days to provide information to prospective accounting
students about career options: “They find out, ‘Hey, this seems to be quite
exciting.’ ”
Jimmy Ye, a professor and chair of the accounting
department at Baruch College of the City University of New York, wrote in an
email to Inside Higher Ed that his department is already fulfilling
some of the report’s recommendations by inviting professionals from
accounting firms into classrooms and bringing in research staff from
accounting firms to interact with faculty members and Ph.D. students.
Ye also said the AICPA should collect and analyze
supply and demand trends in the accounting profession -- but not just in the
short term. “Higher education does not just train students for getting their
first jobs,” he wrote. “I would like to see some study on the career tracks
of college accounting graduates.”
Mohamed Hussein, a professor and head of the
accounting department at the University of Connecticut, also offered ways
for the commission to expand its recommendations. He said the
recommendations can’t be fully put into practice with the current structure
of accounting education.
“There are two parts to this: one part is being
able to have an innovative curriculum that will include changes in
technology, changes in the economics of the firm, including risk,
international issues and regulation,” he said. “And the other part is making
sure that the students will take advantage of all this innovation.”
The university offers courses on some of these
issues as electives, but it can’t fit all of the information in those
courses into the major’s required courses, he said.
Question
The faculty shortage in nursing schools is even more severe than that of
accounting schools. Why are there "bridges over troubled waters" in schools of
nursing in the same context as the new bridges being built for non-accounting
PhDs mentioned above?
Answer with a Question
Would you really want an economics PhD who took a crash course in nursing
teaching the nurses who serve you?
Answer with an Answer ---
http://nln.allenpress.com/pdfserv/i1536-5026-028-04-0223.pdf
The fact of the matter is that the law of supply and demand works better in
schools of accounting than in schools of nursing. In general, accounting
educators are among the highest paid faculty on campus. The number of unfilled
tenure-track job openings in schools of accounting combined with starting
salaries in excess of $130,000 per year are the main reasons that the AACSB
International's "Postdoctoral Bridge to Business" just might work,
although I seriously doubt whether any of the bridged students will be able to
teach upper division financial accounting, auditing, and tax courses.
The fact is that the law of supply and demand works lousy in nursing schools.
In spite of shortages of qualified faculty, nursing educators remain among the
lowest paid faculty on campus. A Nursing International's "Postdoctoral Bridge to
Nursing" probably would not work, and given my cynacism about 90-0Day Wonders it
is some comfort to me that there is no such bridge over troubled waters in
nursing schools.
Question
What do accounting schools and nursing schools have in common?
The
market for nursing graduates remains hot, and plenty of
students are vying for those open positions. Enrollment in
entry-level baccalaureate nursing programs increased by
nearly 8 percent in 2006 from the previous year, which
marked the
sixth straight year of gains.
Community College programs are also
seeing increases in applications
and enrollments.
It’s all
positive news for the health care industry, which has
suffered from a well-documented nursing shortage since the
1990s, when many hospitals cut their staffs and some
colleges cut back their programs.
But for
colleges of nursing, the increasing demand to accommodate
more students presents a dilemma: Who will teach them?
When it
comes to clinical nursing courses, college programs are
bound to strict faculty-to-student ratios, set by individual
states. One instructor to every 10 or 12 students is a
fairly common ratio. So even as administrators and state
lawmakers seek more slots for students, there’s a ceiling on
expansion unless more faculty are recruited or produced.
That’s not
happening quickly. A survey released last year by the
American Association of Colleges of Nursing identified at
least 637 faculty vacancies at more than 300 nursing schools
with baccalaureate or graduate programs — or what amounts to
a nearly 8 percent faculty vacancy rate. The majority of the
openings are tenure-track positions that require applicants
have a doctorate, the survey shows.
Meanwhile,
there continues to be a backlog of students. In 2006, more
than 38,000 nursing school candidates deemed “qualified” by
the AACN were turned away from entry-level baccalaureate
programs, while a total of 50,783 nursing school applicants
enrolled and registered in courses. When the new students
are added to the pool of all students enrolled, total
enrollment rises to 133,578.
Nearly three
quarters of the colleges that responded to the AACN survey
pointed to faculty shortages as a reason for not accepting
the applicants. Community colleges are turning away 3.3
“qualified” applicants for every one turned away by
four-year institutions, said Roxanne Fulcher, director of
health professions policy at the American Association of
Community Colleges.
At many
nursing schools, wait lists are shrinking after years of
growth, officials say, not because slots are opening up, but
because students are becoming frustrated that their chances
of enrolling are dim.
Continued in article
Question
What do accounting schools and nursing schools have in common?
The
market for nursing graduates remains hot, and plenty of
students are vying for those open positions. Enrollment in
entry-level baccalaureate nursing programs increased by
nearly 8 percent in 2006 from the previous year, which
marked the
sixth straight year of gains.
Community College programs are also
seeing increases in applications
and enrollments.
It’s all
positive news for the health care industry, which has
suffered from a well-documented nursing shortage since the
1990s, when many hospitals cut their staffs and some
colleges cut back their programs.
But for
colleges of nursing, the increasing demand to accommodate
more students presents a dilemma: Who will teach them?
When it
comes to clinical nursing courses, college programs are
bound to strict faculty-to-student ratios, set by individual
states. One instructor to every 10 or 12 students is a
fairly common ratio. So even as administrators and state
lawmakers seek more slots for students, there’s a ceiling on
expansion unless more faculty are recruited or produced.
That’s not
happening quickly. A survey released last year by the
American Association of Colleges of Nursing identified at
least 637 faculty vacancies at more than 300 nursing schools
with baccalaureate or graduate programs — or what amounts to
a nearly 8 percent faculty vacancy rate. The majority of the
openings are tenure-track positions that require applicants
have a doctorate, the survey shows.
Meanwhile,
there continues to be a backlog of students. In 2006, more
than 38,000 nursing school candidates deemed “qualified” by
the AACN were turned away from entry-level baccalaureate
programs, while a total of 50,783 nursing school applicants
enrolled and registered in courses. When the new students
are added to the pool of all students enrolled, total
enrollment rises to 133,578.
Nearly three
quarters of the colleges that responded to the AACN survey
pointed to faculty shortages as a reason for not accepting
the applicants. Community colleges are turning away 3.3
“qualified” applicants for every one turned away by
four-year institutions, said Roxanne Fulcher, director of
health professions policy at the American Association of
Community Colleges.
At many
nursing schools, wait lists are shrinking after years of
growth, officials say, not because slots are opening up, but
because students are becoming frustrated that their chances
of enrolling are dim.
Continued in article
Rankings of Universities in Terms of
Doctoral Student Placements
The journal PS: Political Science & Politics has just published
an analysisthat suggests
that there is not a direct relationship between the general
reputation of a department and its success at placing new
Ph.D.’s; some programs far exceed their reputation when it comes
to placing new Ph.D.’s while others lag. The analysis may
provide new evidence for the “halo effect” in which many experts
worry that general (and sometimes outdated) institutional
reputations cloud the judgment of those asked to fill out
surveys on departmental quality. And while the analysis was
prepared about political science, its authors believe the same
approach could be used in other fields in the humanities and
social sciences, with the method more problematic in other areas
because fewer Ph.D. students aspire to academic careers.
Scott Jaschik, "A Ranking That Would Matter," Inside Higher
Ed, August 21, 2007 ---
http://www.insidehighered.com/news/2007/08/21/ranking
Jensen Comment
The big problem here is defining what constitutes "a top job" or
a "a good job." There are so many elements in job satisfaction,
many of which are intangible and cannot be quantified, that I'm
suspect of any study that purports to identify top jobs.
Obviously prestigious universities have a bias for hiring
prestigious university graduates. But this is often due to the
reputations of the graduate student's teachers and thesis
advisors. And the quality of the dissertation may have a great
deal of impact on hiring even if the degree is from No-name
University. Also prestigious universities tend to have the
highest GMAT applicants, but this is not always the case. Often
the highest GMAT applicants are really tremendous graduates.
In disciplines
having great shortages of doctoral graduates, especially
doctoral graduates in accounting and finance, findings from
political science do not necessarily extrapolate.
Be that as it may, the findings of the
above study come as no surprise to me. Particularly in
accounting, some prestigious universities have taken a nose dive
in terms of reputations of faculty supervising dissertations.
And students may not have access to the most reputable faculty,
especially faculty who are too busy with consulting and world
travel. For example, a few years ago I encountered a doctoral
student in accounting at the University of Chicago who claimed
that it was very difficult to even find a faculty member who
would supervise a dissertation. But if he ever graduates from
Chicago, he will have the Chicago halo around his head. In
fairness, I've not had recent information regarding what is
happening with doctoral students in accounting at the University
of Chicago. Certainly it is still a very reputable university in
terms of its business studies and research programs.
Also there is a problem in accountancy that
mathematics-educated accountancy doctoral graduates from
prestigious universities may know very little about accountancy
and additionally have troubles with the English language. On
occasion prestige-university graduates do not get the "top jobs"
where accountancy is spoken.
All is Not Well in Modern Languages Education
Proposal to integrate languages with literature, history,
culture, economics and linguistics
Proposal to use fewer adjuncts who now teach language courses The MLA created a special committee in
2004 to study the future of language education andits
report,being issued today
(May 24, 2007)
is in many ways unprecedented for the association in that it is
urging departments to reorganize how languages are taught and
who does the teaching. In general, the critique of the committee
is that the traditional model has started with basic language
training (typically taught by those other than tenure-track
faculty members) and proceeded to literary study (taught by
tenure-track faculty members). The report calls for moving away
from this “two tiered” system, integrating language study with
literature, and placing much more emphasis on history, culture,
economics and linguistics — among other topics — of the
societies whose languages are being taught.
Scott Jaschik, Inside Higher Ed, May 24, 2007 ---
http://insidehighered.com/news/2007/05/24/mla
Who Teaches First-Year Language Courses?
Rank
Doctoral-Granting Departments
B.A.-Granting Departments
Tenured or tenure-track professors
7.4%
41.8%
Full-time, non-tenure track
19.6%
21.1%
Part-time instructors
15.7%
34.7%
Graduate students
57.4%
2.4%
All is Not Well in Programs for Doctoral Students in Departments/Colleges
of Education The education doctorate, attempting to
serve dual purposes—to prepare researchers and to prepare practitioners—is not
serving either purpose well. To address what they have termed this "crippling"
problem, Carnegie and the Council of Academic Deans in Research Education
Institutions (CADREI) have launched the Carnegie Project on the Education
Doctorate (CPED), a three-year effort to reclaim the education doctorate and to
transform it into the degree of choice for the next generation of school and
college leaders. The project is coordinated by David Imig, professor of practice
at the University of Maryland. "Today, the Ed.D. is perceived as 'Ph.D.-lite,'"
said Carnegie President Lee S. Shulman. "More important than the public
relations problem, however, is the real risk that schools of education are
becoming impotent in carrying out their primary missions to prepare leading
practitioners as well as leading scholars."
"Institutions Enlisted to Reclaim Education Doctorate," The Carnegie Foundation
for Advancement in Teaching ---
http://www.carnegiefoundation.org/news/sub.asp?key=51&subkey=2266
The EED does not focus enough on research, and the PhD program has become a
social science doctoral program without enough education content. Middle ground
is being sought.
Partly the problem is the same as with PhD programs in colleges of
education.
The pool of accounting doctoral program applicants is drying up, especially
accounting doctoral program pool that is increasingly trickle-filled with
mathematically-educated foreign students who have virtually no background in
accounting. Twenty
years ago, over 200 accounting doctoral students were being graduated each year
in the United States. Now it's less than one hundred graduates per year, many of
whom know very little about accounting, especially U.S. accounting. This is
particularly problematic for financial accounting, tax, and auditing education
requiring knowledge of U.S. standards, regulations, and laws.
Accounting
doctoral programs are social science research programs that do not appeal to
accountants who are interested in becoming college educators but have no
aptitude for or interest in the five or more years of quantitative methods study
required for current accounting doctoral programs.
There were only 29
doctoral students in auditing and 23 in tax out of the 2004 total of 391
accounting doctoral students enrolled in years 1-5 in the United States.
The answer here it seems to me is to open doctoral
programs to wider humanities and legal studies research methodologies and to put
accounting back into accounting doctoral programs.
Partly the problem is the same as with
“two-tiered”
departments of modern languages
The huge shortage of accounting doctoral graduates has bifurcated the teaching
of accounting. Increasingly, accounting, tax, systems, and auditing courses are
taught by adjunct part-time faculty or full-time adjunct faculty who are not on
a tenure track and often are paid much less than tenure-track faculty who teach
graduate research courses.
The short run answer here is difficult since there
are so few doctoral graduates who know enough accounting to take over for the
adjunct faculty. If doctoral programs open up more to accountants, perhaps more
adjunct faculty will enter the pool of doctoral program prospects. This might
help the long run problem. Meanwhile as former large doctoral programs (e.g., at
Illinois, Texas, Florida, Indiana, Wisconsin, and Michigan) shrink more and
more, we’re increasingly building two-tier accounting education programs due to
increasing demand and shrinking supply of doctoral graduates in accountancy.
We’re becoming more and more
like “two-tier” language departments in our large and small colleges.
Practitioners in education schools generally are K-12 teachers and school
administrators. In the case of accounting doctoral programs, our dual mission is
to prepare college teachers of accountancy as well as leading scholars. Our
accounting doctoral programs are drying up (less than 100 per year now
graduating in the United States, many of whom know virtually no accounting)
primarily because our doctoral programs have become five years of social science
and mathematics concentrations that do not appeal to accountants who might
otherwise enter the pool of doctoral program admission candidates.
Note that the above Carnegie study also claims that education
doctoral programs are also failing to "prepare researchers." I think the same
criticism applies to current accountancy doctoral programs in the United States.
We're failing in our own dual purpose accountancy doctoral programs and need a
concerted effort to become a "degree of choice" among the accounting
professionals who would like to move into academe in a role other than that of a
low-status and low-paid adjunct professor.
In the
United States, following the Gordon/Howell and Pierson reports, our
accounting doctoral programs and leading academic journals bet the farm on
the social sciences without taking the due cautions of realizing why the
social sciences are called "soft sciences." They're soft because "not
everything that can be counted, counts. And not everything that counts can
be counted."
Leading academic accounting
research journals commenced accepting only esoteric papers with complicated
mathematical models and trivial hypotheses of zero interest to accounting
practitioners ---
http://faculty.trinity.edu/rjensen/395wpTAR/Web/TAR395wp.htm
Accounting doctoral programs made a
concerted effort to recruit students with mathematics, economics, and social
science backgrounds even though these doctoral candidates knew virtually nothing
about accountancy. To compound the felony, the doctoral programs dropped all
accounting requirements except for some doctoral seminars on how to mine
accounting data archives with econometric and psychometric models and advanced
statistical inference testing.
I cannot find the exact quotation in my archives, but some years
ago Linda Kidwell complained that her university had recently hired a
newly-minted graduate from an accounting doctoral program who did not know any
accounting. When assigned to teach accounting courses, this new "accounting"
professor was a disaster since she knew nothing about the subjects she was
assigned to teach.
In the year following his assignment as President of the
American Accounting Association Joel Demski asserted that research focused on
the accounting profession will become a "vocational virus" leading us away from
the joys of mathematics and the social sciences and the pureness of the
scientific academy:
Statistically there are a few youngsters who
came to academia for the joy of learning, who are yet relatively
untainted by the vocational virus.
I urge you to nurture your taste for learning, to follow your joy. That
is the path of scholarship, and it is the only one with any possibility
of turning us back toward the academy. Joel Demski, "Is Accounting an Academic
Discipline? American Accounting Association Plenary Session" August 9,
2006 ---
http://bear.cba.ufl.edu/demski/Is_Accounting_an_Academic_Discipline.pdf
When
Professor Beresford attempted to publish his remarks, an Accounting
Horizons referee’s report to him contained the following revealing reply
about “leading scholars” in accounting research:
1. The paper provides specific
recommendations for things that accounting academics should be doing to make
the accounting profession better. However (unless the author believes that
academics' time is a free good) this would presumably take academics' time
away from what they are currently doing. While following the author's advice
might make the accounting profession better, what is being made worse? In
other words, suppose I stop reading current academic research and start
reading news about current developments in accounting standards. Who is made
better off and who is made worse off by this reallocation of my time?
Presumably my students are marginally better off, because I can tell them
some new stuff in class about current accounting standards, and this might
possibly have some limited benefit on their careers. But haven't I made my
colleagues in my department worse off if they depend on me for research
advice, and haven't I made my university worse off if its academic
reputation suffers because I'm no longer considered a leading scholar?
Why does making the accounting profession better take precedence over
everything else an academic does with their time? As quoted in Jensen (2006a) ---
http://faculty.trinity.edu/rjensen//theory/00overview/theory01.htm#AcademicsVersusProfession
Advice to students planning to take standardized tests such as the SAT, GRE,
GMAT, LSAT, TOEFL, etc. See Test Magic at
http://www.testmagic.com/
There is a forum here where students
interested in doctoral programs in business (e.g., accounting and finance) and
economics discuss the ins and outs of doctoral programs.
Question
Does faculty research improve student learning in the classrooms where
researchers teach?
Put another way, is research more important than scholarship that does not
contribute to new knowledge?
Major Issue
If the answer leans toward scholarship over research, it could monumentally
change criteria for tenure in many colleges and universities.
AACSB
International: the Association to Advance Collegiate Schools of Business, has
released for comment
a reportcalling for the accreditation process for
business schools to evaluate whether faculty research improves the learning
process. The report expresses the concern that accreditors have noted the volume
of research, but not whether it is making business schools better from an
educational standpoint. Inside Higher Ed, August 6, 2007 ---
http://www.insidehighered.com/news/2007/08/06/qt
FL (August 3,
2007) ― A report released today evaluates the nature and purposes of
business school research and recommends steps to increase its value to
students, practicing managers and society. The report, issued by the Impact
of Research task force of AACSB International, is released as a draft to
solicit comments and feedback from business schools, their faculties and
others. The report includes recommendations that could profoundly change the
way business schools organize, measure, and communicate about research.
AACSB
International, the Association to Advance Collegiate Schools of Business,
estimates that each year accredited business schools spend more than $320
million to support faculty research and another half a billion dollars
supports research-based doctoral education.
“Research is
now reflected in nearly everything business schools do, so we must find
better ways to demonstrate the impact of our contributions to advancing
management theory, practice and education” says task force chair Joseph A.
Alutto, of The Ohio State University. “But quality business schools are not
and should not be the same; that’s why the report also proposes
accreditation changes to strengthen the alignment of research expectations
to individual school missions.”
The task force
argues that a business school cannot separate itself from management
practice and still serve its function, but it cannot be so focused on
practice that it fails to develop rigorous, independent insights that
increase our understanding of organizations and management. Accordingly, the
task force recommends building stronger interactions between academic
researchers and practicing managers on questions of relevance and developing
new channels that make quality academic research more accessible to
practice.
According to
AACSB President and CEO John J. Fernandes, recommendations in this report
have the potential to foster a new generation of academic research. “In the
end,” he says, “it is a commitment to scholarship that enables business
schools to best serve the future needs of business and society through
quality management education.”
The Impact of
Research task force report draft for comments is available for download on
the AACSB website:
www.aacsb.edu/research. The website
also provides additional resources related to the issue and the opportunity
to submit comments on the draft report. The AACSB Committee on Issues in
Management Education and Board of Directors
will use the feedback to determine the next steps for implementation.
The AACSB International Impact of Research Task Force
Chairs:
Joseph A. Alutto, interim president, and
John W. Berry, Senior Chair in Business, Max M. FisherCollege of Business,
The Ohio State University
K. C. Chan, The Hong Kong University of Science and
Technology
Richard A. Cosier, Purdue University
Thomas G. Cummings, University of Southern California
Ken Fenoglio, AT&T
Gabriel Hawawini, INSEAD and the University of Pennsylvania
Cynthia H. Milligan, University of Nebraska-Lincoln
Myron Roomkin, Case Western Reserve University
Anthony J. Rucci, The Ohio State University
The Parable Of Being In The Wrong
Paradigm
May 30, 2007 parable by David Albrecht [albrecht@PROFALBRECHT.COM]
Sorry to revive this thread (need a favor) after it
seemed to die 10 days ago. I present this parable with apologies to Ed
Scribner, our resident parable teller.
I call this The Parable Of Being In The Wrong
Paradigm.
A certain professor is the sad-sack of accounting
higher education. It seems as if he's always been a member of an
out-of-power paradigm. He started off college as a music major. He then
switched to chemistry to Spanish to creative writing to history to political
science. After graduation he discovered his degree qualified him to operate
the french frier at a fast food joint. Friends, unhappy with his
unhappiness, advised him to pursue an MBA degree. Our professor switched to
an MA in accounting.
After this graduation he failed to secure an
accounting or auditing job with the Big 8-7-6-5-4, probably due to a
combination of not being young enough and wearing a colored shirt to his
interviews. He wanted a true job, but it was not to be for him. Count him
out of the Big 8-7-6-5-4 paradigm, his first experience with the wrong
paradigm.
But lo and behold, a small school hired him to
teach accounting. He enjoyed it so much that he decided to pursue an
accounting doctorate for that academic union card. On the bright side, he
learned new ways of thinking, new ways to approach a problem, and mental
flexibility (this trait gets him in trouble, though). On the dark side he
tried to pass himself off as a quantoid, but he wasn't. Nor was his degree
from a powerful elite university. So count him out of the elite accounting
school paradigm, and count him out of a top level salary. He is again a
member of the wrong paradigm.
He's been a bust as a research/publishing hound,
never hitting a top four journal. Some of his pubs were practitioner
oriented and out of favor in his department. His last publication was too
many years ago. He hit with the Journal of Excellence in College Teaching,
but was told by his dean that it wouldn't count because his article wasn't
about accounting (and the journal is too lowly ranked anyway). So, count him
out of the dominant accounting research paradigm and from getting annual
raises from his department. He is again a member of the wrong paradigm.
He was curious fellow, though, and always eager to
contribute to making things better. Intrigued by how students learned, he
researched it (but never got anything published, of course). He invested the
results of the research back into his classrooms and became a popular
teacher. As he continued to learn about how students learn, he became more
popular. Eventually, students had to line up to get into one of his classes.
The department chair responded by putting in a special registration process
to keep excess students away from his classes and into other sections. The
lucky students in his classes thrived in his learning-centered environment,
it seems that they had been hungry to learn for a long time. The traditional
paradigm ("tell them and then test them") is alive and well at at his
school, though. He had to endure peer-to-peer evaluations of his teaching
from professors who had difficulty in helping students learn. One accounting
professor, notorious for his long lectures and lethal use of Power Point,
came into our professor's classroom on one of his more non-traditional
approach days. After a few minutes, the notorious accounting professor
angrily steamed out of the classroom, giving our professor the lowest
score ever on a peer evaluation of teaching. It seems our professor didn't
cover enough content. So count him out of another dominant accounting
professor paradigm, and again a member of the wrong paradigm.
Despite being considered the worst accounting
professor (0 for 4) by his department, he received his university's highest
award for contributing to student learning.
One day he was asked how it felt not to be a part
of the crowd or a dominant accounting paradigm. He replied that not being in
a correct paradigm feels like not being invited to a party. He took solace,
though from reading posts to AECM. Contributors seemed to be out of at least
one power paradigm, just like him. They discussed it aud nauseum, year after
year. Eventually he concluded that the more people lament the power of a
dominant paradigm, the more things stay the same. It is like the
weather--people can talk about it a lot but no one can do anything to change
it. Leaving his computer, our professor went back to work, changing the
world one student at a time.
David Albrecht
What's wrong about studying accounting in accounting doctoral
programs?
May 2, 2007 message from Bob Jensen to the AECM Listserv
I have a former student and very good friend who’s interested in applying
for an accounting doctoral program. He’s a good student who became a better
student each year of his five year program. He’s somewhat experienced as a
tax accountant.
But he’s not especially interested in a doctoral program that is heavy in
quantitative methods (dare I say “accountics?”).
I have a couple of suggestions for him. But before I reply to him I would
like some other suggestions from the AECM regarding full-time doctoral
programs that are heavier on accounting and taxation skills and a bit
lighter on the quantitative methods focus of most (all?) respected
accounting doctoral programs at the moment.
You may send your suggestions privately to me or share them on the AECM
if you choose to do so.
Please let me know if I can forward your suggestions under your name or
if I should make your suggestions to him anonymous.
I do recommend this young man for a doctoral program. He’s become very
passionate about becoming an accounting educator.
I would definitely recommend your student speak to
some of the professors at UCF (Central Florida in Orlando)
like Robin Roberts and Steve Sutton. The general approach for the PhD
program here is to provide as much exposure as possible to all areas of
accounting scholarship and let the student decide what area best suits them.
We take five accounting seminars that include a general overview of research
(Kuhn, Burrell & Morgan, etc.), behavioral accounting, accounting
information systems, financial archival, and sociological. A nice mix
overall. Most of us take electives outside the College of Business in
psychology, sociology, education, etc. for our minor as well as for the
methods requirements. We can choose a more quantitative approach but no one
in the last three classes went that route. Of the nine students in the last
two classes, seven came from public accounting (six audit, one tax). The
program has definitely enlightened all of us to other views of accounting,
research, education, and the world in general. We only accept students every
other year and I believe there are one or two spots left for the Fall 2007
class. If you think our program might fit your student, then I strongly
recommend that he contact Robin ASAP.
As a quick point of clarification, the UCF doctoral
program came up in these earlier discussions as an alternative to the "accountics"
type programs common at most U.S. universities. Our Ph.D. degree is
definitely a heavy research degree, but our students tend to specialize in
audit, tax, systems, managerial and it would be unusual for one of our
students to complete an entirely economics-based archival study in their
thesis. Our students are heavily encouraged to use the three-paper
dissertation model and thus normally exit their Ph.D. program with three
papers from the dissertation that are very near to being in a submitable
form. These dissertations generally use multiple methodological approaches
to study an issue of interest from multiple perspectives. In addition,
virtually all students have published one or more academic papers before
working on the dissertation. I perceive UCF as a very heavy research
oriented PhD program, we just have a much more encompassing view of what
constitutes acceptable research methods than many other programs, and
strategically our program is structured to primarily focus on
Behavioral/Public Policy/IT-related research.
Sorry to jump into the flow on this, but thought we
should make sure there wasn't a misperception out there about our program.
I’ve watched this discussion with some interest.
I’m always reluctant to speak of our own PhD program in this forum because
it can be taken and interpreted the wrong way. Our PhD program has carved a
niche out that is different from the ‘glamour’ programs. If we have a
student who applies and wishes to do “accountics” type work, we generally
steer them towards a more appropriate program.
Our program has basically focused on audit, tax and
systems with a focus on behavioral and public policy research. We have what
I believe to be some very accomplished and bright scholars working with our
students, but our research is primarily behavioral from an individual
(psychology-based), organizational (sociology), and societal (critical and
radical humanist perspectives) perspective(s). We believe dialogue about the
professions, accounting institutions, ethical implications and the
philosophy underlying all of those is critical to the role of accounting
academics.
That said, a PhD is still a research degree and not
a technical degree. We assume that a student that has attained an
undergraduate and masters level education in accounting has the technical
accounting knowledge. The PhD is about how to look at accounting with a
critical thinking mind and question the rules, processes and
institutions—and to ask if there is a better way.
What are your friend's aspirations? If he could
describe his ideal faculty position, including the sort of research (if any)
he would like to pursue, what would that be? (He may be uncertain, which is
fine.)
Recommending a set of inputs is easier if the
desired output is clear.
Richard Sansing
May 2, Reply from Bob Jensen
Hi Richard,
I think (surmising at this point) that he might aspire to teach
accounting/tax in a small liberal arts college where publishing in top
research journals is not deemed more important than a dedication for
teaching accounting and inspiring liberal arts students to pursue a career
in accountancy.
In spite of what some of us more familiar with research universities
think, there are many such liberal arts and even smaller state-supported
colleges that still place the highest emphasis on teaching and youth
inspiration.
What I've discovered is that all colleges want evidence of continued
scholarship, but some are much more willing to accept publication in what we
might call lower-tiered journals.
Then again, this young man showed such increased aptitude for accounting
theory. It may be possible that in the course of his doctoral program he
gets fired up for higher level research. His father is a good statistician
and systems analyst in a top university. His mother is a teacher.
I would encourage your friend to think about the
real option aspect of this decision. He should be very confident of his
decision to not pursue a Ph.D. at a research-oriented program before
bypassing that option. If he studies at Chicago and makes an informed
decision not to pursue "mainstream" academic research, then he will be
over-trained for his dream job at the kind of liberal arts college you
describe. But he also has the option of pursuing the research route. But if
he studies at a place that puts less emphasis on research methods, he has
limited his options at the outset.
Richard Sansing
May 2, 2007 reply from Bob Jensen
Hi Richard,
I used to think that way. Then I had one student named XXXXX who had
similar goals to YYYYY, although XXXXX was a much more brilliant math
student according to the Mathematics Department at Trinity University. I
made a special effort to have XXXXX admitted to an "accountics" doctoral
program without having as much as one week of experience in accounting
practice. XXXXX did not even intern and went straight from our Trinity
University masters program to an accounting doctoral program.
To my utter disappointment XXXXX dropped out after the end of the first
semester. He said he was just not interested in getting an econometrics PhD
in an accounting doctoral program. He wanted an accounting PhD and
discovered that he would have four or five years of econometrics,
statistics, and psychometrics.
Honestly Richard, I'm not making this up. XXXXX enrolled in this
accounting doctoral program about three years ago if my memory serves me
correctly. With his exceptional math skills XXXXX was capable of getting his
accounting (ergo econometrics PhD). He just wasn't interested in
econometrics before he applied for the doctoral program, when he was in the
doctoral program, or when he withdrew from the doctoral program.
I did not do XXXXX or that doctoral program any favors by pushing XXXXX
in the way that you would probably have pushed XXXXX. Now when it comes to
YYYYY, we have a similar situation except I don't think YYYYY has the
exceptional math skills of XXXXX. YYYYY admits that he's more like his
mother than his father in this regard.
YYYYY, like XXXXX, really wants to study accountancy rather than
econometrics. If XXXXX wanted to be an econometrics PhD, however, he
probably would have stuck it out in the accountancy doctoral program because
economics PhDs are a dime a dozen relative to accounting econometricians
masquerading as accountants.
My point, Richard, is that sometimes "keeping options open" is not the
best advice for some types of students, especially accounting students who
really do not want to become statisticians, econometricians,
psychometricians, and management scientists. We've pretty much taken the
study of accountancy out of doctoral programs. Those entering doctoral
programs learn very little accounting beyond what they learned before
entering the program.
What accountancy doctoral programs lack is imagination. Why can't there
be a joint accounting/JD doctoral program in law and accountancy? Why can't
there be an accounting/philosophy doctoral program? Why must virtually all
accountancy doctoral programs be accounting/ECONOMICS doctoral programs for
economists who want higher starting salaries?
1. Yes, sometimes options expire out of the money.
A bad outcome ex post does not imply a bad decision ex ante.
2. Not everything you learn has to be learned in a
classroom. I've learned a lot about non-profit organizations over the last
ten years without ever taking a class on the subject.If it is (relatively)
harder to learn about research methods on your own than it is to learn about
institutional detail on your own, a program that focuses on economics and
research methods is likely the most efficient way to learn. There is also an
economy of scale issue. If I have five doctoral students interested in five
different topics, a program that focuses on methods rather than subjects
seems like the way to go; each student can learn about the institutional
issues that interest them in another way.
Richard Sansing
May 2, 2007 reply from Bob Jensen
Hi Richard
Plumlee et al. (2006) discovered that there were only 29
doctoral students in auditing and 23 in tax out of the 2004 total of 391
accounting doctoral students enrolled in years 1-5 in the United States.
With the excessive shortage of new PhDs in accounting
(especially in auditing, tax, and systems), I think those who get a PhD with
accounting skills will have pretty good "options" to become teachers and may
even become the highest paid teachers in smaller colleges.
And you have difficulty separating yourself from the
fundamental profit maximization economics assumption that plagues virtually
all economics models. You assume that all accounting graduates who elect to
go into academe want the highest salaries and probably the lowest teaching
loads possible. In fact, there are students like XXXXX and YYYYY who truly
want the psychic rewards of teaching rather than earn the highest dollar and
the lowest teaching load.
What may be my most important point in this exchange with
you is that there are many smaller colleges that would rather have dedicated
teachers of accounting rather than failed econmetricians belatedly wanting
to teach accounting because they were denied tenure in a top university's
accounting/econometrics program.
And your latter assumption is that accounting can be self
taught. Actually most anything can be self taught, including Egon Balas who
became a well known Carnegie-Mellon mathematics professor after having
taught himself mathematics during ten years of solitary confinement in a
Hungarian prison. But why should an accounting doctoral student have to
spend four or five years studying dreaded econometrics when their first love
is learning accounting, tax, auditing, or systems?
And you might've been interested in learning accountancy
after you earned an economics doctorate. But there are many econometrics
professors in accounting departments who do not share your view. Let me once
again dredge up the best example of the Accounting Horizon's referee who
rejected a paper submitted by Denny Beresford.
When Professor Beresford attempted to publish his paper
appealing for accounting researchers to have more interest in the accounting
profession, an Accounting Horizons referee’s report to him contained
the following revealing reply about “leading scholars” in accounting
research:
Begin Quote
*****************
1. The
paper provides specific recommendations for things that accounting
academics should be doing to make the accounting profession better.
However (unless the author believes that academics' time is a free good)
this would presumably take academics' time away from what they are
currently doing. While following the author's advice might make the
accounting profession better, what is being made worse? In other words,
suppose I stop reading current academic research and start reading news
about current developments in accounting standards. Who is made better
off and who is made worse off by this reallocation of my time?
Presumably my students are marginally better off, because I can tell
them some new stuff in class about current accounting standards, and
this might possibly have some limited benefit on their careers. But
haven't I made my colleagues in my department worse off if they depend
on me for research advice, and haven't I made my university worse off if
its academic reputation suffers because I'm no longer considered a
leading scholar? Why does making the accounting profession better
take precedence over everything else an academic does with their time? As quoted at
http://faculty.trinity.edu/rjensen/theory/00overview/theory01.htm#AcademicsVersusProfession
*****************
End Quote
Particularly relevant in this regard is Dennis Beresford’s
address to the AAA membership at the 2005 Annual AAA Meetings in San
Francisco
Begin Quote
*****************
In my eight years in teaching I’ve concluded that way too many of us
don’t stay relatively up to date on professional issues. Most of us
have some experience as an auditor, corporate accountant, or in some
similar type of work. That’s great, but things change quickly these
days.
Beresford (2005)
*****************
End Quote
I'm glad that you like accounting and tax. Unfortunately,
may of your econometrics friends in accounting academe hate having to teach
such courses as intermediate accounting, advanced accounting, auditing, or
introductory tax courses. And they interpret accounting theory as minimal
accounting and maximal economic theory.
When being recruited I recall my PhD coordinator
showing me statistics about the number of accounting PhD students graduating
each year and the general declining trend, down to around 70-75 per year.
The AAA placement center at the national conference last year listed over
300 job postings. What a dilemma and not getting any better given that many
of the baby boomers still have yet to retire.
The Plumlee et al. (2006) study paints an even
bleaker picture. The general lack of students specializing in non-financial
areas should raise a huge red flag. Will our non-financial accounting
classes eventually be taught by professors outside their research area and
interest? What kind of higher education will that provide? I have been
fervently recruiting friends in public accounting. My approach to date has
been to drop a bug in their ear during the worst of busy season then keep
plugging away. So far, only one success. Many would love to enter academia
but the thought of giving up four years of compensation is unpalatable and
just not feasible for their families. The barriers to entry are great.
Successful recruiting will take a concerted effort by us all.
And you have difficulty separating yourself
from the fundamental profit maximization economics assumption that
plagues virtually all economics models. You assume that all accounting
graduates who elect to go into academe want the highest salaries and
probably the lowest teaching loads possible. In fact, there are students
like XXXXX and YYYYY who truly want the psychic rewards of teaching
rather than earn the highest dollar and the lowest teaching load.
---
Nonsense. From a purely financial perspective, an
academic career for an accoutant is a big negative NPV. But I wouldn't trade
careers with anyone.
Richard Sansing
May 3, 2007 reply from Bob Jensen
Hi Richard,
Negative NPV makes no sense to me for new accounting PhDs. With
universities paying over $180,000 (including summer stipends) as starting
salaries plus generous amounts of free time for personal consulting fees and
textbook writing, I have a difficult time calculating a negative NPV. And
consulting opportunities are relatively easy to get in top universities
because the elite names of those universities are a draw for faculty
opportunities to consult and write books.
Most Harvard, Wharton, MIT, NYU, and Stanford professors that I know make
more in consulting and royalties than their paltry salaries over $200,000
per year plus relatively generous travel allowances. The very top
universities also provide incidental funding for research ranging from
$10,000 to $30,000 each year (plus summer stipends in the range of $40,000
to $60,000).
When you make the NPV calculations you must also factor in the current
fringe benefits averaging 30% of starting salaries. This includes health
care and TIAA-CREF contributions. The 30% probably does not even count
sabbatical leaves, discounts for child care, and entertainment opportunities
such as concerts and theatre.
Sure an accounting or finance professor may have cut off chances of
winning the CEO lottery, but this is a low-probability career track.
Becoming a partner in a large CPA firm can be lucrative, but not necessarily
on a present value basis considering the first ten years at relatively low
salary (around $50,000-$60,000 per year) and the necessity to buy into
(usually by borrowing) the partnership for those lucky few (less than 10% of
the staff accountants) who are eventually invited to become partners.
If our recent undergraduates really took the trouble to compare the NPVs,
I think newly-minted accounting professors have a comparable or even better
outlook if the competing alternatives are weighted by the relatively low
probabilities of becoming an executive partner in a large CPA firm. Smaller
CPA firms are harder to compare, because they vary to such a huge extent.
Some partners of small CPA firms net over a million dollars each year and
many others barely scrape out a living in their home offices.
When you couple this with the wonderful lifestyle opportunities and
sabbatical leaves, I always thought of myself as having lived in tall cotton
for 40 years before I retired. Now I live in grass that's becoming too tall
since I've put off mowing.
CPA firm salary ranges obviously vary
by location, but really not all that much honestly. Here in Orlando, staff
auditors fresh out of school or even experienced hires from smaller firms
into the new Big 6 are receiving offers of $50 with $2-3k signing bonuses
this semester. This is consistent across the more popular disciplines
(audit, tax, business advisory). Business advisory (business process & IT
audit/consulting) starts to pull ahead at the manager stage and takes 1-2
years less per level for promotion. Whereas audit typically takes 12 years
for partner, business advisory can be as quick as 9 years with a greater
probability of making partner due to the demand/supply (not many hybrids out
there that know financial, business process, and IT). As a 2nd year advisory
manager (10 yrs exp) my base was $100k two years ago while the first-year
audit senior manager with comparable experience received less than $90k
which I think is on the low-end. The month I started the PhD program, one of
my friends in a nearby office made audit partner at the age of 34 receiving
a bump in salary from $150k to $225k with the promotion. Not sure about his
loan though.
May 3, 2007 message from Bob Jensen
Hi
Richard (Sansing),
I’m
still trying to find a PhD program that extends beyond the blinders of the
social science research paradigm. I need to look a little closer at
Bentley’s new program. Also there are a few AIS tracks in existing programs,
but my guess is that the AIS majors still have to take the econometrics
qualifying courses and exams.
Your
NPV sidetrack took us off the main issue regarding why our leading academic
journals and virtually all of our accounting doctoral programs define
accounting research as a social science that requires the requisite skills
in advanced statistics, econometrics, psychometrics, sociometrics, etc.
The
fact of the matter is that our current doctoral programs are critically
unable to meet demand according to the AACSB and Plumlee et al ---
http://faculty.trinity.edu/rjensen/395wpTAR/03MainDocumentMar2007.htm
The supply is steadily dwindling with less than 100 graduates per year (and
less than 20 a year in auditing, tax, and systems). The demand is at least
ten times the supply and probably higher. Accounting education programs will
soon be to the point were virtually all of the instructors have no
doctorates or have only doctorates in economics, law, education, etc.
The
problem as I pointed out in earlier correspondence is a mismatch between
accounting graduates who want to study and do research in accounting but
have neither the aptitude nor an interest in becoming social scientists (and
in particular econometricians studying capital markets).
Accounting doctoral programs increasingly have ignored other research
paradigms outside the social science paradigm. For example, I do not find
humanities or legal research paradigm choices being offered in any
accounting doctoral program. Philosophy departments, history departments,
and law schools give doctorates to students who have few, if any, social
science research skills.
Is
there any university in the U.S. where a doctoral student can major in
accounting history without having to become a social scientist? Is there a
doctoral program in the U.S. where a student can major in accounting
philosophy? Is there any doctoral program in the U.S. that uses a law school
research paradigm?
And
lastly, I would like to point out that our leading journals and award
selection committees tend to ignore submissions based upon any research
paradigm other than a social science research paradigm.
The AICPA and the AAA jointly award a "Notable Contributions to
Accounting Literature Award" of $2,500 and a plaque at the AAA's annual
meetings. For the past 20 years, these awards have virtually all gone to
empirical research using positivist research methodologies.
This year I'm on the Selection Committee for the first time. The fact
that the Screening Committee only gave us empirical studies to select from
for the 2007 award to be granted in Chicago makes me wonder why only
empirical studies are candidates for Selection Committee evaluation.
Begin Quote
**************
The Screening Committee for the Joint AICPA/AAA Notable Contributions to
Accounting Literature Award invites nominations of outstanding articles,
books, monographs, or other publications for consideration. Nominations from
regular and irregular (e.g., AICPA-sponsored research studies or monographs)
publications, as well as from nonaccounting publications, may be submitted
as long as the nominated work is relevant to accounting. Both academic and
practitioner nominations will be accepted.
Nominated items must
have been published within the years 2002 to 2006. Each nomination must be
accompanied by a brief supporting statement (no more than 150 words)
summarizing reasons for the nomination that are consistent with the award
selection criteria. These criteria include: uniqueness and potential
magnitude of contribution to accounting education, practice and/or future
accounting research; breadth of potential interest; originality and
innovative content; clarity and organization of exposition; and soundness
and appropriateness of methodology.
End Quote
**************
This important award can Go to both research and other scholarly
literature contributions in accountancy. The Award's research literature is
not restricted to empirical research and positivist methods. What is curious
to me is why only this subset of the literature is repeatedly the only
winning subset.
What is even more curious this is why even the literature pieces
forwarded this year are only esoteric empirical research studies of dubious
value to "accounting education and practice." I say of "dubious value" in
the sense of highly simplified modeling assumptions and no replication of
the findings by other researchers.
The accountics bias seems to be rearing up repeatedly in this award
process for the past two decades. Is it because of narrowness in the
nomination process? Have members of the AAA given up nominating literature
that is not of an esoteric accountics nature? Is it because only empirical
research is deemed notable by the Screening Committees?
I agree that the conversation has drifted a bit
from the original question, but if Bob's friend has been following this
discussion, he might be inclined to think ill of his prospects for doing
what he wants. It is largely the case now that U.S. PhD programs are as
Jagdish and Bob have characterized them.
There are a few places in the U.S. where Bob's
friend might be able to pursue an interest in accounting. Central Florida
and South Florida are PhD programs that offer some diversity of faculty
talent that provide a doctoral student with flexibility for pursuing
whatever interest excites them.
North Texas and Case Western Reserve are other
places. There are probably others, but they are fewer and farther between
than they were when I went through the experience. If Bob's friend is
adventuresome, there are many excellent doctoral opportunities at schools
outside the U.S. For example, the University of Alberta has a diverse
faculty, which allows the pursuit of interests that would simply not be
tolerated in most U.S. doctoral programs.
Then there are schools in the UK and Australia.
Adelaide, Wollongong, Cardiff, Strathclyde, Essex, the list goes on. These
places afford someone a different experience from many US programs and
provide much greater freedom to follow one's intellectual bliss than the
stultifying places that are the U.S. "elite."
Paul
May 11, 2007 reply from Sue P. Ravenscroft [ACCT]
[sueraven@iastate.edu]
Sue gave me permission to forward a somewhat laundered version of her original
message. It confirms what I've been arguing aud nauseum. The number of
accounting student doctoral graduates in the U.S. plunged to less than 100 per
year to meet an exploding demand for accounting professors. A major cause of the
shortage of applicants to doctoral programs is that these econometrics programs
do not interest most accountants in the pool of possible applicants to such
doctoral programs. Nearly all available accounting doctoral programs
(not just Tier I
programs) are no longer accounting programs and have no dedicated
accounting courses. They’re literally social science methodology programs with
most emphasis on econometrics and no choices for other research methodologies
---
http://faculty.trinity.edu/rjensen/395wpTAR/Web/TAR395wp.htm
Dear Bob,
I was just contacted by a wonderful young woman,
who graduated from Iowa State University last year. She is bright,
personable, hard-working, and interested in going into a PhD program. She is
NOT interested in doing a highly quantitative economics-based program, but
can handle the math and statistics needed for behavioral research. I feel
fortunate in the timing of her inquiry, because I observed the discussion
about a young man you know who is looking into doctoral schools, and the
subsequent advice from Sansing that he consider only a Tier One school
because of the "alleged choices" such schools provide versus the
counter-advice of actually getting training to do what one loves.
The young woman has already received the Tier
One type advice and was totally taken aback and turned off by it. The
assistant professor who gave her that advice told her she should take two
years of college level advanced math courses and then apply, because she is
definitely bright enough to Go to a Tier One school and should not even
consider going to a Tier Two type institution.
Her goal was to enter a program in fall of 2008. After that set-back she
wrote me, and I was far more encouraging.......I told her that I had just
seen a rather long (albeit sometimes almost hostile) exchange about the
types of programs available and the wisdom of going to the "Tier One"
schools even if that wasn't where one's interest or heart lay.....This
student is a wise young woman and doesn't want to be trained to do something
she doesn't want to do.....
So, I am writing to ask if you have a final listing
of schools that might be more open to a variety of research
approaches.....If so, could you please write to me (address above or to
her). I would be ever so grateful.
I have followed the need a favor thread with great
interest. I am in my mid 40'sand have taught at community colleges (with a
few years at bachelor granting universities) for 20 years following 3 years
with KPMG. I have always wanted to get my doctorate for personal
actualization and would be interested in teaching at a regional university.
I scored 99 percentile on the verbal portion of the GMAT but just average on
the Mathematics. Two years ago I was told during an interview with a very
prestigous school that with a few semesters of calculus I could probably
gain admission to their Ph. D Program. I was also admitted to a Ph. D in
management at a different college. I decided against both options. I would
definitely be interested in a DBA or some of the teaching oriented or
blended accounting Ph. D's that have been discussed. In my situation (with
fewer years left in my career) I am really not interested in a professorship
at a Top Tier University. For the same reasons I hesitate to give up a job I
love and earn no income for 4 or 5 years at a minimum. I would be interested
in your response to the Accounting DBA question as well as specific ideas as
to programs or perhaps a different field with a concentration in accounting.
Dana Carpenter
(608) 246-6590
May 4, 2007 reply from Bob Jensen
Your experience, Dana, is very typical of the many students at all ages
who are turned off by having to study five years of social science research
to obtain a tenure track position to be an accounting professor.
To my knowledge, the distinction between a PhD and a DBA from a Tier 1
research university is about as marked as the distinction between ketchup
vs. catsup. Both doctoral degrees are intended to instill research skills in
students intent on careers in academia. The DBA used to entail a more
rounded set of business courses (management, organization behavior, finance,
marketing, etc.) but I think most accounting PhD and DBA programs have
dropped required courses except for a few research seminars and possibly
some social science (especially economics) and statistics courses.
The DBA used to focus more on the "application of theory" as opposed to
the "development of new theory" in a PhD program ---
http://dr-hy.com/Menu-Bar/mVita/DBA-vs-PHD.html
In my opinion, these distinctions between the two degrees have largely
evaporated. The U.S. Department of Education and the National Science
Foundation recognize numerous research-oriented doctoral degrees such as the
D.B.A. as "equivalent" to the Ph.D. and do not discriminate between them ---
http://en.wikipedia.org/wiki/Doctor_of_Business_Administration
Certainly the distinction between DBA versus PhD in business schools
is not as great as the distinction between EED and PhD in schools of
education.
Probably the best known business school that offers DBA and PhD degrees
is the Harvard Business School. If you major in a traditional business area
(e.g., accounting, marketing, management strategy, information technology)
you get a DBA. If you major in business economics, health policy, or
organization behavior you get a PhD. The actual distinction between the two
designations is not at all clear to me. About the only thing I can tell is
that some HBS doctoral students get ketchup on their hamburgers and others
get catsup.
Most certainly, having a DBA will not change the criteria for obtaining
tenure later in life. I do not know of any serious university that will put
higher weightings on teaching performance for DBA faculty versus higher
weightings on research for PhD faculty.
Questions raised are how large each program is and what have been the
trends in growth or shrinkage. As new doctoral programs came on line, the
very large doctoral programs such as those in Illinois, Michigan, Texas,
Indiana, and Michigan State greatly reduced doctoral program size in the
1986-2005 period. What used to be large programs shrank greatly in size.
Some smaller programs like Rice have gone out of accounting doctoral
programs entirely. Some like Minnesota seem to have disappeared without
making any official announcements.
A listing of the history of U.S. accounting doctoral programs is provided
in your free Prentice-Hall Hasselback Accounting Faculty Directory
(at least in the hard copy version). The Doctoral Program History table is
on the page preceding the start of the alphabetized listing of accounting
faculty by college. In don't think this table is available in Jim's Online
Directory at http://rarc.rutgers.edu/raw/hasselback/
There are some errors in the Hasselback table that are due mainly to
failures of some programs to accurately report their own data to Jim. But
except for Penn State, I think the recent undercounting is relatively minor.
Jim also provides the totals by year. The last column is generally way
off for the most recent year because of reporting time lags. However, the
preceding columns are relatively accurate.
In the past twenty years, the most accounting doctoral graduates reported
for the U.S. was 207 in 1988. The least was 69 in 2003. It has not been over
100 since 2001.
One of the subsequent messages that I sent to my Student YYYYY is shown
below:
Message from Bob Jensen to YYYYY
I’m particularly happy that you’re now motivated to become an
accounting educator. I loved this profession.
First and foremost is your GMAT score that determines almost
everything regarding admission to any respectable doctoral program.
Consider all your options for having as high a score as possible.
Second you need to honestly evaluate your aptitude for statistics and
mathematics. Nearly all accounting doctoral programs are tantamount to
econometrics programs these days with great stress on econometrics
models of capital markets data.
I don’t know if you followed the recent AECM lively exchange on this
topic or not. You can read some of the messages at
I know you are somewhat interested in taxation. In nearly all
instances, taxation doctoral students still have to master the
econometrics requirements of capital markets research.
If you are looking for the handful of programs that allow you to
customize your program and possibly cut back on the econometrics
hurdles, I recommend that you look into the following programs, messages
about which appear at
Bentley College (Boston) This is a new program that I don’t yet know
much about. Bentley is a very good accounting and finance college,
although I would not expect it to be strong for a tax concentration.
Case Western University (Cleveland)
University of Central Florida (Orlando)
University of South Florida (Tampa)
University of North Texas (Denton)
Various programs outside the U.S. (Please scroll down to the
informative message from Paul Williams in this regard) ---
--- Sue Ravenscroft wrote (to Bob Jensen, who then
posted it here):
I feel fortunate in the timing of her inquiry,
because I observed the discussion about a young man you know who is
looking into doctoral schools, and the subsequent advice from Sansing
that he consider only a Tier One school because of the "alleged choices"
such schools provide versus the counter-advice of actually getting
training to do what one loves.
---
For those interested in what I actually said, as
opposed to how it is characterized above, I repeat it below.
"I would encourage your friend to think about the
real option aspect of this decision. He should be very confident of his
decision to not pursue a Ph.D. at a research-oriented program before
bypassing that option. If he studies at Chicago and makes an informed
decision not to pursue "mainstream" academic research, then he will be
over-trained for his dream job at the kind of liberal arts college you
describe. But he also has the option of pursuing the research route. But if
he studies at a place that puts less emphasis on research methods, he has
limited his options at the outset."
Later in the same thread, I also said:
"My point was that the decision Bob's friend makes
regarding a Ph.D. program will significantly affect the opportunities that
he or she faces upon graduation, which will in turn affect subsequent
academic opportunties as well. Unless one is very sure about what what one's
preferences will be in the future, the course of action that preserves
options has a lot to recommend it. Whether one ultimately prefers a career
that features both research and teaching, or wants to teach and do no
research, it would be nice to have the skill set needed to make have a real
choice."
Richard Sansing
May 12, 2007 reply from Bob Jensen
Hi Richard,
Even better advice would be to avoid accounting
altogether if you want to be a top researcher in a Tier 1 accounting
research university. Consider the role model examples. Ron Dye (Northwestern
Accounting Professor) has his doctorate and undergraduate degrees in
mathematics and economics with almost no accounting. Some of our other top
accounting researchers have management science, mathematics, econometrics,
and psychometric doctorates with very little in the way of accountancy
education and/or experience in accounting practice. What accounting they
learned is when having to teach a little about it after they became
professors.
I'm not trying to be facetious or cynical here.
Those of us that majored in accounting for five years had to take a lot more
time in college to earn a doctorate in an accounting doctoral program. It is
actually quite costly in time and opportunity cost to first become an
accountant and then enter one of our present accounting doctoral programs.
It is far more efficient to major in economics and then earn an econometrics
doctorate from a prestigious Economics Department. Equally great is to earn
a doctorate in computer science.
The only risk of not having an accounting background
as far as I can tell is the risk of not getting tenure in a Tier 1
accounting university. Without accounting, it is more difficult for tenure
rejects to become accounting teachers in Tier 2 and Tier 3 colleges and
universities. Those universities typically require more knowledge of
accountancy.
Accounting majors realistically face 12 years of
full-time undergraduate and graduate studies before graduating with a
doctorate in an accounting program. On top of that, accounting doctoral
programs prefer that doctoral candidates have 1-5 years of accounting
practice experience. This adds up to 13-17 years to graduate from an
accounting doctoral program.
An economics major can earn an economics doctorate
in seven years of full-time studies before graduating with a doctorate from
an Economics Department. If she or he bothers to earn a MBA degree along the
way, it may take eight years to complete the doctorate. Under new AACSB
rules, doctoral graduates in economics, statistics, mathematics, psychology,
etc. are fully qualified to become accounting professors.
I must admit that I reasoned exactly like you,
Richard, until I pushed Student XXXXX into a Tier 1 accounting doctoral
program that he withdrew from after his first semester in spite of his being
a brilliant math student (double major with accounting).This unfortunate
outcome made me think more seriously about why the pool for accounting
doctoral students is drying up.
Once again consider the Plumlee et al findings:
Plumlee et al. (2006) discovered that there were only 29 doctoral students
in auditing and 23 in tax out of the 2004 total of 391 accounting doctoral
students enrolled in years 1-5 in the United States. The number of graduates
has shrunk to less than 100 per year.
If the Tier 1 accounting doctoral programs (and in
fact virtually all accounting doctoral programs) require that all applicants
have the advanced mathematics, statistics, and economics, we have in fact
added possibly two more years to a five-year accounting program just to
enter the accounting doctoral program applicant pool. Alternately, an
applicant might be admitted provisionally into an accounting doctoral
studies program and take the two years of econometrics preparatory courses
in what becomes tantamount to a six or seven year doctoral full-time studies
program in graduate school.
My conclusions are as follows.
1. To become an accounting professor in a Tier 1
accounting program it is far more efficient and possibly more effective
(toward tenure) to earn social science, mathematics, or statistics
doctorate outside accounting in a highly prestigious university.
Accounting doctoral programs are actually inefficient alternatives to
becoming an accounting professor in a Tier 1 accounting program unless
you cannot get into a highly prestigious non-accounting doctoral
program.
2. The pool of applicants for accounting
doctoral programs is drying up. Accountants with 1-5 years of experience
typically want to study accounting if they choose to enter a doctoral
program. Since virtually all accounting doctoral programs in the United
States are social science (particularly econometrics) programs with few
if any accounting courses, these programs do not appeal to accountants.
These doctoral programs might appeal to economists and statisticians,
but it is far more efficient to earn economics and statistics doctorates
from Departments of Economics and Statistics.
Thus I gave the wrong advice to my Student XXXXX who
was a brilliant dual major in accounting and mathematics. Instead of
recommending a doctoral program in accounting (where he really did not want
a forced feeding of econometrics), I should've recommended that he go
directly into a prestigious mathematics doctoral program. Then he could
ultimately apply to become an accounting professor in a Tier 1 accounting
research university after getting his mathematics doctorate.
Since the number of graduates from accounting
doctoral programs is less than 100 students per year, Tier 1 research
universities are often forced to seek top graduates from non-accounting
doctoral programs such as econometrics and management science programs in
prestigious universities.
Isn't it sad that for some accounting professors
like me, majoring in accounting was wasted time.
I suspect that Ron Dye would recommend studying
under Ron Dye at Kellogg's accounting Ph.D. program! One way to find out--
I'll ask him and post his response.
Some of your analysis seems exaggerated. I came
into the doctoral program with a very weak math background. In my three
years of coursework, roughly 1/3 of my classes were accounting research
seminars and 2/3 were math and economics classes. When you say:
"If the Tier 1 accounting doctoral programs (and in
fact virtually all accounting doctoral programs) require that all applicants
have the advanced mathematics, statistics, and economics, we have in fact
added possibly two more years to a five-year accounting program just to
enter the accounting doctoral program applicant pool."
you are double counting. You take those "tools"
courses during the five-year accounting doctoral program, not in addition to
it.
I think that trying to become an accounting
researcher without taking the accounting research seminars and attending the
weekly accounting research workshops would be very difficult.
I would ask someone considering an accounting
academic career what sort of questions they would like to answer. Much of
this thread has framed the questions in negative terms "How do I avoid
course X during my doctoral program?" rather than in positive terms "How do
I learn how to answer question Y?"
Richard Sansing
May 14, 2007 reply from Bob Jensen
Hi Richard,
"Three years" is bad advice these days! Your college (Dartmouth) does not
have a doctoral program. Let me use as a benchmark what I view as a typical
accounting doctoral program in the 21st Century. The University of Florida
writes that it takes 4-5 years to complete an accounting PhD for students
entering with strong mathematics backgrounds. Students who must additionally
take the "mathematics preparatory courses" must anticipate six or seven
years of full-time effort.
Apparently your experience (advice?) differs from the advice given by the
accounting professor who advised Sue's accounting graduate to take two more
years "advanced mathematics" before applying to accounting doctoral
programs.
It also differs from my experience trying to place some top accounting
graduates in accounting doctoral programs in recent years. Nearly all who
were admitted had significantly stronger mathematics credentials than those
that were rejected. Most programs now advise applicants that (even
those with math credentials and masters degrees) the accounting doctoral
program will take 4-5 years (See the University of Florida statement quoted
below).
In fact most universities make a concerted effort to recruit accounting
doctoral program candidates who do not have accounting degrees. Virtually
every accounting doctoral program has a mathematics matriculation
requirement that is now quite formidable (possibly more so for applicants
today than for us applicants in the 20th Century). Consider the following
statement at the Fisher School of Accounting Website at the University of
Florida.
Note in particular the suggested admission alternatives of "economics,
engineering, mathematics, operations research, psychology, and statistics."
No mention is made of such undergraduate degrees as history, philosophy, or
other humanities degrees, and I suspect that unless a humanities graduate is
very strong in mathematics, the chances are zero of being admitted to most
any U.S. accounting doctoral program even among humanities graduates that
are actively recruited by top law schools. By the way, top law schools in
particular recruit accounting graduates more aggressively than accounting
doctoral programs in my opinion. One of the major reasons for the shrinking
pool of applicants to accounting doctoral programs is the now preferred
option to Go to law school (including some who want to specialize in tax and
eventually teach tax at the college level with a JD credential).
Begin Quote
*************
University of Florida Ph.D. in Business Administration
- Accounting
Ph.D.
Program - Accounting Concentration
This program is
open to all applicants who have completed an
undergraduate degree. Individuals with a degree in a
non-business discipline (e.g.,
economics, engineering, mathematics, operations
research, psychology, statistics) are encouraged
to apply.
Students are required to demonstrate
math competency prior to matriculating the doctoral
program. Each student's background will be evaluated
individually, and guidance provided on ways a student
can ready themselves prior to beginning the doctoral
course work. There are
opportunities to complete preparatory course work at the
University of Florida prior to matriculating our
doctoral program.
The accounting concentration is designed
to be completed in four to five years.
The first year of the program is
essentially lockstep with doctoral students in economics
and finance. Starting in the second year,
individual course work is designed by the student in
consultation with his or her supervisory committee and
the accounting graduate coordinator. Other than the
Accounting Seminars (listed below) there are no specific
required courses after the first year of the program.
Accounting Seminars
:
ACG 7939 Theoretical Constructs
in Accounting
ACG 7979 Accounting Readings and Replication
ACG 7885 Empirical Research Methods in
Accounting
ACG 7979 Accounting Readings and Research
Project
ACG 7887 Research Analysis in Accounting
Ph.D. Co-Major Program with the
Department of Statistics
A program of
study for a single degree in which a student satisfies
co-major requirements in two separate academic
disciplines that offer the Ph.D.
End Quote
*************
Is there any accounting doctoral program in the United States that
encourages humanities graduates to apply? Is there an accounting doctoral
program in the entire United States that has a co-major with the Department
of Philosophy or the Department of History?
As of today, The University of Florida graduated four accounting PhDs
since Year 2000. As far as I can tell, none of them were undergraduate
accounting majors. Degrees in engineering, economics, and mathematics most
likely hastened completion of their doctoral degrees in accounting at
Florida in less than six or seven years. I mention Florida only because
Florida is not a unique accounting doctoral program in this regard. I
commend Florida for being more honest than some when stating the program
requirements.
The bottom line is that I don't think that the doctoral program that you
(Richard) entered "with a very weak math background" and completed in three
years makes you a relevant role model for today's applicants to doctoral
programs. My reading is that today you could not even be admitted to the
University of Florida accounting doctoral program unless you completed the "preparatory
course work at the University of Florida prior to matriculating our doctoral
program." We (you and me) are no longer role models in that regard
for applicants to accounting doctoral programs.
In my case I was admitted to the doctoral program but then had to take
all those extra undergraduate math, operations research, economics, and
statistics courses while in the program. My PhD graduation would've been
hastened at Stanford if I had majored in mathematics or statistics instead
of accounting as an undergraduate. I perhaps then could've graduated in
three years instead of the five full (and delightful) years that I spent in
Palo Alto. Now
I think it requires six or seven years in Palo Alto for candidates who must
take the preparatory undergraduate courses. In my day we did not have all
those accounting research seminars at the graduate level.
Bob Jensen
May 13, 2007 reply from
Bob,
You are not confused. And I am not brainwashed. ;-)
My point, as you well know, is that when we do
research using archival data we need math skills. Different types of
research appear to be rewarded differently, as evidenced by the salary
differentials across the schools at a university.
Amy
May 14, 2007 reply from Bob Jensen
Hi
Amy,
You
wrote that "when we do research using archival data we need
math skills."
To which I respectfully
reply as follows:
Not everything
that can be counted, counts. And not everything that counts can be counted. Albert Einstein
I think that
you're confining doctoral scholarship to archives that can be counted and
overlooking the archives, possibly the most relevant archived information,
that cannot be counted.
In the
United States, following the Gordon/Howell and Pierson reports, our
accounting doctoral programs and leading academic journals bet the farm on
the social sciences without taking the due cautions of realizing why the
social sciences are called "soft sciences." They're soft because "not
everything that can be counted, counts. And not everything that counts can
be counted."
It seems to
me that history scholars have a much longer history of analyzing archival
data than most any other type of scholars, I wonder what the discipline of
history would’ve become if every history scholar over the past 1,000 years
had to have two years of preparatory “advanced mathematics” before entering
a doctoral program in history.
It seems to
me that legal scholars have a very long and scholarly history of doing
research on archival data, especially court records, I wonder what the
discipline of law would’ve become if every legal scholar over the past 1,000
years had to have two years of preparatory “advanced mathematics” before
entering a JD program.
Many of our
serious professional problems needing research in accounting are closer to
law than economics. Particularly vexing are the issues of how to account for
complex contracts (e.g., those with derivatives, contingencies, and
intangibles) in settings where the contracts are being written to deceive
investors and creditors. Must years of advanced mathematics and econometrics
necessary conditions for conducting academic research to help the profession
with these contracts?
Where would
we be in medicine, law, and most other professions if it was dictated on
high that all their doctoral programs had to require advanced mathematics?
Would they find themselves in the mess we have today in academic accounting
in the United States where the pool of potential doctoral candidates is
drying up?
Would we
find ourselves in the mess of having to rely on adjuncts to teach more of
the accounting courses than our tenure-track faculty who bargained for
minimal teaching and maximal salaries and benefits so they could conduct
econometric and psychometric research with models of dubious relevance to
the practicing profession?
Why is it
that virtually all of our doctoral programs in accounting are now being
shunned by so many accounting professionals who would like to teach
accounting, auditing, tax, or AIS but are turned off by having to first take
preparatory courses in advanced mathematics and not have the opportunity for
studying accounting in accounting doctoral programs?
In academic
accounting we’ve almost all been seduced by frustrated economists in the
U.S. who found a way to secure a monopoly by putting up barriers to entry
that shrinks the supply of accounting doctoral graduates and lifts the
salaries of accounting professors to the highest levels in every university.
Most of us, especially me, have benefited from these barriers to entry. But
in the process, we’ve widened the schism between professors of accounting
and the accounting profession and students of accounting.
These
barriers to entry to doctoral programs have frustrated practicing
accountants to a point where doctoral programs like the one at the
University of Florida are in many cases more appealing to non-accountants ("economics,
engineering, mathematics, operations research, psychology, and statistics")
who can matriculate into the program with their advanced mathematics skills
and graduate from the program without every having studied the things we
teach our undergraduates and masters students in accounting. In fairness,
the current body of eight accounting doctoral students at the University of
Florida has three candidates with undergraduate degrees in accounting.
Others include a mathematics major, a statistics major, a finance major, a
commerce major, and a student who majored in economics. The finance major
also earned a masters of accounting degree.
It seems to
me that in the United States after the Gordon/Howell and Pierson reports our
accounting doctoral programs and leading academic journals bet the farm on
the social sciences without heeding the due cautions of realizing why the
social sciences are called "soft sciences." They're soft because "not
everything that can be counted, counts. And not everything that counts can
be counted."
Why is it
that only outside the United States various accounting doctoral programs in
prestigious universities have seen the light regarding diversity of research
methodologies in academic accountancy?
Even better advice would be to avoid accounting
altogether if you want to be a top researcher in a Tier 1 accounting
research university. Consider the role model examples. Ron Dye
(Northwestern Accounting Professor) has his doctorate and undergraduate
degrees in mathematics and economics with almost no accounting. Some of
our other top accounting researchers have management science,
mathematics, econometrics, and psychometric doctorates with very little
in the way of accountancy education and/or experience in accounting
practice. What accounting they learned is when having to teach a little
about it after they became professors.
--- end of quote ---
Here is Ron's response, along with the question
that I posed to him.
About the question: by and large, I think it is
a mistake for someone interested in pursuing an academic career in
accounting not to get a phd in accounting. If you look at the "success"
stories, there aren't many: most of the people who make a post-phd
transition fail. I think that happens for a couple reasons. 1. I think
some of the people that transfer late do it for the money, and aren't
really all that interested in accounting. While the $ are nice, it is
impossible to think about $ when you are trying to come up with an idea,
and anyway, you're unlikely to come up with an idea unless you're really
interested in the subject. 2. I think, almost independent of the field,
unless you get involved in the field at an early age, for some reason it
becomes very hard to develop good intuition for the area - which is a
second reason good problems are often not generated by "crossovers."
The bigger thing - not related to the question
you raise - but maybe you could add to the discussion is that there are,
as far as I can tell, not a lot of new ideas being put forth by anyone
in accounting nowadays (with the possible exception of John Dickhaut's
neuro stuff). In most fields, the youngsters are supposed to come up
with the new problems, techniques, etc., but I see a lot more mimicry
than innovation among newly minted phds now.
Anyway, for what it's worth....
Ron
May 14, 2007 reply from Bob Jensen
Hi Richard,
I thank you for obtaining a reply from Ron Dye. He's one among a number
of leading researchers who became an accounting professor without having a
background in accounting. He's also one of the finest mathematics
researchers in academic accounting.
What is especially interesting to me is Ron's conclusion that essentially
our highly touted and highly selective accounting doctoral programs (with
the highest-paid graduates in academe) in the United States are pretty much
failures if we define research as the creation of new and innovative
knowledge. I love his choice of the word "mimicry" in his following
conclusion:
Begin Quote
**********************
The bigger thing - not related to the question
you raise - but maybe you could add to the discussion is that there are,
as far as I can tell, not a lot of new ideas being put forth by anyone
in accounting nowadays (with the possible exception of John Dickhaut's
neuro stuff). In most fields, the youngsters are supposed to come up
with the new problems, techniques, etc., but I see a lot more mimicry
than innovation among newly minted phds now.
**********************
End Quote
I might add that John Dickhaut is nowhere close to being a newly-minted
doctoral student. He's an old guy who got his PhD at Ohio State in 1970
before Ohio State transitioned into its present highly mathematical
accounting doctoral program. This illustrates how innovative research can
come from graduates of accounting doctoral programs that do not (at least
way back then) require advanced mathematics.
I suggested that Ron Dye's route to becoming an accounting academic was
more efficient in the sense of taking less time (three years in an
economics doctoral program at Carnegie built upon his mathematics
undergraduate degree) rather than the route of entering an accounting
doctoral program where it now takes 4-5 years built upon a mathematics
undergraduate degree or 6-7 years built upon a typical accounting
undergraduate degree if the student has to take the two years of preparatory
mathematics required by many of our top accounting doctoral programs.
In terms of accountics, I think our econometrics-based accounting
doctoral programs are probably better for us than doctoral programs in the
economics departments because accounting doctoral students are more likely
to conduct research on archival databases that are more of interest in
accounting than are the databases of interest to economics departments. The
downside is that the econometrics studies published in leading accounting
research journals by graduates of accounting doctoral programs have probably
reflected mostly "mimicry" lamented by Professor Dye.
In his message Professor Dye does not recommend that his streamlined
route to becoming an accounting professor (without an accounting education
background) serve as a role model. I tend to agree, although I now have
newer doubts. I'm currently evaluating publications submitted for the 2007
AICPA/AAA Notable Contributions to Literature Award. The Award's Screening
Committee filtered out all submissions that were not accountics papers.
Among those accountics papers submitted to our Selection Committee by the
Screening Committee, many of the authors do not have accounting backgrounds
and some of the submissions are from such journals as Management Science
and the Journal of Financial Economics. My recommendation for the
award will actually be a finance professor's paper that made it through the
Screening Committee. Sadly we have to Go to finance and management science
graduates to find our most notable contributions to accounting literature.
This is
consistent with Ron's claim that among graduates of accounting doctoral
programs "I see a lot more mimicry than innovation among newly minted phds
now." Even some of our so-called Seminal Contributions to Accounting
Research Award-winning studies mimicked a lot from prior research of
economics and finance professors
1.
Students consider many factors before deciding to enter an accounting PhD
program, some of them random and/or serendipitous (as in my case; my
would-be advisor in Operations Research passed away within four months of my
stay in the program). But we need to ask why there are no takers inspite of
the astronomical salaries we offer, while outstanding candidates are begging
to be admitted into Phd programs in disciplines where tenure-track positions
are almost non-existent, or where a doctoral degree is only ticket to years
of serfdom as Postdocs.
The simple answer is that our field, AS WE PORTRAY
IT, is just not exciting to a young inquiring mind. In accounting there is
no Fermat's last theorem to be proved (as in mathematics), nor Hilbert's
entscheidungsproblem to be solved (as in Computing), nor the mind-body
problem (as in philosophy), nor new chemicals to be synthesised (chemistry),
grammar of lost languages to be discovered (anthropology), genes to be
targeted (medicine)....
A long time ago, Yuji Ijiri tried to convince us
that there were fundamental problems in accounting that are equally
challenging. How many of us even remember them today, or even have heard of
them?
Most of us have sought to use statistics the same
way a drunk uses a lamp post -- more for support than for illumination
(apologies to Mark Twain).
I personally think that often, these days, people
get into a PhD for a wrong reason, and some times live to regret it.
We accounting academics, especially in the
so-called research universities, are living a lie, thanks to AACSB. We
portray ourselves as scholars and yet rarely interact with the scholarly
community on our campuses. We claim to be academics in a professional
discipline and yet hardly interact with the profession in a meaningful way.
Aren't we like race horses with blinders on and no jockies?
2.
The shortage of PhD students in non-financial areas is also rigged. We make
it clear to the students which side of the toast is buttered. We dump on
journals in accounting other than those in the financial area which publish
the so-called "mainstream" (I prefer the term stale) research. Then we make
life difficult at tenure time for those who have not toed the party line. We
tolerate third rate pedagogy as long as it releases time for prima donnas to
indulge in stale irrelevant research. Then we squabble over what is "real"
research, and why what every one else is doing is not that. Is this a recipe
for recruiting young inquiring minds into our discipline?
I left the corporate world in the early seventies
because I was fascinated with the problems I had to deal with there (mostly
in operations) and the promise that Operations Research offered. Today,
however, As someone at the front end of the baby boom generation, I
sometimes wonder if, were I shopping today for a PhD program, I would leave
the corporate world if my success depended on toeing the party line.
Just a plug for the Shidler PhD program. Given the
strategic direction of the Shidler College in international management, our
PhD program is somewhat different than the usual program. The program is in
International Management, with specializations in accounting, marketing, MIS
and so on. Details at
http://shidler.hawaii.edu/Programs/Graduate/PhDinInternationalManagement/PhDOverview/tabid/382/Default.aspx
. We're always looking for high quality candidates,
Roger Debreceny
Shidler College Distinguished Professor of Accounting
School of Accountancy
Shidler College of Business
University of Hawai`i at Mānoa
2404 Maile Way, Honolulu, HI 96822, USA roger@debreceny.comrogersd@hawaii.edu
Office: +1 808 956 8545 Cell: +1 808 393 1352 www.debreceny.com
May 13, 2007 reply from Dan Stone, Univ. of Kentucky
[dstone@UKY.EDU]
Please add the Univ. of Kentucky to the list of
doctoral programs that seek students interested in, and support, a variety
of research methods and topics. For example, among the 12 doctoral students
in residence currently, we have students pursuing research related to:
1. XBRL
2. Accounting issues related to environmental
sustainability 3. Knowledge management in professional service firms 4.
Applications of self-determination theory to motivating accounting
professionals 5. Accounting methods to aid economic development in emerging
economies 6. Corporate social responsibility (CSR) reporting
Information about the Univ. of Kentucky doctoral
program is available at:
We typically admit 2-3 students per year to the
program.
Happy Mother's Day!
Dan Stone (dstone@uky.edu)
Director of Graduate Studies
University of Kentucky
June 12, 2007 reply from doctoral student Randy Kuhn
[jkuhn@BUS.UCF.EDU]
Later this week, I will be attending the AAA
doctoral consortium held in Tahoe each year as a representative of the
University of Central.
Later this week, I will be attending the AAA
doctoral consortium held in Tahoe each year as a representative of the
University of Central Florida. A few minutes ago I received the message
below from one of the professors who will be presenting to the doctoral
candidates. Apparently, some of the students attending do not feel his
non-archival style of research is worth discussing at the consortium and
complained to one of the organizers prompting a well-established professor
from an elite private institution to essentially justify his place on the
agenda BEFORE we even arrive. I find this behavior not only completely rude
and disrespectful but just plain anti-academic from many angles. These folks
are complaining about one article out of 21. Should I email the organizer
complaining that two-thirds of the material on the agenda is from a
neo-classical, efficient markets slant in which I have no interest? My head
was spinning in circles for hours trying to grapple with the analytical
models that ultimately told me what I already intuitively knew. I’m game for
new experiences and will embrace the opportunity to learn about others’
research. Isn’t that what academia is supposed to be about? In the back of
my mind I kind of hope one of the complainers is my roommate so I can bore
him to tears each night discussing how accounting choices exist, are made by
people, are quite often not rational, and have mega impacts to society. Ok
enough of my diatribe, see the lengthy note to the consortium participants
below.
-Randy
June 12, 2007 reply from doctoral student Randy Kuhn
[jkuhn@BUS.UCF.EDU]
Boy, did I misconstrue the original email from the
professor. I emailed the professor to express my interest in his subject
matter and he responded by stating that he did not mean to imply students
had complained negatively about his articles. Rather, several students
complained about the overwhelming econometrics-based research on the agenda
and lack of diversity in the consortium curriculum. Big oopsy on my part!
That is a much brighter situation!
Thanks for the update....I am delighted to hear
that doctoral students are finally expressing some dissatisfaction at the
constrained nature of what is considered "good" research! As we attempt to
replace the retiring professoriate, we need to attract more people, which
should mean that we become more catholic in our research approaches, rather
than more restrictive.
This is encouraging. When I attended the doctoral
consortium the only thing that was on the agenda was EMH. The consortium has
historically been an avenue for the ideologues (just check out who the
faculty at that thing have been over the years). At the one I attended,
Sandy Burton was invited for what appeared to be the sole purpose of
humiliating him because of his "naïve" beliefs about accounting and security
markets (he was invited to be the "normative" that the "positives" aimed to
purge from the academy).
The tide may be turning. Given your interests,
there are some recent books you might find useful.
Bent Flyvbjerg, "Making Social Science Matter,"
Cambridge University Press, 2001. Relying on research mainly from cognitive
psych and sociology he makes the case that, "Predictive theories and
universals cannot be found in the study of human affairs. Concrete,
context-dependent knowledge is therefore more valuable than the vain search
for predictive theories and universals (p. 73)."
A much better book than The Black Swan is David
Orrell's (Oxford U. PhD in mathematics), "The Future of Everything: The
Science of Prediction," Thunder's Mouth Press, 2007. Using the phenomena of
weather, securities markets, and genetic variablility as examples he argues
that complexity makes such phenomena "uncomputable," thus predicting them
with mathematical precision is impossible. Those wanting to understand Bob's
animus to "accountics" might find this a useful read.
Related, but specific to environmental science is
Orrin H. Pilkey and Linda Pilkey-Jarvis, "useless arithmetic: Why
Environmental Scientists Can't Predict the Future," Columbia University
Press, 2007.
Another book which might lend an interesting
direction to a discourse on the SEC is Clarke, F., Dean, G., Oliver, K.
Corporate Collapse – Accounting, regulatory and ethical failure, Cambridge
University Press, Cambridge, 2003.
While directed at the Australian regulatory
framework, the argument could be applied with equal validity to the SEC.
Kind regards,
Mac Wright
Co-Ordinator Aviation Program
Victoria University
Melbourne Australia
What if scholarly books were peer
reviewed by anonymous blog comments rather than by traditional, selected
peer reviewers?
That's the question being posed by an unusual
experiment that begins today. It involves a scholar studying video games, a
popular academic blog with the playful name Grand Text Auto, a nonprofit
group designing blog tools for scholars, and MIT Press.
The idea took shape when Noah Wardrip-Fruin, an
assistant professor of communication at the University of California at San
Diego, was talking with his editor at the press about peer reviewers for the
book he was finishing, The book, with the not-so-playful title Expressive
Processing: Digital Fictions, Computer Games, and Software Studies,
examines the importance of using both software design and traditional
media-studies methods in the study of video games.
One group of reviewers jumped to his mind: "I
immediately thought, you know it's the people on Grand Text Auto."
The blog, which takes
its moniker from the controversial video game Grand Theft Auto, is run by
Mr. Wardrip-Fruin and five colleagues. It offers an academic take on
interactive fiction and video games.
Inviting More Critics
The blog is read by many of the same
scholars he sees at academic conferences, and also attracts readers from the
video-game industry and teenagers who are hard-core video-game players. At
its peak, the blog has had more than 200,000 visitors per month, he says.
"This is the community whose response I want, not
just the small circle of academics," Mr. Wardrip-Fruin says.
So he called up the folks at the Institute for the
Future of the Book, who developed CommentPress, a tool for adding digital
margin notes to blogs (The
Chronicle, September 28, 2007). Would they
help out? He wondered if he could post sections of his book on Grand Text
Auto and allow readers, using CommentPress, to add critiques right in the
margins.
The idea was to tap the wisdom of his crowd.
Visitors to the blog might not read the whole manuscript, as traditional
reviewers do, but they might weigh in on a section in which they have some
expertise.
The institute, an unusual academic center run by
the University of Southern California but based in Brooklyn, N.Y., was game.
So was Mr. Wardrip-Fruin's editor at MIT Press, Doug Sery, but with one
important caveat. He insisted on running the manuscript through the
traditional peer-review process as well. "We are a peer-review press—we're
always going to want to have an honest peer review," says Mr. Sery, senior
editor for new media and game studies. "The reputation of MIT Press, or any
good academic press, is based on a peer-review model."
So the experiment will provide a side-by-side
comparison of reviewing—old school versus new blog. Mr. Wardrip-Fruin calls
the new method "blog-based peer review."
Each day he will post a new chunk of his draft to
the blog, and readers will be invited to comment. That should open the
floodgates of input, possibly generating thousands of responses by the time
all 300-plus pages of the book are posted. "My plan is to respond to
everything that seems substantial," says the author.
The institute is modifying its CommentPress
software for the project, with the help of a $10,000 grant from San Diego's
Academic Senate, to create a version that bloggers can more easily add to
their existing academic blogs.
A Cautious Look Forward
Mr. Wardrip-Fruin's friends have
warned him that sorting through all those comments will take over his life,
or at least take far more time than he expects. "It's been said to me enough
times by people who are not just naysayers that it is in the back of my
mind," he acknowledges. Still, the book's review process "will pale in
comparison to the work of writing it."
He expects the blog-based review to be more helpful
than the traditional peer review because of the variety of voices
contributing. "I am dead certain it will make the book better," he says.
Mr. Sery isn't so sure. "I don't know how this
general peer review is going to help," the editor says, except maybe to
catch small errors that have slipped through the cracks. Traditional peer
review involves carefully chosen experts in the same subject area, who can
point to big-picture issues as well as nitpick details. He bets that the
blog reviews might merely spark flame wars or other unhelpful arguments
about minor points. "I'm curious to see what kind of comments we get back,"
he says.
That probably "depends on what you're writing
about," says Clifford A. Lynch, executive director of the Coalition for
Networked Information, a group that supports the use of technology in
scholarly communication. "If, God help you, you're writing about current
religious or political issues, you're going to get a lot of people with
agendas who aren't interested in having a rational discussion. Some of them
are just psychos."
Even without flame wars, Mr. Sery equates the blog
review with the kind of informal sharing of drafts that many academics do
with close friends. It's useful, but it's still not formal peer review, he
argues. Carefully choosing reviewers "really allows for the expression of
their ideas on the book," he says. Scholars can say with authority, for
instance, that a book just isn't worth publishing.
Ben Vershbow, editorial director at the Institute
for the Future of the Book, concedes that comments on blogs are unlikely to
fully replace peer review. But he says academic blogging can play a role in
the publishing process.
Continued in article
Jensen Comment
This is one of those experiments that is impossible to extrapolate. Blog
comments are totally voluntary and impulsive such that blog comments are going
to be highly variable with respect Go topics, errors in the original document,
and extent of the readership in the blog. Few blog activists are going to give
time and attention to reviews that are not going to be widely read.
Peer reviews are likely to be less impulsive since the
reviewer generally agrees ahead of time to conduct a review. But they are more
variable than blog comments. The reason is that peer reviewers spend less time
reviewing manuscripts that are outliers (i.e., those that are so good that there
are few recommendations for change or those that are so bad that there's little
hope for a future positive recommendation to publish). More time may be spend on
manuscripts that need a lot of repair but have high hopes.
The main problem with peer reviews is that there are so few
reviewers. Much depends upon which two or three reviewers are assigned to review
the manuscript. Three reviewers' garbage may be another three reviewers'
treasure. Another problem is that peer reviews are seldom published in the name
of the anonymous reviewers. Blog commentators generally do so in their own names
and get some reputation enhancement among their blog peers, especially if their
are praiseworthy replies on the blog to the blog review. Anonymous reviewers get
little incremental reputation enhancement for their unpublished reviews.
Still another problem with peer reviews is that editors and
their hand picked reviewers may be a biased subset of a scholarly community.
Others in the community may be shut out, which is now a raging problem in
academic accountancy ---
http://faculty.trinity.edu/rjensen/Theory01.htm#DoctoralPrograms
Here is a DBA program for working professionals
offered by the Coles College of Business at Kennesaw State University. It is
a AACSB accredited university
http://coles.kennesaw.edu/graduate/dba/
Ramesh Fernando
CMA Candidate (Canada)
Ottawa, Ontario, Canada
April 11, 2011 reply from Bob Jensen
The FAQa page discloses many items that should be carefully considered.
First, the program is not an online program. It is a residency program.
Second, the cost is very high --- nearly $100,000 plus room and board. No
tuition relief is given for Georgia residents.
Third, virtually all AACSB schools with accounting doctoral programs have
financial aid in a combination of teaching and research assistance that
pretty well eliminates tuition costs and defrays much of the room and board
cost. I don't think this a atypical DBA program is as generous in its
tuition, room, and board allowances (if there are any at all).
This program is a three-year program that is much lighter on research
education and hands-on research guidance. It's not at all clear that the
accounting programs in major universities will consider graduates from this
program to be fully qualified for the rigors of tenure track appointments
that have heavy research and publication requirements.
Since virtually all accounting programs in AACSB accredited schools are
4-6 year residency programs with GMAT admission requirements, I think this
3-year program without such requirements will make graduates second class
citizens unless they have some wonderful added credentials in government or
industry experience such as four-star generals or former CEOs of Fortune 500
companies or PhD degrees in science or humanities prior to entering this
program.
I'm always dubious of graduate programs that do not require GRE, GMAT, or
equivalent admission test requirements.
It would seem that this program is designed to be a cash cow aimed at
continuing education of executives. As such is is more like some of the
European executive doctoral programs that do not pretend to compete with
rigorous research-oriented doctoral programs. Accordingly, I doubt that
graduates will find many opportunities in major U.S. universities having
research-oriented tenure track programs in accountancy.
Graduates in this program might have to apply for jobs as PQ faculty
rather then AQ faculty. PQ faculty often teach full time without being on
tenure tracks.
From a Boston hotel today,
Bob Jensen
April 12, 2011 reply from Dana Hermanson
Bob,
A colleague passed along the postings about the KSU
DBA program, and I wanted to share a few perspectives. I have been teaching
in the program for two years, have two of my students at the dissertation
stage, and have two more of my students at the end of their first year. I
also have taught the broader group of accounting and business DBA students.
When I first became involved with this program, I
had some uncertainties about a new program's potential quality level, focus,
etc. - concerns similar to some of those in your posting. Those
uncertainties have been resolved in a very, very positive manner, such that
I feel very good about our program and its potential contribution to
accounting academe.
In terms of the program, it is definitely not
designed to be like the European programs (continuing ed for executives),
but it also is not a traditional 4-6 year PhD program (frankly, the 4-6 year
commitment keeps most interested people out of accounting academe). The
program is 3 years, probably 30 hours per week, research focused, and
designed primarily for people with significant business experience (15-25
years) who want to become AQ faculty at KSU-type schools (or at less
research-intensive places). My understanding is that we don’t use the GMAT
because it does not tell us much about the academic potential of students
who are older (e.g., 40-55 years old).
We already are beginning to place students in AQ,
tenure-track faculty positions in AACSB accredited schools - not R1 schools,
but places with a balanced emphasis on research and teaching. We believe
that this is a segment of the market that is crying out for AQ faculty, as
the large PhD schools often serve mainly each others' needs for faculty. In
addition, such "balanced" schools appear to greatly value professional
experience - both for classroom purposes and for producing relevant
research.
I have found the DBA students to be outstanding,
far above what I expected. They bring years of experience, know what the
relevant questions are, and catch on very quickly. They are generating
working papers, and one of my students already has a publication, as well as
a dissertation grant from the IIA and a research grant from the IMA. I
expect their dissertations to lead to several significant publications, and
I am working on other projects and papers with the students as well.
As far as the financial side, the program is
expensive, but my understanding is that it's not a cash cow. We are keeping
the student #s consistent with our ability to serve them well. We involve
both KSU research faculty (in accounting, people such as Audrey Gramling,
Divesh Sharma, Vineeta Sharma, Dennis Chambers, Sri Ramamoorti) and Global
Scholars in the program. For example, Jeff Cohen at Boston College is
serving on a dissertation committee with me, as is Todd DeZoort at the Univ.
of Alabama. Both are leading researchers in the auditing field.
I hope this additional information is helpful. The
KSU DBA is a new model, and I am very excited to be working in this program.
And, I can assure you that I would not be involved in this program if I
thought it lacked rigor and quality. I also would have no interest in
working in a program that was not focused on producing AQ faculty who will
be productive researchers and excellent teachers.
Dana
Dana R. Hermanson
Dinos Eminent Scholar
Chair of Private Enterprise Director of Research
Corporate Governance Center
Kennesaw State University Coles College of Business
1000 Chastain Road, Mail Drop 0402 Kennesaw, GA 30144-5591
April 13, 2011 reply from Bob Jensen
Thank you for the update Dana.
May I post your comments on the AECM?
Is financial aid available to attract minority students? The program
seems well-suited to those students being helped by the KPMG Foundation
since it's designed to be completed in three years.
However, the KPMG Foundation's minority students, along with your
targeted-market executives, are not likely to have the mathematics,
statistics, and economics pre-requisites for doctoral program research
courses.
Do you offer these research preparation courses and does this add to the
three years of study? In a traditional 4-6 six year program these quant
courses are typically taught in the early years and are often the reason
these programs take 4-6 years.
It would also seem that your accounting DBA students must be CPAs or CMAs
before they are admitted to the program in order to complete the program in
three years. In the typical 4-6 year program students weak in accounting
background, such as former math and economics majors, must take
undergraduate financial, auditing, and tax courses before truly
matriculating into the graduate accounting courses.
Is your program attracting many Asian students who are typically strong
in math and weak in US financial, auditing, and tax courses? How long would
these applicants typically take to complete your DBA program?
Thanks,
Bob Jensen
Addendum
Dana's answers are included below (I.m still
getting used to my new T-mail system that does its best to hide some
replies to messages).
It appears that the KSU DBA program with a
concentration in accountancy manages to maintain a three-year target
primarily by only admitting candidates who could teach accounting on a
PQ basis before earning the DBA, by admitting candidates who are not
seeking tenure track positions in R1 research universities (and thereby
minimizing the quantitative methods courses and doctoral theses required
in other North American accounting doctoral programs), and by targeting
executives not in need of financial aid like nearly all accounting
doctoral candidates in other North American accounting doctoral
programs.
It would appear that this DBA program prepares
accounting professors much, much better than the AACSB Bridge Program
except for bridge candidates who already have both strong accounting
backgrounds plus quantitative methods backgrounds such as CPAs who also
have mathematics, statistics, or social science PhD degrees and want to
bridge into AQ teaching and research in accounting programs.
April 13, 2011 reply from Dana Heramanson
> >Is financial aid available to attract minority students? >The program
seems well-suited to those students being helped by the KPMG >Foundation
since it's designed to be completed in three years. >
My understanding is that there is not financial
aid offered specifically through the DBA program, but students can go
through the KSU Financial Aid office to explore their options. Also, my
guess is that the KSU DBA students are, on average, much more senior
than the people coming through the KPMG program. However, I will look
into this and would welcome the chance to collaborate with KPMG.
> >However, the KPMG Foundation's minority students, along with your
>targeted-market executives, are not likely to have the mathematics,
>statistics, and economics pre-requisites for doctoral program research
>courses. > > >Do you offer these research preparation courses and does this
add to the >three years of study? >In a traditional 4-6 six year program
these quant courses are typically >taught in the early years and are often
the reason these programs take 4-6 >years. >
We have a heavy, hands-on quantitative methods
sequence in the early part of our program. All students take this
sequence, and it is part of our 3 year program. Joe Hair (a leading
quant methods person in marketing, formerly at LSU) has designed this
sequence and teaches much of it. In addition, the students get more
discipline-specific quant training in the seminars.
To date, the accounting students have
gravitated primarily toward auditing and corporate governance research
topics, where our faculty is concentrated, and many of the students are
pursuing behavioral/experimental research. As a result, the quantitative
dimension is less overwhelming than if the students were pursuing
traditional financial accounting research targeted at TAR and JAR, which
often involves very advanced econometric techniques. I have been careful
to communicate to the students the strength of our faculty (mainly
auditing and governance but coming on strong in financial with some
recent hires) and the challenges of competing at the top-tier level in
financial accounting research. I encourage them to think about their
backgrounds, professional contacts, etc. and leverage those to produce
unique research. This is the strategy I have used personally.
> >It would also seem that your accounting DBA students must be CPAs or
CMAs >before they are admitted to the program in order to complete the
program in >three years. In the typical 4-6 year program students weak in
accounting >background, such as former math and economics majors, must take
>undergraduate financial, auditing, and tax courses before truly
>matriculating into the graduate accounting courses.
Yes, the students are exceptionally strong in
accounting (they certainly know more accounting than I do!). For
example, one of the Cohort 1 accounting students is a former CEO and
CFO, has an MBA from Columbia Univ., and currently serves as an audit
committee chair for a public company. Another Cohort 1 accounting
student was a CPA firm partner for many years and has recently served as
a bank director and audit committee member. She has taught as a lecturer
at a university for the past several years. The third Cohort 1
accounting student has worked in a variety of financial management and
systems positions with the University System of Ga. See http://coles.kennesaw.edu/graduate/dba/student-profiles.htm
for additional information on the students. These students have all the
practical accounting expertise they need, and we are teaching them to do
research on questions of interest to them.
> > >Is your program attracting many Asian students who are typically
strong in >math and weak in US financial, auditing, and tax courses? >How
long would these applicants typically take to complete your DBA program?
To date, this has not been the profile of our
students, as our students are those with 15-25 years of business
experience looking to transition into academe (several have been
teaching as lecturers in recent years and see the need to become AQ). I
would expect that an international student with limited exposure to U.S.
accounting would be much better served in a traditional Ph.D. program.
Our program is designed for people with significant accounting practice
experience.
If you're
thinking of applying to B-school, then you're likely also
wondering how to conquer the Graduate Management Admission
Test (GMAT)—and whether a commercial test-preparation
service, which can cost upwards of $1,000, is right for you.
Although admissions committees, even at the best-ranked
B-schools, will tell you that your GMAT score is only one of
many criteria for getting accepted, you still should plan on
earning between 600 and a perfect 800, especially if you're
gunning for the A-list. (To find the average and median GMAT
scores of accepted students in individual programs, scan the
BusinessWeek.com B-school profiles.)
. . .
One
popular option is consulting a test-prep company that
provides everything from group instruction to online
courses. Here's an overview of the most popular GMAT
test-preparation services in alphabetical order. For more
opinions on the various test-prep services from test takers
themselves, visit the
BusinessWeek.com B-School forums,
where this subject comes up a lot. And you can also check
out BusinessWeek.com's newly updated
GMAT Prep page ---
http://www.businessweek.com/bschools/gmat/
Continued in article
Jensen Comment
The above article then goes on to identify the main commercial players in GMAT
coaching for a fee, including those with coaching books, coaching CDs, coaching
Websites, coaching courses, and one-on-one coaching tutorials with a supposed
expert near where you live. The Business Week capsule summaries are
rather nice summaries about options, costs, pros and cons of each coaching
option.
Business Week fails to mention one of the better sites
(Test Magic) , in my viewpoint, for GMAT, SAT, GRE, and other test coaching:
Advice to students planning to take standardized tests such as the SAT, GRE,
GMAT, LSAT, TOEFL, etc. See Test Magic at
http://www.testmagic.com/
There is a forum here where students
interested in doctoral programs in business (e.g., accounting and finance) and
economics discuss the ins and outs of doctoral programs.
Nobel prize-winner Daniel Kahneman has issued a
strongly worded call to one group of psychologists to restore the
credibility of their field by creating a replication ring to check each
others’ results.
Kahneman, a psychologist at Princeton University in
New Jersey, addressed his
open e-mail to researchers who work on social
priming, the study of how subtle cues can unconsciously influence our
thoughts or behaviour. For example, volunteers might walk more slowly down a
corridor after seeing words related to old age1,
or fare better in general-knowledge tests after writing down the attributes
of a typical professor2.
Such tests are widely used in psychology, and
Kahneman counts himself as a “general believer” in priming effects. But in
his e-mail, seen by Nature, he writes that there is a “train wreck
looming” for the field, due to a “storm of doubt” about the robustness of
priming results.
Under fire
This scepticism has been fed by failed attempts to
replicate classic priming studies, increasing concerns about replicability
in psychology more broadly (see 'Bad
Copy'), and the exposure of fraudulent social
psychologists such as Diederik Stapel, Dirk Smeesters and Lawrence Sanna,
who used priming techniques in their work.
“For all these reasons, right or wrong, your field
is now the poster child for doubts about the integrity of psychological
research,” Kahneman writes. “I believe that you should collectively do
something about this mess.”
Kahneman’s chief concern is that graduate students
who have conducted priming research may find it difficult to get jobs after
being associated with a field that is being visibly questioned.
“Kahneman is a hard man to ignore. I suspect that
everybody who got a message from him read it immediately,” says Brian Nosek,
a social psychologist at the University of Virginia in Charlottesville.David
Funder, at the University of California, Riverside, and president-elect of
the Society for Personality and Social Psychology, worries that the debate
about priming has descended into angry defensiveness rather than a
scientific discussion about data. “I think the e-mail hits exactly the right
tone,” he says. “If this doesn’t work, I don’t know what will.”
Hal Pashler, a cognitive psychologist at the
University of California, San Diego, says that several groups, including his
own, have already tried to replicate well-known social-priming findings, but
have not been able to reproduce any of the effects. “These are quite simple
experiments and the replication attempts are well powered, so it is all very
puzzling. The field needs to get to the bottom of this, and the quicker the
better.”
Chain of replication
To address this problem, Kahneman recommends that
established social psychologists set up a “daisy chain” of replications.
Each lab would try to repeat a priming effect demonstrated by its neighbour,
supervised by someone from the replicated lab. Both parties would record
every detail of the methods, commit beforehand to publish the results, and
make all data openly available.
Kahneman thinks that such collaborations are
necessary because priming effects are subtle, and could be undermined by
small experimental changes.
Norbert Schwarz, a social psychologist at the
University of Michigan in Ann Arbor who received the e-mail, says that
priming studies attract sceptical attention because their results are often
surprising, not necessarily because they are scientifically flawed.. “There
is no empirical evidence that work in this area is more or less replicable
than work in other areas,” he says, although the “iconic status” of
individual findings has distracted from a larger body of supportive
evidence.
“You can think of this as psychology’s version of
the climate-change debate,” says Schwarz. “The consensus of the vast
majority of psychologists closely familiar with work in this area gets
drowned out by claims of a few persistent priming sceptics.”
Still, Schwarz broadly supports Kahneman’s
suggestion. “I will participate in such a daisy-chain if the field decides
that it is something that should be implemented,” says Schwarz, but not if
it is “merely directed at one single area of research”.
The lack of validation is an enormous problem in accountics science, but the
saving grace is that nobody much cares 574 Shields Against Validity Challenges in Plato's Cave ---
http://faculty.trinity.edu/rjensen/TheoryTAR.htm
A scientist in any serious scientific discipline, such
as genetics, would be in serious trouble if his fellow scientists were unable to
confirm or replicate his claim to have found the gene for fatness. He would gain
a reputation as being 'unreliable' and universities would be reluctant to employ
him. This self-imposed insistence on rigorous methodology is however missing
from contemporary epidemiology; indeed the most striking feature is the
insouciance with which epidemiologists announce their findings, as if they do
not expect anybody to take them seriously. It would, after all, be a very
serious matter if drinking alcohol really did cause breast cancer. James Le Fanu ---
http://www.open2.net/truthwillout/human_genome/article/genome_fanu.htm
Bob Jensen's threads on replication are at
http://faculty.trinity.edu/rjensen//theory/00overview/theory01.htm#Replication
What is a replication?
Below is part of my reply to an accountics professor who sent me a partial
listing of what he viewed as replications in accountics research:
Thanks to your very kind listing of “replications,” I’m looking
at capital markets study replications more seriously. Virtually all
behavioral experiments reported in TAR and JAR are not replicated
whatsoever, probably because nobody is really interested in those harvests
(due to the artificial nature of the experiments).
Please, please be careful what you call a “replication.” Capital markets events studies are more difficult to evaluate
because those studies do tend to build on each other. But I still have
difficulty finding examples that would pass a chemical researcher’s test of
what constitutes a genuine replication.
Suppose Chemist Q conducts research on the reaction of variable Y
to ingredients A, B, and C. If Chemist R wants to replicate the study, he
does so by testing the reaction of variable Y to ingredients A, B, and C to
test the veracity of the findings of Chemist Q. If Chemist R finds that
different outcomes arise from ingredients A, B, C, and D this is not a
replication study. If Chemist Q finds that Chemist R originally used a
corrupted Chemical C then this would be a replication when re-testing with a
pure Chemical C.
If ingredients A, B, and C are temporal and change with time, it
is not a replication when Chemist R examines the impact of ingredients A, B,
and C at a later point in time --- the supposed replication of Bradshaw’s
2004 outcomes in 2009. The problem in finance and accounting is that the
variables studied are seldom stationary over time or the systems in which
they operate are not stationary over time. For example, security analysts in
2009 are operating is quite different systems than security analysts in 1995
or even 2004.
In fairness, it’s very difficult to do replication studies in
accounting and finance at two different points in time because most of the
time the replications are confounded with non-stationary contexts.
Regulations may have changed. Corporate policies may have changed. Media
reporting may have changed behavior. A true replication uses the same data
at the same point in time unless the variables are not temporal (which
rarely happens outside the realm of the natural sciences).
Bob Jensen
November 12, 2009 reply from Professor XXXXX
We could go on for hours about
replications. But you might want to take a look at Nobel Prize Winner Vernon
Smith's writings on replications. I honestly cannot remember if Smith
attributed the following to someone else (I would have to look at the
article from which I recall this), but he uses the analogy of replicating
the time. I say it is 8:51 a.m. and ask you to replicate that assertion. You
might ask to see my watch to conduct a "strict" replication, but that does
little to verify the validity of my assertion other than to see that I have
read my watch correctly. A better replication would be for you to look at
your own watch. If you agree that it is 8:51, we gain additional comfort
that it is truly 8:51, even though you have not strictly maintained "ceteris
paribus" conditions. If say it is 9:51, we ask why the two watches differ,
and perhaps seek a third watch for additional evidence and to seek
theoretical explanations (e.g., perhaps one of us forgot to adjust for
Daylight Savings Time). I submit that most replications in accounting are of
the variety of looking at someone else's watch, not the original author's
watch. Where we may differ is in the value we gain from that sort of
replication vis-a-vis a "strict" replication. Oh, and by the way, the two
studies in the July 2009 issue (Barniv et al. and Chen and Chen) are not
replications of Bradshaw (2004) so much as they are replications of each
other. I should have made that clearer.
Peer Review of Articles versus Peer Review of Underlying Data (Codes),
What he fails to recognize is that if the underlying data is manipulated or
biased or otherwise flawed, a million peer-reviews studies using that data might
be equally flawed from get go. It's important to note that the Climatic Research
Unit ('CRU') at the University of East Anglia, was the United Nations.
designated source for meteorological station data. It's data was widely used by
thousands of scientists and other analysts.
Although there are obviously speculations about raw data was discarded and
the obvious biases of the scientist (Phil Jones) who was in charge of gathering
the meteorological station data, I don't think there is hard evidence
that Jones modified the data used by other meteorological scientists. There is
some evidence of data manipulation by a New Zealand scientist, but that data is
not nearly as important as the CRU data collected for the U.N.
What struck me as more important than Johnson's article cited above is the
following comment accompanying Johnson's article:
Posted by Ryan
Wisnesky , Graduate Student, Computer
Science at Harvard University
on December 8, 2009 at 5:15am EST
How rigorous can the peer-review process be if the
source code used to analyze the raw data is not also thoroughly reviewed?
From looking at the leaked source code comments it appears that even the
programmers who wrote the code (over a period of years) were unsure how it
actually works. If nothing else, this scandal suggests the ever increasing
importance of code review for all scientific disciplines.
Hence, even though scientists can point to nearly 1,000 respected peer
reviewed studies using the CRU data, the peer reviewers mostly accepted the CRU
underlying data as fact without challenging whether some of the most important
data might have been fictionalized by Jones and his team. In fairness, some of
the raw data was destroyed before Professor Jones took over as Director of the
CRU.
This is consistent with my long-standing suspicion of journal policies (like
those of The Accounting Review) that arm twists author willingness to
make underlying data available to readers. Actually I'm in favor of the policies
and was on the AAA Executive Committee when we asked
my
hero Bill Cooper (then Publications Director for the AAA) to commence a policy of
trying to make data available to readers of articles. What I'm worried about is
that, instead of gathering confirming data, researchers will simply do further
research on what might be flawed data.
The scientific community would come
down on me in no uncertain terms if I said the world had cooled from 1998. OK it
has but it is only 7 years of data and it isn't statistically significant.
Note that the date of this email was
July 5, 2005
Dr. Jones never imagined that his admissions would ever be made public in the
2009 Climategate
Phil Jones, Scientist Suspended in the Climategate Scandal for covering up
evidence of planet cooling ---
http://www.eastangliaemails.com/emails.php?eid=544&filename=1120593115.txt
The New Zealand Government’s chief climate
advisory unit NIWA is under fire for allegedly massaging raw climate data to
show a global warming trend that wasn’t there. The scandal breaks as fears grow
worldwide that corruption of climate science is not confined to just Britain’s
CRU climate research centre.In New Zealand’s case, the figures published on
NIWA’s [the National Institute of Water and Atmospheric research] website
suggest a strong warming trend in New Zealand over the past century [Go
to the link to see the graphs; the fraud is astonishing]But
analysis of the raw climate data from the same temperature stations has just
turned up a very different result [Go
to link above to see graphs]
"New Zealand Climate Scientists Faked Data, Too," Evolution News and Views,
December 3, 2009 ---
http://www.evolutionnews.org/2009/12/new_zealand_climate_scientists.html
Let’s say you had two compasses to help you find
north, but the compasses are reading incorrectly. After some investigation,
you find that one of the compasses is located next to a strong magnet, which
you have good reason to believe is strongly biasing that compass’s readings.
In response, would you 1. Average the results of the two compasses and use
this mean to guide you, or 2. Ignore the output of the poorly sited compass
and rely solely on the other unbiased compass?
Most of us would quite rationally choose #2.
However, Steve McIntyre shows us a situation involving two temperature
stations in the USHCN network in which government researchers apparently
have gone with solution #1.
Continued in article
"The Inconvenient Truth: Al Gore "brushes aside" evidence of
scientific misconduct,"
James Taranto, The Wall Street Journal, .December 5, 2009 ---
Click Here
Here is the text of Newsweek’s 1975 story on the trend toward
global cooling. It may look foolish today, but in fact world temperatures had
been falling since about 1940. It was around 1979 that they reversed direction
and resumed the general rise that had begun in the 1880s, bringing us today back
to around 1940 levels. A PDF of the original is available here. A fine short
history of warming and cooling scares has recently been produced. It is
available here. Newsweek Magazine, April 28, 1975
---
http://denisdutton.com/cooling_world.htm
Who knows? In the long run, global warming
skeptics may be wrong, but the importance of healthy skepticism in the face
of conventional thinking is, once again, validated.
What we know now is that someone hacked
into the e-mails of leading climate researchers at the University of East
Anglia's Climatic Research Unit and others, including noted alarmists
Michael Mann at Pennsylvania State University and Kevin Trenberth of the
U.S. National Center for Atmospheric Research in Boulder, Colo.
We found out that respected men discussed
the manipulation of science, the blocking of Freedom of Information
requests, the exclusion of dissenting scientists from debate, the removal of
dissent from the peer-reviewed publications, and the discarding of
historical temperature data and e-mail evidence.
You may suppose that those with resilient
faith in end-of-days global warming would be more distraught than anyone
over these actions. You'd be wrong. In the wake of the scandal, we are told
there is nothing to see. The administration, the United Nations, and most of
the left-wing punditry and political establishment have shrugged it off.
What else can they do?
To many of these folks, the science of
global warming is only a tool of ideology. To step back and re-examine their
thinking would also mean—at least temporarily—ceding a foothold on policy
that allows government to control behavior. It would mean putting the brakes
on the billions of dollars allocated to force fundamental economic and
societal manipulations through cap-and-trade schemes and fabricated "new
energy economies," among many other intrusive policies.
We have little choice but to place a
certain level of trust in scientists—even when it comes to the model-driven
speculative discipline of climate change. And, need it be said, most
scientists take great care in being honest, principled and precise.
In the same way, a conscientious citizen
has little choice but to be uneasy when those with financial, ideological,
and political interest in peddling the most over-the-top ecological doomsday
scenarios also become the most zealous evangelizers.
As President Barack Obama heads to
Copenhagen to work on an international deal that surrenders even more of our
unsightly carbon-driven prosperity to the now-somewhat-less-than-irrefutable
science of climate change, shouldn't he offer more than a flippant statement
through a spokesman on the scandal?
The talks, after all, will be based on the
U.N.'s Intergovernmental Panel on Climate Change's Fourth Assessment Report,
which partially was put together by the very same scandal-ridden scientists.
Now, I do not, on any level, possess the
expertise to argue about the science of anthropological global warming. Nor
do you, most likely. This certainly doesn't mean an average citizen has the
duty to do the lock step.
Yes, you apostates will be tagged "denialists"—because
skepticism is synonymous with the Holocaust denial, don't you know—or some
other equally unfriendly moniker.
Don't worry; you won't be alone. Gallup
recently found that 41 percent of Americans now believe global warming news
reports are exaggerated—the highest number in more than a decade despite the
fact that this time frame has coincided with concentrated and highly funded
scaremongering. That number is sure to rise as soon as word of this scandal
spreads.
The uglier the names get, the more anger
you see, the more that science-challenged politicians push invasive
legislation, the more skeptics will join you. True believers will question
your intelligence, your sanity and your intentions.
But as ClimateGate proves, a bit of
skepticism rarely steers you wrong. In fact, it's one of the key elements of
rational thinking.
David Harsanyi is a columnist at The Denver Post and the author of "Nanny
State." Visit his Web site at
www.DavidHarsanyi.com
Bob Jensen's rants on replications or lack thereof in accountics research
are at shown below.
If you're going to attack empirical accounting research, hit it where it
has no defenses!
One type of accounting research is "Spade Research" and our leading
Sam Spade in recent decades was Abe Briloff when he was at Baruch College in
NYC. Abe and his students diligently poured over accounting reports and
dug up where companies and/or their auditors violated accounting standards,
rules, and professional ethics. He was not at all popular in the accounting
profession because he was so good at his work. Zeff and Granof wrote as
follows:
Floyd Norris, the chief financial
correspondent of The New York Times, titled a 2006 speech to the
American Accounting Association "Where Is the Next Abe Briloff?" Abe
Briloff is a rare academic accountant. He has devoted his career to
examining the financial statements of publicly traded companies and
censuring firms that he believes have engaged in abusive accounting
practices. Most of his work has been published in Barron's and in
several books — almost none in academic journals. An accounting gadfly
in the mold of Ralph Nader, he has criticized existing accounting
practices in a way that has not only embarrassed the miscreants but has
caused the rule-making authorities to issue new and more-rigorous
standards. As Norris correctly suggested in his talk, if the academic
community had produced more Abe Briloffs, there would have been fewer
corporate accounting meltdowns.
"Research on Accounting Should Learn From the
Past," by Michael H. Granof and Stephen A. Zeff, Chronicle of Higher
Education, March 21, 2008
In the 1960s and 1970s leading academic accounting researchers
abandoned "Spade" work and loosely organized what might be termed an
Accounting Center for Disease Control where spading was replaced with mining
of databases using increasingly-sophisticated accountics (mathematical)
models. Leading academic accounting research journals virtually stopped
publishing anything but accountics research ---
http://faculty.trinity.edu/rjensen/395wpTAR/Web/TAR395wp.htm
In the past five decades readers of leading academic accounting
research journals had to accept on faith that there were no math errors in
the analysis. The reason is that no empirical accounting research is
ever exactly replicated and verified. In fact the leading academic
accounting research journals adopted policies against publishing
replications or even commentaries. The Accounting Review (TAR) does
technically allow commentaries, but in reality only about one appears each
decade.
Many of the empirical research studies are rooted in privately
collected databases that are never verified for accuracy and freedom from
bias.
On occasion empirical studies are partly verified with anecdotal
evidence. For example the excellent empirical study of Eric Lie in
Management Science on backdating of options was partly verified by court
decisions, fines, and prison sentences of some backdating executives.
However, anecdotal evidence has severe limitations since it can be cherry
picked to either validate or repudiate empirical findings at the same time.
See
http://en.wikipedia.org/wiki/Options_backdating
Replication is part and parcel to the scientific method. All
important findings in the natural sciences are replicated our verified by
some rigorous approach that convinces scientists about accuracy and freedom
from bias.
One of my most popular quotations is that "empirical
accounting farmers are more interested in their tractors than in their
harvests." When papers are presented at meetings most of the
focus is on the horsepower and driving capabilities of the tractors
(mathematical models). If the harvests were of importance to the accounting
profession, the profession would insist on replication and verification. But
the accounting profession mostly shrugs off academic accounting research as
sophisticated efforts to prove the obvious. There are few surprises in
empirical accounting research.
Another sad part about our leading academic accounting research
journals is that they have such a poor citation record relative to our
academic brethren in finance, marketing, and management. American
Accounting Association President Judy Rayburn made citation outdomes the
centerpiece of her emotional (and failed) attempt to get leading academic
accounting research journals to accept research paradigms other than
accountics paradigms ---
http://faculty.trinity.edu/rjensen/395wpTAR/Web/TAR.htm
But the saddest part of all is that the Accounting Center for Disease
Control literally took over every doctoral program in the United States
(slightly excepting Central Florida University) by requiring that all
accounting doctoral graduates be econometricians or psychometricians. As
a result doctoral programs realistically require five years beyond the
masters degree. Accountants who enter these programs must spend years
learning mathematics, statistics, econometrics, and psychometrics.
Mathematicians who enter these programs must spend years learning
accounting. The bottom line is that practicing accountants who would like to
become accounting professors are turned off by having to study five years of
accountics. Each year the shortage of graduates from accounting doctoral
programs in North America becomes increasingly critical/
The American
Accounting Association (AAA) has a new research report on the future supply
and demand for accounting faculty. There's a whole lot of depressing
colored graphics and white-knuckle handwringing about anticipated shortages
of new doctoral graduates and faculty aging, but there's no solution offered
---
http://aaahq.org/temp/phd/AccountingFacultyUSCollegesUniv.pdf
Zeff and Granof concluded the following:
Starting in the 1960s, academic research on
accounting became methodologically supercharged — far more quantitative and
analytical than in previous decades. The results, however, have been
paradoxical. The new paradigms have greatly increased our understanding of
how financial information affects the decisions of investors as well as
managers. At the same time, those models have crowded out other forms of
investigation. The result is that professors of accounting have contributed
little to the establishment of new practices and standards, have failed to
perform a needed role as a watchdog of the profession, and have created a
disconnect between their teaching and their research.
. . .
The unintended consequence has been that
interesting and researchable questions in accounting are essentially being
ignored. By confining the major thrust in research to phenomena that can be
mathematically modeled or derived from electronic databases, academic
accountants have failed to advance the profession in ways that are expected
of them and of which they are capable.
Academic research has unquestionably
broadened the views of standards setters as to the role of accounting
information and how it affects the decisions of individual investors as well
as the capital markets. Nevertheless, it has had scant influence on the
standards themselves.
The research is hamstrung by restrictive
and sometimes artificial assumptions. For example, researchers may construct
mathematical models of optimum compensation contracts between an owner and a
manager. But contrary to all that we know about human behavior, the models
typically posit each of the parties to the arrangement as a "rational"
economic being — one devoid of motivations other than to maximize pecuniary
returns.
Moreover, research is limited to the
homogenized content of electronic databases, which tell us, for example, the
prices at which shares were traded but give no insight into the decision
processes of either the buyers or the sellers. The research is thus unable
to capture the essence of the human behavior that is of interest to
accountants and standard setters.
Further, accounting researchers
usually look backward rather than forward. They examine the impact of a
standard only after it has been issued. And once a rule-making authority
issues a standard, that authority seldom modifies it. Accounting is probably
the only profession in which academic journals will publish empirical
studies only if they have statistical validity. Medical journals, for
example, routinely report on promising new procedures that have not yet
withstood rigorous statistical scrutiny.
"Research on Accounting Should Learn From the Past,"
by Michael H. Granof and Stephen A. Zeff, Chronicle of Higher Education,
March 21, 2008
The Immature Pseudo Sciences of Manamatics and Accountics
Let's face, for purposes of tenure and promotion and prestige in top business
schools the only kind of research that counts are "testable
knowledge-based claims." Accounting and business professors are wasting their
time trying to do research on tough real-world problems that can't be modeled
and tested! This is a a sign of the immaturity of academic business research.
Of course over in the science and humanities divisions, where creativity is
given more credence and researchers are encouraged to attack the most difficult
problems imaginable, top researchers can publish normative reasoning and
creative thinking, even poetic thinking, about problems not yet amenable to
testable hypotheses.
When the great scientists enter the land of testable hypotheses they often
discover that the poets have paved the roads. It's like the army mopping up
after the marines landed beforehand.
Manamatics (a play on "accountics") and the journal called The Academy
of Management Review
While the public clamors for the return of managerial
leadership in ethics and social responsibility, surprisingly little research on
the subject exists, and what does get published doesn't appear in the top
journals. The reasons are varied, but perhaps more than anything it's that those
journals are exclusively empirical: Take The Academy of Management Review, the
only top journal devoted to management theory.
Its mission statement says it publishes only "testable
knowledge-based claims." Unfortunately, that
excludes most of what counts as ethics, which is primarily a conceptual, a
priori discipline akin to law and philosophy. We wouldn't require, for example,
that theses on the nature of justice or logic be empirically testable, although
we still consider them "knowledge based." Julian Friedland, "Where Business Meets Philosophy: the Matter of Ethics,"
Chronicle of Higher Education, November 8, 2009 ---
http://chronicle.com/article/Where-Business-Meets/49053/
It remains to be seen if many business professors
will achieve tenure by doing ethics properly speaking. Most of what now gets
published in top business journals under the rubric of "ethics" is limited
to empirical studies of the success of various policies presumed as ethical
("the effects of management consistency on employee loyalty and efficiency,"
perhaps). Although valuable, such research does precious little to hone the
mission of business itself.
While the public clamors for the return of
managerial leadership in ethics and social responsibility, surprisingly
little research on the subject exists, and what does get published doesn't
appear in the top journals. The reasons are varied, but perhaps more than
anything it's that those journals are exclusively empirical: Take The
Academy of Management Review, the only top journal devoted to management
theory. Its mission statement says it publishes only "testable
knowledge-based claims." Unfortunately, that excludes most of what counts as
ethics, which is primarily a conceptual, a priori discipline akin to law and
philosophy. We wouldn't require, for example, that theses on the nature of
justice or logic be empirically testable, although we still consider them
"knowledge based."
The major business journals have a responsibility
to open the ivory-tower gates to a priori arguments on the ethical nature
and mission of business. After all, the top business schools, which are a
model for the rest, are naturally interested in hiring academics who publish
in the top journals. One solution is for at least one or two of the top
journals to rewrite their mission statements to expressly include articles
applying ethical theory to business. They could start by creating special
ethics sections in the same way that some have already created
critical-essay sections. Another solution is for academics to do more
reading and referencing of existing business-ethics journals. Through more
references in the wider literature, those journals can rise to the top.
Until such changes occur, business ethics will largely remain a second-class
area of research, primarily concerned with teaching.
Meanwhile, although I seem to notice more
tenure-track positions in business ethics appearing every year—a step in the
right direction—many required business-ethics courses are taught by relative
outsiders. They are usually non-tenure-track hires from the private sector
or, like me, from various other academic disciplines, such as psychology,
law, and philosophy. In my years as a philosopher in business schools, I've
often held a place at once exalted and reviled. It's provocative and
alluring. But it can also be about as fitting as a pony in a pack of wolves.
During my three years at a previous college I became accepted—even a valued
colleague of many. But deans sometimes treated me with the kind of suspicion
normally suited to a double agent behind enemy lines.
For a business-ethics curriculum to succeed, it
must be at least somewhat philosophical. And that is difficult to establish
in the university context, in which departments are loath to give up turf.
Not surprisingly, few business Ph.D. programs offer any real training in
ethical theory. Naturally, dissertations in applied ethics are generally
written in philosophy departments, and those addressing business are rare,
since few philosophers are schooled in business practices. Business schools
should begin collaborating with centers for applied ethics, which seem to be
cropping up almost everywhere in philosophy departments. Conversely,
philosophers in applied ethics should reach out to business and law
professors interested in ethics. With that kind of academic infrastructure,
real prog ress can be made.
Perhaps then fewer business students will view
their major mainly as a means to gainful employment, and might instead see
it as a force of social progress. Colleges like mine, which root their
students in ethics and liberal arts, are training them to think for
themselves. Business schools that fail to do so are clinging to the past.
Continued in article
Julian Friedland is an assistant professor of business ethics at
Eastern Connecticut State University and editor of "Doing Well and Good: The
Human Face of the New Capitalism" (Information Age Publishing, 2009).
Jensen Comment
What makes matters worse is that the pseudo science of manamatics, like the
pseudo science of accounics, only rarely does not accept one published study as
truth without requiring replication and verification.
Let's face it, unlike chemists, manamatics and accountics researchers just
never, ever make mistakes in their research ---
http://faculty.trinity.edu/rjensen/theory01.htm#Replication
Jagdish, Bob, et al.
Relevant to this thread is an article by Jon Elster. Titled "Excessive
Ambitions" it was recently published in Capitalism and Society, Vol. 4,
Issue 2, 2009 Article 1. In it he takes the whole social science enterprise
to task. A quote from page 9 gives a sense of what he is on about: "My claim
is that much work in economics and political science is devoid of empirical,
aesthetic or mathematical interest, which means that it has no value at all
(emphasis in original).
I cannot make any quantitative assessment of the
proportion of work in leading journals that fall in this category. I am
firmly convinced, however, that the proportion is non-negligible and
important enough to constitute something of a scandal. I also believe, more
tentatively, that the proportion may be higher in the leading journals than
in the non-leading ones."
The issue is not just replication (accounting is so
derivative we would merely be replicating other disciplines' experiments),
but whether the original experiments are at all meaningful.
"Lab Experiments Are a Major Source of Knowledge in the Social Sciences,"
by Armin Falk and James J. Heckman, IZA Discussion Paper No. 4540, October 2009
---
http://ftp.iza.org/dp4540.pdf
Laboratory experiments
are a widely used methodology for advancing causal knowledge in the physical and
life sciences. With the exception of psychology, the adoption of laboratory
experiments has been much slower in the social sciences, although during the
last two decades, the use of lab experiments has accelerated. Nonetheless, there
remains considerable resistance among social scientists who argue that lab
experiments lack “realism” and “generalizability”. In this article we discuss
the advantages and limitations of laboratory social science experiments by
comparing them to research based on nonexperimental data and to field
experiments. We argue that many recent objections against lab experiments are
misguided and that even more lab experiments should be conducted.
Jensen Comment
It disappointed me that Falk and Heckman did not really discuss the issue of
replication and verifiability while claiming that "lab experiments are a major
source of knowledge in the social sciences." The might've given more examples
where studies were independently replicated, and there are such studies ---
especially lab experiments in psychology.
They do mention in passing that lab experiments might support or run counter
to empirical studies, but here again it would've helped to provide some
examples. I did a bit of searching and found one example that they might've used
for such purposes ---
http://www.jsecjournal.com/JSEC_Mesoudi_1-2.pdf
I suspect there are hundreds of similar examples.
The trade-offs between lab experiments versus field studies are discussed in
the following paper:
"Internal and External Validity in Economics Research: Tradeoffs between
Experiments, Field Experiments, Natural Experiments and Field Data," by Brian E.
Roe and David R. Just, 2009
Proceedings Issue, American Journal of Agricultural Economics ---
http://aede.osu.edu/people/roe.30/Roe_Just_AJAE09.pdf
Abstract: In the realm of
empirical research, investigators are first and foremost concerned with the
validity of their results, but validity is a multi-dimensional ideal. In this
article we discuss two key dimensions of validity – internal and external
validity – and underscore the natural tension that arises in choosing a research
approach to maximize both types of validity. We propose that the most common
approaches to empirical research – the use of naturally-occurring field/market
data and the use of laboratory experiments – fall on the ends of a spectrum of
research approaches, and that the interior of this spectrum includes
intermediary approaches such as field experiments and natural experiments.
Furthermore, we argue that choosing between lab experiments and field data
usually requires a tradeoff between the pursuit of internal and external
validity. Movements toward the interior of the spectrum can often ease the
tension between internal and external validity but are also accompanied by other
important limitations, such as less control over subject matter or topic areas
and a reduced ability for others to replicate research. Finally, we highlight
recent attempts to modify and mix research approaches in a way that eases the
natural conflict between internal and external validity and discuss if employing
multiple methods leads to economies of scope in research costs.
Lab experiments, but not field studies, are quite popular in some of the
leading accounting research journals and are most commonly conducted on student
volunteers. The problem is the behavioral lab experiments findings are
apparently not important enough to verify and replicate, although the hypotheses
may have been generated from anecdotal observations in the real world or even,
on occasion, by related empirical studies.
I've always contended that more experiments might be replicated if journal
editors encouraged replications by adopting policies of sending replication
submissions out for review with at least a chance of publication for studies
that corroborate findings as well as negate findings. The fact that behavioral
experiments published in TAR, JAR, and JAE are virtually never replicated sends
out signals that the findings are either too obvious or too unimportant or too
superficial to be of interest in and of themselves.
Unlike some leading social science journals, the leading accounting journals
tend not to publish case and field research studies even if these sometimes
indirectly support the lab experimental outcomes.
Interestingly, in his reply to Paul Williams, Steve
backs up my assertion above
“Yes, I have biases, as I
freely acknowledge. I like research that puts the method before the message,
meaning that if the conclusion comes first, as in much of what I perceive under
the “critical perspectives” banner, I view that to be advocacy for a cause, not
research.”
What I think is sad that accountics researchers not only place their tractors ahead of
their harvests, they have no interest in independently authenticating
(replicating) reports of their harvests (a few of which are about as honest as a Madoff financial report) ---
http://faculty.trinity.edu/rjensen/theory01.htm#Replication
Accountics researchers will, in my eyes, always be
pseudo scientists until their research findings are independently verified
against error and fraud.
By the way, I admire Paul William’s philosophic and
historical scholarship greatly, but in this exchange he personalized his
arguments too much with respect to his own submissions to TAR. And he rambles on
this to distraction. We’ve nearly all have had positive and negative TAR
referees and editors. I once had TAR flatly reject a paper (in 2007) in which
one referee refused to even put his remarks in writing. When the paper was
published in the Accounting Historians Journal it even won a monetary prize. But
I don’t blame the editor of TAR, because editors are beholding to their
often-biased referees, and my paper indeed centered on criticisms of TAR over
the past four decades ---
http://faculty.trinity.edu/rjensen/395wpTAR/Web/TAR395wp.htm
The above submission to TAR was not something I ever expected TAR to publish,
but at least I tried. My co-author up front thought we were just wasting time by
submitting it to TAR. He was correct --- the referee comments that were put into
writing were virtually worthless.
My point is that an accept/reject decision on any
particular submission is too anecdotal to be of much use. Paul’s complaint of a
six-month lag in the decision process also does not disturb me. I once had a
paper acceptance decision delayed (not by TAR) for over three years. When the
editor at last published the paper it was embarrassingly obsolete. The AHJ
referees, however, were in some ways tougher but highly constructive toward
improving the paper.
I was also disappointed in that Steve has taken it upon
himself to stop inviting and/or publishing commentaries in TAR. It seems to me
that this is a return to TAR at its acccountics worst.
And yes I do think it is the prerogative of a journal
editor to inject personal biases into decisions regarding invited and randomly
submitted papers/commentaries. Steve Zeff certainly had some biases when he was
editor of TAR. Anthony Hopwood is suspectingly biased regarding AOS. Who would
not accuse Tony Tinker of bias in Critical Perspectives? I wish Steve
would inject more bias into TAR by inviting commentaries that are likely to
reflect his own biases.
I’m not afraid of your biases Steve. But I’m
disappointed that you have not taken any initiative to encourage replication in
accountics research findings.
I do give you, Steve, credit for responding in such
detail to Paul’s letter. I can’t think of a single TAR editor since Steve Zeff
who I think would’ve have taken the time and trouble to answer Paul’s personal
remarks with such a personalized and heartfelt reply.
In science there’s
little doubt about what happens when one team is unable to replicate the
original team’s findings (sometimes with different methods). For example, I
doubt whether Eric Lie’s empirical findings on options backdating would’ve had
much impact if so much anecdotal evidence commenced to verify Lie’s findings,
especially the mounting court cases.
What happens in
science when one team is unable to replicate the original work it inspires a
raft of other teams to attempt replications. Eventually the truth emerges --- I
don’t think that scientists leave many unanswered questions about the original
harvest.
I was responsible for an afternoon workshop and enjoyed the privilege to sit
in on the tail end of the morning workshop on journal editing conducted by Linda
and Mike Bamber. (At the time Linda was Editor of The Accounting Review).
I have great respect for both Linda and Mike, and my criticism here applies
to the editorial policies of the American Accounting Association and other
publishers of top accounting research journals. In no way am I criticizing Linda
and Mike for the huge volunteer effort that both of them are giving to The
Accounting Review (TAR).
Mike’s presentation focused upon a recent publication in TAR based upon a
behavioral survey of 25 auditors. Mike greatly praised the research and the
article’s write up. My question afterwards was whether TAR would accept an
identical replication study that confirmed the outcomes published original TAR
publication. The answer was absolutely NO! One subsequent TAR editor even told me it would be confusing of the
replication contradicted the original study.
Now think of the absurdity of the above policy on publishing replications.
Scientists would shake their heads and snicker at accounting research. No
scientific experiment is considered worthy until it has been independently
replicated multiple times. Science professors thus have an advantage over
accounting professors in playing the “journal hits” game for promotion and
tenure, because their top journals will publish replications. Scientists are
constantly seeking truth and challenging whether it’s really the truth.
Thus I come to my main point that is far beyond the co-authorship issue that
stimulated this message. My main point is that in academic accounting research
publishing, we are more concerned with the cleverness of the research than in
the “truth” of the findings themselves.
Have I become too much of a cynic in my old age? Except in a limited number
of capital markets events studies, have accounting researchers published
replications due to genuine interest by the public in whether the earlier
findings hold true? Or do we hold the findings as self-evident on the basis of
one published study with as few as 25 test subjects? Or is there any interest in
the findings themselves to the general public apart from interest in the methods
and techniques of interest to researchers themselves?
This is replication effort eventually failed: In Accounting We Need More of
This
Purdue University is investigating “extremely serious” concerns about the
research of Rusi Taleyarkhan, a professor of nuclear engineering who has
published articles saying that he had produced nuclear fusion in a tabletop
experiment,
The New York Timesreported. While the research was published in Science in 2002, the
findings have faced increasing skepticism because other scientists have been
unable to replicate them. Taleyarkhan did not respond to inquiries from The
Times about the investigation. Inside Higher Ed, March 08, 2006 ---
http://www.insidehighered.com/index.php/news/2006/03/08/qt
The New York Times March 9 report is at
http://www.nytimes.com/2006/03/08/science/08fusion.html?_r=1&oref=slogin
The Now-Dubious Hawthorne Effect and the Need for Research Replication
(something that's virtually non-existent in accounting research)
Since empirical accounting research studies are almost never replicated, I've
long contended that "accountics" farmers are more interested in their tractors
than their harvests. Accounting research is almost all form rather than
substance.
Sometimes experimental outcomes impounded for years in textbooks become
viewed as "laws" by students, professors, and consultants. One example, is the
Hawthorne Effect impounded into psychology and management textbooks for the for
more than 50 years ---
http://en.wikipedia.org/wiki/Hawthorne_Effect
But Steven Levitt and John List, two economists at
the University of Chicago, discovered that the data had survived the decades in
two archives in Milwaukee and Boston, and decided to subject them to econometric
analysis. The Hawthorne experiments had another surprise in store for them.
Contrary to the descriptions in the literature, they found no systematic
evidence that levels of productivity in the factory rose whenever changes in
lighting were implemented.
"Light work," The Economist, June 4, 2009, Page 74 ---
http://www.economist.com/finance/displaystory.cfm?story_id=13788427
One problem is that if old experiments are not periodically verified in terms
of new analysis of old data or replications using new data, they become urban
legends in the literature.
A scientist in any serious scientific discipline,
such as genetics, would be in serious trouble if his fellow scientists were
unable to confirm or replicate his claim to have found the gene for fatness. He
would gain a reputation as being 'unreliable' and universities would be
reluctant to employ him. This self-imposed insistence on rigorous methodology is
however missing from contemporary epidemiology; indeed the most striking feature
is the insouciance with which epidemiologists announce their findings, as if
they do not expect anybody to take them seriously. It would, after all, be a
very serious matter if drinking alcohol really did cause breast cancer. James Le Fanu ---
http://www.open2.net/truthwillout/human_genome/article/genome_fanu.htm
Bob Jensen's threads on replication are at
http://faculty.trinity.edu/rjensen//theory/00overview/theory01.htm#Replication
If you're going to attack empirical accounting research, hit it where it
has no defenses!
One type of accounting research is "Spade Research" and our leading
Sam Spade in recent decades was Abe Briloff when he was at Baruch College in
NYC. Abe and his students diligently poured over accounting reports and
dug up where companies and/or their auditors violated accounting standards,
rules, and professional ethics. He was not at all popular in the accounting
profession because he was so good at his work. Zeff and Granof wrote as
follows:
Floyd Norris, the chief financial
correspondent of The New York Times, titled a 2006 speech to the
American Accounting Association "Where Is the Next Abe Briloff?" Abe
Briloff is a rare academic accountant. He has devoted his career to
examining the financial statements of publicly traded companies and
censuring firms that he believes have engaged in abusive accounting
practices. Most of his work has been published in Barron's and in
several books — almost none in academic journals. An accounting gadfly
in the mold of Ralph Nader, he has criticized existing accounting
practices in a way that has not only embarrassed the miscreants but has
caused the rule-making authorities to issue new and more-rigorous
standards. As Norris correctly suggested in his talk, if the academic
community had produced more Abe Briloffs, there would have been fewer
corporate accounting meltdowns.
"Research on Accounting Should Learn From the
Past," by Michael H. Granof and Stephen A. Zeff, Chronicle of Higher
Education, March 21, 2008
In the 1960s and 1970s leading academic accounting researchers
abandoned "Spade" work and loosely organized what might be termed an
Accounting Center for Disease Control where spading was replaced with mining
of databases using increasingly-sophisticated accountics (mathematical)
models. Leading academic accounting research journals virtually stopped
publishing anything but accountics research ---
http://faculty.trinity.edu/rjensen/395wpTAR/Web/TAR395wp.htm
In the past five decades readers of leading academic accounting
research journals had to accept on faith that there were no math errors in
the analysis. The reason is that no empirical accounting research is
ever exactly replicated and verified. In fact the leading academic
accounting research journals adopted policies against publishing
replications or even commentaries. The Accounting Review (TAR) does
technically allow commentaries, but in reality only about one appears each
decade.
Many of the empirical research studies are rooted in privately
collected databases that are never verified for accuracy and freedom from
bias.
On occasion empirical studies are partly verified with anecdotal
evidence. For example the excellent empirical study of Eric Lie in
Management Science on backdating of options was partly verified by court
decisions, fines, and prison sentences of some backdating executives.
However, anecdotal evidence has severe limitations since it can be cherry
picked to either validate or repudiate empirical findings at the same time.
See
http://en.wikipedia.org/wiki/Options_backdating
Replication is part and parcel to the scientific method. All
important findings in the natural sciences are replicated our verified by
some rigorous approach that convinces scientists about accuracy and freedom
from bias.
One of my most popular quotations is that "empirical
accounting farmers are more interested in their tractors than in their
harvests." When papers are presented at meetings most of the
focus is on the horsepower and driving capabilities of the tractors
(mathematical models). If the harvests were of importance to the accounting
profession, the profession would insist on replication and verification. But
the accounting profession mostly shrugs off academic accounting research as
sophisticated efforts to prove the obvious. There are few surprises in
empirical accounting research.
Another sad part about our leading academic accounting research
journals is that they have such a poor citation record relative to our
academic brethren in finance, marketing, and management. American
Accounting Association President Judy Rayburn made citation outdomes the
centerpiece of her emotional (and failed) attempt to get leading academic
accounting research journals to accept research paradigms other than
accountics paradigms ---
http://faculty.trinity.edu/rjensen/395wpTAR/Web/TAR.htm
But the saddest part of all is that the Accounting Center for Disease
Control literally took over every doctoral program in the United States
(slightly excepting Central Florida University) by requiring that all
accounting doctoral graduates be econometricians or psychometricians. As
a result doctoral programs realistically require five years beyond the
masters degree. Accountants who enter these programs must spend years
learning mathematics, statistics, econometrics, and psychometrics.
Mathematicians who enter these programs must spend years learning
accounting. The bottom line is that practicing accountants who would like to
become accounting professors are turned off by having to study five years of
accountics. Each year the shortage of graduates from accounting doctoral
programs in North America becomes increasingly critical/
The American Accounting Association (AAA) has a new research report on
the future supply and demand for accounting faculty. There's a whole lot
of depressing colored graphics and white-knuckle handwringing about
anticipated shortages of new doctoral graduates and faculty aging, but
there's no solution offered ---
http://aaahq.org/temp/phd/AccountingFacultyUSCollegesUniv.pdf
Since empirical accounting research studies are almost never replicated, I've
long contended that "accountics" farmers are more interested in their tractors
than their harvests. Accounting research is almost all form rather than
substance.
June 11, 2009 reply from David Fordham, James Madison University
[fordhadr@JMU.EDU]
Bob (et al):
As my generation would have said: "right on".
One of my many vices is an interest in several
fields besides accounting. About a quarter of a century ago, I remember two
physicists at UofU (Stanley Pons and Martin Fleischmann, if memory serves)
who published a report about cold fusion (which technically, if you read
their paper, wasn't real fusion to start with, but alas the popular press
took their usual liberty with the facts to sell stories).
F&P's experiments were replicated out the wazoo,
and interestingly enough, their results were reproduced on an intermittent
basis: sometimes the results came up, and sometimes they didn't, using the
same experimental design over and over. To this day, those who duplicated
the results believe in their findings, while those who didn't pooh-pooh the
idea.
Because the majority of attempts didn't reproduce
the results, interest in the experiment seems to have waned, lending
credence to the idea that science is something of a democracy (complete with
lobbying, wasteful spending, campaigning, shameless lying to drum up votes,
and massive corruption) after all. If too many people vote against you,
you're toast.
But back to replications: The disappointing thing
about F&P is, no one seems to be pursuing the question of WHY the
replications produced varying results. To my mind, the question of why
replications sometimes worked and sometimes didn't was an important question
worth pursuing, but (sigh) the vagaries of the "marketplace for research",
influenced so unseemly by the vitriolic criticism of the self-proclaimed
pundits of the day on the quiet majority, seem to have let the
really-important question just fade away into the abyss of oblivion.
And I believe this is one of the maladies affecting
accounting research (assuming one buys into the position that accounting
research is beset by maladies): We seem to have lost interest in pursuing
the really important questions -- ones that might end up making a difference
-- by listening to the pundits who seem to hold undue influence over the
silent majority.
David Fordham (who never really left the abyss to
start with...)
JMU
But sadly, the academic profession shows a strong
tendency to create stable and self-sustaining but completely false legends of
its own, and hang on to them grimly, transmitting them from article to article
and from textbook to textbook like software viruses spreading between students'
Macintoshes . . . But the lack of little things like verisimilitude and
substantiation are not enough to stop a myth. Martin tracks the great Eskimo
vocabulary hoax through successively more careless repetitions and embroiderings
in a number of popular books on language. Roger Brown's Words and Things (1958,
234-36), attributing the example to Whorf, provides an early example of careless
popularization and perversion of the issue. His numbers disagree with both Boas
and Whorf (he says there are "three Eskimo words for snow", apparently getting
this from figure 10 in Whorf's paper; perhaps he only looked at the pictures).'
Linguistics Hoax: Pullum-Eskimo Vocabulary Hoax, 1991 ---
http://www.cs.trinity.edu/~rjensen/temp/Pullum-Eskimo-VocabHoax.pdf
Forwarded by Jagdish Gangolly
> > > I'm disturbed by the tone of this
discussion, implying that most of > accounting research/publication is
just a big game.
I think it is fair to say that some members of this
group view accounting research as a game, and a rigged one at that. Other
members of this group do not share that view. Keeping these different
perspectives in mind is helpful when trying to make sense of the discussion.
Richard
June 17, 2009 reply from Bob Jensen
Hi Richard,
I think you're correct Richard, but until academic accountics researchers
and their leading journals begin to take replication more seriously, it's
very hard to believe in non-replicated harvests of accountics research.
Those that are truly serious about accounting research must become more
serious about authenticating accounting research.
Perhaps it would seem less of a game if independent researchers took the
trouble to replicate findings. On occasion there are some replications (such
as the verification of Eric Lie's stock options backdating research), but
publication of replications is indeed rare.
> I'm disturbed by the tone of this discussion,
implying that most of > accounting research/publication is just a big
game. It seems to demean our
> efforts in a Pogo-like way (we are being our own worst enemy if we
don't
> respect our own work). Does some game-playing occur? Undoubtedly. Is
it
> the norm? I don't think so (though it's always possible that I'm naive
and
> out-of-touch)
A Pogo-like way is healthy because Pogo was
thoughtful enough to face some realities. I have done considerable work on
the structure of the US academy (as has Bob) and the way Bob characterizes
it is closer to the truth -- when work deserves to be disparaged,
intellectual honesty compels us to disparage it. At an AAA meeting a number
of years ago I listened to an editor of one of our most prominent US
accounting journals offer the following alternative hypothesis to the one
that the academy was structured to advance accounting knowledge: "We have
constructed a game to identify who the cleverest people are so we know who
to give the money to."
The research on the structure of our academy, if
viewed with an open, Pogo-like mind suggests that this alternative
hypothesis is more credible than one of being honestly engaged in
understanding (if that were the case our research would not be almost
entirely structured as tests of conventional economic theories that are
constructed not be testable).
I have served numerous times on our university's
promotion and tenure committee. I chaired it this past year. I have reviewed
the dossiers of people from many disciplines. In the process I have learned
quite a bit about the cultures of other disciplines. The discussion about
multiple authors, which is the rule in the hard sciences (sometimes there
are literally dozens of them), is an interesting contrast. Those disciplines
have developed protocols on the order of author listing (it isn't
alphabetical) that reflects the relative contributions of the authors to the
project.
I've seen people denied tenure because they were
not the "lead" author on enough papers. It is a system that is
self-reinforcing. Is it abused? Sure, what one isn't, but it seems to work
reasonably well. Accounting has no such protocol. At my shop we have reached
the point where the same credit is given to a person on a three-author paper
as is given to a person with a single authored paper. Without the protocol
that exists in the natural sciences on credit for multiple authors, there is
little other way to describe our process as other than a game.
Another protocol in the laboratory or bench
sciences is the maintenance of a lab journal. You can always spot a lab
scientist at our faculty senate meetings because they are the people taking
notes in a bound journal (a diary). Because replication is crucial to
science, there is a moral imperative that an experimental scientist keep a
precise record of each step in the experimental process. He or she must
provide the exact recipe so that any scientist is able to produce the
result. (One of the most interesting studies of the sociology of science
involved the lab journals of Millikin reporting his various iterations of
the oil-drop experiment; guess which ones he published -- you guessed it --
the ones most consistent with his prior beliefs.
Without those lab journals, this knowledge would be
lost forever). Most of the work published in our leading accounting journals
is laboratory work (accountics, as Bob describes it). Data are gathered
(usually selected from a publicly available data source) and all manner of
choices are made by the experimenter in conducting the experiment before the
final published result is obtained. For example, do we know what truncation
decisions were made or how many different models were run before the
published one arose? But we have no requirement that the experimenter keep a
detailed log of all of these choices. We have to rely on the recipe given in
the article itself, which is seldom sufficient to replicate what was
actually done.
When Bill Cooper suggested that the AAA require
authors publishing in TAR to provide their data (not their logs, because
they don't have them) to the public, our noted accounting scientists
screamed bloody murder. We still have only a voluntary disclosure policy. If
we were truly serious about learning something from our work, we would
mandate that sufficient information be provided to allow anyone to replicate
the experiments before we publishe the results. That we don't do that may
say something about us.
For the interested: Adil E. Shamoo and David B.
Resnik, Responsible Conduct of Research, 2003, Oxford University
Press. I took a course in this taught by one of NC State's philosophers.
There is a huge literature on appropriate research conduct in the sciences
(social and natural). In accounting there is practically none. For a
discipline whose alleged expertise is "controls" we have virtually none over
the research process. Guess we are all saints.
Thanks for an excellent post. For those interested,
the Shamoo and Resnik text you mention is now into its second edition
Adil E. Shamoo and David B. Resnik, Responsible
Conduct of Research # Paperback: 440 pages # Publisher: Oxford University
Press; Second Edition edition (Feb 24 2009) # Language: English # ISBN-10:
019536824X # ISBN-13: 978-0195368246
To be clear about what I think (as if anybody
cares), I think that a substantial amount of game playing takes place, but
accounting research itself does not need to be characterized as a game. I
believe that (1) there are many incentives to manipulate the system for
personal gain, (2) many accounting professors participate in the system and
play games because they are forced to participate and game playing seems to
be efficient and effective, and (3) there are enough ethically challenged
amongst the accounting professoriate to justify a general world view of
skepticism.
Dave Albrecht
June 20, 2009 reply from Bob Jensen
Hi David,
I wish I could repeat some private messages I'm
receiving from accounting professors about (ratting?) how some of their
colleagues are gaming the research/publishing system.
Most mention a 99-1 model or its near-equivalent.
Others mention the 98-1-1 model. The worst is a message revealing a
94-1-1-1-1-1-1-model.
Of course I believe many, probably most, joint
authoring efforts are legitimate for reasons astutely mentioned by Ron
Huefner. But there also is a lot a gaming going on.
Paul Williams notes that at every juncture empirical
accounting researchers make subjective decisions that make it almost
impossible to truly replicate outcomes. In a private message he notes that a
top researcher (who chaired a lot of doctoral dissertations) made an
on-campus presentation in which he admitted to 16 times in his research
study being presented where he made decisions that would've made it
virtually impossible to independently replicate his work. The source of the
data was a commercial database that can be purchased by anybody, but it
alone would not have been sufficient for research outcomes authentication.
It would seem that if the top research journals
announced a change in policy and invited submissions of research
replications there might be few submissions that actually authenticate
earlier published outcomes. Until accounting
researchers commence keeping "lab journal" (and making them available to
teams of authentication researchers) I doubt that there will be serious
replication of empirical academic accounting research. Until then we must,
in the words of Paul Williams, regard our empirical accounting researchers
as "saints."
What's more disheartening are
reports of failed efforts to replicate the empirical results of some of the
AAA's Seminal and/or Notable contributions award winners. The makes me
wonder if another type of gaming (selectively massaging of data) is going on
at the highest level of prestige in academic accounting research.
Seeking Alpha Question
Wouldn't all empirical researchers like smaller samples?
Then a coauthor on another paper told me that she'd
found an error she made in her coding. In this case, when she found and
corrected her error, it quadrupled our sample size. If you're an empiricist, you
know how much an increase from about 90 observations to about 400 means. If not,
let's just say it's a big deal to the alpha nerds among us (and that description
applies to most of my friends). Financial Rounds Blog, August 7, 2009 ---
http://financialrounds.blogspot.com/
Jensen Comment
I often use another blog called Seeking Alpha (
http://seekingalpha.com/
). I never thought much about the title of that blog. Now whenever I see the
name "Seeking Alpha" I'm going to think of the irony of sample sizes of 90
versus 400 and the games played by empirical researchers.
Of course in accounting Alpha tests of Type 1 error are less important
because findings will not be replicated in any case, which says a whole lot
about the importance of the findings in the first place. Oops! You must be tired
of my sermonizing on replications by now (see below).
It's a research fact: Natural blondes are becoming extinct!
Suppose this study had actually been reported a leading accounting research
journal such as The Accounting Review.
Keep in mind that leading accounting research journals do not publish
replication studies.
As a result few accounting researchers conduct replication studies since they
cannot be published.
The logical deduction becomes that accountants would forever think that natural
blondes are going extinct.
From the WSJ Opinion Journal on March 6,
2006
"Media outlets around the world, from CBS, ABC and CNN to the British
tabloids" all fell for a hoax--a fake study from the World Health
Organization claiming blondes are going extinct.
"The decline and fall of the blonde is most
likely being caused by bottle blondes, who researchers believe are more
attractive to men than true blondes," said CBS "Early Show" co-host
Gretchen Carlson.
"There's a study from the World Health
Organization--this is for real--that says that blondes are an endangered
species," Charlie Gibson said on "Good Morning America," prompting Diane
Sawyer to say she's "going the way of the snail darter." . . .
"We've certainly never conducted any research
into the subject," WHO spokeswoman Rebecca Harding said yesterday from
Geneva. "It's been impossible to find out where it came from. It just
seems like it was a hoax."
The health group traced the story to an account
Thursday on a German wire service, which in turn was based on a
two-year-old article in the German women's magazine Allegra, which cited
a WHO anthropologist. Harding could find no record of such a man working
for the WHO.
Hey, if you're a journalist, we've got a great human-interest story for
you: Did you hear about the blonde who invented the solar flashlight? ---
http://www.zelo.com/blonde/no_brains.asp
Now you see how ridiculous the accounting journal
policy of not publishing replications becomes. Hopefully this published story in
a leading U.S. newspaper (I mean The Washington Post that broke the
Watergate scandal) the next time you read the findings in a leading accounting
research journal.
Question
What research methodology flaws are shared by studies in political science and
accounting science?
"Methodological Confusion: How indictments of
The Israel Lobby (by John J. Mearsheimer, Stephen M. Walt, ISBN-13:
9780374177720) expose political science's flaws" by Daniel W. Drezner, Chronicle
of Higher Education's Chronicle Review, February 22, 2008, Page B5 ---
http://chronicle.com/weekly/v54/i24/24b00501.htm
Does the public understand how political science
works? Or are political scientists the ones who need re-educating? Those
questions have been running through my mind in light of the drubbing that
John J. Mearsheimer and Stephen M. Walt received in the American news media
for their 2007 book, The Israel Lobby and U.S. Foreign Policy
(Farrar, Straus and Giroux, 2007). Pick your periodical — The Economist,
Foreign Affairs, The Nation, National Review, The New Republic, The New York
Times Book Review, The Washington Post Book World — and you'll find a
reviewer trashing the book.
From a political-science perspective, what's
interesting about those reviews is that they are largely grounded in
methodological critiques — which rarely break into the public sphere.
What's disturbing is that the methodologies used in The Israel Lobby and
U.S. Foreign Policy are hardly unique to Mearsheimer and Walt. Are the
indictments of their book overblown, or do they expose the methodological
flaws of the discipline in general?
The most persistent public criticism of Mearsheimer
and Walt has been their failure to empirically buttress their argument with
interviews. Writing in the Times Book Review, Leslie H. Gelb,
president emeritus of the Council on Foreign Relations, criticized their
"writing on this sensitive topic without doing extensive interviews with the
lobbyists and the lobbied." David Brooks, a columnist for The New York
Times, recently seconded that notion: "If you try to write about
politics without interviewing policy makers, you'll wind up spewing all
sorts of nonsense."
That kind of critique has a long pedigree. For
decades public officials and commentators have decried the failure of social
scientists to engage more deeply with the objects of their studies.
Secretary of State Dean Acheson once objected to being treated as a
"dependent variable." The New Republic ran a cover story in 1999 with the
subhead, "When Did Political Science Forget About Politics?"
To the general reader, such critiques must sound
damning. International-relations scholars know full well, however, that
innumerable peer-reviewed articles and university-press books utilize the
same kind of empirical sources that appear in The Israel Lobby. Most
case studies in international relations rely on news-conference transcripts,
official documents, newspaper reportage, think-tank analyses, other
scholarly works, etc. It is not that political scientists never interview
policy makers — they do (and Mearsheimer and Walt aver that they have as
well). However, with a few splendid exceptions, interviews are not the bread
and butter of most international-relations scholarship. (This kind of
fieldwork is much more common in comparative politics.)
Indeed, the claim that political scientists can't
write about policy without talking to policy makers borders on the absurd.
The first rule about policy makers is that they always have agendas — even
in interviews with social scientists. That does not mean that those with
power lie. It does mean that they may not be completely candid in outlining
motives and constraints. One would expect that to be particularly true about
such "a sensitive topic."
Further, most empirical work in political science
is concerned with actions, not words. How much aid has the United States
disbursed to Israel? How did members of Congress vote on the issue? Without
talking to members of Congress, thousands of Congressional scholars study
how the legislative branch acts, by analyzing verifiable actions or words —
votes, speeches, committee hearings, and testimony. Statistical approaches
allow political scientists to test hypotheses through regression analysis.
By Brooks's criteria, any political analysis of, say, 19th-century policy
decisions would be pointless, since all the relevant players are dead.
Other methodological critiques are more difficult
to dismiss. Walter Russell Mead's dissection of The Israel Lobby in Foreign
Affairs does not pull any punches. Mead, a senior fellow at the Council on
Foreign Relations, wrote that Mearsheimer and Walt "claim the clarity and
authority of rigorous logic, but their methods are loose and rhetorical.
This singularly unhappy marriage — between the pretensions of serious
political analysis and the standards of the casual op-ed — both undercuts
the case they wish to make and gives much of the book a disagreeably
disingenuous tone."
Mead enumerates several methodological sins, in
particular the imprecise manner in which the "Israel Lobby" is defined in
the book. For their part, the book's authors acknowledge that the term is
"somewhat misleading," conceding that "the boundaries of the Israel Lobby
cannot be identified precisely." It is certainly true that many of the
central concepts in international-relations theory — like "power" or
"regime" — have disputed definitions. But most political scientists deal
with nebulous concepts by explicitly offering their own definition to guide
their research. Even if others disagree, at least the definition is
transparent. In The Israel Lobby, however, Mearsheimer and Walt essentially
rely on a Potter Stewart definition of the lobby: They know it when they see
it. That makes it exceedingly difficult for other political scientists to
test or falsify their hypotheses.
Many of the reviews of the book highlight two flaws
that, disturbingly, are more pervasive in academic political science. The
first is the failure to compare the case in question to other cases. For
example, Mearsheimer and Walt Go to great lengths to outline the
"extraordinary material aid and diplomatic support" the United States
provides to Israel. What they do not do, however, is systematically compare
Israel to similarly situated countries to determine if the U.S.-Israeli
relationship really is unique. An alternative, strategic explanation would
posit that Israel falls into a small set of countries: longstanding allies
bordering one or multiple enduring rivals. The category of states that meet
that criteria throughout the time period analyzed by Mearsheimer and Walt is
relatively small: Pakistan, South Korea, Taiwan, and Turkey. Compared to
that smaller set of countries, the U.S. relationship with Israel does not
look anomalous. The United States has demonstrated a willingness to expend
blood, treasure, or diplomatic capital to ensure the security of all of
those countries — despite the wide variance in the strength of each's
"lobby."
Continued in article
Daniel W. Drezner is an associate professor of international politics
at the Fletcher School at Tufts University.
Jensen Comment
When I read the above review entitled "Metholological Confusiion" I kept
thinking of the thousands of empirical and analytical studies by accounting
faculty and students that have similar methodology confusions. How many
mathematical/empirical database studies relating accounting events (e.g., a new
standard) with capital market behavior also conduct formal interviews with
investors, analysts, fund managers, etc. Do analytical researchers conduct
formal interviews with real-world decision makers before building their
mathematical models? The majority of behavioral accounting studies conducted by
professors use students as surrogates for real-world decision makers. This
methodology is notoriously flawed and could be helped if the researchers had
also interviewed real-world players.
And Drezner overlooked another common flaw shared by both political science
and
accountics research. If the findings are as important as claimed by
authors, why aren't other researchers frantically trying to replicate the
results? The lack
of replication in accounting science (accountics research) is scandalous
---
http://faculty.trinity.edu/rjensen/Theory01.htm#Replication
Formal and well-crafted interviews with important players (investors, standard
setters, CEOs, etc.) constitute possible ways of replicating empirical and
analytical findings.
The closest things we have to in-depth contact with real world players in
accounting research is research conducted by the standard setters themselves
such as the FASB, the IASB, the GASB, etc. Sometimes these are interviews,
although more often then not they are comment letters. But accountics
researchers wave off such research as anecdotal and seldom even quote the public
archives of such interviews and comments. Surveys are frequently published but
these tend to be relegated to less prestigious academic research journals and
practitioner journals.
Most importantly of all in accountics is that the leading accounting research
journals for tenure, promotion, and performance evaluation in academe are
devoted to accountics paper. Normative methods, case studies, and interviews are
rarely used in studies published in such journals. The following is a quotation
from “An Analysis of the Evolution of Research Contributions by The Accounting
Review (TAR): 1926-2005,” by Jean L. Heck and Robert E. Jensen, Accounting
Historians Journal, Volume 34, No. 2, December 2007, Page 121.
Leading accounting
professors lamented TAR’s preference for rigor over relevancy [Zeff,
1978; Lee, 1997; and Williams, 1985 and 2003]. Sundem [1987] provides
revealing information about the changed perceptions of authors, almost
entirely from academe, who submitted manuscripts for review between June
1982 and May 1986. Among the 1,148 submissions,
only 39 used archival
(history) methods; 34 of those submissions were rejected.
Another 34
submissions used survey methods; 33 of those were rejected.
And 100 submissions
used traditional normative (deductive) methods with 85 of those being
rejected. Except for
a small set of 28 manuscripts classified as using “other” methods
(mainly descriptive empirical according to Sundem), the remaining larger
subset of submitted manuscripts used methods that Sundem [1987, p. 199]
classified these as follows:
292 General Empirical
172 Behavioral
135 Analytical modeling
119 Capital Market
97 Economic modeling
40 Statistical modeling
29 Simulation
It is clear that by
1982, accounting researchers realized that having mathematical or
statistical analysis in TAR submissions made accountics virtually a
necessary, albeit not sufficient, condition for acceptance for
publication. It became increasingly difficult for a single editor to
have expertise in all of the above methods. In the late 1960s, editorial
decisions on publication shifted from the TAR editor alone to the TAR
editor in conjunction with specialized referees and eventually associate
editors [Flesher, 1991, p. 167]. Fleming et al. [2000, p. 45] wrote the
following:
The big change was in
research methods. Modeling and empirical methods became prominent during
1966-1985, with analytical modeling and general empirical methods
leading the way. Although used to a surprising extent, deductive-type
methods declined in popularity, especially in the second half of the
1966-1985 period.
I think the emphasis highlighted in red above demonstrates
that "Methodological Confusion" reigns supreme in accounting science as well as
political science.
A couple of years ago, P. Kothari, one of the
Editors of JAE and a full professor at MIT, visited the U. of Maryland to
present a paper. In my private discussion with him, I asked him to identify
what he considered to the settled findings associated with the last 30
years of capital markets research in accounting. I pointed out that
somewhere over half of all accounting research since Ball and Brown fit into
this category and I was curious as to what the effort had added to Ball and
Brown. That is, what conclusions have been drawn that could be considered
settled ground so that researchers could move on to other topics. His
response, and I quote, was "I understand your point, Jim." He could not
identify one issue that researchers had been able to "put to bed" after all
that effort.
P. Kothari's response is to be expected. I have had
similar responses from at least two ex-editors of TAR; how appropriate a TLA!
But who wants to bell the cats (or call off the naked emperors' bluff)?
Accounting academia knows which side of the bread is buttered.
That you needed to flaunt Kothari's resume to
legitimise his vacuous response shows the pathetic state of accounting
academia.
If accounting academia is not to be reduced to the
laughing stock of accounting practice, we better start listening to the
problems that practice faces. How else can we understand what we profess to
"research"? We accounting academics have been circling our wagons too long
as a ploy to keep our wages arbitrarily high.
In as much as we are a profession, any academic on
such a committee reduces the whole exercise to a farce.
As David Bartholomae observes, “We make a huge
mistake if we don’t try to articulate more publicly what it is we value in
intellectual work. We do this routinely for our students — so it should not be
difficult to find the language we need to speak to parents and legislators.” If
we do not try to find that public language but argue instead that we are not
accountable to those parents and legislators, we will only confirm what our
cynical detractors say about us, that our real aim is to keep the secrets of our
intellectual club to ourselves. By asking us to spell out those secrets and
measuring our success in opening them to all, outcomes assessment helps make
democratic education a reality. Gerald Graff, "Assessment Changes
Everything," Inside Higher Ed, February 21, 2008 ---
http://www.insidehighered.com/views/2008/02/21/graff
Gerald Graff is professor of English at the University of Illinois at Chicago
and president of the Modern Language Association. This essay is adapted from a
paper he delivered in December at the MLA annual meeting, a version of which
appears on the MLA’s Web site and is reproduced here with the association’s
permission. Among Graff’s books are Professing Literature, Beyond the
Culture Wars and Clueless in Academe: How School Obscures the Life of the Mind.
The consensus report, which was approved by the
group’s international board of directors, asserts that it is vital when
accrediting institutions to assess the “impact” of faculty members’ research on
actual practices in the business world.
Ask anyone with an M.B.A.: Business school provides
an ideal environment to network, learn management principles and gain access
to jobs. Professors there use a mix of scholarly expertise and business
experience to teach theory and practice, while students prepare for the life
of industry: A simple formula that serves the school, the students and the
corporations that recruit them.
Yet like
any other academic enterprise, business schools expect their
faculty to produce peer-reviewed research. The relevance,
purpose and merit of that research has been debated almost
since the institutions started appearing, and now a new
report promises to add to the discussion — and possibly stir
more debate. The Association to Advance Collegiate Schools
of Business on Thursday released the final report of its
Impact of Research Task Force, the
result of feedback from almost 1,000 deans, directors and
professors to a preliminary draft circulated in August.
The consensus
report, which was approved by the group’s international
board of directors, asserts that it is vital when
accrediting institutions to assess the “impact” of faculty
members’ research on actual practices in the business world.
But it does not settle on concrete metrics for impact,
leaving that discussion to a future implementation task
force, and emphasizes that a “one size fits all” approach
will not work in measuring the value of scholars’ work.
The report
does offer suggestions for potential measures of impact. For
a researcher studying how to improve manufacturing
practices, impact could be measured by counting the number
of firms adopting the new approach. For a professor who
writes a book about finance for a popular audience, one
measure could be the number of copies sold or the quality of
reviews in newspapers and magazines.
“In the
past, there was a tendency I think to look at the
[traditional academic] model as kind of the desired
situation for all business schools, and what we’re saying
here in this report is that there is not a one-size-fits-all
model in this business; you should have impact and
expectations dependent on the mission of the business school
and the university,” said Richard Cosier, the dean of the
Krannert School of Management at Purdue University and vice
chair and chair-elect of AACSB’s board. “It’s a pretty
radical position, if you know this business we’re in.”
That
position worried some respondents to the initial draft, who
feared an undue emphasis on immediate, visible impact of
research on business practices — essentially, clear
utilitarian value — over basic research. The final report
takes pains to alleviate those concerns, reassuring deans
and scholars that it wasn’t minimizing the contributions of
theoretical work or requiring that all professors at a
particular school demonstrate “impact” for the institution
to be accredited.
“Many
readers, for instance, inferred that the Task Force believes
that ALL intellectual contributions must be relevant to and
impact practice to be valued. The position of the Task Force
is that intellectual contributions in the form of basic
theoretical research can and have been extremely valuable
even if not intended to directly impact practice,” the
report states.
“It also is
important to clarify that the recommendations would not
require every faculty member to demonstrate impact from
research in order to be academically qualified for AACSB
accreditation review. While Recommendation #1 suggests that
AACSB examine a school’s portfolio of intellectual
contributions based on impact measures, it does not specify
minimum requirements for the maintenance of individual
academic qualification. In fact, the Task Force reminds us
that to demonstrate faculty currency, the current standards
allow for a breadth of other scholarly activities, many of
which may not result in intellectual contributions.”
Cosier, who
was on the task force that produced the report, noted that
business schools with different missions might require
differing definitions of impact. For example, a traditional
Ph.D.-granting institution would focus on peer-reviewed
research in academic journals that explores theoretical
questions and management concepts. An undergraduate
institution more geared toward classroom teaching, on the
other hand, might be better served by a definition of impact
that evaluated research on pedagogical concerns and learning
methods, he suggested.
A further
concern, he added, is that there simply aren’t enough
Ph.D.-trained junior faculty coming down the pipeline, let
alone resources to support them, to justify a single
research-oriented model across the board. “Theoretically,
I’d say there’s probably not a limit” to the amount of
academic business research that could be produced, “but
practically there is a limit,” Cosier said.
But
some critics have worried that the
report could encourage a focus on the immediate impact of
research at the expense of theoretical work that could
potentially have an unexpected payoff in the future.
Historically, as the report notes, business scholarship was
viewed as inferior to that in other fields, but it has
gained esteem among colleagues over the past 50 or so years.
In that context, the AACSB has pursued a concerted effort to
define and promote the role of research in business schools.
The report’s concrete recommendations also include an awards
program for “high-impact” research and the promotion of
links between faculty members and managers who put some of
their research to use in practice.
The
recommendations still have a ways to go before they become
policy, however. An implementation task force is planned to
look at how to turn the report into a set of workable
policies, with some especially worried about how the
“impact” measures would be codified. The idea, Cosier said,
was to pilot some of the ideas in limited contexts before
rolling them out on a wider basis.
Jensen Comment
It will almost be a joke to watch leading accountics researchers trying of show
how their esoteric findings have impacted the practice world when the professors
themselves cannot to point to any independent replications of their own work ---
http://faculty.trinity.edu/rjensen/Theory01.htm#Replication
Is the practice world so naive as to rely upon findings of scientific research
that has not been replicated?
I’d surprised to see much reaction from
“accountics” researchers as they are pretty secure, especially since the
report takes pains not to antagonize them. Anyway, in the words of Corporal
Klinger of the 4077th MASH Unit, “It takes a lot of manure to produce one
perfect rose.”
> On one hand there is
no respect for accounting research in B-schools. On the other
> hand, publishing
accounting research in peer-reviewed pubs is a requirement for AQ
> status in B-schools.
>
> More and more I am
attracted to Ernest Boyer's description of multiple forms of
> scholarships and
multiple outlets of scholarship.
Re: this conversation.
Ian Shapiro, professor of
Political Science at Yale, has recently published a book "The Flight
from Reality in the Human Sciences" (Princeton U. Press, 2005) that
assures that the problem is not confined to accounting (though it is
more ludicrous a place for a discipline that is actually a practice).
All of the social sciences have succumbed to rational decision theory
and methodological purity to the point that academe now largely deals
with understanding human behavior only within a mathematically tractible
unreality made real in the academy essentially because of its
mathematical tractibility. Jagdish recent post is insightful (and
inciteful to the winners of this game in our academy). The problem the
US academy has defined for itself is not solvable. Optimal information
systems? Information useful for decision making (without any
consideration of the intervening "motives" (potentially infinite in
number) that convert assessments into actions)?
As Bob has so frequently
reminded us replication is the lifeblood of science, yet we never
replicate. But we couldn't replicate if we wanted to because
replication is not the point. Anyone with a passing familiarity with
laboratory sciences knows that a fundamental ethic of those sciences is
the laboratory journal. The purpose of the journal is to provide the
precise recipe of the experiments so that other scientists can
replicate. All research in accounting (that is published in the "top"
journals, at least) is "laboratory research." But do capital market or
principal/agent researchers maintain a log that decribes in minute
detail the innumerable decisions that they made along the way in
assembling and manipulating their data (as chemists and biologists are
bound to do by virtue of the research ethics of their disciplines) ?
No way. From any published article, it is nearly impossible to actually
replicate one of their experiments because the article is never
sufficient documentation. But, of course, that isn't the point.
Producing politically correct academic reputations is what our
enterprise is about. Ideology trumps science every time. We don't want
to know the "truth." Sadly, this suits the profession just fine. (It's
this dream world that permits such nonsensical statements like trading
off relevance for reliability -- how can I know how relevant a datum is
unless I know something about its reliability? Isn't the whole idea of
science to increase the relevance of data by increasing their
reliability?)
A Fraudulent Paper Published in Nature, a Prestigious Science
Journal
Another Case for Better Replication in Research Reporting
"'Grape harvest dates are poor indicators of summer warmth', as well as about
scientific publication generally," by Douglas J. Keenan, Informath,
November 3, 2006 ---
http://www.informath.org/apprise/a3200.htm
That is, the authors had developed a method that
gave a falsely-high estimate of temperature in 2003 and falsely-low
estimates of temperatures in other very warm years. They then used those
false estimates to proclaim that 2003 was tremendously warmer than other
years.
The above is easy enough to understand. It does not
even require any specialist scientific training. So how could the peer
reviewers of the paper not have seen it? (Peer reviewers are the scientists
who check a paper prior to its publication.) I asked Dr. Chuine what data
was sent to Nature, when the paper was submitted to the journal. Dr. Chuine
replied, “We never sent data to Nature”.
I have since published a short note that details
the above problem (reference below). There are several other problems with
the paper of Chuine et al. as well. I have written a brief survey of those
(for people with an undergraduate-level background in science). As described
in that survey, problems would be obvious to anyone with an appropriate
scientific background, even without the data. In other words, the peer
reviewers could not have had appropriate background.
What is important here is not the truth or falsity
of the assertion of Chuine et al. about Burgundy temperatures. Rather, what
is important is that a paper on what is arguably the world's most important
scientific topic (global warming) was published in the world's most
prestigious scientific journal with essentially no checking of the work
prior to publication.
Moreover—and crucially—this lack of checking is not
the result of some fluke failures in the publication process. Rather, it is
common for researchers to submit papers without supporting data, and it is
frequent that peer reviewers do not have the requisite mathematical or
statistical skills needed to check the work (medical sciences largely
excepted). In other words, the publication of the work of Chuine et al. was
due to systemic problems in the scientific publication process.
The systemic nature of the problems indicates that
there might be many other scientific papers that, like the paper of Chuine
et al., were inappropriately published. Indeed, that is true and I could
list numerous examples. The only thing really unusual about the paper of
Chuine et al. is that the main problem with it is understandable for people
without specialist scientific training. Actually, that is why I decided to
publish about it. In many cases of incorrect research the authors will try
to hide behind an obfuscating smokescreen of complexity and sophistry. That
is not very feasible for Chuine et al. (though the authors did try).
Finally, it is worth noting that Chuine et al. had
the data; so they must have known that their conclusions were unfounded. In
other words, there is prima facie evidence of scientific fraud. What will
happen to the researchers as a result of this? Probably nothing. That is
another systemic problem with the scientific publication process.
This is replication doing its job Purdue University is investigating “extremely
serious” concerns about the research of Rusi Taleyarkhan, a professor of
nuclear engineering who has published articles saying that he had produced
nuclear fusion in a tabletop experiment,
The New York Timesreported. While the research
was published in Science in 2002, the findings have faced increasing
skepticism because other scientists have been unable to replicate them.
Taleyarkhan did not respond to inquiries from The Times about the
investigation. Inside Higher Ed, March 08, 2006 ---
http://www.insidehighered.com/index.php/news/2006/03/08/qt
The New York Times March 9 report is at
http://www.nytimes.com/2006/03/08/science/08fusion.html?_r=1&oref=slogin
Question
What is an "out of sample" test?
Hint: It's related to the concept of "replication" that almost seems to be
unheard of in academic accounting research?
I am a big fan of so called "out of sample" tests.
When researchers find some anomaly within a data set and then others test
for the presence in the same data set, we really do not learn much if they
find the same thing. But when a new data set is used for the test, we have a
much better understanding of the possible anomaly.
In the current
JFQA
there is just such an article by
Richard Grossman and Stephen Shore. Using a data
set that goes from 1870 to 1913 for British stocks, the authors find no
small firm effect, and only a limited value effect.
In their own words:
"Unlike modern CRSP data, stocks that do not pay
dividends do not outperform stocks that pay small dividends during this
period. But like modern CRSP data, there is a weak relationship between
dividend yield and performance for stocks that pay dividends. In sum,
the size and reversal anomalies present in modern data are not present
in our historical data, while there is some evidence for a value
anomaly."
Which makes me wonder how many other things we think
we "know" we really don't.
The current version of the paper is not listed on SSRN, but a past version
of the paper is available (at least right now)
here.
Faculty interest in a
professor’s “academic” research may be greater for a number of reasons.
Academic research fits into a methodology that other professors like to
hear about and critique. Since academic accounting and finance journals
are methodology driven, there is potential benefit from being inspired
to conduct a follow up study using the same or similar methods. In
contrast, practitioners are more apt to look at relevant (big) problems
for which there are no research methods accepted by the top journals.
Accounting
Research Farmers Are More Interested in Their Tractors Than in Their
Harvests
For a long time I’ve argued
that top accounting research journals are just not interested in the
relevance of their findings (except in the areas of tax and AIS). If the
journals were primarily interested in the findings themselves, they
would abandon their policies about not publishing replications of
published research findings. If accounting researchers were more
interested in relevance, they would conduct more replication studies. In
countless instances in our top accounting research journals, the
findings themselves just aren’t interesting enough to replicate. This is
something that I attacked at
http://faculty.trinity.edu/rjensen/book02q4.htm#Replication
At one point back in the 1980s
there was a chance for accounting programs that were becoming “Schools
of Accountancy” to become more like law schools and to have their elite
professors become more closely aligned with the legal profession. Law
schools and top law journals are less concerned about science than they
are about case methodology driven by the practice of law. But the elite
professors of accounting who already had vested interest in scientific
methodology (e.g., positivism) and analytical modeling beat down case
methodology. I once heard Bob Kaplan say to an audience that no elite
accounting research journal would publish his case research. Science
methodologies work great in the natural sciences. They are problematic
in the psychology and sociology. They are even more problematic in the
professions of accounting, law, journalism/communications, and political
“science.”
We often criticize
practitioners for ignoring academic research Maybe they are just being
smart. I chuckle when I see our heroes in the mathematical theories of
economics and finance winning prizes for knocking down theories that
were granted earlier prizes (including Nobel prices). The Beta model was
the basis for thousands of academic studies, and now the Beta model is a
fallen icon. Fama got prizes for showing that capital markets were
efficient and then more prizes for showing they were not so “efficient.”
In the meantime, investment bankers, stock traders, and mutual funds
were just ripping off investors. For a long time, elite accounting
researchers could find no “empirical evidence” of widespread earnings
management. All they had to do was look up from the computers where
their heads were buried.
Few, if any, of the elite
“academic” researchers were investigating the dire corruption of the
markets themselves that rendered many of the published empirical
findings useless.
Academic researchers worship at
the feet of Penman and do not even recognize the name of Frank Partnoy
or Jim Copeland.
Bob Jensen
Question
In science it is somewhat common for published papers to subsequently be
withdrawn because the outcomes could not be replicated.
In the history of
accounting research has any published paper ever been "withdrawn" or “retracted”
because the results could not be replicated?
A Columbia University researcher has reportedly
retracted four more scientific papers because the findings could not be
replicated.
Chemistry Professor Dalibor Sames earlier this year
retracted two other papers and part of a third published in a scientific
journal, The New York Times reported Thursday. All of the papers involved
carbon-hydrogen bond activation research.
Although Sames is listed as senior author on all of
the papers, one of his former graduate students -- Bengu Sezen -- performed
most of the experiments, the Times said.
Sames said each experiment has been repeated by at
least two independent scientists who have not been able to replicate the
results.
Sezen, a doctoral student in another field at the
University of Heidelberg in Germany, disputed the retractions, questioning
whether other members of Sames's group had tried to exactly repeat her
experiments, the newspaper said.
The retraction of one paper, published in the
journal Organic Letters in 2003, appeared Thursday, while the three others
published in The Journal of the American Chemical Society in 2002 and 2003
are to be formally retracted later this month, the Times said.
Jensen Comment
What's disappointing and inconsistent is that leading universities pushed
accounting research into positivist scientific methods but did not require that
findings be verified by independent replication. In fact leading academic
accounting research journals discourage replication by their absurd policies of
not publishing replications of published research outcomes. They also do not
publish commentaries that challenge underlying assumptions of purely analytical
research. Hence I like to say that academic accounting
researchers became more interested in their tractors than their harvests.
I have not heard of any one in accounting
retracting his/her work. It does not surprise me because of what I see to be
the philosophical suppositions of most empirical accounting researchers.
In my opinion, most of us in empirical accounting
research are, in many ways, stuck with the philosophical suppositions of
late 19th and early 20th century positivists of the Vienna school, the most
vocal proponent of the ideas whose work I am familiar with is A.J. Ayer. In
his view of the world, a synthetic (that is, not an analytical) sentence
must be verifiABLE to be considered a scientific statement, and is added to
the stock of science when verified.
The physical sciences have passed by this view, and
in fact, in my opinion, regard the latter-day positivist Popperian ideas of
falsificationism to be the ideal. Here, a sentence is scientific if it is
FalsifIABLE. The stock of sentences that are not repeatedly falsified is
science in some sense. Therefore, in most physical sciences, when a
statement is falsified (by not being replicable) is treated as nonsense
rather than science. For example, when theory about cold fusion in the
Utah experiments met failure in repeated attempts to replicate them, theory was treated as nonsensical and not scientific.
The unfortunate thing is that verification (or
falsification) is misinterpreted by most, since I don't think either Ayer or
Popper intended their views to form a theory of meaning.
The above approach has had a whole host of severe
critics. My shortlist would include C.S. Peirce, William James, Quine
(though a verificationist he did not accept logical positivism), Feyerabend,
Davidson, and a bunch of others.
We have twisted the meaning of Popperian as well as
Logical positivist thought to consider "scientific propositions" as those "veriFIED"
or "not falsiFIED". Philosopher of those schools, on the other hand used
veriFIABILITY and falsiFIABILITY as criterion to answer the question whether
a proposition is scientific or not. We mistake an epistemic community for a
theory of meaning. While it might help reaffirm our belief in our epistemic
community to do so, it certainly would not provide our community a resilient
philosophical foundation. It also would make us more of a theological
community.
It’s common for many at research universities to
say that just because they value scholarly production doesn’t mean they
don’t care about teaching. But a new study of political science departments
at doctoral institutions -- published in the journal PS -- suggests that
there may be a tradeoff.
The study examined 122 departments at universities
that grant doctorates in political science to see which institutions offer a
course for doctoral students on how to become good teachers. It turns out
that only a minority of departments (41) do so -- even though the American
Political Science Association and others have urged graduate programs to
recognize that the odds favor their students finding jobs at institutions
that place at least as much value on teaching as on research. Of the 41
programs with courses, 28 are required and the rest are optional.
The analysis then tried to determine which programs
were most likely to offer these courses. The size of the department and the
size of the universities -- both of which could be thought to measure the
resources available for courses -- were found not to be factors.
But there was an inverse relationship between
research productivity in departments and the odds of offering such a course.
The relationship, while significant, had notable exceptions in the survey
among public but not among private institutions. Some of the public
institutions with strong research records -- such as Ohio State University,
the University of California at Berkeley and the University of Wisconsin at
Madison -- do have such courses. But as a general rule, highly ranked
private university departments do not.
Over all, public institutions were seven times more
likely than private institutions to offer such courses, the study found,
citing as a possible explanation “the public service component of state
institutions or the fact that public institutions are consistently faced
with state-mandated programs to enhance teaching generally.”
The study notes that there are innovations that go
beyond just having a single course on teaching techniques. For example,
Baylor University, in its relatively young doctoral program in political
science, has placed an emphasis on the idea that it is training future
college teachers with a “teaching apprentice” program. In this program, grad
students are assigned to work with senior professors teaching an
undergraduate course -- not by becoming teaching assistants, but by
analyzing the course. The grad students prepare an annotated syllabus --
different from the syllabus used -- to explore various teaching issues.
During the fourth year of the program, the grad
students are “instructors of record” for a course, but then in their fifth
year they shift to a focus on finishing dissertations. The study suggests
that this approach provides in-depth exposure to teaching issues.
The paper on these issues was written by a professor (John Ishiyama)
and two doctoral students (Tom Miles and Christine Balarezo) at the
University of North Texas.
Question
What research methodology flaws are shared by studies in political science and
accounting science?
"Methodological Confusion: How indictments of
The Israel Lobby (by John J. Mearsheimer, Stephen M. Walt, ISBN-13:
9780374177720) expose political science's flaws" by Daniel W. Drezner, Chronicle
of Higher Education's Chronicle Review, February 22, 2008, Page B5 ---
http://chronicle.com/weekly/v54/i24/24b00501.htm
Does the public understand how political science
works? Or are political scientists the ones who need re-educating? Those
questions have been running through my mind in light of the drubbing that
John J. Mearsheimer and Stephen M. Walt received in the American news media
for their 2007 book, The Israel Lobby and U.S. Foreign Policy
(Farrar, Straus and Giroux, 2007). Pick your periodical — The Economist,
Foreign Affairs, The Nation, National Review, The New Republic, The New York
Times Book Review, The Washington Post Book World — and you'll find a
reviewer trashing the book.
From a political-science perspective, what's
interesting about those reviews is that they are largely grounded in
methodological critiques — which rarely break into the public sphere.
What's disturbing is that the methodologies used in The Israel Lobby and
U.S. Foreign Policy are hardly unique to Mearsheimer and Walt. Are the
indictments of their book overblown, or do they expose the methodological
flaws of the discipline in general?
The most persistent public criticism of Mearsheimer
and Walt has been their failure to empirically buttress their argument with
interviews. Writing in the Times Book Review, Leslie H. Gelb,
president emeritus of the Council on Foreign Relations, criticized their
"writing on this sensitive topic without doing extensive interviews with the
lobbyists and the lobbied." David Brooks, a columnist for The New York
Times, recently seconded that notion: "If you try to write about
politics without interviewing policy makers, you'll wind up spewing all
sorts of nonsense."
That kind of critique has a long pedigree. For
decades public officials and commentators have decried the failure of social
scientists to engage more deeply with the objects of their studies.
Secretary of State Dean Acheson once objected to being treated as a
"dependent variable." The New Republic ran a cover story in 1999 with the
subhead, "When Did Political Science Forget About Politics?"
To the general reader, such critiques must sound
damning. International-relations scholars know full well, however, that
innumerable peer-reviewed articles and university-press books utilize the
same kind of empirical sources that appear in The Israel Lobby. Most
case studies in international relations rely on news-conference transcripts,
official documents, newspaper reportage, think-tank analyses, other
scholarly works, etc. It is not that political scientists never interview
policy makers — they do (and Mearsheimer and Walt aver that they have as
well). However, with a few splendid exceptions, interviews are not the bread
and butter of most international-relations scholarship. (This kind of
fieldwork is much more common in comparative politics.)
Indeed, the claim that political scientists can't
write about policy without talking to policy makers borders on the absurd.
The first rule about policy makers is that they always have agendas — even
in interviews with social scientists. That does not mean that those with
power lie. It does mean that they may not be completely candid in outlining
motives and constraints. One would expect that to be particularly true about
such "a sensitive topic."
Further, most empirical work in political science
is concerned with actions, not words. How much aid has the United States
disbursed to Israel? How did members of Congress vote on the issue? Without
talking to members of Congress, thousands of Congressional scholars study
how the legislative branch acts, by analyzing verifiable actions or words —
votes, speeches, committee hearings, and testimony. Statistical approaches
allow political scientists to test hypotheses through regression analysis.
By Brooks's criteria, any political analysis of, say, 19th-century policy
decisions would be pointless, since all the relevant players are dead.
Other methodological critiques are more difficult
to dismiss. Walter Russell Mead's dissection of The Israel Lobby in Foreign
Affairs does not pull any punches. Mead, a senior fellow at the Council on
Foreign Relations, wrote that Mearsheimer and Walt "claim the clarity and
authority of rigorous logic, but their methods are loose and rhetorical.
This singularly unhappy marriage — between the pretensions of serious
political analysis and the standards of the casual op-ed — both undercuts
the case they wish to make and gives much of the book a disagreeably
disingenuous tone."
Mead enumerates several methodological sins, in
particular the imprecise manner in which the "Israel Lobby" is defined in
the book. For their part, the book's authors acknowledge that the term is
"somewhat misleading," conceding that "the boundaries of the Israel Lobby
cannot be identified precisely." It is certainly true that many of the
central concepts in international-relations theory — like "power" or
"regime" — have disputed definitions. But most political scientists deal
with nebulous concepts by explicitly offering their own definition to guide
their research. Even if others disagree, at least the definition is
transparent. In The Israel Lobby, however, Mearsheimer and Walt essentially
rely on a Potter Stewart definition of the lobby: They know it when they see
it. That makes it exceedingly difficult for other political scientists to
test or falsify their hypotheses.
Many of the reviews of the book highlight two flaws
that, disturbingly, are more pervasive in academic political science. The
first is the failure to compare the case in question to other cases. For
example, Mearsheimer and Walt Go to great lengths to outline the
"extraordinary material aid and diplomatic support" the United States
provides to Israel. What they do not do, however, is systematically compare
Israel to similarly situated countries to determine if the U.S.-Israeli
relationship really is unique. An alternative, strategic explanation would
posit that Israel falls into a small set of countries: longstanding allies
bordering one or multiple enduring rivals. The category of states that meet
that criteria throughout the time period analyzed by Mearsheimer and Walt is
relatively small: Pakistan, South Korea, Taiwan, and Turkey. Compared to
that smaller set of countries, the U.S. relationship with Israel does not
look anomalous. The United States has demonstrated a willingness to expend
blood, treasure, or diplomatic capital to ensure the security of all of
those countries — despite the wide variance in the strength of each's
"lobby."
Continued in article
Daniel W. Drezner is an associate professor of international politics
at the Fletcher School at Tufts University.
Jensen Comment
When I read the above review entitled "Metholological Confusion" I kept
thinking of the thousands of empirical and analytical studies by accounting
faculty and students that have similar methodology confusions. How many
mathematical/empirical database studies relating accounting events (e.g., a new
standard) with capital market behavior also conduct formal interviews with
investors, analysts, fund managers, etc. Do analytical researchers conduct
formal interviews with real-world decision makers before building their
mathematical models? The majority of behavioral accounting studies conducted by
professors use students as surrogates for real-world decision makers. This
methodology is notoriously flawed and could be helped if the researchers had
also interviewed real-world players.
And Drezner overlooked another common flaw shared by both political science
and
accountics research. If the findings are as important as claimed by
authors, why aren't other researchers frantically trying to replicate the
results? The lack
of replication in accounting science (accountics research) is scandalous
---
http://faculty.trinity.edu/rjensen/Theory01.htm#Replication
Formal and well-crafted interviews with important players (investors, standard
setters, CEOs, etc.) constitute possible ways of replicating empirical and
analytical findings.
The closest things we have to in-depth contact with real world players in
accounting research is research conducted by the standard setters themselves
such as the FASB, the IASB, the GASB, etc. Sometimes these are interviews,
although more often then not they are comment letters. But accountics
researchers wave off such research as anecdotal and seldom even quote the public
archives of such interviews and comments. Surveys are frequently published but
these tend to be relegated to less prestigious academic research journals and
practitioner journals.
Most importantly of all in accountics is that the leading accounting research
journals for tenure, promotion, and performance evaluation in academe are
devoted to accountics paper. Normative methods, case studies, and interviews are
rarely used in studies published in such journals. The following is a quotation
from “An Analysis of the Evolution of Research Contributions by The Accounting
Review (TAR): 1926-2005,” by Jean L. Heck and Robert E. Jensen, Accounting
Historians Journal, Volume 34, No. 2, December 2007, Page 121.
Leading accounting
professors lamented TAR’s preference for rigor over relevancy [Zeff,
1978; Lee, 1997; and Williams, 1985 and 2003]. Sundem [1987] provides
revealing information about the changed perceptions of authors, almost
entirely from academe, who submitted manuscripts for review between June
1982 and May 1986. Among the 1,148 submissions,
only 39 used archival
(history) methods; 34 of those submissions were rejected.
Another 34
submissions used survey methods; 33 of those were rejected.
And 100 submissions
used traditional normative (deductive) methods with 85 of those being
rejected. Except for
a small set of 28 manuscripts classified as using “other” methods
(mainly descriptive empirical according to Sundem), the remaining larger
subset of submitted manuscripts used methods that Sundem [1987, p. 199]
classified these as follows:
292 General Empirical
172 Behavioral
135 Analytical modeling
119 Capital Market
97 Economic modeling
40 Statistical modeling
29 Simulation
It is clear that by
1982, accounting researchers realized that having mathematical or
statistical analysis in TAR submissions made accountics virtually a
necessary, albeit not sufficient, condition for acceptance for
publication. It became increasingly difficult for a single editor to
have expertise in all of the above methods. In the late 1960s, editorial
decisions on publication shifted from the TAR editor alone to the TAR
editor in conjunction with specialized referees and eventually associate
editors [Flesher, 1991, p. 167]. Fleming et al. [2000, p. 45] wrote the
following:
The big change was in
research methods. Modeling and empirical methods became prominent during
1966-1985, with analytical modeling and general empirical methods
leading the way. Although used to a surprising extent, deductive-type
methods declined in popularity, especially in the second half of the
1966-1985 period.
I think the emphasis highlighted in red above demonstrates
that "Methodological Confusion" reigns supreme in accounting science as well as
political science.
A couple of years ago, P. Kothari, one of the
Editors of JAE and a full professor at MIT, visited the U. of Maryland to
present a paper. In my private discussion with him, I asked him to identify
what he considered to the settled findings associated with the last 30
years of capital markets research in accounting. I pointed out that
somewhere over half of all accounting research since Ball and Brown fit into
this category and I was curious as to what the effort had added to Ball and
Brown. That is, what conclusions have been drawn that could be considered
settled ground so that researchers could move on to other topics. His
response, and I quote, was "I understand your point, Jim." He could not
identify one issue that researchers had been able to "put to bed" after all
that effort.
P. Kothari's response is to be expected. I have had
similar responses from at least two ex-editors of TAR; how appropriate a TLA!
But who wants to bell the cats (or call off the naked emperors' bluff)?
Accounting academia knows which side of the bread is buttered.
That you needed to flaunt Kothari's resume to
legitimise his vacuous response shows the pathetic state of accounting
academia.
If accounting academia is not to be reduced to the
laughing stock of accounting practice, we better start listening to the
problems that practice faces. How else can we understand what we profess to
"research"? We accounting academics have been circling our wagons too long
as a ploy to keep our wages arbitrarily high.
In as much as we are a profession, any academic on
such a committee reduces the whole exercise to a farce.
Bob Jensen wrote:
The troubles with multiple regression and discriminant analysis models
are those nagging assumptions of linearity, predictor variable
independence, homoscedasticity, and independence of error terms. If we
move up to non-linear models, the assumption of robustness is a giant
leap in faith. And superimposed on all of this is the assumption of
stationarity needed to have any confidence in extrapolations from past
experience.
In the end, if gaming is allowed in the future as
it has been allowed by bankers and their auditors for decades, putting
accountics into the standards is not the answer.
Sophisticated accountics is just perfume sprayed on
the manure pile.
Amy Dunbar comment/questions: Oh my, what a
metaphor. ;-)
I continue to struggle with the dismissal of
econometric analysis (accountics?) as an approach to address accounting
issues. Many disciplines use econometric analysis in research, despite the
limitations you point out. What research methods do you think are
appropriate for studying accounting issues? In my opinion, research requires
a disciplined approach that can be replicated, which you argue is crucial.
Can one replicate research using the research methods that you favor? Or
perhaps I am misunderstanding your points.
For example, consider the FIN 48 tax disclosures.
My coauthors and I have collected data from the tax footnotes of300
companies to determine how firms are handling the FIN 48 21d requirement of
forecasting the expected tax reserve change over the next 12 months. We want
to know how accurate forecasts are and if the forecast errors result because
of the inherent difficulty of providing the forecast or if firms do not want
to disclose because they do not want to provide a roadmap for taxing
authorities. We use econometric methods to test our hypotheses. How would
you address this issue? By the way, the Illinois tax conference in October
has a panel session on FIN 48 disclosures, including the forecast
requirement, which suggests others are grappling with the informativeness of
these disclosures.
I ordered the book that Paul Williams suggested:
The Flight from Reality in the Human Sciences. I hope I will have a better
understanding of your position after I read it.
Amy Dunbar
UConn
September 8, 2009 reply from Bob Jensen
Hi Amy,
If you really want to understand the problem you’re
apparently wanting to study, read about how Warren Buffett changed the whole
outlook of a great econometrics/mathematics researcher (Janet Tavkoli). I’ve
mentioned this fantastic book before ---Dear Mr. Buffett. What opened her eyes is how Warren Buffet
built his vast, vast fortune exploiting the errors of the sophisticated
mathematical model builders when valuing derivatives (especially options)
where he became the writer of enormous option contracts (hundreds of
millions of dollars per contract). Warren Buffet dared to go where
mathematical models could not or would not venture when the real world
became too complicated to model. Warren reads financial statements better
than most anybody else in the world and has a fantastic ability to retain
and process what he’s studied. It’s impossible to model his mind.
I finally grasped what
Warren was saying. Warren has such a wide body of knowledge that he does not
need to rely on “systems.” . . . Warren’s vast knowledge of corporations and
their finances helps him identify derivatives opportunities, too. He only
participates in derivatives markets when Wall Street gets it wrong and
prices derivatives (with mathematical models) incorrectly. Warren tells
everyone that he only does certain derivatives transactions when they are
mispriced.
Wall Street derivatives
traders construct trading models with no clear idea of what they are doing.
I know investment bank modelers with advanced math and science degrees who
have never read the financial statements of the corporate credits they
model. This is true of some credit derivatives traders, too. Janet Tavakoli, Dear Mr. Buffett, Page 19
The part of my message
that you quoted was in the context of a bad debt estimation message. I don’t
think multivariate models in general work well in the context of bad debt
estimation because of the restrictive assumptions of the models (except in
some industries where bad debt losses are dominated by one or two really
good predictor variables). There is an exception in the case of the Altman,
Beaver, and Ohlson bankruptcy prediction models, but predicting bankruptcy
is in a different ball park than predicting defaults among 10 million rather
small accounts receivable.
As to multivariate models
as applied in TAR, JAR, and JAE I’ve no objection since the 1970s after
referees became much better at challenging model assumptions (in the 1960s
refereeing of econometrics models in accounting literature was often a
joke). "FANTASYLAND ACCOUNTING RESEARCH: Let's Make Pretend..." by Robert E.
Jensen, The Accounting Review,
Vol. 54, January 1979, 189-196.
The problem, as I see it,
is that there’s nothing wrong with our econometrics tool bag when applied to
problems where the tools fit the problem. The econometrics models (except
for nonlinear models) are relatively robust in most papers that do get
published these days.
An Example of
Challenges of Multivariate Model Assumptions
"Is accruals quality a priced risk factor?" by John E.
Corea, Wayne R. Guaya, and Rodrigo Verdib, Journal of Accounting and
Economics ,Volume 46, Issue 1, September 2008, Pages 2-22
Abstract
In a recent and influential empirical paper, Francis, LaFond, Olsson, and
Schipper (FLOS) [2005. The market pricing of accruals quality. Journal of
Accounting and Economics 39, 295–327] conclude that accruals quality (AQ) is
a priced risk factor. We explain that FLOS’ regressions examining a
contemporaneous relation between excess returns and factor returns do not
test the hypothesis that AQ is a priced risk factor. We conduct appropriate
asset-pricing tests for determining whether a potential risk factor explains
expected returns, and find no evidence that AQ is a priced risk factor.
We need to see the above disputes become the rule
rather than the exception!
Francis, LaFond, Olsson, and Schipper vigorously disagree with criticisms of
their work such that there are some interesting disputes that on occasion
arise in accountics research. For the most part, however, published papers
like this are rarely replicated such that errors and frauds go unchallenged
in most of the thousands of accountics papers that have been published in
the past four decades ---
http://faculty.trinity.edu/rjensen/theory01.htm#Replication
The Corea, Guaya, and Verdib replication is a very,
very, very rare exception. I only wish there were more such disputes over
underlying modeling assumptions --- they should be extended to data quality
as well.
Now let me ask about your
FIN 48 tax disclosure study. Was there any independent replication to verify
that you did not make any significant data collection or modeling analysis
errors (you would be the last person in the world that I would suspect of
research fraud)? Do we accept your harvest as totally edible without a
single taste test by independent replicators?
http://faculty.trinity.edu/rjensen/theory01.htm#Replication
The Bigger Problems
Accountics models seldom
focus on the big problems of the profession, because the econometrics and
mathematical analysis tools just are not suited to our systemic accountancy
problems (such as the vegetable nutrition problem) ---
http://faculty.trinity.edu/rjensen/FraudConclusion.htm#BadNews
The editorial problem in TAR, JAR, and JAE is that they
commenced in the 1980s to ignore problems that could not be attacked with
accountics mathematics and statistical tool bags. This leaves out most
problems faced in the accounting profession since practitioners and standard
setters seldom (almost never) have copies of TAR, JAR, JAE, and even AH on
the table when they are dealing with client issues or standards issues. AH
evolved from its original charge to where articles in AH versus TAR are
virtually interchangeable. I repeat from a message yesterday:
Not everything that can be counted, counts.
And not everything that counts can be counted. Albert Einstein
For a long time, elite accounting
researchers could find no “empirical evidence” of widespread earnings
management. All they had to do was look up from the computers where their
heads were buried. Bob Jensen ---
http://faculty.trinity.edu/rjensen/395wpTAR/Web/TAR395wp.htm
“Research should be problem driven rather
than methodologically driven," said Lisa Garcia Bedolla, a member of the
task force who teaches at the University of California at Berkeley. Scott Jascik ---
http://www.insidehighered.com/news/2009/09/04/polisci
"I understand your point,
Jim." He could not identify one issue that (accountics)
researchers had been able to "put to bed" after all that effort. P. Kothari, one of the Editors of JAE and a full professor at
MIT, as quoted by Jim Peters below.
Do we forecast? You bet. Do we have
confidence in our forecasts? Never! Confidence about a non-linear chaotic
system can only come in degrees, and even those degrees of confidence are
guesses. Not all hope is lost. There are times when it seems our ability to
predict is better than others. Thus we need to take advantage of it if we
see it. Trading ranges, pivot points, support and resistance, and the like
can help, and do help the trader. Michael Covel,
Trading Black Swans, September 2009 ---
http://www.michaelcovel.com/pdfs/swan.pdf
Most importantly of all in accountics is that the leading accounting
research journals for tenure, promotion, and performance evaluation in
academe are devoted to accountics paper. Normative methods, case studies,
and interviews are rarely used in studies published in such journals. The
following is a quotation from “An Analysis of the Evolution of Research
Contributions by The Accounting Review (TAR): 1926-2005,” by Jean L. Heck
and Robert E. Jensen, Accounting Historians Journal, Volume 34, No.
2, December 2007, Page 121.
Leading accounting professors lamented
TAR’s preference for rigor over relevancy [Zeff, 1978; Lee, 1997; and
Williams, 1985 and 2003]. Sundem [1987] provides revealing information about
the changed perceptions of authors, almost entirely from academe, who
submitted manuscripts for review between June 1982 and May 1986. Among the
1,148 submissions, only 39 used
archival (history) methods; 34 of those submissions were rejected.
Another 34
submissions used survey methods; 33 of those were rejected.And 100 submissions used traditional normative
(deductive) methods with 85 of those being rejected.
Except for a small set of 28 manuscripts classified as using “other” methods
(mainly descriptive empirical according to Sundem), the remaining larger
subset of submitted manuscripts used methods that Sundem [1987, p. 199]
classified these as follows:
292 General Empirical
172 Behavioral
135 Analytical modeling
119 Capital Market
97 Economic modeling
40 Statistical
modeling
29 Simulation
It is clear that by 1982, accounting researchers realized
that having mathematical or statistical analysis in TAR submissions made
accountics virtually a necessary, albeit not sufficient, condition for
acceptance for publication. It became increasingly difficult for a single
editor to have expertise in all of the above methods. In the late 1960s,
editorial decisions on publication shifted from the TAR editor alone to the
TAR editor in conjunction with specialized referees and eventually associate
editors [Flesher, 1991, p. 167]. Fleming et al. [2000, p. 45] wrote the
following:
The big change was in research
methods. Modeling and empirical methods became prominent during 1966-1985,
with analytical modeling and general empirical methods leading the way.
Although used to a surprising extent, deductive-type methods declined in
popularity, especially in the second half of the 1966-1985 period.
I think the emphasis highlighted in red
above demonstrates that "Methodological Confusion" reigns supreme in
accounting science as well as political science.
A couple of years
ago, P. Kothari, one of the Editors of JAE and a full professor at MIT,
visited the U. of Maryland to present a paper. In my private discussion with
him, I asked him to identify what he considered to the settled findings
associated with the last 30 years of capital markets research in accounting.
I pointed out that somewhere over half of all accounting research since Ball
and Brown fit into this category and I was curious as to what the effort had
added to Ball and Brown. That is, what conclusions have been drawn that
could be considered settled ground so that researchers could move on to
other topics. His response, and I quote, was "I understand your point, Jim."
He could not identify one issue that researchers had been able to "put to
bed" after all that effort.
P. Kothari's response
is to be expected. I have had similar responses from at least two ex-editors
of TAR; how appropriate a TLA! But who wants to bell the cats (or call off
the naked emperors' bluff)? Accounting academia knows which side of the
bread is buttered.
That you needed to
flaunt Kothari's resume to legitimise his vacuous response shows the
pathetic state of accounting academia.
If accounting
academia is not to be reduced to the laughing stock of accounting practice,
we better start listening to the problems that practice faces. How else can
we understand what we profess to "research"? We accounting academics have
been circling our wagons too long as a ploy to keep our wages arbitrarily
high.
In as much as we are
a profession, any academic on such a committee reduces the whole exercise to
a farce.
Jagdish
September 10, 2009 reply from Bob Jensen
Hi again Amy,
Accountics is the mathematical science of values.
Charles Sprague [1887] as quoted by McMillan [1998, p. 1][NH1]
The history of the accountics takeover of leading academic accounting
research journals around the world as well as the takeover of accountancy
doctoral programs in the U.S. and other nations can be found at http://faculty.trinity.edu/rjensen/395wpTAR/Web/TAR395wp.htm
The more I read in the book Dear Mr. Buffet by Janet
Tavakoli, the more I see a parallel between investment bankers and
accountics researchers.
After almost 20 years working for Wall
Street firms in New York and London, I made my living running a
Chicago-based consulting business. My clients consider my expertise in
product they consume. I had written books on credit derivatives and
complex structured finance products, and financial institutions, hedge
funds, and sophisticated investors came to identify and solve potential
problems. Janet Tavokoli, Dear
Mr. Buffett (Wiley, 2009, Page 5)
Jensen Comment
Before she wrote Dear Mr. Buffett, her technical book on
Structural Finance & Collateralized Debt Obligations (Wiley) sat on
my desk for constant reference. Janet also runs her own highly
successful hedge fund. She won't disclose how big it is, but certain
clues make me think it is over $100 million with very wealthy clients.
Her professional life changed when she commenced to correspond with what
was the richest man in the world in 2008 (before he gave much of
his wealth to the Gates Charitable Foundation). He's also one of the
nicest and most transparent and most humble men in the world.
Warren Buffett ---
http://en.wikipedia.org/wiki/Warren_Buffett
Warren Buffett disproved theory of
efficient markets that states that prices reflect all known information.
His shareholder letters, readily available (free)
through Berkshire Hathaway's Web site, told
investors everything they needed to know about mortgage loan fraud,
mospriced credit derivatives, and overpriced securitizations, yet this
information hid in plain "site." Janet Tavokoli, Dear
Mr. Buffett (Wiley, 2009, Page 7)
Jensen Comment
Berkshire Hathaway ---
http://en.wikipedia.org/wiki/Berkshire_Hathaway
Jensen Comment
This of course does not mean that on occasion Warren is not fallible.
Sometimes he does not heed his own advice, and rare occasions he loses
billions. But a billion or two to Warren Buffett is pocket change.
I finally grasped what
Warren was saying. Warren has such a wide body of knowledge that he does not
need to rely on “systems.” . . . Warren’s vast knowledge of corporations and
their finances helps him identify derivatives opportunities, too. He only
participates in derivatives markets when Wall Street gets it wrong and
prices derivatives (with mathematical models) incorrectly. Warren tells
everyone that he only does certain derivatives transactions when they are
mispriced. Janet Tavokoli,
Dear Mr. Buffett (Wiley, 2009, Page 19)
Why
investment bankers are like many accoutics professors
Wall Street derivatives traders construct trading models with no clear idea
of what they are doing. I know investment bank modelers
with advanced math and science degrees
who have never read the financial statements of the corporate credits they
model. This is true of some credit derivatives traders, too. Janet Tavokoli, Dear Mr. Buffett (Wiley, 2009, Page 19) Jensen Comment
Especially note the above quotation when I refer to Reviewer A below.
Warren is aided by the fact that most
investment banks use sophisticated Monte Carlo models that misprice the
transactions. Some of the models rely on (credit) rating agency inputs,
and the rating agencies do a poor job of rating junk debt. Janet Tavokoli, Dear
Mr. Buffett (Wiley, 2009, Page 21)
Investment banks could put on the
same trades if they did fundamental analysis of the underlying
companies, but they are too busy
playing with correlation models.
Janet Tavokoli, Dear
Mr. Buffett (Wiley, 2009, Page 24)
Warren has another advantage: Wall
Street underestimates him. I mentioned that Warren Buffett and I have
similar views on credit derivatives . . . My former colleague, a Wall
Street structured products "correlation" trader, wrinkled his nose and
sniffed: "That old guy? He hates derivatives." Janet Tavokoli, Dear
Mr. Buffett (Wiley, 2009, Page 24)
Warren Buffett writes billions of dollars worth of put options When Warren sells a put buyer the right to make
him pay a specific price agreed today for the stock index (no matter
what the value 20 years from now), Warren receives a premium. Berkshire
Hathaway gets to invest that money for 20 years. Warren thinks the
buyer, the investment bank, is paying him too much . . . Furthermore,
Berkshire Hataway invests the premiums that will in all likelihood cover
anything he might need to pay out anything at all, since the stock index
is likely to be higher than today's value. Janet Tavokoli, Dear
Mr. Buffett (Wiley, 2009, Page 24)
My Four Telltale Quotations about accoutics professors
Although there are no longer any investment banks in the United States since
early 2009, how were investment bankers much like accountics researchers?
There is of course very little similarity now since investment bankers are
standing in unemployment lines and investment banks are out of business ---
http://faculty.trinity.edu/rjensen/2008Bailout.htm#InvestmentBanking
Accountics professors are still happily in business dancing behind tenure
walls and biased journal editors who still cannot see beyond accountics
research methodology.
I provide three quotations below that, I think, pretty well tell the
story of why many, certainly not all, accountics professors are pretty much
like investment bankers that were superior at mathematics and model building
and lousy at accounting and finance fundamentals. You, Amy, will probably
recall each of these quotations although they may not have sunk in like they
should've sunk in.
Quotation 1
Denny Beresford gave a 2005 luncheon speech at the annual meetings of the
American Accounting Association. Having been both a former executive partner
with E&Y and, for ten years, Chairman of the FASB before becoming an
accounting professor at the University of Georgia, Denny has lived all sides
of accounting --- practice, standard setting, and academe. In his speech
Denny very politely suggested that accountics professors should take and
interest in and learn a bit more about, gasp, accounting.
After he gave his speech, Denny submitted his speech for publication to
Accounting Horizons. Referee A flatly rejected the Denny's submission
for the following reasons:
The paper provides specific recommendations for
things that accounting academics should be doing to make the accounting
profession better. However (unless the author believes that academics'
time is a free good) this would presumably take academics' time away
from what they are currently doing. While following the author's advice
might make the accounting profession better, what is being made worse?
In other words, suppose I stop reading current academic research and
start reading news about current developments in accounting standards.
Who is made better off and who is made worse off by this reallocation of
my time? Presumably my students are marginally better off, because I can
tell them some new stuff in class about current accounting standards,
and this might possibly have some limited benefit on their careers. But
haven't I made my colleagues in my department worse off if they depend
on me for research advice, and haven't I made my university worse off if
its academic reputation suffers because I'm no longer considered a
leading scholar? Why does making the accounting profession better take
precedence over everything else an academic does with their time?
Referee A's rejection letter,
Accounting Horizons, 2005
What riled me the most was the arrogance of Referee A. I read into it
that, whereas mathematicians and econometricians are true "scholars," other
accounting professors are little better than teachers of bookkeeping and
fairy tales. This is the same arrogant attitude held by previous investment
bankers trying to take advantage of Warren Buffet as their counterparties in
derivatives or other financial transactions.
Investment bankers and many accountics professors put on superior airs
because of their backgrounds in mathematics and science. To hell with
knowledge of fundamentals in accounting and finance apart from mathematical
models. To hell with reading and analyzing financial statements in great
depth. Accountics scholars, at least some of them who referee many
submissions to journals, don't waste their time on such mundane things.
Quotation 2
My second quotation laments that accounting education programs now often
have to pay the highest starting salaries for some graduates of accounting
doctoral programs who know very little accounting. Before she moved to
Wyoming, Linda Kidwell wrote a revealing message to the AECM listserv.
I cannot
find the exact quotation in my archives, but some years ago Linda Kidwell
complained that her university had recently hired a newly-minted graduate
from an accounting doctoral program who did not know any accounting. When
assigned to teach accounting courses, this new "accounting" professor was a
disaster since she knew nothing about the subjects she was assigned to
teach.
Quotation 3
In the year following his assignment as President of the American Accounting
Association Joel Demski asserted that research focused on the accounting
profession will become a "vocational virus" leading us away from the joys of
mathematics and the social sciences and the pureness of the scientific
academy:
Statistically there are a few youngsters who came to academia for the joy of
learning, who are yet relatively untainted by the
vocational virus.
I urge you to nurture your taste for learning, to follow your joy. That is
the path of scholarship, and it is the only one with any possibility of
turning us back toward the academy. Joel
Demski,
"Is Accounting an Academic Discipline? American Accounting Association
Plenary Session" August 9, 2006 ---
http://bear.cba.ufl.edu/demski/Is_Accounting_an_Academic_Discipline.pdf
Accounting professors are no longer "leading scholars" if they succumb to a
vocational virus and focus on accounting rather than mathematics,
econometrics, and/or psychometrics ---
http://faculty.trinity.edu/rjensen/395wpTAR/Web/TAR.htm
Quotation 4
One of the very leading accountics professors is employed by the graduate
school at Northwestern University. Ron Dye's academic background is in
mathematics rather than accounting, and he's written some of the most
esoteric accountics research papers ever published in leading accounting
research journals.
Richard Sansing
from Dartmouth, on the AECM, occasionally stresses the importance of a
background in mathematics for students seeking fame and fortune as
accounting professors. Although I agree with Richard because of the
dominance of accountics in the accounting academy over the past four
decades, I don't think Richard anticipated the response he got from Ron Dye
when he (Richard Sansing) asked Ron Dye to comment about accountics research
and about the possible desirability of getting a doctorate in mathematics,
econometrics, psychometrics, statistics, etc. before becoming an accounting
assistant professor.
About the question: by and large, I think it is
a mistake for someone interested in pursuing an academic career in
accounting not to get a phd in accounting. If you look at the
"success" stories, there aren't many: most of the people who make a
post-phd transition fail. I think that happens for a couple reasons.
1. I think some of the people that transfer
late do it for the money, and aren't really all that interested in
accounting. While the $ are nice, it is impossible to think about $
when you are trying to come up with an idea, and anyway, you're
unlikely to come up with an idea unless you're really interested in
the subject.
2. I think, almost independent of the
field, unless you get involved in the field at an early age, for
some reason it becomes very hard to develop good intuition for the
area - which is a second reason good problems are often not
generated by "crossovers."
The bigger thing - not related to the question
you raise - but maybe you could add to the discussion is that there are,
as far as I can tell, not a lot of new ideas being put forth by
anyone in accounting nowadays (with the possible exception of John
Dickhaut's neuro stuff). In most fields, the youngsters are supposed to
come up with the new problems, techniques, etc., but I see a lot more
mimicry than innovation among newly minted phds now.
Anyway, for what it's worth.... Ron Dye, Northwestern
University
I think Ron Dye is being extremely
blunt and extremely honest. What really strikes me is that four decades of
accountics research as pretty much evolved into sterile research where "not
a lot of new ideas are being put forth" by accountics professors.
What the big problem is with
accountics research is that it is too restrictive as to what problems are
taken on by accountics researchers, what papers are written for submission
to the leading academic accounting research journals, and the high level of
mathematics required for admission/progression in an accountancy doctoral
program.
What a boring time it is in accountics
research where virtually nothing comes out that is deemed worth replicating
and verifying.
Accountics researchers, however,
should thank the heavens that they did not become, like those "correlation
investment bankers," counterparties in derivatives with Warren Buffet.
It's far better to be among the highest paid professors in a university
while dancing behind the protective walls of tenure.
I will probably send out a lot more
tidbits from my hero Janet Tavaloli (she became more of a hero after she
delved into the mind of Warren Buffett).
Having been very busy at my "day job" the last few
days, I've missed much of this thread, but I'd like to comment on something
Ron Dye said in the excerpt below about "new ideas." I apologize if my
thoughts are not fully developed, so I'll label them observations or
questions.
How many new PhDs actually have any experience in
accounting or of thinking about accounting issues outside of their
undergraduate degree program?
Although I'm generally on the side of the non-accountics
folks in the debate about relevant research, I also believe it's difficult
for someone to come up with new and interesting questions about which to do
even accountics research if that person hasn't spent time thinking about the
issues of financial reporting (or management decisions-making, etc).
I don't see the problem raised by Ron as one
related to the methodology used for the research. Rather my observation is a
lack of experience about the issues that cause us to want/need some research
in the first place.
Thoughts?
Pat
September 10, 2009 reply from Bob Jensen
Hi Pat,
Gary Sundem,
while editor of TAR and while AAA President, made a major point of saying
that the accounting profession should not look to empirical research for
"new theories."
The following is a quote from the 1993
President’s Message of Gary Sundem, President’s Message. Accounting
Education News 21 (3). 3.
Although empirical
scientific method has made many positive contributions to accounting
research, it is not the method that is likely to generate new theories,
though it will be useful in testing them. For example, Einstein’s theories
were not developed empirically, but they relied on understanding the
empirical evidence and they were tested empirically. Both the development
and testing of theories should be recognized as acceptable accounting
research.
If we ever had an accounting Einstein in the past four
decades, that accounting Einstein probably could’ve never published in TAR,
JAR, JAE, CAR, or even AH (in later years). Hence, we do not look to these
“leading” research journals of the accounting academy for the development of
new theories that perhaps cannot be immediately tested.
When I was
Program Director for an AAA annual meeting in NYC, I arranged for Joel
Demski to be on a plenary session (actually a debate with Bob Kaplan). Among
other things I asked Joel to identify at least one seminal and creative idea
from the academy of accountics researchers that impacted on the practitioner
world. In his speech, Joel suggested Dollar-Value Lifo. Later I inspired
accounting historian Dale Flesher investigate the origins of Dollar-Value
Lifo.
-----Original
Message-----
From: Dale Flesher University of Mississippi
[mailto:actonya@HOTMAIL.COM]
Sent: Friday, January 25, 2002 1:35 PM
To:
AECM@LISTSERV.LOYOLA.EDU
Subject: Re: The Only Invention of Academic Accountants
Contrary to a recent
statement in this forum, Dollar-Value Lifo (DVL) was not developed by a
professor. The father of DVL was Herbert T. McAnly, who retired in 1964 as a
partner at Ernst & Ernst after 44 years with the firm. Throughout his
career, McAnly was known as "Mr. LIFO."
Although he did not
develop LIFO, which had been around for decades in the form of the
base-stock method, he did develop DVL after the Internal Revenue began
accepting LIFO from all types of companies. The Treasury would probably
never have agreed to allow all companies to use LIFO (in 1939) had they been
able to prognosticate McAnly's idea. He first described the concept in an
address delivered at the Accounting Clinic and the Central States Accounting
Conference in Chicago in May 1941. His concept was finally accepted by the
IRS following the Hutzler Brothers Co. case in 1947 (8 TC 14 (1947)). He
later worked with the Treasury Department trying to get more practical
regulations relating to LIFO.
Dale L. Flesher
Professor of Accountancy University of Mississippi
I repeat a
few quotations below:
For a long time, elite accounting
researchers could find no “empirical evidence” of widespread earnings
management. All they had to do was look up from the computers where their
heads were buried. Bob Jensen ---
http://faculty.trinity.edu/rjensen/395wpTAR/Web/TAR395wp.htm
If we ever had an accounting Einstein
in the past four decades, that accounting Einstein probably could’ve never
published in TAR, JAR, JAE, CAR, or even AH (in later years). Hence, we do
not look to these “leading” research journals of the accounting academy for
the development of new theories that perhaps cannot be immediately tested.
Bob Jensen
“Research should be problem driven rather
than methodologically driven," said Lisa Garcia Bedolla, a member of the
task force who teaches at the University of California at Berkeley. Scott Jascik ---
http://www.insidehighered.com/news/2009/09/04/polisci
"I understand your point,
Jim." He could not identify one issue that (accountics)
researchers had been able to "put to bed" after all that effort. P. Kothari, one of the Editors of JAE and a full professor at
MIT, as quoted by Jim Peters in an AECM message.
Amy,
Why don't you ask the protagonists what they are doing and why?
Anthropolotgists and sociologists do it all the time. At the AAA meeting in
NYC I used an analogy that Sylvia Earle provided at an Emerging Issues Forum
here at NC State a number of years ago. She is an oceanographer who holds
all the records for time and depth spent under water by a woman. She
described her discipline before and after the invention of SCUBA and other
forms (bathosphere) of deep diving technology. Before the ability to immerse
in the ocean environment she likened her research to being in a balloon over
NYC throwing a basket through the clouds and dragging it along the streets.
From the bits and pieces (much of which was simply
the detritus of life in the city) you had to infer what life was actually
like in a place you couldn't see. What underwater breathing technology did
for her field was absolutely revolutionary because, as she said, you could
actually be in the life of the sea. Obviously what we thought was the case
from the bits of stuff retrieved turned out to be woefully inadequate for
developing a rich understanding of oceanic life.
Accountics research is still little more than
throwing a basket over the side. It is observing at a distance the detritus
(bits of accounting data that float to the surface in the form of public
archives) and inferring what must be happening. This is further limited by
the invariable assumption that whatever is happening must be economic!
Little wonder we have made so little progress.
Ackerloff and Shiller (Animal Spirits) provide an
interesting, two dimensional matrix for understanding human behavior (they
are still economists, but at least Shiller's wife is a social psychologist
who has had a very positive influence on his thinking): One dimension is
Motives -- economic and non-economic (people are likely more non-economic
than economic) and Responses -- rational and irrational. Of the four boxes,
accountics research has confined itself to just one: motives must be
economic and responses must be rational. Seventy five percent of the terrain
of human social behavior is completely ignored.
Added to Bob's shortcomings to accountics research
I would add one more. Sue Ravenscroft and I have a working paper trying to
sort out the inadequacies of "decsion usefulness" as both a policy criterion
and a research objective. One problem with accounting research is that the
accountics approach privileges exclusively algorithmic knowledge -- behavior
that can be modeled (so Wayne Gretzky's famous observation, "I skate to
where the puck is going to be" is beyond understanding). Much of this
research utilizes accounting data as a principal source of measurement. The
problem is that though accountants produce numbers, they don't produce
Quantities, which is essential for performing mathematical operations.
Brian West discusses this extensively in his
Notable Contribution Award winner Professionalism and Accounting Rules. To
perform even the simplest arithmetic operation of addition the numbers you
add must represent quantities of a like type. I can add a coffee cup to a
Volkswagon and claim I have two, but two of what?
Accounting numbers are what Gillies describes as
operational numbers, i.e., numbers obtained by performing operations,
analogous to grading an exam. As West points out financial statements today
consist of numbers developed by performing operations that require cost,
unamortized cost, lower-of-cost or market (with floor and ceiling rules),
exit market values, present values, and, now, "fair" value. When you add all
of these up what do you have? Good question. You have a number, but you most
certainly do not have a quantity. So when an accountics researcher develops
a 20 variable regression model where the dependent variable and at least
half of the independent variables are the operational numbers produced by
accountants (numbers, not quantities), what could the results possibly MEAN.
It is a false precision of the most egregious
kind (GIGO?). In your study you will use operational numbers and assert this
is what my measures mean, but you have no way of knowing if this describes
the actual context in which the decisions were actually made (you are
looking at the stuff from the basket). What it means to you isn't
necessarily what it meant to the actual people who made these decisions.
My issue with so much accountics research is that
it means what the researcher chooses to have it mean; the researcher assigns
the meaning, but to understand what is going on with human beings it is
important to know what their behavior means to them.
And in accountics research this remains a mystery.
A couple of other books (once you finish Shapiro"s) are by Bent Flyvbjerg:
Rationality and Power and Making Social Science Matter. In the latter he
discusses the work of Dreyfus and Dreyfus on what they call "a-rational"
behavior (what Gretzsky is doing when he skates to where the puck is going
to be). See also Gerd Gigerenzer, Gut Feelings: The Intelligence of the
Unconscious..
Statistical methods are not inherently faulty. But they can be, and far too
frequently are, misused. So, to turn your metaphor on its head, much accountics
econometrics work is more like spraying manure in a perfumed room, or more like
a skunk spraying in a perfumed room.
Statistical methods are used for classifying, associating, predicting,
inferring (causally as well as associatively), organising, and learning. It is
important to always keep in mind in which context you are using statistics.
1.
In the accountics stuff I am familiar with, determining association is the
avowed objective, but the language subtly takes a predictive turn in
discussions. The reason usually is the positivist dogma having to do with
absence of causation in a naive positivist's lexicon.
I have been stunned by well known accounticians professing that we do not study
causes because there are no statistical methods for causal inference. And to the
last person, these folks have not heard of modern statistical tools for the
study of causation in statistics.
Ignorance is bliss in this wonderland. Social scientists, however, have used
them for a long time. Theological commitments are dangerous for ANY "science".
2.
Classification is the first step in learning. It is only VERY recently that
accounting folks have started talking about the use of classification by use of
clustering, support vector machines, neural nets, etc., but most of these
discussions take place in non-mainstream contexts.
3.
Many of the techniques in 2 are nowadays considered part of the field of machine
learning, a hybrid between statistics and computing. I am sure one of these
days, when they have become stale elsewhere,They’ll be used in accounting.
Mainstream accountics academics are far too conservative to accept any
statistical method unless they have been certified stale.
4.
Often, in conversations, accountics folks revert to counterfactual
statements.That is natural in the sciences. Underlying such statements are
usually causal inferences. It is in this context that I had made observation 1
above. Building a better mousetrap is a legitimate objective of sciences, and
therefore predictive models are essential component of any science. Accountics'
theological commitment to positivist dogma makes them schizophrenic in that they
cannot admit causality without jeopardising their philosophical suppositions and
yet cannot ignore it if they are to maintain their credibility as scientists.
As to some work in these areas of statistics, any list I prepare would include
the following books.
As David Bartholomae observes, “We make a huge
mistake if we don’t try to articulate more publicly what it is we value in
intellectual work. We do this routinely for our students — so it should not be
difficult to find the language we need to speak to parents and legislators.” If
we do not try to find that public language but argue instead that we are not
accountable to those parents and legislators, we will only confirm what our
cynical detractors say about us, that our real aim is to keep the secrets of our
intellectual club to ourselves. By asking us to spell out those secrets and
measuring our success in opening them to all, outcomes assessment helps make
democratic education a reality. Gerald Graff, "Assessment Changes
Everything," Inside Higher Ed, February 21, 2008 ---
http://www.insidehighered.com/views/2008/02/21/graff
Gerald Graff is professor of English at the University of Illinois at Chicago
and president of the Modern Language Association. This essay is adapted from a
paper he delivered in December at the MLA annual meeting, a version of which
appears on the MLA’s Web site and is reproduced here with the association’s
permission. Among Graff’s books are Professing Literature, Beyond the
Culture Wars and Clueless in Academe: How School Obscures the Life of the Mind.
The consensus report, which was approved by the
group’s international board of directors, asserts that it is vital when
accrediting institutions to assess the “impact” of faculty members’ research on
actual practices in the business world.
My 67th birthday April 30, 2005 commentary on how research in
business schools has run full circle since the 1950s. We've now
completed the circle of virtually no science (long on speculation without rigor)
to virtually all science (strong on rigor with irrelevant findings) to
criticisms that science is not going to solve our problems that are too complex
for rigorous scientific methods.
The U.S. led the way in bringing accounting, finance, and other business
education and research into respectability in separate schools or colleges
the business (so called B-schools) within top universities of the country.
The movement began in the 1960s and followed later in Europe after leading
universities like Harvard, Chicago, Columbia, Chicago, Pennsylvania, UC
Berkeley and Stanford showed how such schools could become important sources
of cash and respectability.
A major catalyst for change was the Ford Foundation that put a large
amount of money into first the study of business schools and second the
funding of doctoral programs and students in business studies. First
came the Ford-Foundation's Gordon and Howell Report (Gordon, R.A., & Howell,
J.E. (1959). Higher education for business. New York: Columbia
University Press) that investigated the state of business higher education
in general. You can read the following at
http://siop.org/tip/backissues/tipoct97/HIGHHO~1.HTM
The Gordon and Howell report, published in
1959, examined the state of business education in the United States.
This influential report recommended that managerial and organizational
issues be studied in business schools using more rigorous scientific
methods. Applied psychologists, well equipped to undertake such an
endeavor, were highly sought after by business schools. Today, new
psychology Ph.D.s continue to land jobs in business schools. However, we
believe that this source of academic employment will be less available
in the future because psychologists in the business schools have become
well established enough to have their own "off-spring," who hold
business Ph.D.s. More business school job ads these days contain the
requirement that applicants possess degrees in business administration.
Prior to 1960, business education either took place in economics
departments of major universities or in business schools that were viewed as
parochial training programs by the more "academic" departments in humanities
and sciences where most professors held doctoral degrees. Business
schools in that era had professors rooted in practice who had no doctoral
degrees and virtually no research skills. As a result some
universities avoided having business schools altogether and others were
ashamed of the ones they had.
The Gordon and Howell Report concluded that doctoral programs were both
insufficient and inadequate for business studies. Inspired by the
Gordon and Howell Report, the Ford Foundation poured millions of dollars
into universities that would upgrade doctoral programs for business studies.
I was one of the beneficiaries of this initiative. Stanford University
obtained a great deal of this Ford Foundation money and used a goodly share
of that money to attract business doctoral students. My relatively
large fellowship to Stanford (which actually turned into a five-year
fellowship for me) afforded me the opportunity to get a PhD in accounting.
The same opportunities were taking place for other business students at
major universities around the country.
Another initiative of the Gordon and Howell Report was that doctoral
studies in business would entail very little study in business.
Instead the focus would be on building research skills. In most
instances, the business doctoral programs generally sent their students to
doctoral studies in other departments in the university. In my own
case, I can only recall having one accounting course at Stanford University.
Instead I was sent to the Mathematics, Statistics, Economics, Psychology,
and Engineering (for Operations Research) graduate studies. It was
tough, because in most instances we were thrown into courses to compete
head-to-head with doctoral students in those disciplines. I was even
sent to the Political Science Department to study (critically) the current
research of Herb Simon and his colleagues at Carnegie Mellon. That
experience taught me that traditional social science researchers were highly
skeptical of this new thrust in "business" research.
Another example of the changing times was at Ohio State University when
Tom Burns took command of doctoral students. OSU took the Stanford
approach to an extreme to where accounting doctoral students took virtually
all courses outside the College of Business. The entire thrust was one
of building research skills that could then be applied to business problems.
The nature of our academic research journals also changed. Older
journals like The Accounting Review (TAR) became more and more biased
and often printed articles that were better suited for journals in
operations research, economics, and behavioral science. Accounting
research journal relevance to the profession was spiraling down and down.
I benefited from this bias in the 1960s and 1970s because I found it
relatively easy to publish quantitative studies that assumed away the real
world and allowed us to play in easier and simpler worlds that we could
merely assume existed somewhere in the universe if not on earth. In
fairness, I think that our journal editors today demand more earthly
grounding for even our most esoteric research studies. But in the many
papers I published in the 1960s and 1970s, I can only recall one that I
think made any sort of practical contribution to the profession of
accounting (and the world never noticed that paper published in TAR).
I even got a big head and commenced to think it was mundane to even teach
accounting. In my first university I taught mostly mathematical
programming to doctoral students. When I got a chair at a second
university, I taught mathematical programming and computer programming (yes
FORTRAN and COBOL) to graduate students. But my roots were in
accounting (as a CPA), my PhD was in accounting (well sort of), and I
discovered that the real opportunities for an academic were really in
accounting. The reasons for these opportunities are rooted the various
professional attractions of top students to major in accounting and the
shortage of doctoral faculty across the world in the field of accountancy.
So I came home so to speak, but I've always been frustrated by the
difficulty of making my research relevant to the profession. If you
look at my 75+ published research papers, you will find few contributions to
the profession itself. I'm one of the guilty parties that spend most
of my life conducting research of interest to me that had little relevance
to the accounting profession.
I was one of those accounting research farmers more interested in my
tractors than in my harvests. Most of my research during my entire
career devoted to a study of methods and techniques than on professional
problems faced by accounting standard setters, auditors, and business
managers. I didn't want to muck around the real world gathering data
from real businesses and real accounting firms. It was easier to live
in assumed worlds or, on occasion, to study student behavior rather than
have to go outside the campus.
What has rooted me to the real world in the past two decades is my
teaching. As contracting became exceedingly complex (e.g., derivative
financial instruments and complex financial structurings), I became
interested in finding ways of teaching about this contracting and in having
students contemplate unsolved problems of how to account for an increasingly
complex world of contracts.
In accounting research since the 1950s we've now completed the circle of
virtually no science (long on speculation without rigor) to virtually all
science (strong on rigor with irrelevant findings) to criticisms that
science is not going to solve our problems that are too complex for rigorous
scientific methods. We are also facing increasing hostility from
students and the profession that our accounting, finance, and business
faculties are really teaching in the wrong departments of our universities
--- that our faculties prefer to stay out of touch with people in the
business world and ignore the many problems faced in the real world of
business and financial reporting. For more on this I refer you to http://faculty.trinity.edu/rjensen//theory/00overview/theory01.htm#AcademicsVersusProfession
Things won’t change as long as our "scientists" control our editorial
boards, and they won’t give those up without a huge fight. I’m not sure that
even Accounting Horizons (AH) is aimed at practice research at the
moment. The rigor hurdles to get into AH are great as of late. Did you
compare the thicknesses of the recent AH juxtaposed against the latest
Accounting Review? Hold one in each of each in your hands.
What will make this year’s AAA plenary sessions interesting will be to
have Katherine defending our economic theorists and Denny Beresford saying
“we still don’t get it.” Katherine is now a most interesting case since, in
later life, she’s bridging the gap back to practice somewhat. Denny’s an
interesting case because he came out of practice into academe only to
discover that, like Pogo, “the enemy is us.”
I think what is misleading about the recent HBR article is that focusing
more on practice will help us solve our “big” problems. If you look at the
contributions of the HBR toward solving these problems in the last 25 years,
you will find their contributions are superficial and faddish (e.g.,
balanced score card). The real problem in accounting (and much of business
as well), is that our big problems don’t have practical solutions. I
summarize a few of those at
http://faculty.trinity.edu/rjensen/FraudConclusion.htm#BadNews
Note the analogy with “your favorite greens.”
So what can we conclude from having traveled the whole circle from
virtually no scientific method to virtually all scientific method to new
calls to back off of scientific method and grub around in the real world?
What do we conclude from facing up to the fact that research rigor and our
most pressing problems don't mix?
My recommendation at the moment is to shift the focus from scientific
rigor to cleverness and creativity in dealing with our most serious
problems. We should put less emphasis on scientific rigor applied to
trivial problems. We should put more emphasis on clever and creative
approaches to our most serious problems. For example, rather than seek
optimal ways to classify complex financial instruments into traditional debt
and equity sections on the balance sheet, perhaps we should look into clever
ways to report those instruments in non-traditional ways in this new era of
electronic communications and multimedia graphics. Much of my earlier
research was spent in applying what is called cluster analysis to
classification and aggregation. I can envision all sorts of possible
ways of extending these rudimentary efforts into our new multimedia world.
Bob Jensen on my 67th birthday on April 30, 2005
A December 5,
2002 reply from David Stout about the replications thing --- an AAA
journal editor’s inside perspective!
Note that I think that a big
policy weakness is that the policy of accounting research journals
to not publish confirming replications (even in abstracted form) is
that this policy discourages efforts to perform confirming
replications.
But the most serious
problem is that the findings themselves may not be interesting
enough for researchers to perform replications whether or not those
replications will be published. Are the findings so uninteresting
that researchers aren’t really interested in seeking truth?
Bob Jensen
-----Original
Message----- From: David E. Stout [mailto:david.stout@villanova.edu] Sent:Thursday,
December 05, 2002 To: Jensen, Robert Subject: Re: Are we
really interested in truth?
I read through
the material you sent (below)--one thing caught my eye: the issue of
REPLICATIONS. This is a subject about which I am passionate. When I
assumed the editorship of Issues, I had to appear before the AAA
Publications Committee to present/defend a plan for the journal
during my (then) forthcoming tenure. One of my plans was to
institute a "Replications Section" in the journal. (The sad reality,
beyond the excellent points you make, is that the lack of
replications has a limiting effect on our ability to establish a
knowledge base. In short, there are not many things where, on the
basis of empirical research, we can draw firm conclusions.) After
listening to my presentation, the chair of the Publications
Committee posed the following question: "Why would we want to devote
precious journal space to that which we already know?" To say the
least, I was shocked--a rather stark reality check you might say.
The lack of replications precludes us, in a very real sense, from
"knowing."
I applaud your
frank comments regarding the whole issue of replications, and their
(proper) place within the conduct of "scientific" investigations.
You made my day!
In a recent
issue of Golf World, a letter writer was commenting on the need for professional
golfers to be more "entertaining." He went on to say:
"Fans pay top dollar to
attend tournaments and to subscribe to cable coverage.
Not many would
pay to see an accountant work in his office or watch The Audit Channel."
That's probably a true
comment. On the other hand, wouldn't at least some of us have liked to
watch The Audit Channel and see what was being done on Enron, WorldCom,
HeathSouth, or some of the other recent interesting situations?
Denny Beresford
December 15, 2004 reply from Bob Jensen
You know better than the rest of us, Denny, that academic accounting
researchers won't tune in to watch practitioners on the Audit Channel. They're
locked into the SciFi Channel.
Bob Jensen
December 1, 2004 message from Dennis Beresford [dberesfo@TERRY.UGA.EDU]
Denny is now a professor of accounting at the University of Georgia. For
ten years he was Chairman of the Financial Accounting Standards Board and is a
member of the Accounting Hall of Fame.
I've enjoyed the recent
"debate" on AECM relating to the Economist article about the
auditing profession. I'm delighted to see this interest in such
professional issues. But I'm concerned that academic accountants, by and
large, aren't nearly enough involved in actually trying to help solve
professional issues. Let me give an illustration, and I'd certainly be
interested in reactions.
Last night our Beta Alpha Psi chapter was fortunate
to have Jim Copeland as a guest speaker. Jim retired as the managing
partner of Deloitte a couple of years ago and he continues to be a leading
voice in the profession through, among other things, his role in chairing a
major study by the U.S. Chamber of Commerce on the auditing profession.
Jim also serves as a director of three major corporations and on their audit
committees. In short, he is the kind of person that all students and
faculty should be interested in meeting and hearing.
Students turned out in fairly large numbers, as did
quite a few practitioners who always are there to further their recruiting
efforts. However, only four faculty members attended (out of a group of
about 18) and this included our department head and the BAP advisor, both of
whom were pretty much obligated to be there. No PhD students attended.
I'm sure that some faculty members had good excuses but most simply weren't
sufficiently interested enough to attend. Perhaps at some other schools
more faculty would have been there but my own experience in speaking to about
100 schools over the years would indicate that this lack of interest is pretty
common.
On the other hand, this coming Friday a very young
professor from another university will present a research workshop and I
expect that nearly all faculty members and PhD students will be there.
The paper being discussed is replete with formulas using dubious (in my humble
view) proxies for real world economic matters that can't be observed directly.
The basic conclusion of the paper is that companies are more inclined to give
stock options rather than cash compensation because options don't have to be
charged to expense. Somehow I thought that this was a conclusion that
was pretty clear to most accountants and business people well before now.
I've heard some faculty members say that they feel
obligated to attend such workshops even if they aren't particularly interested
in the paper being discussed. They want to show support for the person
who is visiting as well as reinforce the importance of these events to the PhD
students. I certainly understand that thinking and tend to share it.
However, for the life of me I can't understand why faculty members don't feel
a similar "obligation" to show respect for a person like Jim
Copeland, one of the most important people in the accounting profession in
recent years and someone who is making a personal sacrifice to visit our
school.
My purpose in this brief note is not to belittle the
research paper. But I simply observe that it would be nice if there were
a little more balance between interest in professional matters and such high
level research among faculty members at research institutions. As the
Economist article noted, and as should be clear to all of us in the age of
Sarbanes-Oxley, etc., there are tremendous issues facing the accounting
profession. Rather than simply complaining about things, it seems to me
that academics could become more familiar with professionals and the issues
they face and then try to work with them to help resolve those issues.
When is the last time that you called an auditor or
corporate accountant and asked him or her to have lunch to just kick around
some of the tremendously interesting issues of the day?
Denny Beresford
December 1, 2004 reply from Bob Jensen
(The evidence lies in lack of interest in replication)
Hi Denny,
Jim gave a plenary session at the AAA meetings in Orlando. You may have
been in the audience. I thought Jim’s presentation was well received by the
audience. He handled himself very well in the follow up Q&A session.
I think academics have some preconceived notions about the auditing “establishment.”
They may be surprised at some of the positions taken by leaders of that
establishment if they took the time to learn about those positions. I
summarized some of Jim’s more controversial statements at http://faculty.trinity.edu/rjensen/book04q3.htm#090104
Note that he proposed eliminating the corporate income tax (but he said he
hoped none of his former partners were in the audience).
Faculty interest in a professor’s “academic” research may be greater
for a number of reasons. Academic research fits into a methodology that other
professors like to hear about and critique. Since academic accounting and
finance journals are methodology driven, there is potential benefit from being
inspired to conduct a follow up study using the same or similar methods. In
contrast, practitioners are more apt to look at relevant (big) problems for
which there are no research methods accepted by the top journals.
Accounting Research Farmers Are More Interested in Their Tractors Than in
Their Harvests
For a long time I’ve argued that top accounting research
journals are just not interested in the relevance of their findings (except in
the areas of tax and AIS). If the journals were primarily interested in the
findings themselves, they would abandon their policies about not publishing
replications of published research findings. If accounting researchers were
more interested in relevance, they would conduct more replication studies. In
countless instances in our top accounting research journals, the findings
themselves just aren’t interesting enough to replicate. This is something
that I attacked at
http://faculty.trinity.edu/rjensen/book02q4.htm#Replication
At one point back in the 1980s there was a chance for accounting programs
that were becoming “Schools of Accountancy” to become more like law
schools and to have their elite professors become more closely aligned with
the legal profession. Law schools and top law journals are less concerned
about science than they are about case methodology driven by the practice of
law. But the elite professors of accounting who already had vested interest in
scientific methodology (e.g., positivism) and analytical modeling beat down
case methodology. I once heard Bob Kaplan say to an audience that no elite
accounting research journal would publish his case research. Science
methodologies work great in the natural sciences. They are problematic in the
psychology and sociology. They are even more problematic in the professions of
accounting, law, journalism/communications, and political “science.”
We often criticize practitioners for ignoring academic research Maybe they
are just being smart. I chuckle when I see our heroes in the mathematical
theories of economics and finance winning prizes for knocking down theories
that were granted earlier prizes (including Nobel prices). The Beta model was
the basis for thousands of academic studies, and now the Beta model is a
fallen icon. Fama got prizes for showing that capital markets were efficient
and then more prizes for showing they were not so “efficient.” In the
meantime, investment bankers, stock traders, and mutual funds were just
ripping off investors. For a long time, elite accounting researchers could
find no “empirical evidence” of widespread earnings management. All they
had to do was look up from the computers where their heads were buried.
Few, if any, of the elite “academic” researchers were investigating the
dire corruption of the markets themselves that rendered many of the published
empirical findings useless.
Academic researchers worship at the feet of Penman and do not even
recognize the name of Frank Partnoy or Jim Copeland.
Bob Jensen
As you recall, this thread was initiated when Denny Beresford raised concern
about the University of Georgia's accounting faculty lack of interest in
listening to an on-campus presentation by the recently retired CEO of Deloitte
& Touche (Jim Copeland). A leading faculty member from another major
research university raises much the same concern. Jane F. Mutchler is the
J. W. Holloway/Ernst & Young Professor of Accounting at Georgia State
University. She is also the current President of the American Accounting
Association.
"President's Message," Accounting Education News, Fall 2004,
Page 3. This is available online to paid subscribers but cannot be copied
due to a terrible policy established by the AAA Publications Committee.
Any typos in the following quotation are my own at 4:30 this morning.
How many of us are now sitting down with the firms
that recruit our students and having good, critical discussions about the
state of practice?
How many of us are spending our time writing
articles that critically analyze the state of the profession and
accounting and auditing practices for a journal like Accounting
Horizons?
How many of us are conducting rigorous research
that is focused first on the crucial practice issues and then only
secondly on getting a publication in a top journal such as The
Accounting Review or one of the section journals?
How many of us are evaluating and revamping our
courses to deal with the realities of the world today?
I raise these questions because I worry that we are
all too quick to blame all the problems on the practitioners. But we
must remember that we were the ones responsible for the education of the
practitioners. And unless we analyze the issues and the questions I
raised, I fear that we won't make any changes ourselves. So it is
important that we examine our approaches to the classes we are teaching and
ask ourselves if we are doing all we canto assure that our students are being
made aware of the pressures they will face in practice and if we are helping
them develop the skills they need to appropriately deal with those
pressures. In my mind these issues need to be dealt with in every class
we teach. It will do no good to simply mandate new stand alone ethics
courses where issues are examined in isolation.
Continued in Jane’s
Message to the Membership of the American Accounting Association
I enjoyed Denny's
commentary on the interplay between accounting research and practice, and,
Jane's AAA President's statement on this issue.
A few thoughts:
1. Yes, accounting
research is largely, though not entirely, divorced from accounting practice.
This is no coincidence or anomaly. It is by design. Large sample, archival,
financial accounting research -- which dominates mainstream academic
accounting -- is about the role of accounting information in markets. It is
not about understanding the institutions and individuals who produce and
disseminate this information, or, the technologies that make its production
possible. We could have an accounting scholarship takes seriously issues of
accounting practice. The US institutional structures of accounting scholarship
currently eliminate this possibility. Change these institutional structures
and we change accounting scholarship.
2. There is a
particular and peculiar hubris of financial accounting academics to assume
that all accounting scholarship is, or should be, about financial accounting.
Am I reading this into Denny's argument? Am I reading beyond the text here?
The unity model of
accounting scholarship increasingly, which says that all accounting
scholarship is or should be about financial accounting, is no coincidence or
anomaly. It is by design. The top disseminators of accounting scholarship in
the US increasingly publish, and the major producers of accounting scholars
increasingly produce scholars who know about, only 1 small sub-area of
accounting -- financial, archival accounting. Change the institutional
structures of the disseminators and the producers and we change accounting
scholarship.
Best,
Dan Stone
Gatton Endowed Chair
University of Kentucky
Lexington, Kentucky
To add to Dan's
observations. He is correct that until we change the structure of the US academy
nothing is going to change re practice. As Sara Reiter and I argued (with
evidence) in our AOS piece, accounting in the academy has been transformed from
an autonomous, professional discipline into a lab practice for a discipline for
which lab practices are incidental to the main activity, i.e, accounting is an
empirical sub discipline of a sub discipline of a sub discipline for which
empirical work is irrelevant. The purpose of scholarship in accounting is now
purely instrumental -- to create politically correct academic reputations.
The powers that be are
not interested in accounting research for its intrinsic value or for improving
practice broadly understood, but only as a means to enhance their own careers
(to get "hits" in the major journals). The profession is not powerless
to assist in changing that structure. For example, KPMG funds (or at least used
to) the JAR conferences. Stop doing that!! Why subsidize that which is doing you
more harm than good? The profession has abandoned the AAA in droves -- in the
mid-60s the AAA had nearly 15,000 members, 2/3 of which were practitioners. Now
we are approximately 8,000 of which only about 1/7 are practitioners. If
practitioners aren't happy about the academy they are not powerless to engage
it.
Bob sent us an excerpt
from Jane Mutchler's presidential address suggesting things that should be done.
They already have been. At the Critical Perspectives conference in New York in
2002 there were numerous sessions devoted to how academics have failed in their
educational responsibilities (someone credentialed Andy Fastow). Do the firms
help fund that conference? Of course not -- too left wing. Accounting Education:
An International Journal dedicated an entire issue to accounting education after
Enron, as has the European Accounting Review. Have any AAA journals done so? The
insularity of the US academy is evident in that Jane doesn't seem aware that
there already has been significant activity for at least the last three years,
but none of it as visible as that which is promoted by AAA. Let's have genuine
debates in Horizons where others besides those vetted for political correctness
are permitted to speak to the issues.
Let me remind you of
the Briloff affair -- Abe wrote a piece for Horizons critical of the COSO
report. Abe argued that the "problem" was not just small firms with
small auditors. Was Abe right? Less than two years after he wrote that article
we had Enron, WorldCom, Tyco, Andersen's implosion, etc. See the special issue
of Critical Perspectives on Accounting, "AAA, Inc." to see first hand
how the structure of the academy handles candid discussion of the profession's
problems. If people aren't happy with the way the AAA manages the academy, they
are not powerless to change it. The structure stays the same because of the
apathy of the membership. It only takes 100 signatures to challenge for an AAA
office. Since less than 100 people bother to vote (out of 8,000) it wouldn't
take much effort for someone with the resources to effect significant changes.
Denny could get his colleagues' attention and get them interested in attending
his guests' talks by running for president of AAA -- I will gladly sign his
petition to be put on the ballot for 2005. That will shake them up! Change won't
happen unless enough members of the academy recognize that we have some very
real, serious problems that require candid, adult conversation and a willingness
to accept responsibility.
Realize that there are
more of us than there are of them (that is the whole idea of the current
structure - to keep the number of them very, very small). Change the executive
committee, select editors of the AAA journals that aren't committed to the
narrow notion of rigor that now predominates and, as Dan says, things will
change. There are plenty of qualified, thoughtful people who could manage an
academy more dedicated to the practice of accounting (in all its many
manifestations besides financial reporting, likely the most insignificant of
accounting's functions). It just takes people with the political and financial
leverage to put their efforts into altering that intellectually oppressive
structure. PFW
I could not agree more. May be most "top"
journals suffer a case of "analysis paralysis". In a practical field
such as accounting, how do we know what relevant problems are if we have
little contact with the real world (and I would not count sporadic consulting
as contact).
There are ways in which the academia and industry
mingle in a meaningful way. In the areas I am interested in (computationally
oriented work in information systems and auditing), for example, I have found
a very healthy relationship between the academia and industry, and in fact far
more exciting research reported in computing journals during the past three
years than in accounting/auditing journals during the past 30. (I can think of
work in computational auditing done by folks at Eindhoven and Delloitte &
Touche; work on role-based access control at George Mason and Singlesignonnet,
work on formal models of accounting systems as discrete dynamical systems done
also at Delloitte and Eindhoven, work on interface of formal models of
accounting systems and back-end databases done at Promatis and Goethe-Universität
Frankfurt & University of Karlsruhe, to name just a few). In fact it has
got to a point where I attend AAA meetings only to meet old friends and have a
good time, and not for intellectual stimulation. For that, I Go to computing
meetings.
The reason for the schism between academia and the
profession in accounting, in my opinion, is the almost total lack of
accountability in academic accounting research. Once the control of
"academic" journals have been wrested, research is pursued not even
for its own sake, but for the preservation of control and perpetuation of ones
genes. We have not had a Kuhnian paradigm shift for close to 40 years in
accounting, because we haven't found the need for anomalies. We use
"academic" journals the same way that the proverbial Mark Twain's
drunk uses a lamp post, more for support than for illumination.
Bob is right that the accounting academy in the US
(not so much the rest of the world) is driven mainly by the interests of
methidoliters -- those that suffer from a terminal case of what McCloskey
described as the poverty of economic modernism. Sara Reiter and I had a study
published in AOS last summer that included an analysis of the rhetorical
behavior of the JAR conferences through time to see if the discursive
practices of the "leading" forum were conducive to progressive
critique -- all sciences "advance" via destruction -- received
wisdom is constantly under assault. When the JAR conferences started
practiioners and scholars from other disciplines like law and sociology were
invited to participate. These were the people that asked the most troublesome
questions, the ones who provided the most enervating critique. How did the
geniuses at JAR deal with the problem of heretics in the temple? They simply
stopped inviting practitioners and scholars from other disciplines. The
academy in the US is an exceedingly closed society of only true believers.
Accounting academics are now more interested in trying to prove that an
imaginary world is real, rather than confront a world too messy for the
methods (and, it must be noted, moral and political commitments) to which they
unshakeably devoted REGARDLESS OF WHAT THE EMPIRICAL EVIDENCE SAYS! (As Bob
notes, who in their right mind can still say market efficiency without a smirk
on their face. The stock exchange, after all, has members. Does anyone know of
any group of "members" that writes the rules of the organization to
benefit others equally to themselves? Invisible hands, my a..)
But it must be said the profession is not without
guilt in all of this. I avoid listening to big shots from the Big 4 myself
because they are as predictable as Jerry Falwell. Accountants have a license,
which is a privilege granted to them by the public to serve the broad society
of which they are citizens. But whenever you hear them speak, all they do is
whine about the evils of government regulation, the onerous burden of taxes on
the wealthy (I have never heard a partner of a Big 4 firm complain that taxes
were too regressive); they simply parrot the shiboleths that underlay the
methodologies of academics. No profession has failed as spectacularly as
accounting has just done. If medicine performed as poorly as public accounting
has just done in fulfilling its public responsibilities, there would be doctor
swinging from every tree. Spectacular audit failures, tax evasion schemes for
only the wealthiest people on the planet, liability caps, off-shore
incorporation, fraud, etc., a profession up to its neck in the corruption that
Bob mentioned. But have we heard one word of contrition from this profession?
Has it dedicated itself to adopting the skeptical posture toward its
"clients" required of anyone who wants to do a thorough audit? Don't
think so. All we still hear is the problem ain't us, it all those corrupt
politicians, etc. (Who corrupted them?). And PWC has the gall to run ads about
a chief courage officer -- do these guys have no shame? If the profession
wants to engage with the academy with an open mind and the courage to hear the
truth about itself, the courage to really want to become a learned profession
(which it isn't now), then maybe we could get somewhere. But for now, both
sides are comfortable where they are -- the chasm serves both of their
exceedingly narrow interests.
There are now 7 volumes of Carl's essays. Thanks to
Yuji Ijiri's efforts, the AAA published the first 5 volumes as Studies in
Accounting Research #22, Essays in Accounting Theory. A sixth volume, edited
by Harvey Hendrickson, Carl Thomas Devine Essays in Accounting Theory: A
Capstone was published by Garland Publishing in 1999. A seventh volume was
being edited by Harvey when he died. I was asked to finish Harvey's work and
that volume, Accounting Theory: Essays by Carl Thomas Devine has been
published by Routledge, 2004. Carl also had a collection of Readings in
Accounting Theory he compiled mainly for his teaching during his stint in
Indonesia (I think). Those were mimeographed as well, but, to my knowledge,
have never been published. I have copies of those 4 volumes but their
condition is not good -- paper is yellowed and brittle. Thoughtful, curious,
imaginative, humble, and kind -- we don't see the likes of Carl much anymore.
His daughter Beth told me that he even approach his death with the same
vibrant intellectual curiousity he brought to everything.
Seems to me that most
folks on this list take a pretty harsh view of the accounting research
"establishment" for being closed, methodology-driven, irrelevant to
practice, self-serving, and just generally in the wrong paradigm. Yet I see
things like the following in the JAR and the AR that appear relevant and
"practice-oriented" to me.
--- Journal of
Accounting Research, Volume 42: Issue 3 "Auditor Independence, Non-Audit
Services, and Restatements: Was the U.S. Government Right?"
Abstract Do fees for
non-audit services compromise auditor's independence and result in reduced
quality of financial reporting? The Sarbanes-Oxley Act of 2002 presumes that
some fees do and bans these services for audit clients. Also, some registrants
voluntarily restrict their audit firms from providing legally permitted
non-audit services. Assuming that restatements of previously issued financial
statements reflect low-quality financial reporting, we investigate detailed
fees for restating registrants for 1995 to 2000 and for similar nonrestating
registrants. We do not find a statistically significant positive association
between fees for either financial information systems design and
implementation or internal audit services and restatements, but we do find
some such association for unspecified non-audit services and restatements. We
find a significant negative association between tax services fees and
restatements, consistent with net benefits from acquiring tax services from a
registrant's audit firm. The significant associations are driven primarily by
larger registrants.
---
I also see articles
on topics other than financial accounting. Are these just window-dressing?
Journal editors are
always saying that they want work that has "policy implications."
Yet it seems to me that important questions in accounting tend to be more
complicated than, "Does this medication cause nausea in the control
group?" Tough questions are tough to address rigorously.
What are some
examples of specific questions (susceptible to rigorous research) that
academia should be addressing but is not?
Ed "Paton's
Advocate" (am I alone?)
P.S. Many years ago a
senior faculty member told me the "top" journals were a closed
society, and hitting them was a matter of whom you knew. I made some naïve
reply to the effect that the top journals reflected the best work--"the
cream rises to the top." Next morning I found in my mailbox photocopies
of the tables of contents of then-recent JARs, along with the editorial board,
with lines drawn connecting names on the board with names of authors, as if it
were a "matching question" on an exam.
December 1, 2004 reply from Bob Jensen
Hi Paul,
During one of the early JAR conferences that I
attended had an assistant professor present a behavioral research study. A
noted psychologist, also from the University of Chicago, Sel Becker, was
assigned to critique the paper.
Sel got up and announced words to the affect that
this garbage wasn't worth discussing.
I'm not condoning the undiplomatic way Sel treated a
colleague. But this does support your argument as to why experts from other
disciplines were no longer invited to future JAR conferences.
Paul makes some
excellent points. Sociologists are interesting to listen to because they tend
to get folks' backs up (and if they didn't want to do that they probably
wouldn't be sociologists in the first place). That's especially the case in
accounting where both the profession and the academics are (with notable
exceptions) hidebound in their own way. If you want a new perspective on
things, get a sociologist to comment, throw away any half of what's been said
and the remainder will still be an interesting pathway to further thought,
whichever half you choose.
The scorn that
certain academics in other areas show for accounting academics (and indeed,
business academics in general) may be justified (sometimes? often?)- but
no-one ever built bridges out of scorn. I think that if Sel Becker was really
interested in advancing the cause of academic enquiry he would have figured
out that whatever was going on was, from his point of view, an immature
contribution and taken the time to give his views on the gap between the
contribution and the issues he considered important, and identify some
"road map" to move from one position to another.
But then, Sel is a
"big, important" person. (From what I can gather), instead of taking
a little time to build bridges he indulged in a spot of academic tribalism.
Trashing a colleagues paper (isn't that something a noted member of the
Rochester School was famous for?) is cheap in terms of effort and may generate
some petty self-satisfaction; it may even be justified if the presenter is
arrogant in turn -but again, arrogance is a destroyer rather than a builder.
On the other hand,
the JAR reaction is just as bad if not worse. Closing one's ears to
criticism will only lead to the prettification of the academy; the dogmatists
will have won.
Question - is there a
way of enticing the various parties out of their bunkers ? If there is, what
are the chances that the "generals" of the profession and academia
won't use their power to squash the proposals of the "subalterns" ?
Some years ago a
University of Alberta prof. had the temerity to suggest that the local oil
companies' financial statements weren't all that they should have been. He was
promptly jumped on from every direction. Why ? I suspect, because there is a
general (not inevitably true) assumption that business schools are the
"cash cows" of the university, and other academics tolerate them on
that basis. (Nowadays, pharmaceutical research departments seem to be vying
for that label). Maybe the only way out is poverty; poor accounting profs will
have less to lose and more reason to explore..
Regards - tongue
partly in cheek,
Roger Roger
Collins
UCC (soon to be TRU) School of Business.
Good question. We won't
be able to do that in the US until we change the structure of the AAA. I was on
Council when the great debate over Accounting Horizons occurred. Jerry Searfoss,
a person who served time on both sides of the chasm, was a vigorous proponent
for creating a medium through which academe and practice could communicate. If
you peruse the editorial board of the first issues of Horizons, it reflected
this eclectic approach to scholarship. What happened to it? Look at Horizons
now. Its editorial board looks just like the editorial board at The Accounting
Review and its editor is a University of Chicago PhD! The AAA has a particular
structure -- an organizational culture that reproduces itself generation after
generation. Horizons, as originally conceived by people like Searfoss, Sack,
Mautz, etc., posed a threat to the overwhelmingly anal retentive, ideological
commitments (the shadow of William Paton still chills the intellectual climate
of the US academy) of the organization. Anti-bodies were quickly mobilized and,
voila, Horizons looks just like TAR (two years ago a plan to eliminate Horizons
and Issues and roll them into one ill-defined journal was proposed). This body
will protect itself at all costs (even declining membership, banal research,
etc. will not dissuade them from jumping over the cliff).
The only way to
change that is to create a structure that fosters a place where Sel Beckers
and Big 4 partners can say what they have to say IN PRINT and be forced to
defend it as often as the Dopuchs, Demskis, Watts and Zimmermans, and
Schippers of the world (who never have to defend themselves in print). That
will only happen when the selection of executive committees, editors, etc. is
democratic. As long as the Politburo structure of the AAA exists and the
culture of fear and suspicion of ideas remains, nothing will change. Good
models for what the journals should look like are the proceedings of
conferences like Tinker's Critical Perspectives conference, Lee Parker's APIRA,
and the IPA sponsored by Manchester. Those conferences are so much more
exhilirating than the AAA meetings. I'm like Jagdish -- I Go to AAA to see old
friends and work for the Public Interest Section. The "technical"
sessions are of little interest. When the AAA gives Seminal Contribution
Awards to "contributions" lifted wholesale from the radical Lockean/monetarist
wing of economics, how can you take such an organization seriously. This is
particularly true when there are genuinely seminal contributions possessed by
the discipline itself, e.g., Ijiri's work, Paton's Accounting Theory, Andy
Stredry's budget work, Bill Cooper's QM applications, Sterling/Edwards and
Bell/Chambers, etc. (the copyrights on these tell you how long it has been
since accounting acted like an autonomous discipline!).
PFW
December 2 reply from Paul Williams
(after a request that he elaborate on Bill Paton)
While Carl Devine was
still alive, I used to visit him whenever I could. When Jacci Rodgers and I did
our work on editorial boards at The Accounting Review I consulted Carl about how
the review process worked at TAR since the first time TAR published the members
of an editorial board was 1967 (I beleive). According to Carl, Paton edited TAR
for many years after its founding via a process that was, shall we say, less
than transparent. According to Carl, Paton and Littleton between them virtually
hand picked the AAA presidents for years. You can see a pattern of early
presidencies -- one president not from one of the elite 15, then two from, then
one, etc. This encouraged the illusion that the AAA was open to everyone, but in
fact it was pretty tightly controlled. Now there is no attempt whatsoever to
create the illusion of an open organization -- every president for the last 30
years (save one or two) is an elite school grad. It was never permitted to veer
too far from the nucleus of schools that founded it.
Everyone should be
familiar with Paton's politics -- he was conservative in the extreme (he
published a book that was a rather rabid screed on the evils of Fabian
socialism). There were competing root metaphors for accounting during the era of
Paton, e.g., the institutionalism of DR Scott (whose spin on the role of
accounting seems prescient now that we have a few years separating us from him),
there was the accounting as fulfilling social needs of Littleton etc. But what
clearly has emerged triumphant was the radical free market ideology of Paton.
So, even though accounting seems clearly part of the regulatory apparatus and
part of the justice system in the US, the language we use to talk about what
accountants are for is mainly that of efficent markets, rational economic
actors, etc. No wonder Brian West is able to build such a persuasive case that
accounting currently has no coherent cognitive foundation, thus, is not a
"learned" profession. Accounting enables market functions in a world
of economic competitors whose actions are harmoniously coordinated by the magic
fingers of invisible hands (a metaphor that Adam Smith didn't set too much stock
in -- it was merely an off-hand remark to which he never returned). Carl Devine
has a very useful essay in Essays in Accounting theory, volume six, edited by
Harvey Hendrickson (Garland) where he provides an insightful analysis of the
contributions to theory of those persons of his generation and his generation of
mentors (he particularly admired Mattesich.)
Carl noted that Paton
was a very effective rhetorician, so was perhaps more influential than his ideas
really merited (like the relative influence of the contemporaries Malthus and
Ricardo; Ricardo, the much better writer overshadowed Malthus in their day).
Paton influenced a disproportionate number of the next generation of accounting
academics; he was, after all, a classicaly trained economist.
There is, in my view,
absolutely no compelling reason why accountants should be the least bit
concerned with new classical economic theory, but Paton, because of his
influence, set the US academy on a path that brings us to where we are today. It
is an interesting thought experiment (ala Trevor Gambling's buddhist accounting)
to imagine what we would be doing and talking about if we had taken the
institutionalists, or Ijiri's legal imagery more seriously. But, as they say
here in NC, "It is what it is."
PFW
December 2, 2004 reply from Bob Jensen
Bill
Paton was all-powerful on the Michigan campus and was considered
an economist as well as an accountant. For
a time under his power, a basic course in accounting was in the common core
for all majors.One of the
most noted books advocating historical cost is called Introduction
to Corporate Accounting Standards by William Paton
and A.C. Littleton (Sarasota: American Accounting Association, 1940).
Probably no single book has ever had so much influence or is more widely cited
in accounting literature than this thin book by Paton
and
Littleton
.See http://faculty.trinity.edu/rjensen//theory/00overview/theory01.htm#UnderlyingBases
Later
on Paton changed horses and was apologetic about
once being such a strong advocate of historical cost. He
subsequently favored fair value accounting, while his co-author clung to
historical cost. However, Paton
never became widely known as a valuation theorist compared to the likes of
Edwards,
Bell
, Canning, Chambers, and
Sterling
.(In case you did not know this,
former FASB Board Member and SEC Chief Accountant Walter Scheutz
is also a long-time advocate of fair value accounting.)
Paton wrote many books and articles on many
issues over his long life, but he rarely changed his mind. One writer
who did effect a temporary change was Littleton, who persuaded him to
give up the idea of ‘value’ in accounting, as it was the self-evident
source of his problems.
A.C. Littleton
Littleton’s main contribution
to the debate was his argument that accounting could achieve its primary
aim of accountability and avoid the Scylla of the LTV and the Charybdis
of economic value, if accounting theorists abandoned the search for a
theory of value, and focused on controlled use-values, but, without one,
he failed to resolve any fundamental questions of practice.
Littleton dismisses any role
for Fisherian economic value in accounting. Failure to sharply
distinguish between economic value and price, he says, "makes for
confusion" (1929, p.148).(
Littleton says this ‘confusion’ existed in 1929 "as it did in the
lifetime of Adam Smith and David Ricardo" (1929, p.148), studiously
ignoring Marx who claimed to have removed precisely these confusions.)
To remove it, Littleton points out
that ‘value’ is subjective and ‘price’ is objective. "Value is a
subjective estimate of an article’s relative importance; price, however,
is a compromise between such subjective estimates and is measured by the
quantity of money for which an article is exchanged…; a value, however,
can exist in one mind alone" (Littleton, 1929, p.149). However, if price
is objective value, this raises the question, an objective value of
what? Littleton goes out of his way to stifle the idea that this value
is a commodity’s labour value, to distance himself from any association
with the LTV. It is, as he said, "easy to see how…some writers feel that
profit represented a certain portion of income created by labor but
retained by enterprisers or the result of a superior bargaining power on
the part of proprietors" (Littleton, 1928, p.281). He naturally
dismissed "the old idea that [value] was stored up labor of the past"
(1929, p.149), "that cost is the basis of value", and Marx’s idea that
capitalists set prices to return them at least the required return on
capital, the idea that price = cost + profit:
"Much of the loose usage of ‘value’ in
accountancy may perhaps be due to the generally held view that value
in business has a cost base, that Price = Cost + Profit. As a matter
of fact: Price – Cost = Profit. …[I]f cost is a proper basis for the
inventory of a stock of unsold goods it must be for other reasons
than that it express the value of the goods. As an expression of the
investment
in goods, cost is quite acceptable, but not as an
expression of their value…[,] a record of
recoverable
outlay, and not a record of values. …What they are
worth
will depend upon future circumstances" (1929, pp.150-152).
Although Littleton was unwavering in defense
of historical cost as the main basis of financial reporting and defended his
"costs attach" theory in the Paton and Littleton (1940) monograph, Bill
Paton later withdrew his strong support of the "costs attach" justification
for historical cost and the importance of matching revenues earned with the
costs attached to the product or service being sold. You can find various
references to this effect in Accounting History Newsletter,
1980-1989 and Accounting History, 1989-1994: A Tribute to Robert William
Gibson, by Garry Carnegie, Peter W. Wolnizer (Editor): (Taylor and
Francis, 1996) ---
Click Here
http://snipurl.com/patonrecant [books_google_com]
It should be noted that Bill Paton was in an
advocate of "value accounting" clear back in his 1922 Accounting
Theory, but I take this to be replacement cost rather than exit value
later advocated by MacNeal in 1939 and Chambers and Sterling in the 1960s.
In his famous (prior to the 1940 Paton and Littleton monograph)
Accountants Handbook (Ronald Press, 1932, Second Edition, Page 525) it
is stated:
In particular the case of specialized equipment
market value is usually little more than scrap value. That is, a
specialized machine, bolted to the factory floor, has little value apart
from the particular situation, and hence its market value, unless it is
being considered as an element of the market value of the entire
business as a going concern, is limited to net salvage ... buildings and
equipment have a "going concern value"
or "value in use" in excess of
liquidation or market value.
I've long argued that exit value
non-financial items has the drawback in that the balance sheet is no
different for a bankrupt firm as is the balance sheet of a dynamic going
concern. Who cares about exit values if there is virtually no likelihood of
liquidation of assets used in delivering a product or service?
On this vital issue, Paton and
Littleton go out of their way to distinguish their notion that ‘costs
attach’ from an anonymous "cost theory of value".
32
First, they explain the
function of accounting in monitoring the circuit of capital in a way
that Marx himself could have written:
"When production activity effects a change
in the form of raw materials by the consumption of human labour and
machine-power, accounting keeps step by classifying and summarizing
appropriate portions of materials cost, labor cost, and machine cost
so that together they become product-costs. In other words, it is a
basic concept of accounting that costs can be marshalled into new
groups that possess real significance. It is as if costs had a power
of cohesion when properly brought into contact" (Paton and
Littleton, 1940, p.13).
Rather than say that Paton recanted his
position on historical costs and the "costs attach" theory, it should be
emphasized that Paton was always a "value man" who returned to his roots
after after temporarily being influenced by the "cost man" Ananias
Littleton. Littleton never viewed costs as a measure of value. Instead they
measured sacrifices made at one historical point in time for generating
future revenues. Profits measured the efficiency and effectiveness of
managing purchased for generating those revenues, which is why Littleton
strongly advocated the cost attachment to those resources until they were
used up or otherwise disposed of in operations.
Using MAAW and Jstor for Accounting History Research
A summary of what historical research can be like on the Web
How I found a very, very interesting "Statement by William A. Paton" when he was
91 year old.
The point I was
trying to make there was the approach to theory building in accounting
(something that crudely initates the axiomatic approach) that Paton
essentially started. However, Paton had a "theory" in the sense of a
set of axioms, but no theorems. In other words it was a sort of laundry list
of axioms with out a detailed study of their collective implications (this is
what struck me most while I was a student, but that might have been my problem
since I came to accounting via applied mathematics/statistics). In fact most
of the work of Paton & Littleton, Ijiri, Sprouse & Moonitz,... never
really followed through their thoughts to their logical conclusions. One
reason might have been that they did not really state their axioms in logic.
Mattesich, as I understand, went a bit further, but he must have realised that
a field like accounting where most sentences are deontic (normative, stated in
English sentences in the imperative mood) rather than alethic (descriptive,
stated in English sentences in the indicative mood). In normative systems, as
even Hans Kelsen has admitted, there is no concept of truth and therefore
logical deduction as we know it is not possible.
I think this becomes
clear in one of the later books of Mattesich on Instrumental Reasoning (all
but ignored by accountants because it is more philosophical, but in my opinion
one of his most fascinating works).
I would not put Paul
Grady, Carman Blough,... in the same group. For Paul Grady, for example,
accounting "principles" were no more than a grab bag of mundane
rules.
Leonard Spacek, one
of my heroes, on the other hand, tried to emphasize accounting as
communication of rights people had to resources UNDER LAW. He also emphasized
fairness as an objective.
One reason for this
chasm between practice and academia is that almost all practice is normatively
based, whereas in the academia in accounting, for the past 40 years we have
cared just about only for descriptive work of the naive positivist kind.
I hate peddling my
work, but those interested might like to take a look at an old paper of mine
(I consider it the best that I ever wrote) where some of these issues are
discussed :
Generally Accepted
Accounting Principles: Perspectives from Philosophy of Law, J. Gangolly &
M. Hussein Critical Perspectives on Accounting, vol. 7 (1996), pp.
383-407.
I think we need to realise that we are not the only
discipline that has gone astray from the original lofty goals.
Consider economics in the United States. In Britain,
at least till the 70s (I haven't kept in touch since then), it was considered
important that Economics teaching devoid of political and philosophical
discussions was some how deficient; probably the main reason popular Oxford
undergraduate major is PPE (Politics, Philosophy, Economics, with Economics
taking the third seat). Specially in the US, attempts to make Economics
value-free (wertfrei) have, to an extent also succeeded in making it a bit
sterile. In his critique of Ludwig von Mises, Murray Rothbard ("Praxeology,
Value Judgments, and Public Policy") states:
"The trouble is that most economists burn to
make ethical pronouncements and to advocate political policies - to say, in
effect, that policy X is "good" and policy Y "bad."
Properly, an economist may only make such pronouncements in one of two ways:
either (1) to insert his own arbitrary, ad hoc personal value judgments and
advocate policy on that basis; or (2) to develop and defend a coherent ethical
system and make his pronouncement, not as an economist, but as an ethicist,
who also uses the data of economic science."
Or, that Economics is the "value-free handmaiden
of ethics".
In accounting too, the positivists have worked hard
over the past forty years or so to make it pretentiously value-free (remember
disparaging references to non-descriptive work, and Carl Nelson's virtual
jihad to rid accounting of "fairness" as an objective?). The result
has been that it is perhaps not unfair to speak of "fair" in the
audit reports just cheap talk.
Renaissance in accounting will come only when we look
as much at Politics and Law as at Economics to inspire research.
Jagdish
December 3, 2004 reply from Paul Williams
For many subscribers this thread may have started to
fray; to them I apologize, but I have to chime in to add a contrarian view to
Bob's contention that Paton, Edwards and Bell ,etc. were advocates of fair value
accounting. Fair value accounting is (in my view) a classic case of eliding into
a use of a concept as if it were what we traditionally understood it to be while
radically redefining it (see Feyerabend's analysis of Galileo's use of this same
ploy). None of the early theorists were proponents of fair value
accounting.
They may have been advocates of replacement cost or
opportunity cost, but never of "fair value," which is a purely
hypothetical number generated through heroic assumptions about an undivinable
future. As Carl Devine famously said, "No one has ever learned anything
from the future." All subscribed to the principle that accounting should
report only what actually occurred during a period of time -- this was the
essence of E&B's argument that accounting data are for evaluating decisions;
its value lies in its value as feedback and accounting data, therefore,
categorically should not be generated on assumptions about the outcomes
resulting from decisions that have already been made. The significant
accomplishment of these theorists was to provide a defense of accounting's
avoidance of subjective values. i.e., the accounting was in its essence
objective (anyone remember Five
Monographs on Business Income, particularly Sidney
Alexander's critique of accounting measures of profit?). Now we accept seemingly
without question the radical transformation of accounting affected by FASB to a
system of nearly exclusively subjective values, i.e., your guess is as good as
mine. In spite of the optimism people seem to express, we have no technology
(nor would a believer in rational expectations theory ever expect there to be)
that can divine the economic future. Perhaps a renaissance of some of these old
ideas is overdo. I believe it was Clarence Darrow who opined that "Contempt
for law is brought about by law making itself ridiculous." As writers of
LAW (kudos to Jagdish's paper) the FASB seems to make accounting more ridiculous
by the day.
PFW
December 3, 2004 reply from David Fordham
For those who don't know, Paul is an FSU alum, and
Bob is a former Seminole, too, although they pre-dated me and may have had
some professional interaction with Carl Devine. ...
David Fordham
December 3, 2004 reply from Bob Jensen
Hi David,
I arrived on the faculty at FSU in 1978. Carl was a recluse for all
practical purposes. I don' think anybody had contact with him except a very
devoted Ed McIntyre. Paul Williams was very close to Ed and may also have had
some contact. (Paul later reminded me that Carl grew interested in
discussing newer directions with Ed Arrington.)
I think Carl was still actively writing and to the walls. His labor of love
may have been lost if Ed and Paul didn't strive to share Carl's writings with
the world. Carl was a classic scholar who'd lived most of his life in
libraries.
Carl could've added a great deal to our intellectual growth and historical
foundations if he participated in some of our seminars. He was a renaissance
scholar.
It would've been interesting to know how Carl's behavior might've changed
in the era of email. Scholars who asked him challenging questions might've
gotten lengthy replies (Carl was not concise) that he would not provide
face-to-face.
It almost seems there's a consensus on the AECM
listserv on all this! Given the widespread interest and existng intellectual
wherewithal among AECMs to do it, maybe it's time to start up the
"Journal of Neo-Classical Accounting Theory"? Revisiting Edwards,
Bell, Sterling, Chambers, Paton, et al. certainly seems worthwhile; especially
if it can be fit into or reconciled with the more recent literature in
accounting and finance.
December 1, 2004 reply from Glen Gray [glen.gray@CSUN.EDU]
Your story does surprise me. A few years ago I
convinced Barry Melancon (President) and Louis Matherne (at that time,
Director of IT) from the AICPA to come to L.A. and speak at a dinner meeting
of the L.A. chapter of the California Society of CPAs. The meeting was at
UCLA, not my campus, however, the chapter offered to waive the $35 dinner
charge for any CSUN faculty who want to attend. Other than myself, one (out of
about 20) other faculty member attended the dinner. I asked some of the
faculty members why they did not attend. The most common answer was something
like “We know what he (Barry) is going to say—use more computers in your
accounting courses.”
First, I agree with
the gist of your sentiment. Hanging around real world accountants can inform
both our teaching and research, and most of us underinvest in such activities.
Second, the effect of
"citizenship" considerations looks like an easy cost-benefit
tradeoff to me. Seminars are attended only by faculty and doctoral students,
so one's presence in the room is more noticable for a research seminar than a
presentation attended by lots of undergraduates. Furthermore, the personal
cost of attending a daytime event is much less than a nightime event. So if
one is driven by citizenship considerations, I expect many more faculty to
attend the daytime research seminar than the nightime practitioner
presentation.
Richard C.
Sansing
Associate Professor of Business Administration
Tuck School of Business at Dartmouth
email: Richard.C.Sansing@dartmouth.edu
December 1, 2004 reply from Chuck Pier [texcap@HOTMAIL.COM]
Dennis,
I think that you have put your finger on, or maybe
stumbled onto, one of the major splits in academic accounting today. You
happen to be looking at this situation from one of the "research"
universities. Most all of us (I use the term "us" to refer to
academic accountants) have been associated with a research university.
However, many of us have only been there as students during our doctoral
studies. These universities place heavy premiums on both their faculties and
students for what we call "basic research" that is quite replete
with formulas and theories and the like. Faculty are tenured, promoted and
financially rewarded to produce cutting edge research that is published in the
top journals, and doctoral students are judged on their ability to analyze and
conduct similar research.
On the other hand, many of "us" teach in
"teaching universities" that place more emphasis on teaching and
"professional" research. In other words, research that has a direct
application to either the accounting profession or the teaching of accounting.
There is usually not a penalty exerted on those who chose to do the more
academic research, but there is also not any special rewartds for that
research either.
I feel that many of "us" at teaching
schools attend the lectures that you describe with a lot more regularity than
your experience at your university. For example, at my school we have a weekly
meeting during the fall of our Beta Alpha Psi chapter that inculeds a
presentation on a topic by one of the firms in our area. These firms include
all of the big four, as well as other national, regional, and local firms. The
presentations run the gamut from interview techniques for the students to the
latest updates on SOX or forensic accounting. As with any sample, some are
better than others and many are appropriate to just the students. Despite the
uneveness of the presentations I would estimate that at least 80% of our
tenure track faculty are at each meeting, with the missing 20% having some
other engagement and unable to attend. There is not a single member of our
faculty that routinely does not attend. These meetings are not mandatory, but
most of us feel that it supports both or students and the presenters, who hire
our students to attend.
I am not trying to indite or point fingers at either
side of the academic accounting community but it is obvious that we each have
separate priorities. I for one chose the institution that I am at for the very
reason that we do have a heavy emphasis on the practioneer and the
undergraduate student. I know that many would abhor what I do and could not
picture themselves here. They, like me have decided what they like and what
they are best suited for. I do feel that at times we who are not at the big
research schools feel that we are overlooked, but I wouldn't trade my place
with anyone else. I think that I am providing a good service and enjoy the
opportunities that it presents.
Interesting. I too came from a math background and
finally realized there was no accounting theory in the scientific sense. I also
came to suspect it was not a system of measurement either because to be so,
there has to be something to measure independent of the measuring tool. Rather
it seemed to me accounting defined, for instance, income rather than measured
it.
Robin Alexander
December 3, 2004 reply from Bob Jensen
Hi Robin,
I think the distinction lies not so much on "independence" of the
measuring tool as it does on behavior induced by the measurements themselves,
although this may be what you had in mind in your message to us.
Scientists measure the distance to the moon without fear that behavior of
either the earth or the moon will be affected by the measurement process.
There may some indirect behavioral impacts such as when designing fuel tanks
for a rocket to the moon. In natural science, except for quantum mechanics,
the measurers cannot re-define the distance to the moon for purposes of being
able to design smaller fuel tanks.
In economics, and social science in general, behavior resulting from
measurements is often more impacted by the definition of measurement itself.
Changed definitions of inflation or a consumer price index might result in
wealth transfers between economic sectors. Plus there is the added problem
that measurements in the social sciences are generally less precise and
stable, e.g., when people change behavior just because they have been
"measured" or diagnosed.
Similarly in accounting, changed definitions of what goes into things like
revenue, eps, asset values, and debt values may lead to wealth transfers. The
Silicon Valley executives certainly believe that lowering eps by booking stock
options will affect share prices vis-a-vis merely disclosing the same
information in a footnote rather than as a booked expense. Virtually all
earnings management efforts on the part of managers hinges on the notion that
accounting outcomes affect wealth transfers. In fact if they did not do so,
there probably would not be much interest in accounting numbers See
"Toting Up Stock Options," by Frederick Rose, Stanford Business,
November 2004, pp. 21 --- http://www.gsb.stanford.edu/news/bmag/sbsm0411/feature_stockoptions.shtml
Early accounting theorists such as Paton, Littleton, Hatfield, Edwards,
Bell, Chambers, etc. generally believed there was some kind of optimal set of
definitions that could be deduced without scientifically linking possible
wealth transfers to particular definitions. And it is doubtful that subsequent
events studies in capital market empiricism will ever solve that problem
because human behavior itself is too adaptive. Academic researchers are still
seeking to link behavior with accounting numbers, but they're often viewed as
chasing moving windmills with lances thrust forward.
Auditors are more concerned about being faithful to the definitions. If the
definition says book all leases that meet the FAS 13 criteria for a capital
lease, then leases that meet those tests should not have been accounted for as
operating leases. The audit mission is to do or die, not to question why. The
FASB and other standard setters are supposed to question why. But they are
often more impacted by the behavior of the preparers than the users. The
behavior of preparers trying to circumvent accounting standards seems to have
more bearing than the resulting impacts on wealth transfers that defy being
built into a conceptual framework. Where science fails accounting in this
regard is that the wealth transfer process is just too complicated to model
except in the case of blatant fraud that lines the pockets of a villain.
It is not surprising that accounting "theory" has plummeted in
terms of books and curricula. Theory debates never seem to go anywhere beyond
unsupportable conjectures. I teach a theory course, but it has degenerated to
one of studying intangibles and how preparers design complex contracts such as
hedging and SPE contracts that challenge students into thinking how these
contracts should be accounted for given our existing standards like FAS 133
and FIN 46. One course that I would someday like to teach is to design a new
standard (such as a new FAS 133) and then predict how preparers would change
behavior and contracting. Unfortunately my students are not interested in wild
blue yonder conjectures. The CPA exam is on their minds no matter where I try
to fly. They tolerate "theory" only to the point where they are also
learning about existing standards. In their minds, any financial accounting
course beyond intermediate should simply be an extension of intermediate
accounting.
The Financial Accounting Standards Board and the
International Accounting Standards Board have joined forces to flesh out a
common conceptual framework. Recently they issued some preliminary views on
the "objectives of financial reporting" and the "qualitative characteristics
of decision-useful financial reporting information" and have asked for
comment.
To obtain "coherent financial reporting," the
boards feel that they need "a framework that is sound, comprehensive, and
internally consistent" (paragraph P3). In P5, they also state their hope for
convergence between U.S. and international accounting standards.
P6 indicates a need to fill in certain gaps, such
as a "robust concept of a reporting entity." I presume that they will
accomplish this task later, as the current document does not develop such a
"robust concept."
Chapter 1 presents the objective for financial
reporting, and the description differs little from what is in Concepts
Statement No. 1. This objective is "to provide information that is useful to
present and potential investors and creditors and others in making
investment, credit, and similar resource allocation decisions." The emphasis
lay with capital providers, as it should. If anything, I would place greater
accent on this aspect, because in the last 10 years, so many managers have
defined the "business world" as including managers and excluding investors
and creditors. To our chagrin, we learned that managers actually believed
this lie, as they pretended that the resources supplied by the investment
community belonged to the management team.
FASB and IASB further explain that these users are
interested in the cash flows of the entity so they can assess the potential
returns and the potential variability of those returns (e.g., in paragraph
OB.23). I wish they had drawn the logical conclusion that financial
reporting ought to exclude income smoothing. Income smoothing leads the user
to assess a smaller variance of earnings than warranted by the underlying
economics; income smoothing biases downward the actual variability of the
earnings and thus the returns.
Later, in the basis of conclusions, the document
addresses the reporting of comprehensive income and its components (see
BC1.28-31). Currently, FASB has four items that enter other comprehensive
income: gains and losses on available-for-sale investments, losses when
incurring additional amounts to recognize a minimum pension liability,
exchange gains and losses from a foreign subsidiary under the all-current
method, and gains and losses from derivatives that hedge cash flows.
The purported reason for this demarcation between
earnings and other comprehensive income rests with the purported low
reliability of measurements of these four items; however, the real reason
for these other comprehensive items seems to be political. For example, FASB
capitulated in Statement No. 115 when a number of managers objected to
reporting gains and losses on available-for-sale securities because that
would create volatility in earnings. (I find it curious how FASB caters to
the whims of managers but claims that the primary rationale for financial
reporting is to serve the investment community.) Because one has a hard time
reconciling other comprehensive income with the needs of investors and
creditors, it would serve the investment community better if the boards
eliminate this notion of comprehensive income.
Two IASB members think that an objective for
financial reporting should encompass the stewardship function (see AV1.1-7).
Stewardship seems to be a subset of economic usefulness, so this objection
is pointless. It behooves these two IASB members to explain the consequences
of adopting a stewardship objective and how these consequences differ from
the usefulness objective before we can entertain their protestation
seriously.
Sections BC1.42 and 43 ask whether management
intent should be a part of the financial reporting process. Given management
intent during the last decade, I think decidedly not. Management intent is
merely a license to massage accounting numbers as managers please.
Fortunately, the Justice Department calls such tactics fraud.
Chapter 2 of this document concerns qualitative
characteristics. For the most part, this presentation is similar to that in
Concepts Statement No. 2, though arranged somewhat differently. Concepts 2
had as its overarching qualitative characteristics relevance and
reliability. This Preliminary Views expounds relevance, faithful
representation, comparability, and understandability as the qualitative
characteristics.
The discussion on faithful representation is
interesting (QC.16-19) inasmuch as they distinguish between accounts that
depict real world phenomena and accounts that are constructs with no real
world referents. They explain that deferred debits and credits do not
possess faithful representation because they are merely the creation of
accountants. I hope that analysis applies to deferred income tax debits and
credits.
Verifiability implies similar measures by different
measurers (QC.23-26). I wish FASB and IASB to include auditability as an
aspect of verifiability; after all, if you cannot audit something, it is
hardly verifiable. Yet, the soon to be released standard on fair value
measurements includes a variety of items that will prove difficult if not
impossible to audit.
Understandability is obvious, though the two boards
feel that users with a "reasonable knowledge of business and economic
activities" can understand financial statements. I no longer agree. Such a
person might employ a profit analysis model or ratio analysis on a set of
financial statements and mis-analyze a firm's condition because he or she
did not make analytical adjustments for off-balance sheet items and other
fanciful tricks by managers. This includes so many of Enron's investors and
creditors. No, to understand financial reporting today, you must be an
expert in accounting and finance.
Benefits-that-justify-costs acts as a constraint on
financial reporting. While this criterion is acceptable, too often the
boards view costs only from the perspective of the preparers. I wish the
boards explicitly acknowledged the fact that not reporting on some things
adds costs to users. When a business enterprise engages in aggressive
accounting, the expert user needs to employ analytical adjustments to
correct this overzealousness. These adjustments consume the investor's
economic resources and thus involve costs to the investment community.
In the basis-for-conclusions section, FASB and IASB
explain that the concept of substance over form is included in the concept
of faithful representation (see paragraphs BC2.17 and 18). While I don't
have a problem with that, I think they should at least emphasize this point
in Chapter 2 rather than bury it in this section. Substance over form is a
critically important doctrine, especially as it relates to business
combinations and leases, so it deserves greater stress.
On balance, the document is well written and
contains a good clarification of the objective of financial reporting and
the qualitative characteristics of decision-useful financial reporting
information. I offer the criticisms above as a hope to strengthen and
improve the Preliminary Views.
My most important comment, however, does not
address any particular aspects within the document itself. Instead, I worry
about the usefulness of this objective and these qualitative characteristics
to FASB and IASB. To enjoy coherent financial reporting, there not only is
need for a sound, comprehensive, and internally consistent framework, we
also must have a board with the political will to utilize the conceptual
framework. FASB ignored its own conceptual framework in its issuance of
standards on:
* Leases (Aren't the financial commitments of the
lessee a liability?) * Pensions (How can the pension intangible asset really
be an asset as it has no real world referent?) * Stock options (Why did the
board not require the expensing of stock options in the 1990s when stock
options clearly involve real costs to the firm?), and * Special purpose
entities (Why did the board wait for the collapse of Enron before dealing
with this issue?).
Clearly, the low power of FASB -- IASB likewise
possesses little power -- explains some of these decisions, but it is
frustrating nonetheless to see the board ignore its own conceptual
framework. Why engage in this deliberation unless FASB is prepared to follow
through?
J. EDWARD KETZ is accounting professor at The Pennsylvania
State University. Dr. Ketz's teaching and research interests focus on
financial accounting, accounting information systems, and accounting ethics.
He is the author of
Hidden Financial Risk, which explores the causes of recent
accounting scandals. He also has edited
Accounting Ethics, a four-volume set that explores ethical
thought in accounting since the Great Depression and across several
countries.
A different way to think about ... Professional
Education This month's Carnegie Perspective is written by Carnegie Senior
Scholar William Sullivan, whose extensively revised second edition of Work and
Integrity was just released by Jossey-Bass. The Perspective is based on the
book's argument that in today's environment of unrelenting economic and social
pressures, in which professional models of good work come under increasing
strain, the professions need their educational centers more than ever as
resources and as rallying points for renewal.
Since our goal in Carnegie Perspectives is to
contribute to the dialogue on issues and to provide a different way to think
and talk about concerns, we have opened up the conversation by creating a
forum—Carnegie Conversations—where you can engage publicly with the author
and read and respond to what others have to say.
However, if you would prefer that your comments not
be read by others, you may still respond to the author of the piece through CarnegiePresident@carnegiefoundation.org
.
If you would like to unsubscribe to Carnegie
Perspectives, use the same address and merely type unsubscribe in the subject
line of your email to us.
We look forward to hearing from you.
Sincerely,
Lee S. Shulman President
The Carnegie Foundation for the Advancement of Teaching
Preparing Professionals as Moral Agents By William
Sullivan
Breakdowns in institutional reliability and
professional self-policing, as revealed in waves of scandals in business,
accounting, journalism, and the law, have spawned a cancerous cynicism on the
part of the public that threatens the predictable social environment needed
for a healthy society. For professionals to overcome this public distrust,
they must embrace a new way of looking at their role to include civic
responsibility for themselves and their profession, and a personal commitment
to a deeper engagement with society.
The highly publicized unethical behavior that we see
today by professionals is still often thought by many—physicians, lawyers,
educators, scientists, engineers—as "marginal" matters in their
fields, to be overcome in due course by the application of the value-neutral,
learned techniques of their profession. But this conventional view fails to
recognize that professionals' "problems" arise outside the sterile,
neutral and technical and instead lie within human social contexts. These are
not simply physical environments or information systems. They are networks of
social engagement structured by shared meanings, purposes, and loyalties. Such
networks form the distinctive ecology of human life.
For example, a doctor faced with today's lifestyle
diseases—obesity, addictions, cancer, strokes—rather than with infectious
biological agents, soon realizes that he or she must take into account how
individuals, groups, or whole societies lead their lives. Or in education, it
is often assumed that schools can improve student achievement by setting clear
standards and then devising teaching techniques to reach them. But this
approach has been confounded when it encounters students who do not see a
relationship between academic performance and their own goals, or when the
experience of students and parents has made trusting school authorities appear
a dubious bargain.
In order to "solve" the apparently
intractable problems of health care, education, public distrust, or developing
a humane and sustainable technological order, the strategies of intervention
employed by professionals must engage with, and if possible, strengthen, the
social networks of meaning and connection in people's lives—or their efforts
will continue to misfire or fail. And not only will they be less effective in
meeting the needs of society and the individuals who entrust their lives to
their care, but they will also find in their midst colleagues who do not
uphold the moral tenets of the profession.
The idea of the professional as neutral problem
solver, above the fray, which was launched with great expectations a century
ago, is now obsolete. A new ideal of a more engaged, civic professionalism
must take its place. Such an ideal understands, as a purely technical
professionalism does not, that professionals are inescapably moral agents
whose work depends upon public trust for its success.
Since professional schools are the portals to
professional life, they bear much of the responsibility for the reliable
formation in their students of integrity of professional purpose and identity.
In addition to enabling students to become competent practitioners,
professional schools always must provide ways to induct students into the
distinctive habits of mind that define the domain of a lawyer, a physician,
nurse, engineer, or teacher. However, the basic knowledge of a professional
domain must be revised and recast as conditions change. Today, that means that
the definition of basic knowledge must be expanded to include an understanding
of the moral and social ecology within which students will practice.
Today's professional schools will not serve their
students well unless they foster forms of practice that open possibilities of
trust and partnership with those the professions serve. Such a reorientation
of professional education means nothing less than a broadening and rebalancing
of professional identity. It means an intentional abandonment of the image of
the professional as superior and detached problem-solver. It also requires a
positive engagement. Professional education must promote the opening of
professional life to meet clients and patients as also fellow citizens,
persons with whom teachers, physicians, lawyers, nurses, accountants,
engineers, and indeed all professionals share a larger, common
"practice"—that of citizen, working to contribute particular
knowledge and specialized skills toward improving the quality of life, perhaps
especially for those most in need.
Professional schools have too often held out to their
students a notion of expert knowledge that remains abstracted from context.
Since the displacement of apprenticeship on the job by academic training in a
university setting, professional schools have tilted the definition of
professional competence heavily toward cognitive capacity, while downplaying
other crucial aspects of professional maturity. This elective affinity between
the academy's penchant for theoretical abstraction and the distanced stance of
problem solving has often obscured the key role played by the face-to-face
transmission of professional understanding and judgment from teacher to
student. This is the core of apprenticeship that must not be allowed to wither
from lack of understanding and attention.
A new civic awareness within professional preparation
could go a long way toward awakening awareness that the authentic spirit of
each professional domain represents more than a body of knowledge or skills.
It is a living culture, painfully developed over time, which represents at
once the individual practitioner's most prized possession and an asset of
great social value. Its future worth, however, will depend in large measure on
how well professional culture gets reshaped to answer these new needs of our
time
"The Practitioner-Professor Link," by Bonita K. Peterson, Christie W.
Johnson, Gil W. Crain, and Scott J. Miller, Journal of Accountancy, June 2006
---
http://www.aicpa.org/pubs/jofa/jun2005/kramer.htm
EXECUTIVE SUMMARY
PERIODIC FEEDBACK FROM PRACTITIONERS
to faculty about the strengths and
weaknesses of their graduates and their
program can help to positively influence
the accounting profession.
CPAs ALSO CAN INSPIRE STUDENTS’
education by providing internship
opportunities for accounting students,
or serving as a guest speaker in class.
MEMBERSHIP ON A UNIVERSITY’S ACCOUNTING
advisory council permits a CPA to
interact with faculty on a regular basis
and directly affect the accounting
curriculum.
SERVING AS A “PROFESSOR FOR A DAY”
is another way a CPA can
promote the profession to accounting
students and answer any questions they
have.
CPAs CAN SUPPORT STUDENTS’ PROFESSIONAL
development by providing advice
on proper business attire and tips for
preparing resumes, and conducting mock
interviews.
CPAs CAN SHARE EXPERIENCES with
a professor to cowrite an instructional
case study for a journal, which can
reach countless students in classrooms
across the world.
ORGANIZING OR CONTRIBUTING to
an accounting education fund at the
university can help fund a variety of
educational purposes, such as student
scholarships and travel expenses to
professional meetings.
PARTICIPATION BY PRACTITIONERS
in the education of today’s accounting
students is a win-win-win situation for
students, CPAs and faculty.
Rankings of Academic Accounting Research
Journals and Schools
Questions
Do College Rankings Matter?
Should College Rankings Matter?
Existing tools and measurements could allow colleges to develop meaningful
rankings to replace widely discredited rankings developed by magazines,
according toa reportbeing
released today by Education Sector, a think tank. The report repeats criticisms
that have been made of the U.S. News & World Report rankings, saying that they
are largely based on fame, wealth and exclusivity. Anew system
might use data from the National Survey of Student Engagement and the Collegiate
Learning Assessment as well as considering new approaches to graduation rates
and retention, the report says. Current rankings reward colleges that enroll
highly prepared, wealthy students who are most likely to graduate on time. But a
system that compared predicted and actual retention and graduation rates — based
on socioeconomic and other data — would give high marks to colleges with great
track records on educating disadvantaged students, even if those rates were
lower than those of some colleges that focus only on top students. Inside Higher Ed, September 22, 2006
When person is unfamiliar with details of a school that they are to evaluate,
the elitist reputation of the university as a whole, in my viewpoint, dominates
the evaluation of the business school. For example, Princeton University does
not have a business school. If Princeton started up a business school, before
evaluators knew a single thing about that business school they would probably
rate it in the Top 20 simply because it is la la Princeton. The same thing would
never happen if one of the various St. Cecelia institutions started up a
business school. They aren't sufficiently la la la in terms of international
prestige of their universities as a whole.
I do know these rankings are important to some schools for some purposes.
Seattle University undergraduate business school comes in at Business Week's
Rank 46 in the West region, It's probably a big deal for Seattle University to
be ranked so far ahead of the University of Utah coming in at Rank 109. And
Seattle University is not all that far down from cross town "rival" --- that
immense research University of Washington that came in at Rank 33. Can these two
business schools even be compared meaningfully? Yeah I know they can be compared
on some basis, but I don't think there's any use for comparing Rank 33 with Rank
46 among the hundreds of schools being ranked by Business Week.
And its probably an embarrassment for the University of Utah that will
probably not mention its Rank 109 on its Website. The business school at Utah
might've mentioned it if it had made the Top 20. Sigh!
When Anna Poletti found out she'd had an article
accepted by the journal Biography: An Interdisciplinary Quarterly,
the young Australian scholar of life writing—autobiography, biography,
letters, and other forms of recorded experience—was thrilled. "It got me a
whole lot of attention in the field," she says, because Biography
is highly regarded by her peers.
It is not so esteemed, however, by the Australian
government. A new journal-ranking plan—which helps the government determine
how research money is doled out to universities—has dropped Biography
from the highest ranking, A*, to a lowly C. Judged that way, an association
with Biography looked like more of a career killer than a coup.
"I am actually dragging down the overall score of
my unit by publishing in a C journal," says Ms. Poletti, a lecturer in
English at Monash University—her first tenure-track job.
The ranking is part of an overall evaluation system
devised by the Australian Research Council, an agency that finances
scholarship and innovation in the country through grants and through advice
to other government departments. At stake is a share of about $1.63-billion
(U.S.), which supports a multitude of activities including academic
research, says Margaret M. Sheil, chief executive officer of the council.
The system, called Excellence in Research for Australia, helps the
government decide how much goes to a given research unit at a university.
Journal rankings are not just an Australian
phenomenon. Scholars worldwide are tangling with what Ms. Poletti calls "the
culture of audit." The United States does not have such a ranking system,
but U.S.-based researchers and journal editors find their work drawn into
such assessments anyway.
Biography, for instance, comes out of the
University of Hawaii's Center for Biographical Research. Around the world—in
Britain, South Africa, New Zealand, and elsewhere—cash-strapped governments
are experimenting with schemes to measure the quality of the academic
research they pay to support.
In Europe, the European Science Foundation is about
to release a
new round of journal rankings as part of its
European Reference Index for the Humanities. Ms. Sheil, who talks regularly
with assessors in other countries, has recently traveled to the United
States to discuss Australia's evaluation system.
Continued in article
Journal Ranking Site: Eigenfactor
Eigenfactor
ranks journals much as Google ranks websites.
It is somewhat similar to Thomson Scientific's (ISI) Journal Citation Index
(JCI), though it's dataset is larger.
Some points to note:
* JCI only looks at the 8000 or so journals indexed by Thomson Scientific
while potentially any journal could be included in Eigenfactor.
* The JCI is calculated based on the most recent 2-year's worth of citation
data; Eigenfactor is based on the most recent 5 years.
* In collaboration with
journalprices.com, Eigenfactor
provides information about price and value for thousands of scholarly
periodicals.
* Article Influence (AI): a measure of a journal's prestige based on per
article citations and comparable to Impact Factor. Eigenfactor (EF): A
measure of the overall value provided by all of the articles published in a
given journal in a year.
* The Eigenfactor Web site also presents the ISI Impact Factors, so it's
possible to compare the
ISI's "Impact Factors" with Eigenfactor's "Article Influence"
* Both simple and advanced searching is available: "You can search by
partial or full journal name, ISSN number, or you can view a selected ISI
category, only ISI-listed journals, only non-ISI-listed journals or both
listed and unlisted."
* Eigenfactor is Free!
From the Eigenfactor
Web site:
Eigenfactor provides
influence rankings for 7000+ science and social science journals and
rankings for an additional 110,000+ reference items including newspapers,
and popular magazines.
Borrowing
methods from network theory,
eigenfactor.org ranks the
influence of journals much as Google's PageRank algorithm ranks the
influence of web pages. By this approach, journals are considered to be
influential if they are cited often by other influential journals. Iterative
ranking schemes of this type, known as eigenvector centrality methods, are
notoriously sensitive to "dangling nodes" and "dangling clusters" -- nodes
or groups of nodes which link seldom if at all to other parts of the
network. Eigenfactor modifies the basic eigenvector centrality algorithm to
overcome these problems and to better handle certain peculiarities of
journal citation data.
Different
disciplines have different standards for citation and different time scales
on which citations occur. The average article in a leading cell biology
journal might receive 10-30 citations within two years; the average article
in leading mathematics journal would do very well to receive 2 citations
over the same period. By using the whole citation network, Eigenfactor
automatically accounts for these differences and allows better comparison
across research areas.
Eigenfactor.org is
a non-commercial academic research project sponsored by the Bergstrom lab in
the Department of Biology at the University of Washington. We aim to develop
novel methods for evaluating the influence of scholarly periodicals and for
mapping the structure of academic research. We are committed to sharing our
findings with interested members of the public, including librarians,
journal editors, publishers, and authors of scholarly articles.
In my opinion citation indices are quite unreliable since for-profit journal
publishing houses often urge paid editors and referees to push for citations to
journals they publish. Hence, the bibliography of many research papers becomes
somewhat artificial.
At the AAA annual meeting in San Francisco in August, 2005, Judy Rayburn
addressed the low citation rate of accounting research when compared to citation
rates for research in other fields. Rayburn concluded that the low citation rate
for accounting research was due to a lack of diversity in topics and research
methods:
Accounting research is different from other business disciplines
in the area of citations: Top-tier accounting journals in total have fewer
citations than top-tier journals in finance, management, and marketing. Our
journals are not widely cited outside our discipline. Our top-tier journals as a
group project too narrow a view of the breadth and diversity of (what should
count as) accounting research.
Rayburn [2006, p. 4]
As quoted at
http://faculty.trinity.edu/rjensen/395wpTAR/Web/TAR395wp.htm
Her data was derived from a Texas !&M study headed up by Ed Swanson.
Journal rankings greatly affect tenure and promotion decisions and annual
performance evaluations in virtually all top North American universities. Many
universities, however, have customized rankings developed by their own faculty
members. For example, the University of Texas at Dallas has a very unique
ranking system in its college of business that results in its program ranking in
the top 10 in the nation with respect to research (I'm not certain if UT Dallas
still publishes this controversial ranking system that, in my viewpoint, cherry
picked the journals to receive highest priority).
It's probably an embarrassment for Southern Methodist to fall from grace
according to Business Week graduate business rankings? But its fall from
grace in football is probably more of an embarrassment to alumni of SMU.
To begin the ranking process, we sent a 50-question
survey to 17,941 MBA graduates from the Class of 2010 at 101 schools in
North America, Europe, and Asia. We received 9,827 responses for a response
rate of 55 percent. In 2008,
Harvard
Business School (Harvard
Full-Time MBA Profile) and the University of
Pennsylvania's
Wharton School (Wharton
Full-Time MBA Profile) declined to provide student
contact information for our survey; this year all 101 schools helped us
contact grads, either by supplying e-mail addresses or distributing the
survey invitations to students on our behalf.
The Web-based survey asks graduates to rate their
programs according to teaching quality, the effectiveness of career
services, and other aspects of their b-school experience, using a scale of 1
to 10. The Class of 2010 survey results count for 50 percent of each
school's total student satisfaction score. Our 2008 survey, which polled
16,704 graduates, and our 2006 survey, which polled 16,565, each count for
an additional 25 percent. Using six years' worth of survey data encompassing
26,389 individual responses effectively ensures that short-term issues,
problems, and improvements won't skew results.
Next we asked David M. Rindskopf and Alan L. Gross,
professors of educational psychology at City University of New York Graduate
Center, to analyze the data. The idea was to ensure that the results were
not marred by any attempts to influence student responses or otherwise
affect the outcome. The professors tested the responses to verify the data's
credibility and to guarantee the poll's integrity.
The second stage of the ranking process involves a
survey of corporate MBA recruiters. This year we surveyed 514 recruiters and
received 215 responses, for a response rate of 42 percent.
Recruiters were asked to rate the top 20 schools
according to the perceived quality of grads and their company's experience
with MBAs past and present. Companies could rate only schools at which they
have actively recruited in recent years, on- or off-campus. With the survey
completed, we first calculated each school's point total, awarding 20 points
for every No. 1 ranking, 19 points for every No. 2 ranking, and so on. Using
each school's point total—along with information on the schools where each
recruiter hires and the number of MBAs it hires—we calculate a recruiter
score. The 2010 score was then combined with scores from the 2008 and 2006
recruiter surveys, totaling 680 responses. (The 2010 survey contributes 50
percent, while the 2008 and 2006 polls each contribute 25 percent.)
At this stage, 26 schools with poor response rates
on one or both 2010 surveys were eliminated from ranking consideration,
leaving 75 schools eligible to be ranked.
Continued in article
Jensen Comment
The top business school media ranking outfits are US News, The Wall
Street Journal (WSJ) and Business Week. Business Week used to
use alumni. It tends to be a bit more of a combination approach using
alumni and recruiters.
US News rankings are based upon surveys of business school deans who tend to
favor research reputations in such schools as Stanford, Chicago, UC Berkeley,
Wharton, MIT, Harvard, etc. The WSJ surveys recruiters who hire MBA graduates.
Recruiters are often looking for "best buys" in terms of quality at less price
which, at least before the demise of Wall Street investment banks, tended to
favor Dartmouth's Tuck School over outrageously high priced Harvard and Wharton
graduates.
The most glaring weakness in all of these media rankings is that the people
providing inputs to these rankings have such variable knowledge of all the
schools being ranked. They are most familiar with the schools they attended, the
schools where they visit on recruiting trips, and in the case of deans the
schools where they are employed.
When person is unfamiliar with details of a school that they are to evaluate,
the elitist reputation of the university as a whole, in my viewpoint, dominates
the evaluation of the business school. For example, Princeton University does
not have a business school. If Princeton started up a business school, before
evaluators knew a single thing about that business school they would probably
rate it in the Top 20 simply because it is la la Princeton. The same thing would
never happen if one of the various St. Cecelia's institutions started up
a business school. They aren't sufficiently la la la in terms of traditional
prestige.
There is also a certain amount of tradition that keeps some schools ahead of
the pack. For example, Babson (Rank 17 undergraduate) has always ranked ahead of
Bentley and will probably continue to do so even though I personally think
Bentley should move ahead of its cross town rival Babson.
There was a time when one professor could make or break the reputation of a
program such as back in the 1950s when having accounting research professor Carl
Nelson on the faculty of the University of Minnesota made the Gofer's accounting
PhD program Golden. Minnesota never attained such prominence among the top
accounting doctoral programs since the days of Carl Nelson (who by the way like
Ohio State's Tom Burns was more of a research leader than a research publisher)
---
http://www.jrhasselback.com/AtgDoct/XDocChrt.pdf
And thus I return to sleep not caring two hoots about how business schools
get ranked basically on the basis of either how they ranked the last time or the
prestige image of their host universities as a whole.
Four accounting
researchers (Professors Coyne, Summers,
Williams, and Wood) at Brigham Young University
have written a paper that ranks accounting
research programs in the academy according to
varying criteria. This controversial paper can
be downloaded for free from SSRN and is worth
your time to read. Note especially that the
study is not limited to accounting research
centers in the United States. Names like
Melbourne, Manchester, and Waterloo appear in
the rankings ---
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1337755
To its credit, this
study’s findings are based on current
affiliations of leading researchers and attempts
not to give ranking credits for an institution’s
ghosts. This may, in part, explain some of the
unexpected rankings of some institutions. I
think in some cases a doctoral student might be
a little misled by the outcomes. In other
instances, however, there is richness in these
outcomes that can lead a doctoral program
applicant to ask the right questions. For
example, why is Bentley College so highly ranked
in AIS? There is a reason! Why does Florida
International rank so very high in international
accounting research?
The study possibly
should’ve noted which accounting research
centers have no doctoral programs. For example,
BYU and Rice and Dartmouth have no doctoral
programs in accountancy. A doctoral program
listing is available in the Hasselback
Directory, although Hasselback has some
errors such as the failure to list Yale’s
doctoral program and the listing of Penn State
as not having graduated any doctoral students
since 1998 (actually Penn State has graduated
more than five a year in recent years).
There are other
noteworthy innovations in this (Professors
Coyne, Summers, Williams, and Wood) study.
However, I think the analysis falls short of
what is possible from this and related data. The
analysis is weak on history and possible
explanations of trends. A table of trends in
doctoral student graduation numbers would help
along with a table of faculty size of leading
accounting programs. The analysis also does not
discuss how poorly academic accounting research
is perceived in academe relative to finance,
marketing, and management research ---
http://faculty.trinity.edu/rjensen/theory01.htm#DoctoralPrograms
My first reaction
is that size matters in these rankings,
especially in terms of the number of accounting
researchers in a given area. This is probably
why the University of Chicago and Yale come out
so poorly in this study relative to the huge
accounting programs of Texas, Texas A&M, OSU,
Michigan State, Illinois, and USC. The
University of Rochester does not even get
mentioned. This may also be due, at least in
part, by not counting ghosts who left for
greener pastures. And what happened to that
former research powerhouse on the eastern side
of the Bay Bridge leading out of San Francisco?
Carnegie-Mellon,
Michigan, UC Berkeley, Rochester, and Chicago
were at certain points in history the leading
centers of accounting research. They do not do
well in this later study. Times are changing.
Even mighty Stanford slipped down a lot of
notches in some categories.
The non-mention of
the University of Rochester and Lancaster
(England) might be due to small numbers of
accounting researchers, albeit influential
researchers. The relatively poor showings larger
research centers at MIT and NYU are more
surprising. Harvard is also less than stellar in
these outcomes to say the least.
Some of the larger
doctoral programs in accountancy get a zero in
this study. Examples include the non-mention of
Kent State University and the University of
Nebraska.
An unexpected
outcome is that the huge accounting research
center at the University of Florida does not
rank highly in comparison to lesser-known
Florida International University, the University
of Southern Florida, and Florida State
University just to name a few of its closest
rivals. The same can be said for the huge
research center at the University of Georgia
vis-à-vis its geographical rivals Georgia State,
Georgia Tech, and Emory. The same can also be
said for the University of Arizona (except for
its Number 2 ranking in tax research).
I think the general
conclusion is that the centers for academic
research in accounting have shifted in recent
years. In many respects this reflects how
graduates of former leading research centers
commenced to populate the larger accounting
programs that, until then, were not especially
known for accounting research. Examples include
Arizona State University, the University of
Washington, BYU, and Texas A&M. The University
of Iowa dropped in terms of its ranking in
financial accounting research but graduated some
leading researchers that now are at other
universities. Similarly, Michigan State
University graduated some of the leading AIS
researchers in the U.S. but only ranks Number 12
in the listing of AIS research centers. Some of
Bill McCarthy’s gifted alumni are at
higher-ranked AIS research centers.
The study also
indicates how some of the historically leading
accounting research centers such as the
University of Illinois and the University of
Texas did not change with the times in emerging
areas of research. For example, except for
Missouri the top ten AIS research centers were
not particularly noted as accounting research
centers in the past before AIS emerged as a
research discipline in accounting.
One criticism I
have of this study is the bibliography. It’s
missing most of the previous studies related to
historical trends in accounting research people
and universities. Many of the missing
references, for example, are cited and quoted in
the following paper:
“Evolution of Research Contributions by The
Accounting Review (TAR): 1926-2005,” by Jean L.
Heck and Robert E. Jensen, Accounting
Historians Journal, Volume 34, No. 2,
December 2007
Former studies
along these lines enable readers to reflect on
trends in academic accounting research centers.
One limitation of
the study is the failure to note how common it
is for accounting researchers to be more
productive in the early years before becoming
full professors. Jensen and Heck note the fall
off of leading-researcher publications after
their assistant professorships. Hence there may
be an assistant-professor bias in some of the
rankings in this new Coyne, Summers, Williams,
and Wood study. A few institutions that have
some of the leading doctoral program advisors
may not rank high because those leading advisors
just do not publish much as senior professors.
Also it may be common of some of these
institutions to have a leading researcher and
publisher who just does not have many colleagues
that help to raise the ranking in the CSWW
study. I can name a few such universities but
will not do so since this is anecdotal on my
part.
Remember that there
are Accounting Hall of Fame doctoral studies
advisors not noted for any publication records.
Tom Burns at Ohio State and Carl Nelson at
Minnesota produced some of the best accounting
researchers in history, but I don’t think Tom
and Carl were ever noted for their bibliographic
listings of research publications. My point here
is that faculty advisors recommend doctoral
programs to prospective doctoral students for
reasons other than the publication records of
faculty in doctoral programs.
Hence when an
aspiring accounting professor is trying to
decide on where to get a doctoral degree, I
would sometimes advise looking more closely for
the particular woman or man at an institution
relative to an institutional ranking. Some
people Go to Florida just to study under Joel
Demski. Others Go to Duke just because of
Katherine Schipper or Southern California
because of Zoe-Vonna Palmrose. Ken Peasnell
attracts doctoral students to Lancaster across
the pond. Others want UCONN now that Amy Dunbar
heads up the doctoral program or Stanford
because of the IASB’s Mary Barth. Some people
choose Yale just to be near Shyam Sunder. Some
people Go to Chicago just to learn from Ray Ball
for reasons other than his knowledge of fine
wines.
An aspiring
doctoral program applicant might’ve never heard
the names above, but that applicant usually
relies heavily on the prejudices of his or her
undergraduate and masters program mentors who
often love to drop names. Name dropping can be
misleading in some instances such as in the case
for getting a doctoral degree from Bentley
College where the ranking in this SCWW study is
very relevant relative to name dropping. For
this we owe Professors Coyne, Summers, Williams,
and Wood a debt of gratitude.
I received the
following message from a staff member of the
FASB. I altered it slightly to keep it
anonymous.
Hi Bob,
As you know,
after 16 years in the corporate world, I
spent over (XX) years teaching as a
non-tenure track, non PhD in accounting.
Several times during my stay in academia, i
investigated PhD programs in accounting.
Each time i found the mathematical
requirements to be distasteful. Precious few
programs actually included courses in
accounting or current FASB/IASB practice
issues and those who did still did so
sparingly. I could not see myself, at
advanced age and experience, subjecting
myself to several year of extremely low pay
and distasteful (to me) study. What joy is
there in producing "research" that includes
heavy statistical analysis that nobody
outside a very small circle of researchers
looking for citations will ever read? There
certainly would have been no time or
encouragement to pursue relevant topics like
XBRL.
While I at the
FASB, I see first hand the low esteem
members of academia held inside FASB. Not
once did I hear a staff member indicate that
they would be calling a professor to ask an
opinion on an accounting issue. I'm sure
some did, but they were quiet about it. I
also did not see any academic journals in
the bookcases of FASB staff members. The
library held copies of the top level
journals but it was as rare occasion indeed
when the library sent a notice to staff
alerting them to a new accounting journal
article. In contrast, Accounting Today, CFO
magazine, Wall Street Journal, The Times,
New York Times and the news services that
produced digests of current accounting
issues were in daily their reads.
Eigenfactor
ranks journals much as Google
ranks websites. It is somewhat similar to Thomson Scientific's (ISI)
Journal Citation Index (JCI), though it's dataset is larger.
Some points to note:
* JCI only looks at the 8000 or so journals indexed by Thomson
Scientific while potentially any journal could be included in
Eigenfactor.
* The JCI is calculated based on the most recent 2-year's worth
of citation data; Eigenfactor is based on the most recent 5
years.
* In collaboration with
journalprices.com,
Eigenfactor provides information about price and value for
thousands of scholarly periodicals.
* Article Influence (AI): a measure of a journal's prestige
based on per article citations and comparable to Impact Factor.
Eigenfactor (EF): A measure of the overall value provided by all
of the articles published in a given journal in a year.
* The Eigenfactor Web site also presents the ISI Impact Factors,
so it's possible to compare the
ISI's "Impact Factors" with Eigenfactor's "Article Influence"
* Both simple and advanced searching is available: "You can
search by partial or full journal name, ISSN number, or you can
view a selected ISI category, only ISI-listed journals, only
non-ISI-listed journals or both listed and unlisted."
* Eigenfactor is Free!
From the
Eigenfactor Web site:
Eigenfactor provides influence rankings for 7000+ science and
social science journals and rankings for an additional 110,000+
reference items including newspapers, and popular magazines.
Borrowing methods from network theory,
eigenfactor.org ranks
the influence of journals much as Google's PageRank algorithm
ranks the influence of web pages. By this approach, journals are
considered to be influential if they are cited often by other
influential journals. Iterative ranking schemes of this type,
known as eigenvector centrality methods, are notoriously
sensitive to "dangling nodes" and "dangling clusters" -- nodes
or groups of nodes which link seldom if at all to other parts of
the network. Eigenfactor modifies the basic eigenvector
centrality algorithm to overcome these problems and to better
handle certain peculiarities of journal citation data.
Different disciplines have different standards for citation and
different time scales on which citations occur. The average
article in a leading cell biology journal might receive 10-30
citations within two years; the average article in leading
mathematics journal would do very well to receive 2 citations
over the same period. By using the whole citation network,
Eigenfactor automatically accounts for these differences and
allows better comparison across research areas.
Eigenfactor.org is a non-commercial academic research project
sponsored by the Bergstrom lab in the Department of Biology at
the University of Washington. We aim to develop novel methods
for evaluating the influence of scholarly periodicals and for
mapping the structure of academic research. We are committed to
sharing our findings with interested members of the public,
including librarians, journal editors, publishers, and authors
of scholarly articles.
The most likely source of the review-overload
problem is that the reviewer pool has become too
constricted. Editors are relying too much on the
same set of reviewers. I'm guessing that many of the other 10,499 potential
reviewers in the ASA are never asked to pitch in. Another segment simply refuses
to review—burned out, tired of wasting time, or just plain selfish, their
critical contribution to the discipline is lost.
"The Peer-Review System is Broken," by Daniel J. Myers, Chronicle of
Higher Education's The Chronicle Review, September 4, 2009 , Page B4 ---
http://chronicle.com/article/The-Peer-Review-System-Is-B/48187/
I fear writing this essay. I fear it because I'm
sure that some journal editor out there is going to see my name and think,
"Oh yeah, Dan Myers. We haven't asked him for a review in a while. He'd be
perfect for that paper on X." Please, no, I beg you, a thousand times, no.
In the past month, I have been asked to review not
one (which would be reasonable), or two (understandable), or three
(excessive), four, five, six, or even seven manuscripts for publication, but
indeed, a total of eight! While I confess to no small amount of pride in
becoming what must be my discipline's pre-eminent arbiter of scholarly
quality and its gatekeeper supreme, I really must object. It's getting
impossible to produce any of my own work because I'm spending so much time
assessing others'. And so far I'm only tallying journal manuscripts. On top
of that, I have tenure and promotion cases, grant proposals, book
manuscripts and prospectuses, and the everyday work of reading student
papers and dissertation drafts (tasks for which I'm actually drawing
salary).
Is this rate of review requests really necessary?
Well, let's take a look at my discipline, sociology. The American
Sociological Association claims to have some 14,000 members. Let's suppose
that my past month's review rate is the accepted standard. Furthermore,
imagine that only 75 percent (10,500) of ASA members are deemed acceptable
reviewers. With those numbers, the association membership could generate
more than one million reviews per year! Even if we cut the review rate to
four per month, we'd still be able to produce 500,000 reviews per year.
Let's take that thought experiment one step
further. Suppose a typical manuscript could claw its way through two rounds
of reviews in a year (pretty speedy by today's standards), receiving three
reviews on each round. Those 500,000 reviews could therefore handle almost
84,000 manuscripts each year, or six papers for every member of the ASA.
Prolific as we are, sociologists don't produce an average of six papers a
year, nor do we need a half-million journal-manuscript reviews to conduct
our business each year.
Now if I were an isolated case, you could simply
dismiss me as a crank and suggest that I learn to say no. Or if sociology
were unique in its reviewing practices, you could just tell us to get our
house in order. But I know from talking to colleagues in my own department,
in other departments, and in other disciplines that I'm not all that
isolated. I have many comrades (not "in arms" yet, but it is coming) who are
experiencing an unbearable overload of review duties. And that is not the
only problem with the review system.
Editors complain about frequent refusals from
potential referees, low quality and brevity of reviews, lack of engagement
with the papers' arguments and evidence, and the ever-increasing time it
takes referees to produce their reports. Authors, especially graduate
students and pretenure faculty members, also worry about the increased
length of the review process and consider compromising on where their
manuscript is published in hopes of getting another line on their CV before
hitting the job market or submitting their tenure packets.
What are the sources of these problems? First, some
journal editors are asking for too many reviews of each paper. Is it really
necessary to have three, four, or five reviews to make a decision? Second,
journal editors are far too reluctant to "reject without review." Many seem
to reason that if a paper is submitted, it deserves to be reviewed. I
disagree. By agreeing to review papers that have no chance of being
published in the journal, editors are hobbling their journal's ability to
give feedback where it really counts. Journals are not social-service
agencies required to provide feedback to every poor soul with a half-baked
idea. There are many ways to get feedback on one's work without submitting
it to the premier journal in one's field. Every review wasted on an unworthy
paper means fewer available for the papers that really need careful
attention. Likewise, editors may be giving too many "revise and resubmit"
decisions. It's nice to give authors a second chance, but the way most
review processes unfold, issuing the R&R doubles the amount of review effort
necessary for that paper. The paper ought to have more than just a chance—it
ought to have an awfully good chance if we're going to double the amount of
work that other people are putting into it.
Editors aren't the only ones creating the problem,
of course. Authors too often submit papers to journals that are beyond their
reach. Then, after the papers are rejected, the authors blindly submit them
to other journals, having paid little or no attention to the critiques
generated in the first submission. Reviewers write unengaged, useless
reviews, requiring editors to get more reviews before making a decision.
That produces an overload on other reviewers, who skim papers and write
hasty reviews, or take forever to get to their eighth review request of the
month.
The most likely source of the review-overload
problem is that the reviewer pool has become too constricted. Editors are
relying too much on the same set of reviewers. I'm guessing that many of the
other 10,499 potential reviewers in the ASA are never asked to pitch in.
Another segment simply refuses to review—burned out, tired of wasting time,
or just plain selfish, their critical contribution to the discipline is
lost.
Continued in article
Question: Where do academic accounting research journals rank
among scientific journals according to their eigenfactor scores?
Answer
I think this is an objectively derived ranking leading to
a pile of crap since the research findings of the top-ranked accounting journals
are never authenticated/replicated ---
http://faculty.trinity.edu/rjensen/theory01.htm#Replication
Journal Name (multiple listings occur because journals are ranked by date of
issue with some having multiple dates)
Article Influence (AI):
a measure of a journal's prestige based on per
article citations and comparable to Impact Factor.
Eigenfactor (EF): A
measure of the overall value provided by all of the
articles published in a given journal in a year.
The U.S. Security and Exchange Commission
implemented Regulation Fair Disclosure in 2000. The regulator aims to reduce
information asymmetry among investors, and expects public forums to subsume
the forbidden information channel of selective forums. We show that even
with cooperative managers and effective technology, current public forums is
problematic if participants have asymmetric awareness. Namely, when a
participant is aware of more uncertainties than are other participants, with
zero incentives to share the insights, he would search information privately
rather than raising questions in public forums. This causes inefficient
information production compared to "unfair'' selective disclosure. Since
asymmetric awareness is assumed away in rational expectations models, these
models cannot justify the value of insightful questions. Nevertheless, using
a standard quote-driven market model, we can compare the effect of the
regulation on the price behavior and investors' welfare when awareness is
either symmetric or asymmetric, and derive detailed implications. Empirical
predictions are presented and they can match some intriguing empirical
findings. Finally, we discuss the regulator's consideration on investor
awareness.
. . .
At first glance, fair disclosure seems the best
remedy for the information asymmetry caused by selective disclosure, without
sacrificing the availability of high quality information. However,
practitioners have argued that the regulation has produced some undesirable
side effects:
1. The ambiguous definition of material
information makes issuers reluctant to provide "immaterial" information
in private .
2. Professionals may be unable to obtain
information because of ineffective technology utilized in public
communications.
3. Professionals 'with the most perception,
intuition, or experience are not willing to share their insights with
other investors under fair disclosure, so that less information can be
revealed.
From FAF: USA GAAP Education Helper Site
November 19, 2014 message from Terry Warfield
This week the FAF launched
a new web page
focused on the benefits of Generally Accepted Accounting Principles—GAAP—to
public companies, private companies, not-for-profit organizations, and state
and local governments in the U.S. The web page is available at
www.accountingfoundation.org/gaap.
This educational portal is part
of a broader FAF initiative to highlight the benefits of preparing financial
reports according to GAAP.
While many regard GAAP as the
“gold standard” of financial reporting for public companies and state
governments, there are many private companies, not-for-profits, local
governments, and others that may not be familiar with the benefits of using
GAAP.
This initiative explores those
benefits and also seeks to educate and inform all stakeholders—including
preparers, investors, lenders, auditors, taxpayers, and other users—on how
GAAP is essential to the efficient functioning of our capital markets and
the strengthening of our economy and governments.
From the 24/7 Wall Street newsletter on October 28, 2013
Earnings season is in full swing and this coming
week will bring many key earnings reports. This will also be the last week
of major on-calendar earnings for the third quarter, even if important
earnings will still be coming out in the next two weeks or three weeks. 24/7
Wall St. has decided to publish previews for what it feels are the ten most
important earnings reports on the calendar for the week ahead. While these
may be market movers in their own right, they are definitely all sector
movers.
These are the 10 most important earnings in the week ahead.
Accounting theorists who sometimes argue that earnings numbers between firms
or even over time with within a firm are misleading and should not be compared.
Why then do earnings numbers and derivatives like earnings-per-share and P/E
ratios dominate the analyses of both investors and financial analysts?
"Accounting Alchemy," by Robert E. Verrecchia, Accounting Horizons,
September 2013, pp. 603-618.
Verrecchia alleges that it's not that managers have a functional fixation for
earnings metrics as it is that they believe that other managers and investors
are so fixated with earnings that it because of monumental importance not
because it is inherently a great metric but because they believe deeply that the
market itself makes this index of vital importance.
. . .
In summary, my thesis is that managers project that
others are fixated on earnings—independent of any evidence in support
of, or contrary to, this phenomenon. This leads to managers resisting the
inclusion in earnings items that fail to enhance performance, such as the
amortization of Goodwill, or measures that make future performance more
volatile, such as those based on fair value. In the absence of acknowledging
PEF and attempting to grapple with it, I continue to see confrontations over
accounting regulation along the lines of recent debates about fair value
accounting, in addition to further impediments along the path to greater
transparency in financial statements.
Questions
Should you believe these many claims that the equity capital markets are
inefficient and that it's worth investing the time and money to beat the market?
Answer
A Dartmouth College finance professor would have us conclude that in recent
years the equity markets are a bit like Las Vegas. It's possible to leave Las
Vegas more than a million dollars ahead if you take high risks, but the odds are
decidedly in favor of the casinos. Similarly, it's possible to beat the stock
index funds if you take the risks, but the odds are definitely against beating
the index funds.
This we return to the age old paradox. It's rather useless to carefully
conduct a financial analysis of audited accounting reports in an effort to gain
superior knowledge to take advantage of more naive investors. On the other hand
if a sufficiently large number of investors did not make a sufficient number of
"sophisticated-knowledge" buys and sells the equity markets might be less
efficient. The sophisticated investors (apart from insiders) cannot take
advantage of naive investors because there are so many sophisticated investors.
Of course insiders can exploit efficient markets, but the SEC spends most of its
budget trying to prevent insider trading. If the SEC was not successful in this
effort by and large, the equity capital markets would cease to exist.
"Can You Beat the Market? It’s a $100 Billion Question," by Mark Hulbert,
The New York Times, March 9, 2008 ---
Click Here
The study, “The Cost of Active Investing,” began
circulating earlier this year as an academic working paper. Its author is
Kenneth R. French, a finance professor at Dartmouth; he is known for his
collaboration with Eugene F. Fama, a finance professor at the University of
Chicago, in creating the Fama-French model that is widely used to calculate
risk-adjusted performance.
In his new study, Professor French tried to make
his estimate of investment costs as comprehensive as possible. He took into
account the fees and expenses of domestic equity mutual funds (both open-
and closed-end, including exchange-traded funds), the investment management
costs paid by institutions (both public and private), the fees paid to hedge
funds, and the transactions costs paid by all traders (including commissions
and bid-asked spreads). If a fund or institution was only partly allocated
to the domestic equity market, he counted only that portion in computing its
investment costs.
Professor French then deducted what domestic equity
investors collectively would have paid if they instead had simply bought and
held an index fund benchmarked to the overall stock market, like the
Vanguard Total Stock Market Index fund, whose retail version currently has
an annual expense ratio of 0.19 percent.
The difference between those amounts, Professor
French says, is what investors as a group pay to try to beat the market.
In 2006, the last year for which he has
comprehensive data, this total came to $99.2 billion. Assuming that it grew
in 2007 at the average rate of the last two decades, the amount for last
year was more than $100 billion. Such a total is noteworthy for its sheer
size and its growth over the years — in 1980, for example, the comparable
total was just $7 billion, according to Professor French.
The growth occurred despite many developments that
greatly reduced the cost of trading, like deeply discounted brokerage
commissions, a narrowing in bid-asked spreads, and a big reduction in
front-end loads, or sales charges, paid to mutual fund companies.
These factors notwithstanding, Professor French
found that the portion of stocks’ aggregate market capitalization spent on
trying to beat the market has stayed remarkably constant, near 0.67 percent.
That means the investment industry has found new revenue sources in direct
proportion to the reductions caused by these factors.
What are the investment implications of his
findings? One is that a typical investor can increase his annual return by
just shifting to an index fund and eliminating the expenses involved in
trying to beat the market. Professor French emphasizes that this typical
investor is an average of everyone aiming to outperform the market —
including the supposedly best and brightest who run hedge funds.
Professor French’s study can also be used to show
just how different the investment arena is from a so-called zero-sum game.
In such a game, of course, any one individual’s gains must be matched by
equal losses by other players, and vice versa. Investing would be a zero-sum
game if no costs were associated with trying to beat the market. But with
the costs of that effort totaling around $100 billion a year, active
investing is a significantly negative-sum game. The very act of playing
reduces the size of the pie that is divided among the various players.
Even that, however, underestimates the difficulties
of beating an index fund. Professor French notes that while the total cost
of trying to beat the market has grown over the years, the percentage of
individuals who bear this cost has declined — precisely because of the
growing popularity of index funds.
From 1986 to 2006, according to his calculations,
the proportion of the aggregate market cap that is invested in index funds
more than doubled, to 17.9 percent. As a result, the negative-sum game
played by active investors has grown ever more negative.
The bottom line is this: The best course for the
average investor is to buy and hold an index fund for the long term. Even if
you think you have compelling reasons to believe a particular trade could
beat the market, the odds are still probably against you.
A Hedge Fund Manager's Indictment of Accountants (and the regulators) The book also shows why good accounting really
matters. It is easy to mock finicky people with green eyeshades who worry about
financial footnotes. But reliable numbers are essential if capital is to be
allocated properly in our economy. Otherwise good projects starve and foolish
ones burn up money.
Most of David Einhorn's ideas work out brilliantly.
He is a 39-year-old hedge-fund manager in Manhattan who oversees $6 billion.
Bull markets? Bear markets? It hardly matters. His stock portfolio has
averaged 25% annual returns since 1996, when he opened Greenlight Capital.
Now Mr. Einhorn has written a book. But instead of
packaging the real or contrived "secrets" to his success – as cliché would
have it – he has tried to do something less triumphant and far gutsier. In
"Fooling Some of the People All of the Time," he turns the spotlight on a
single, stubborn investment play that never made much money for him but
created six years of headaches.
It is a surprisingly dark story, in which Mr.
Einhorn's usual winning touch vanishes for most of the narrative. As he
struggles to figure out why, he appears naïve at certain times, petulant at
others. But he presses on anyway, confident that vindication will come. It
never really does.
The story starts in 2002, with Mr. Einhorn rightly
proud of his ability to spot companies with shoddy accounting practices. He
sells their shares short, betting on a stock-price collapse. Generally he
wins big within months. Convinced that he has found another juicy target, he
zeroes in on Allied Capital, a business- financing company that seems to
dawdle when it comes to marking down the value of its troubled loans.
Bad call. Allied eventually did take big
write-downs – but only after the overall economy had improved, allowing
Allied to enjoy offsetting gains from other investments. Allied's stock,
rather than sinking from Mr. Einhorn's short-sale price of $26.25 a share,
climbed past $30 over the next few years.
Mr. Einhorn didn't retreat, though. He grew so
irate about the company's accounting that he alerted the Securities and
Exchange Commission. The SEC did little with his complaint; in fact, it
investigated him instead for spreading negative views about Allied.
Mr. Einhorn survived that episode and kept
hammering away. He found evidence that one of Allied's affiliates, Business
Loan Express, was making what appeared to be excessive, poorly documented
loans to operators of shrimp boats and service stations. The deals looked
like fraud to him. He tried to tip off journalists and regulators but was
mostly met with yawns.
Large chunks of "Fooling Some of the People All of
the Time" amount to an angry man's recital of his grievances – and Mr.
Einhorn has some good ones. An SEC lawyer who quizzed him aggressively about
his short-selling methods later went into private practice and registered as
a lobbyist for Allied. Mr. Einhorn, understandably, regards such a career
move as an ethics violation.
Allied also ended up with purloined copies of Mr.
Einhorn's phone records, something he had long suspected. Allied had
originally told him that it had no evidence that his phone records had been
grabbed but later admitted to getting them. He labels the company
"dishonest" at one point and expresses the hope that regulators and auditors
may still "remedy the situation." For its part, Allied calls Mr. Einhorn's
book "a self-serving rehash of the same discredited charges that Mr. Einhorn
has made for the past six years."
Without some broader significance, Einhorn v.
Allied Capital would be small beer in the chronicles of modern-day corporate
showdowns. There is no lurid scandal here involving drugs, bimbos or $6,000
shower curtains. There is no cataclysmic ending. Allied stock has faded to
about $19 in the current credit crunch but hasn't fared worse than many of
its rivals. After a long tug-of-war, Mr. Einhorn's initial short sale has
proved neither disastrous nor especially lucrative.
What gives the book a special value, beyond its
backstage look at the life of an elite trader, is its insight into two
important but usually neglected aspects of the investment business. First,
Mr. Einhorn's carefully documented battles with Allied Capital say a lot
about the temperament needed to be a great investor. Tenacity is vital. So
is patience. And so, too, is an ability to keep a sane perspective.
As Mr. Einhorn's own firm prospered, he could have
jammed far more money into his Allied Capital short position, determined to
prevail by brute force. He didn't. He kept 3% of assets in that position but
invested most of his money in other ideas that worked out better. Such
discipline, we come to realize, is what distinguishes the wisest long-term
investors from obstinate short-timers who veer between triumph and ruin.
The book also shows why good accounting really
matters. It is easy to mock finicky people with green eyeshades who worry
about financial footnotes. But reliable numbers are essential if capital is
to be allocated properly in our economy. Otherwise good projects starve and
foolish ones burn up money.
Mr. Einhorn is a hard-liner, wanting strict
accounting standards that punish missteps quickly. Allied Capital, to judge
by his version of events, liked living in a more lenient world, where there
was plenty of time to patch up problems quietly. Regulators were comfortable
with an easy-credit philosophy, too, to a degree that startled Mr. Einhorn.
In the current financial shakeout, people like Mr.
Einhorn are entitled to say: "I told you so." It's to his credit that,
telling the Allied story, he is often angry but never smug.
"Resistance is
futile” is actually a quote from the Borg – a possible (and much more scary)
replacement.
Tracey Sutherland, Executive Director of the American Accounting
Association
This paper reviews the literature on the effects of
International Financial Reporting Standards (IFRS) adoption. It aims to
provide a cohesive picture of empirical archival literature on how IFRS
adoption affects: financial reporting quality, capital markets, corporate
decision making, stewardship and governance, debt contracting, and auditing.
In addition, we also present discussion of studies that focus on specific
attributes of IFRS, and also provide detailed discussion of research design
choices and empirical issues researchers face when evaluating IFRS adoption
effects. We broadly summarize the development of the IFRS literature as
follows: The majority of early studies paint IFRS as bringing significant
benefits to adopting firms and countries in terms of (i) improved
transparency, (ii) lower costs of capital, (iii) improved cross-country
investments, (iv) better comparability of financial reports, and (v)
increased following by foreign analysts. However, these documented benefits
tended to vary significantly across firms and countries. More recent studies
now attribute at least some of the earlier documented benefits to factors
other than adoption of new accounting standards per se, such as enforcement
changes. Other recent studies examining the effects of IFRS on the inclusion
of accounting numbers in formal contracts point out that IFRS has lowered
the contractibility of accounting numbers. Finally, we observe substantial
variation in empirical designs across papers which makes it difficult to
reconcile differences in their conclusions.
Accounting History Blast from the Past
Demski, J. S. 1973. The general impossibility of normative accounting
standards. The Accounting Review (October): 718-723. (JSTOR link).
Cushing, B. E. 1977. On the possibility of optimal accounting principles.
The Accounting Review (April): 308-321. (JSTOR
link).
Abstract
Several authors have examined the issue of choice among financial reporting
standards and principles using the framework of rational choice theory.
Their results have been almost uniformly pessimistic in terms of the
possibilities for favorable resolution of this issue. Upon further analysis,
these results are revealed to be an artifact of the way in which the issue
is initially formulated. Several possible methods of reformulating of this
issue within the rational choice framework are proposed and explored in this
paper. The results here support a much more optimistic conclusion and
suggest numerous avenues of further research which could provide
considerable insight into the conditions under which optimal accounting
principles are possible.
Purpose of Theory:
Prediction Versus Explanation
"Higgs ahoy! The elusive boson has probably been found. That is a triumph
for the predictive power of physics," The Economist, February 17, 2012 ---
http://www.economist.com/node/21541825
IN PHYSICS, the trick is often to ask a question so
obvious no one else would have thought of posing it. Apples have fallen to
the ground since time immemorial. It took the genius of Sir Isaac Newton to
ask why. Of course, it helps if you have the mental clout to work out the
answer. Fortunately, Newton did.
It was in this spirit, almost 50 years ago, that a
few insightful physicists asked themselves where mass comes from. Like the
tendency of apples to fall to the ground, the existence of mass is so
quotidian that the idea it needs a formal explanation would never occur to
most people. But it did occur to Peter Higgs, then a young researcher at
Edinburgh University, and to five other scientists whom the quirks of
celebrity have not treated so kindly. They, too, had the necessary mental
clout. They got out their pencils and papers and scribbled down equations
whose upshot was a prediction.
The reason that fundamental particles have mass,
the researchers calculated, is their interaction with a previously unknown
field that permeates space. This field came to be named (with no disrespect
to the losers in the celebrity race) the Higgs field. Technically, it is
needed to explain a phenomenon called electroweak symmetry breaking, which
divides two of the fundamental forces of nature, electromagnetism and the
weak nuclear force. When that division happens, a bit of leftover
mathematics manifests itself as a particle. This putative particle has
become known as the Higgs boson, whose possible discovery was announced to
the world on December 13th (see
article).
Physicists demand a level of proof that would in
any other human activity (including other scientific ones) be seen as
ludicrously high—that a result has only one chance in 3.5m of being wrong.
The new results—from experiments done at CERN, the world’s premier
particle-physics laboratory, using its multi-billion-dollar Large Hadron
Collider, the LHC—do not individually come close to that threshold. What has
excited physicists, though, is that they have got essentially identical
results from two experiments attached to the LHC, which work in completely
different ways. This coincidence makes it much more likely that they have
discovered the real deal.
If they have, it would be a wonderful thing, and
not just for science. Though nations no longer tremble at the feet of
particle physicists—the men, and a few women, who once delivered the
destructive power of the atom bomb—physics still has the power to produce
awe in another way, by revealing the basic truths that underpin reality.
Model behaviour
Finding the Higgs would mark the closing of one
chapter in this story. The elusive boson rounds off what has become known as
the Standard Model of physics—an explanation that relies on 17 fundamental
particles and three physical forces (though it stubbornly refuses to
accommodate a fourth force, gravity, which is separately explained by Albert
Einstein’s general theory of relativity). Much more intriguingly, the Higgs
also opens another chapter of physics.
The physicists’ plan is to use the Standard Model
as the foundation of a larger and more beautiful edifice called
Supersymmetry. This predicts a further set of particles, the heavier
partners of those already found. How much heavier, though, depends on how
heavy the Higgs itself is. The results just announced suggest it is light
enough for some of the predicted supersymmetric particles to be made in the
LHC too.
That is a great relief to those at CERN. If the
Higgs had proved much heavier than this week’s announcement implies they
might have found themselves with a lot of redundant kit on their hands. Now
they can start looking for the bricks of Supersymmetry, to see if it, too,
resembles the physicists’ predictions. In particular, in a crossover between
particle physics and cosmology, they will be trying to find out if (as the
maths suggest) the lightest of the supersymmetric partner particles are the
stuff of the hitherto mysterious “dark matter” whose gravity holds galaxies
together.
A critique of pure reason
One of the most extraordinary things about the
universe is this predictability—that it is possible to write down equations
which describe what is seen, and extrapolate from them to the unseen. Newton
was able to go from the behaviour of bodies falling to Earth to the
mechanism that holds planets in orbit. James Clerk Maxwell’s equations of
electromagnetism, derived in the mid-19th century, predicted the existence
of radio waves. The atom bomb began with Einstein’s famous equation,
E=mc{+2}, which was a result derived by asking how objects would behave when
travelling near the speed of light. The search for antimatter, that staple
of science fiction, was the consequence of an equation about electrons which
has two sets of solutions, one positive and one negative.
Eugene Wigner, one of the physicists responsible
for showing, in the 1920s, the importance of symmetry to the universe (and
who was thus a progenitor of Supersymmetry), described this as the
“unreasonable effectiveness of mathematics”. Not all such predictions come
true, of course. But the predictive power of mathematical physics—as opposed
to the after-the-fact explanatory power of maths in other fields—is still
extraordinary.
Accounting History Corner (I suspect Tom Selling will
like this one)
Book Review by Jacob S. Soll The Accounting Review
Article Volume 91, Issue 4 (July 2016)
http://aaajournals.org/doi/full/10.2308/accr-10493
KARTHIK RAMANNA Political Standards: Corporate Interest, Ideology, and
Leadership in the Shaping of Accounting Rules for the Market Economy
(Chicago, IL: University of Chicago Press, 2015, pp. 277, hardcover).
In his prodigiously researched new book, Karthik
Ramanna makes a profession of faith in accounting. As he tells the reader,
accounting is the grease on the gears of capitalism; the numbers that allow
decisions to be made by the public, shareholders, investors, managers,
financiers, and the government. Audited financial statements are the
representations of companies (and, indeed, often public entities and even
individuals), and these numbers are what drive market capitalism. They are
the very essence of trust, as decisions of entrepreneurial risk, investment,
and management cannot be made without them. This trust is inherent to
flourishing capitalism—and capitalism, Ramanna insists, is an “ethic” that
“allocates resources” and enables individual economic and even political
“freedom” (p. 172). Ramanna is a believer.
It is because of Ramanna's faith in accounting's
under-celebrated fundamental role in capitalism that he believes the
protection of its reliability and independence is utterly necessary. Yet,
according to him, this is less and less the case as accounting standards and
laws have come under the “ideological capture” of certain “corporate
interests” that undermine market capitalism. Ramanna's work claims to be an
academic stress test of the independence, fairness, and function of
accounting rules. In his blunt opinion, the industry, in certain cases, is
undermining many of its core principles and the market itself by not
protecting reliable and accurate valuations due to the interpretive breadth
allowed by fair value accounting.
His central argument is that the accounting
standard-setters of the FASB have become beholden to corporate interests and
their political allies. Ramanna's broader story, as understood with the
example of mergers and acquisitions, goes like this: As the financial
industry began to make more and more money from advising on mergers and
acquisitions in the late 1990s, it became emboldened to argue that
amortizing goodwill acquired from target companies was “a drag” (p. 53) on
the earnings of acquiring firms. With the rise of tech companies and
companies claiming vast intangible assets—think Time Warner Inc.'s
disastrous acquisition of an inflated AOL and its subsequent $54 billion
write down— these companies, and the banks and auditing firms that did
business with them—think Arthur Andersen—pushed for more malleable valuation
standards. Yet even after the crash of 2008, banks and managers who oversaw
contributory mergers and acquisitions made the case for tailor-made fair
value accounting standards to reasonably measure the value of intangible
assets, now the prominent assets in tech and many other companies. His
evidence highlights the banking industry, in particular, for pushing for
accounting metrics with which it could “emphasize” good or bad numbers to
their advantage (p. 26).
Until 2009, says Ramanna, the FASB had hewn, at
least on paper, to a conceptual framework of financial information in
accounting based on “reliability” and “verifiability” (p. 34). But these
principles of conservative valuation—concepts essential to accounting since
its inception—continued to be seen by some as outmoded vehicles of
undervaluation. Indeed, many of the bankers who believed that their mortgage
bundles had been undervalued, thus leading to the crash of 2008, lobbied for
more creativity and less conservatism. The FASB and its IASB
standard-setting cousin were persuaded, and replaced the relatively clear
concepts of “reliability” and “verifiability” with the nebulous concept of
“faithful representation.” Ramanna's cited research evidence indicates that
the new precepts themselves are less reliable than the old conservative
ones.
Ramanna ascribes the broken standards process to
his ideas of a “thin political market” and “ideological capture” (p. 46).
This is the process by which interested companies—his examples include The
Goldman Sachs Group, Morgan Stanley, and Merrill Lynch, among others—secure
favorable regulatory outcomes through a combination of expertise, ideology,
and political power (often drawn from longstanding campaign contributions to
influential members of Congress). His data point to a direct correlation
between banking representation on the FASB, as well campaign contributions
to Congress members, with a successful move to support fair value standards
in the name of financial creativity and the “synergy” of mergers. These
mergers of aggressively valued companies, Ramanna argues, enables managers,
bankers, and lawyers to extract profits from ordinary shareholders.
Not content with anecdotes,
Ramanna produces regressions, graphs, and sets of
data, often reproduced from his peer-reviewed articles, to make his point
that it is common practice for deep-pocketed interested parties to push for
standards that are advantageous to them.
Due to the complexity and obscurity of proposed laws such as HR 5365, The
Financial Accounting for Intangibles Reexamination Act, this type of
legislation happens in “a thin political market,” that is to say only
between the interested parties and the standard-setters. According to this
theory, public debate is largely absent from the process due not only to
lack of awareness, but also to the fact that most players, aside from
Congress, come from accounting and finance backgrounds where they have been
imbued with a particular “ideology” or worldview. This is not easy to prove
and surely more complex than Ramanna lets on. Yet, almost no one outside the
financial professions would be aware of bills such as HR 5365 and rules such
as SFAS 142 and there has been little sustained discussion of them in any
serious public forum. And yet they have massive ramifications on the economy
and how valuation and performance information flows through the economy at
large.
Ramanna's argument that
standard-setters are beholden to political interests and cater to industries
from which they come is not conclusive, but rather is intriguing and
suggestive of a need for internal and public review. He never suggests that
FASB members have personally benefitted from the process. His prime example
of the process to push for fair value standards focuses on the influence of
political action committee (PAC) money and links between congressional
oversight and the standard-setting community. In light of Ramanna's claims,
many in the industry and, without doubt, the FASB, will take umbrage with
Ramanna's assertions, and it is their turn now to rebut his accusations.
Among the questions raised by Ramanna is why FASB
members come mostly from the accounting and financial industries and not
from a more disinterested track of financial civil servants and experts. The
talent is out there. And, there is little doubt that fair value standards
need to be further examined for their potential risks. Ramanna's questions
merit a very serious public debate. Alas, as Ramanna shows, it seems
unlikely that such a debate will happen outside of the industry itself,
unless Congress decides to get involved on behalf of the public. One would
imagine that, in the long tradition of accounting reform in the U.S., the
Big 4 auditing firms would want to follow the lead of the great accounting
leader of the 1930s, George O. May, and look into their own affairs before
another Enron-Andersen fiasco opens it up to even more litigation and
regulation. The industry is both monolithic and fragile. This condition is
not sustainable, and to remedy it will take sustained and visionary
leadership to address questions surrounding fair value standards.
Jensen Comment
Not many folks are aware that Ray Ball is also a tremendous expert on wine. I
think I've already told a Ray Ball anecdote on the AECM about wine and a
restaurant in Italy that mistakenly brought an extremely rare vintage to his
table. Unlike the waiter Ray recognized immediately that it was a very rare
bottle of wine based on an exceptional wine year in history.
This I've got to see
The standard setters' (IASB and FASB) balance sheet priority over the income
statement totally destroyed the concepts of "income" and "earnings."
I'm anxiously awaiting to see the IASB's operational definition of "earnings"
underlying the forthcoming definition of EBIT, etc.
One of my main concerns in this definition is the jumbling of legally earned
revenues with unrealized value changes.
From the CFO Journal's Morning Ledger
on November 3, 2016
IASB evaluating EBIT
The International Accounting Standards Board said
Wednesday it would look at providing new
definitions of common financial terms such as earnings before interest and
taxes, or ebit. The new definitions will be introduced over the next five
years, in order to provide sufficient time for suggestions and comment from
market participants, Nina Trentmann reports.
The International Accounting Standards Board, or
IASB, which sets reporting standards in more than 120 countries, said
Wednesday it would look at providing new definitions of common financial
terms such as earnings before interest and taxes, or ebit.
The new definitions will be introduced over the
next five years, in order to provide sufficient time for suggestions and
comment from market participants.
The changes will not result in new standards but
will require the board to overhaul existing ones.
At the moment, terms like operating profit are not
defined by the IASB. The aim is to help market participants judge the
suitability of a particular investment.
“We want to give investors the right handles to
look at a balance sheet,” said IASB chairman Hans Hoogervorst.
Up until now, International Financial Reporting
Standards, known as IFRS, leave companies too much flexibility in defining
such terms, which often makes it difficult to compare financials, Mr.
Hoogervorst said.
“Even within sectors, there is a lack of
comparability,” Mr. Hoogervorst said. This affects both investors and
companies, he added.
It is too early to tell what the changes will mean
for companies reporting under IFRS, according to Mr. Hoogervorst. “They
should be less revolutionary than the introduction of new standards but
every change results in work”, he said.
Some firms might find that they have less latitude
when reporting financial results, he said. That could mean more work.
Firms that decide against adopting the new IASB
definition for ebit, for example, could be required to reconcile their own
ebit calculation into one based on the IASB’s definition.
The IASB in 2017 also plans to finalize a single
accounting model that would be applied to all forms of insurance contracts.
Besides that, the board will work on updating the
system through which filers add disclosures to the electronic versions of
their financial statements. The system is updated on a regular basis and the
IASB produces an annual compilation of all changes each year.
How did I get here? Somebody pushed me. Somebody
must have set me off in this direction and clusters of other hands must have
touched themselves to the controls at various times, for I would not have picked
this way for the world. Joseph Heller (as he might have described this sate of
convergence of the FASB with the IASB)
Getting accountants and auditors to follow the
rules, as well as their spirit, isn’t easy—keeping them honest has been an
uphill battle for going on 80 years.
In a
Fortune article three weeks ago, former SEC
Chief Accountant Lynn Turner told me that the current accounting and
auditing systems we all rely on need wholesale reform.
Since then, there has been a flurry of activity
from regulators, who have issued proposals to shore up weaknesses in U.S.
corporate accounting and auditing. The Securities and Exchange Commission
(SEC) issued a concept release on potential new audit committee disclosures,
including possible new requirements for information about how the audit
committee actually oversees the company’s auditor. And the Public Company
Accounting Oversight Board (PCAOB) issued two new proposals. One could
require disclosure of the partner and others involved in a company audit.
The second relates to the potential creation and disclosure of what the
PCAOB calls “measures that may provide new insights into audit quality.”
Since audits have been required of public companies
for 80 years, you’d think that measures of audit quality would already be
clear, well established, and tracked. So why is this just now in the works?
Given the choice between the stricter accountability of clear metrics and
the greater freedom of none, companies, their auditors, and regulators have
chosen flexibility.
Coninued in article
"Financial Engineering and the Arms Race Between Accounting Standard Setters
and Preparers," by Ronald A. Dye, Jonathan C. Glover, and Shyam
Sunder, Accounting Horizons, Volume 29, Issue 2 (June 2015) ---
http://aaapubs.org/doi/full/10.2308/acch-50992
This article is free only to AAA members.
Abstract
This essay analyzes some problems that accounting standard setters confront
in erecting barriers to managers bent on boosting their firms' financial
reports through financial engineering (FE) activities. It also poses some
unsolved research questions regarding interactions between preparers and
standard setters. It starts by discussing the history of lease accounting to
illustrate the institutional disadvantage of standard setters relative to
preparers in their speeds of response. Then, the essay presents a general
theorem that shows that, independent of how accounting standards are
written, it is impossible to eliminate all FE efforts of preparers. It also
discusses the desirability of choosing accounting standards on the basis of
the FE efforts the standards induce preparers to engage in. Then, the essay
turns to accounting boards' concepts statements; it points out that no
concept statement recognizes the general lack of goal congruence between
preparers and standard setters in their desires to produce informative
financial statements. We also point out the relative lack of concern in
recent concept statements for the representational faithfulness of the
financial reporting of transactions. The essay asserts that these oversights
may be responsible, in part, for standard setters promulgating recent
standards that result in difficult-to-audit financial reports. The essay
also discusses factors other than accounting standards that contribute to
FE, including the high-powered incentives of managers, the limited
disclosures and/or information sources outside the face of firms' financial
statements about a firm's FE efforts, firms' principal sources of financing,
the increasing complexity of transactions, the difficulties in auditing
certain transactions, and the roles of the courts and culture. The essay
ends by proposing some other recommendations on how standards can be written
to reduce FE.
Jensen Comment
The analytics of this Accounting Horizons article, rooted heavily in
Blackwell's Theorem, add academic elegance to the accountics science of the
article but do not carry over well in the real world --- largely because of the
limiting Plato's Cave assumptions of Blackwell's Theorem, However, the article
lives up to the fine academic reputations of its authors in other respects that
make it important to consider when pitting financial engineering against
regulation.
What needs to be extended is how financial engineering is not something that can
be reduced per se. Changes in regulation are more apt to impact some
firms positively (i.e., opportunity) and other firms negatively (i.e.,
cost) simultaneously. And there are always considerations of direct impacts
versus externalities. For example, eliminating coal as an energy source cleans
the air and water but puts generations of miners and entire towns out of work as
well as increasing the cost of electric power.
The FASB requirement to book employee stock options when vested makes
employee compensation more transparent to investors while making startups more
costly to operate. And with each significant increase in financial reporting and
compliance regulations businesses are increasingly mummified in red tape. As the
saying goes: "The road to Hell is paved with good intentions."
The above article features lease accounting standards but ignores the positives
and negatives of alternative details in setting such standards and the virtual
impossibility of reliably measuring some liabilities such as estimating
operating lease renewals ad infinitum.
The above article ignores trade-offs in the standards. The prominent example is
how balance sheet priorities of the FASB and IASB greatly harmed income
statements.
Net earnings and EBITDA cannot be defined since
the FASB and IASB elected to give the balance sheet priority over the income
statement in financial reporting --- "The Asset-Liability Approach: Primacy does not mean Priority,"
by Robert Bloomfield, FASRI Financial Accounting Standards Research
Initiative, October 6, 2009 ---
http://www.fasri.net/index.php/2009/10/the-asset-liability-approach-primacy-does-not-mean-priority/
Abstract:
Since the 1970s, the decision-usefulness has taken center stage and our
attention has been concentrated on valuation of assets and liabilities
instead of income measurement. The concept of income, once considered the
gravitational center of accounting has lost its primacy and become a
byproduct of the balance sheet derived from the measurement of assets and
liabilities.
However, we have not been equipped with robust
conceptual foundation supporting theoretically reasoned accounting
measurement. It is not only theoretically but also practically important to
renew our seemingly waned interest in the concept of income because ongoing
reforms of accounting standards cannot be successfully implemented without a
sound understanding of the concept of income.
From the CFO Journal's Morning Ledger on July 24, 2015
Amazon posts surprising profit
http://www.wsj.com/articles/amazon-posts-surprising-profit-1437682791?mod=djemCFO_h
For just the second time, Amazon.com Inc. shared
sales figures Thursday for its cloud-computing division
Thursday. Amazon Web Services sales rose to $1.82 billion from $1 billion a
year earlier, and operating profit increased to $391 million from $77
million. Some believe the unit could operate on a stand-alone basis and,
because of its growth, is a primary reason to invest in Amazon. Amazon
posted a profit of $92 million for the third quarter, helped by sales which
rose a better-than-expected 20% to $23.18 billion.
Jensen Comment
"Surprising profits" and "record profits" make us wish that someday the
accounting standard setters (think FASB and IASB) would someday be able to
operationally define "profit" and make "profit" measures more comparable between
business firms.
Net earnings and EBITDA are all-important because
investors change their portfolios based on net earnings and its derivatives more
than anything in the balance sheet.
"Accounting Alchemy," by Robert E. Verrecchia, Accounting Horizons,
September 2013, pp. 603-618.
Verrecchia alleges that it's not that managers have a functional fixation for
earnings metrics as it is that they believe that other managers and investors
are so fixated with earnings that it because of monumental importance not
because it is inherently a great metric but because they believe deeply that the
market itself makes this index of vital importance.
. . .
In summary, my thesis is that managers project that
others are fixated on earnings—independent of any evidence in support
of, or contrary to, this phenomenon. This leads to managers resisting the
inclusion in earnings items that fail to enhance performance, such as the
amortization of Goodwill, or measures that make future performance more
volatile, such as those based on fair value. In the absence of acknowledging
PEF and attempting to grapple with it, I continue to see confrontations over
accounting regulation along the lines of recent debates about fair value
accounting, in addition to further impediments along the path to greater
transparency in financial statements.
Investors change their portfolios based on
earnings, eps, EBITDA, and P/E ratios when in fact those metrics are not defined
and may have a lot of misleading noise and secret manipulation
ICAEW’s review looked across numerous topics,
including transparency, comparability, cost of capital and capital flows
across border – to see if authors could discern improvements since 2005.
“For each, the findings are mixed,” says
Singleton-Green. “Overall, we think the balance of the research evidence is
that there is a positive response. Some researchers disagree. No one is
saying that all companies and all countries benefit. The overall answer
seems to be that there are more winners than losers.”
So far so good: allowing for those variations from
study to study, country to country and even within sectors, the results
found a broadly positive response to the notion that IFRS has gone some way
to achieving its stated goals and thereby helped to increase investor
confidence. Nigel Sleigh-Johnson, head of the faculty, says: “There are
inevitably caveats, but overall IFRS has gone a long way to achieving its
objectives.”
One acknowledged area of difficulty is the fact
that IFRS implementation did not occur in a vacuum. It is hard to isolate
its impact to the point where one can know whether it is IFRS or the
evolution of corporate governance that is the most significant factor.
“It’s a very difficult thing to reflect on because
there is no control group,” says Peter Hogarth, partner and head of PwC’s UK
accounting services division.
The academic research is ultimately limited in what
it can communicate, given the mixed messages within it, says Veronica Poole,
global IFRS technical leader at Deloitte. “Yes, there is now a better
understanding of risks and exposures. Some EU countries had no GAAP per se –
they accounted for tax reasons.
So a single set of standards is a big improvement.
And on the cost of capital, many studies suggest that it has indeed lowered
barriers. Within the FD 100 Group, for instance, if you talk to the
companies themselves, they say they have better access to capital markets.”
- See more at: http://economia.icaew.com/finance/january-2015/ifrs-common-good#sthash.jPGpqu4U.dpuf
Comparability has not always been readily achieved.
From a starting point of 17 different national GAAPs across Europe, and with
larger companies starting to adopt US GAAP, IFRS had much ground to cover.
Mark Vaessen, global head of IFRS at KPMG, says the change has been
necessarily gradual: “I would say they are broadly applied consistently.”
At first lots of national traditions continued, he
says. “Now it’s more mature. New standards are coming through that don’t
have a national history so we are losing national bias. Everyone is trying
to speak the same language. IFRS is becoming a language on its own.”
Importantly, the investor community agrees on the
comparability point. Hilary Eastman, director of investment engagement at
PwC, says the evolution means that companies and even countries that
investors might have excluded as investment possibilities are now part of
the investment landscape: “What we hear is that comparability is much
enhanced. Even if individual companies within different countries might
apply standards differently, there is at least a common framework. Investors
don’t have to make so many adjustments and the work to do so is less. With
regard to the common framework, you can see who’s applying it more
rigorously and that helps in investment decisions. They [investors] make
decisions globally so they like to see the consistent accounting around the
world.”
Paul Lee, head of investment affairs at the
National Association of Pension Funds, says that the ability to compare
across national markets is a genuine step forward.
“Inevitably from an investor perspective you want
to look at the universe of possible investments, look at individual
companies and their performance and look at how the market is pricing them.
The ability to compare across national markets is a genuine step forward. We
have a European market instead of a collection of different national
markets.”
From its earliest days, IFRS formalised accounting
procedures, and brought more disclosure and more rigour to financial
reporting. Segment reporting, which had a standard under UK GAAP, was far
from the norm across the EU.
In 2005, IFRS also inherited a pension standard
that the ASB had long been trying to introduce. Perhaps the biggest change
has been the controversial and long-debated financial instruments standard –
still effectively some way off, since the implementation date for IFRS 9 is
January 2018.
“A lot of companies never accounted for financial
instruments. The introduction of the standard shone a light on some of the
exposures that existed,” says Peter Hogarth.
The wider parameters don’t add up to simplification
of corporate reporting, however. Complexity is a charge often levelled at
IFRS – and it doesn’t always stand up well to the accusation. “There are
companies where it’s harder to see what is going on,” says Lee. Again, it’s
difficult to unpick which areas are down to IFRS and which are down to the
added complexity of business life.
“The world of business has changed dramatically,
particularly on the risk management front – a major increase in the use of
derivatives to manage currency risk for example. The whole complexity of
Treasury and interest rate risk – that’s taken off across a whole range of
companies. Life is more complicated and that inevitably means reporting will
be too,” he says.
IFRS defenders will say that the world is better
off for having companies that disclose more and that firms would be in still
worse shape and the investor community would have a much less clear idea
about listed companies and their exposure to risk without it. Along the way,
listed companies have accrued benefits in terms of transparency and access
to capital. “On the cost of capital, many studies suggest that it has indeed
lowered barriers. Within the FD 100 Group, for instance, if you talk to the
companies themselves, they say they have better access to capital markets,”
says Veronica Poole.
There is still a debate raging around financial
stability and the performance of IFRS at the time of the financial crisis.
And the Barnier-commissioned Maystadt Report recommendations to increase the
influence of EFRAG have drawn concern that IFRS will become politicised.
“There are certainly some who want to have
political control of international standards. There is a threat – and that’s
not too strong a word – that such an approach will start to move us towards
an EU version of IFRS.
“If what we are looking for is comparability,
different markets having different flavours of international standards is
potentially a disaster and takes us back towards the situation where we had
numerous different GAAPs. Most of all it will erode confidence and that will
increase the cost of capital,” says Paul Lee.
What is more, Philippe Maystadt’s recommendation
that the goal of international standards contributing to financial stability
and not hindering economic growth be made more explicit has raised eyebrows.
“Our view is that it’s not needed,” says Mark Vaessen. “It is already
included within the public good criteria and it is inherent in the aims of
international standards.”
There are dangers for IFRS in this argument,
Vaessen says. Prudential regulators may understandably want to take a
conservative line and smooth out performance in financial institutions. But
that approach has led to hidden reserves in the past. Vaessen adds: “From a
stewardship point of view that’s bad, because you are not holding management
to account.” - See more at: http://economia.icaew.com/finance/january-2015/ifrs-common-good#sthash.jPGpqu4U.dpuf
Jensen Comment
The benefits of adopting IFRS in a given nation depends a lot on the quality of
that nation's accounting standards before IFRS. For example, for nations having
virtually no accounting standards or no enforced standards the benefits are
greater, especially when audit firms are credible in the global markets.
However, benefits do not always pass the cost-benefit test, especially in the
eyes of some companies that did not see significant improvements in how capital
is raised (e.g., some companies in Germany and Japan where bankers tend to be
part and parcel to management of a company). IFRS has not always been a magic
bullet for opening equity capital markets, but these standards cannot be
entirely blamed for those failures.
From FAF: USA GAAP Education Helper Site
November 19, 2014 message from Terry Warfield
This week the FAF launched
a new web page
focused on the benefits of Generally Accepted Accounting Principles—GAAP—to
public companies, private companies, not-for-profit organizations, and state
and local governments in the U.S. The web page is available at
www.accountingfoundation.org/gaap.
This educational portal is part
of a broader FAF initiative to highlight the benefits of preparing financial
reports according to GAAP.
While many regard GAAP as the
“gold standard” of financial reporting for public companies and state
governments, there are many private companies, not-for-profits, local
governments, and others that may not be familiar with the benefits of using
GAAP.
This initiative explores those
benefits and also seeks to educate and inform all stakeholders—including
preparers, investors, lenders, auditors, taxpayers, and other users—on how
GAAP is essential to the efficient functioning of our capital markets and
the strengthening of our economy and governments.
We
have updated our US GAAP/IFRS accounting differences
identifier tool, which was developed to help
entities that are converting from US GAAP to IFRS or that are
evaluating the effects of IFRS adoption. We also have updated
our US GAAP versus IFRS – The basics
publication, which provides an overview of common differences
between US GAAP and IFRS. Both releases generally reflect
guidance effective in 2016 and guidance finalized by the FASB
and the IASB as of 31 May 2016. They both also discuss current
standard-setting activities at the FASB and the IASB. These
publications have not been updated for IFRS 9, Financial
Instruments, ASU 2016-01, Recognition and Measurement of
Financial Assets and Financial Liabilities, IFRS 15,
Revenue from Contracts with customers, ASU 2014-09,
Revenue from Contracts with Customers, IFRS 16, Leases,
and ASU 2016-02, Leases.
The US GAAP/IFRS Accounting Differences
Identifier Tool is designed to help entities that are
considering a future conversion to IFRS, typically during
the diagnostic phase of a conversion project, or in
conjunction with a transaction. While the Identifier Tool is
intended to help users identify some of the more common
accounting differences between US GAAP and IFRS that may
affect a converting entity’s financial statements, no
resource can possibly identify all of the differences that
exist between the two sets of standards. Many differences
depend on an entity’s specific industry, the nature and
extent of its transactions, and, where choices are
available, accounting policy elections. Accordingly, the
Identifier Tool should be viewed as a starting point for
analyzing potential accounting differences, not a
comprehensive checklist. It is not a substitute for a
careful reading of the appropriate US GAAP and IFRS
literature, or the guidance contained in EY’s US Financial
Reporting Developments publications (FRDs) or our annual
publication International GAAP®.
IFRS standards often are more “principles-based”
with less interpretive and application guidance than their
US counterparts. As a result, while some might read an IFRS
standard to require an approach similar to that contained in
its more detailed US counterpart, others might not. As the
more general IFRS standards are not always interpreted
similarly by entities in the same or similar circumstances,
not everyone will agree on whether an accounting difference
actually exists.
The Identifier Tool was developed from the
perspective of a US entity that is converting to IFRS.
Therefore, when the required accounting treatment an entity
presently follows under US GAAP would comply with IFRS, but
alternative accounting treatments are also permitted under
IFRS, such alternatives may not be described herein.
Table
of contents
Importance of being financially bilingual 4
IFRS first-time adoption 7
Revenue recognition 11
Expense recognition—share-based payments 30
Expense recognition—employee benefits 41
Assets—nonfinancial assets 54
Assets—financial assets 80
Liabilities—taxes 102
Liabilities—other 114
Financial liabilities and equity 123
Derivatives and hedging 139
Consolidation 157
Business combinations 177
Other accounting and reporting topics 185
IFRS for small and medium-sized entities 205
FASB/IASB project summary exhibit 209 Noteworthy updates 211
Index 215
Jensen Comment
Many of the newer differences will come about with the forthcoming
implementation of IFRS 9 (Financial Instruments). There are important
differences in the inventory accounting rules that are still pending.
A U.S. investigation
into the lack of write-downs at Exxon Mobil Corp. despite the slump in
oil-prices has brought to light the challenge of assessing impairments under
U.S. Generally Accepted Accounting Principles (GAAP).
But, for international
companies and U.S. firms with foreign operations, figuring out GAAP is not
the only contest, as there is second set of rules.
International Financial
Reporting Standards (IFRS) are a single set of accounting standards that are
now mandated for use by more than 100 countries, including the EU and more
than ⅔ of the G20.
U.S. companies with
overseas operations keep two sets of books, as they have to convert their
IFRS results into GAAP. International firms that are stocklisted in the U.S.
are exempt from this rule, they file in IFRS.
According to its latest
earnings report, Exxon consolidates in GAAP.
Both in GAAP and in
IFRS, the goal is to ensure that assets are not reported above their
so-called fair value, or the amount that can be recovered from liquidating
the asset, said Emmanuel De George, assistant professor of accounting at
London Business School.
Once it is determined
that an asset requires a write-down, reporting entries and disclosure are
similar between IFRS and GAAP, the professor said.
However, there are
substantial distinctions between IFRS and GAAP. “The key difference arises
in the determination of whether or not an asset requires a write-down,” Mr.
De George said.
Exxon said it hasn’t
needed to record a write-down since oil-prices came falling 2014. Last year,
a trade publication quoted Exxon Chief Executive Rex Tillerson with saying
“we don’t do write-downs.”
It is much harder to
write down assets under GAAP than under IFRS, Mr. De George said.
This is because under
IFRS impairment losses can be reversed if economic conditions change and
value is restored, whereas under GAAP reversals are prohibited, once a
write-down has taken place, even if economic conditions improve.
“Under GAAP, a
write-down is triggered if the sum of the undiscounted expected future cash
flows from the asset fall below the net book value,” said Mr. De George.
This means that over
time changes to the value of the asset, for example due to currency
fluctuations, are not taken into consideration when calculating the expected
future cash flow that is generated by the asset.
For the write-down
itself, however, companies don’t reference undiscounted expected future cash
flows, but the discounted expected future cash flow.
This is also described
as “fair value,” the “price that would be expected upon sale of the asset,”
said Mr. De George.
Under IFRS, there’s a
difference in testing whether there needs to be a write-down. IFRS starts
with the discounted future expected cash flows, thus directly accounting for
over time changes to the value of the asset.
The second step, the
write-down, follows the same route as GAAP.
In addition there is
another major difference between GAAP and IFRS. IFRS does not permit a
method called last-in-first-out (LIFO) which shows a lower cost of sales and
higher gains during periods of declining oil prices, said Karthik
Balakrishnan, assistant professor of accounting at London Business School.
“This is what Exxon and
most U.S. oil companies use,” said Mr. Balakrishnan.
Because of the
difference in assessing write-downs and LIFO, IFRS will produce more
conservative numbers for earnings during periods of declining prices, said
Mr. Balakrishnan.
In the case of Exxon,
the experts warn against simply accrediting the lack of write-downs to the
differences in accounting standards between the U.S. and other parts of the
world.
“That would be an
unfair comparison, given that the threshold for impairment testing is higher
under GAAP,” said Mr. De George.
Exxon tends to be more
conservative when capitalizing the costs of their fields which lead to lower
book values to begin with, Mr. George said. “That further reduces the
probability that they will trigger an impairment event,” he said.
Jensen Comment
I think we have to first ask why newer accounting standards and revisions are so
complex? The Number One reason in my book is that contracts that we account for
have become so varied and complex in recent decades. I remember when Andersen's
standards executive partner guru on accounting standards, John Stuart, pointed
out that accounting for derivatives was complex because there were over 1,000
types of derivatives contracts that do highly varied things. Either we have a
complex accounting standard to address complex contracts or we do like the
recent IASB simplifications to IAS 39 that are a cop out --- if it's a
complicated contract let the accountant subjectively account for the contract
such that the same contract may be accounted for differently in different
clients ---
http://faculty.trinity.edu/rjensen/Theory01.htm#BrightLines
Accounting standards seek comparability in financial reporting. If a standard
covers over 1,000 uniquely different contracts there should be some hope that
identical contracts will be accounted for in the same way if the way they are
measured significantly affects the financial statements. For example, there
should be some guidance on accounting for embedded derivatives rather than take
the IASB approach of no longer having to bifurcate embedded derivatives or even
discover if they exist. What nonsense!
The FASB had to form the Derivatives Implementation Group (DIG) for FAS 133
which served as a panel of experts for issuing guidelines on accounting for
derivatives contracts that standard setters had not previously encountered. The
DIG pronouncements are very technical and complicated ---
http://faculty.trinity.edu/rjensen/acct5341/speakers/133glosf.htm#D-Terms
(Scroll down)
But at the same time there's a chance that such contracts will be accounted for
consistently rather than have the auditor in charge any audit making subjective
decisions on how to account for technical and complicated contracts.
Derivatives contracts are by no means the only very technical and very
complex contracts. In fact complexity of contracting is the name of the game,
especially in large corporations.
I defy any accounting standard setting body to come up with simple standards
that apply to complicated contracts. Yes there's a commandment that declares
"though shall not kill." But the legal archives are stuffed with court cases
where killing is justified in unique circumstances. But we don't allow each
killer carte blanche rules are when killing is justified. Instead we have
numerous and complicated statutes that try to have greater consistency as to
when killing is justified.
In a similar manner, the FASB dictates that hedgers cannot simply act
carte blanche regarding deciding what portion of a hedge is effective for
accounting purposes. Sadly, the IASB made hedge effectiveness decisions
carte blanche for
purposes of reducing complexity in IAS 39.
Of course that does not mean we should ignore problems of complexity of
accounting standards, and I'm certain that Tom probably has some good
suggestions in this regard. However, I will only go along with Tom's suggestions
if there is high probability that two identical contracts in different companies
will be accounted for consistently. I don't think that will happen by simply
assuming there are valuation markets that do not exist. I vote for DIG type
implementation interpretations for dealing with complexity --- much like the USA
legal system deals with complexity.
Although the government's bailout of selected banks was deemed in the media
as "The Greatest Swindle in the History of the World," Professor Catanach
suggests that the Big Four attempt to thrust IFRS on the USA is the Great IFRS
Scandal." Some folks on the AECM (no names mentioned) are not going to like this
essay.
When we think about the worst U.S. accounting
scandals ever, those new to the profession usually cite the
Lehman collapse or Madoff scam of 2008, or maybe even the
Enron tragedy in 2001 which has become symbolic for bad
accounting and auditing. And those of us with gray (or no
hair) might recall the ZZZZ Best, Crazy Eddie, or Equity
Funding debacles. However, many of us may have missed what
may be the largest and longest running accounting swindle
ever, one that finds
accountants scamming accountants.
For almost a decade now, accounting educators, local and
regional practitioners, students, and regulators have
been bilked of their limited financial resources by the
large global accounting firms (GAFS). Yes, those of us that
make up what’s left of the “real” accounting profession may
have been victimized, forced to spend our cold, hard cash
(and time) to stimulate the IFRS conversion advisory
practices of these revenue-crazed consulting behemoths.
Why resurrect IFRS now you ask? Well,
most of you that have followed the Grumpies in the past,
already know that
“IFRS is for Criminals.” But in
case you missed it, IFRS adoption in this country is on a
deathwatch, and Tom Selling of the
Accounting Onion has even been so
bold as to proclaim its actual death. And how did you miss
the news of the demise, you ask? Well, you don’t really
believe that the GAFS, or the major industry trade
associations they dominate, will go public with any news
that negatively impacts their revenue generating abilities,
do you? The deathwatch began last summer with the issuance
of a
staff report by the US Securities
and Exchange Commission (SEC) that failed to endorse IFRS
adoption. Instead, it offered no recommendations or
adoption time line, and also raised serious implementation
concerns. And preparations for the wake have accelerated
since we learned that our accounting brethren “across the
pond,” also now are having
second thoughts about IFRS. Given
these developments, it just seemed appropriate to evaluate
who paid the price for the IFRS adoption initiative forced
upon us by the GAFS. Here’s how the swindle worked…
With revenues from Sarbanes-Oxley compliance consulting
beginning to wane, the GAFS needed a “new wave” to ride.
They found one in the European Union’s required adoption of
IFRS in 2005, and then planned to extend this to other
markets including the US. But given the SEC’s role in
standard-setting, the GAFS had to “build” a demand for IFRS
adoption that would effectively force the SEC to mandate
their use. Their well coordinated marketing plan included
the following components:
Convince the
accounting community that not only did everyone favor
IFRS adoption, but that everyone was preparing to adopt.
This was accomplished via poorly constructed surveys
delivered to heavily biased samples, that yielded weekly
newsletters touting IFRS support.
Large industry trade
associations were enlisted in the scam by promises of
new revenues from IFRS training courses which they would
provide to prepare practicing accountants for adoption.
Many accounting educators
also became unwitting accomplices enticed by grant
monies provided by the GAFS to create new IFRS courses
and conduct research into the benefits of IFRS adoption.
So, if awareness and demand could be built,
and enough political muscle exercised, the SEC could be
pushed into adopting IFRS in the US. The result: a really
“big wave” of revenue for the GAFS. And who would pick up
the tab for creating this “make believe” demand for IFRS
adoption services? You guessed it…companies, educators,
students, practitioners…anyone foolish enough to embraced
the GAFS propaganda. And fooled we were by the numerous
half-truths (i.e., the deception) intended to stimulate the
demand for their consulting services. This Grumpy Old
Accountant found one particular assertion particularly
offensive: that the entire world except the US was
adopting IFRS. What the GAFS forgot to tell you was
that this global IFRS adoption was not unconditional, and
was based on numerous “carve-outs,” and often contingent on
IFRS consistency with local GAAP. Hence, the swindle: the
GAFS together with large industry associations generated
large revenues by creating and selling products to meet a
largely fictitious need. So there we have it:
accountants scamming accountants.
But we were warned! David Albrecht
addressed the GAFS motivation for adopting IFRS in “They
Still Don’t Get It” when he so
eloquently and passionately stated:
Fortunately, the “good
guys” appear to have prevailed (at least for now). And on
page 2 of its
staff report, the SEC
recognized that a demand for IFRS adoption simply does not
exist in this country, thus clearly exposing the GAFS’
contrived consulting market:
So there you have it…we
were scammed! But exactly how much did we lose? It’s really
hard to tell, but the number appears to be fairly
substantial. In an incremental analysis of IFRS adoption in
the United States,
David Albrecht suggests that the
total net cost potentially could reach $5 trillion if
complete adoption were to occur. Thank goodness we dodged
that bullet. But what losses have actually been
sustained…let’s look a little deeper at a couple of the more
seriously “injured” parties.
First, there are the
companies electing to adopt IFRS. According
to the SEC, costs to adopt could
consume up to 13 percent of revenue in the first year of
adoption, creating for some large companies an estimated $32
million in “extra” 10-K filing costs. And
recent research also suggests that
IFRS adoption drives up audit costs by over 20 percent in
the adoption year. These are pretty hefty price tags for any
early adopters who bought into the GAFS propaganda,
especially
for something you don’t really need.
Next, there are the
non-trivial sunk costs imposed on both academics and their
students by the GAFS’ IFRS agenda. Now to be fair, several
of the GAFS did provide
“seed” money to select
universities to develop courses and materials in advance of
IFRS adoption. However, most institutions did not receive
any such financial support. So, reacting to artificial
market pressures created by the GAFS, these programs were
forced to fund development of IFRS related courses and
instructional tools largely on their own. And then there is
the time wasted by teachers in preparing themselves to teach
and deliver this “valuable” IFRS content. Also, let’s not
forget the monies and time squandered on IFRS adoption
research in the US. Not only are there “hard” costs
associated with data collection, travel costs, and the like,
but there also are countless opportunity costs associated
with NOT researching other more important topics,
particularly in today’s challenging financial reporting
environment.
Yes, accounting educators paid a stiff price
in this accounting swindle.
Then there are the
students. Textbook publishers embraced the GAFS IFRS fable
wholeheartedly and rushed to revise all accounting related
texts at both undergraduate and graduate levels to include
IFRS related content. And naturally, they could charge more
for these new editions. No longer could students rely on
used books, they had to buy the new editions with the new
IFRS content. And let’s not forget the cost of enrolling in
the newly-created IFRS accounting courses whose benefit to
professional competence remains questionable. Finally, our
accounting students bear the cost of having to study for
IFRS related questions on the CPA exam. Yes, this shows you
just how far the GAFS went to create demand…isn’t the exam
hard enough testing just US GAAP? With today’s rising
tuition costs and student debt a growing problem, the GAFS
should be ashamed of themselves for
fleecing our youth for the sake of their IFRS
adoption “wave.”
FULL convergence with the United States - leading to the creation of one
single set of global accounting standards - is no longer an achievable
project, said Hans Hoogervorst, chairman of the International Accounting
Standards Board (IASB), at the Singapore Accountancy Convention (SAC) on
Thursday.
His grim pronouncement leaves no doubt as to the fate of collaborative
efforts that began over a decade ago; it also comes shortly after the IASB -
the global accounting standards setter - published its completed
international financial reporting standard (IFRS) on financial instruments,
IFRS 9, without the US Financial Accounting Standards Board's (FASB)
participation.
"The FASB decided to stick to current American practices and leave the
converged position," Mr Hoogervorst said.
"It's a pity. Convergence would have allowed the US to make the ultimate
jump to IFRS. But nobody can force it to do so; if it wants to stick with US
GAAP (Generally Accepted Accounting Principles - the US financial reporting
standard), that's its choice. But IFRS moves on - we have a large part of
the world to take care of."
The Emerging Political Shakedown of the IASB
Jensen Comment
Prior to this openness of a political fight involving the IASB I repeatedly
wrote that my concerns about convergence of USA and IASB standards were
political more than technical. However, I was wrong about the political trouble
commencing with enemies of the USA. As of late the political turmoil is being
created by friends of the USA in Europe.
As of late the sheer audacity of Europe to dominate the standard
setting in over 100 nations must be an insult to those nations that are not part
of Europe. To think the USA almost got involved in this political dog and cat
fight is frightening. It's a good thing the SEC backed away from replacing FASB
standards with IASB standards. What a political mess for the IASB ---
http://faculty.trinity.edu/rjensen/Theory01.htm#MethodsForSetting
(Reuters) - The European Union is seeking to
increase its influence over global accounting standards by beefing up the
agency that scrutinizes new rules and in certain cases tweaking how they are
applied in the bloc.
The book-keeping standards, the bedrock of
markets, are written by the International
Accounting Standards Board (IASB). They apply in over 100 countries,
including the EU, but not the United States.
Accounting rules have become highly politicized
after policymakers around the world blamed them for exacerbating the 2007-09
financial crisis.
The standards must first be endorsed by the
European Commission for use in the bloc but member states and the European
Financial Reporting Advisory Group, or EFRAG, often give different views on
their suitability.
The EU is the biggest contributor to the IASB's
budget - it provided about a third of the 20 million pounds the board
received in 2012 - but feels its voice is not adequately heard.
Michel Barnier, commissioner for financial
services, asked former European Investment Bank chief Philippe Maystadt to
recommend how the bloc can streamline advice and endorsement.
In a report published on Tuesday, Maystadt
recommended beefing up EFRAG financially through compulsory levies on listed
companies, and elevating its board to look at the political and economic as
well as technical aspects of rules.
In a challenge to IASB authority, Maystadt also
recommended changing how the commission endorses a standard, broadening it
out from a simple yes or no to include the ability for "carve ins" - or
local tweaks to the rules - but only to improve the "public good".
"I am particularly keen that Mr Maystadt's
recommendations should be implemented swiftly," Barnier said in a statement.
He will present them to EU
finance ministers on Friday.
France, Britain,
Italy and
Germany will become permanent members of
the expanded EFRAG board. The European Central Bank and EU banking,
markets and
insurance watchdogs will also be members, a signal of how policymakers are
keen for lessons from the financial crisis to be applied.
"What is proposed gives us a means to build
something that is going to be efficient," said Jerome Haas, president of the
French accounting standards board ANC.
The IASB had no comment.
Maystadt's recommendations put heavy emphasis on
making sure IASB rules do not destabilize
banks,
insurers and markets.
The current requirement to value some bank assets
at the going rate was seen as accentuating the crisis by forcing lenders
into fire sales to shore up depleted capital.
Another accounting rule is seen as leaving it too
late for
banks to make provisions on souring loans,
forcing taxpayers to bail them out in the crisis.
"EXCESSIVE"
Barnier criticized the "excessive" focus in recent
years on the IASB trying to align its rules with those of the United States,
as called for by world leaders so that investors can compare companies more
easily.
Maystadt said he does not see the United States
adopting IASB rules in the foreseeable future and in the meantime other
parts of the world want to increase their influence.
Barnier said the recommendations will allow the
European Union to better organize itself to ensure the "needs of its
markets" are taken fully into account in IASB rulemaking.
The carve-in provision, along with tougher
conditions for endorsing a rule in the first place, such as not harming
financial stability, are intended to give the European Union more leverage
over shaping new IASB rules in future.
Haas said the "carve in" formalizes what is already
happening across the world, such as selective implementation by supervisors
and companies.
U.S. Securities and Exchange Commission Chairman
Mary Jo White said lawmakers left the agency “no room” for independent
judgment when they mandated rules related to mining safety and conflict
minerals.
Those legislative directives “seem more directed at
exerting societal pressure on companies to change behavior, rather than to
disclose financial information that primarily informs investment decisions,”
White said in remarks prepared for a speech today at Fordham Law School in
New York. “I must question, as a policy matter, using the federal securities
laws and the SEC’s powers of mandatory disclosure to accomplish these
goals.”
The SEC has faced court challenges of rules
mandated by the 2010 Dodd-Frank Act related to minerals originating in the
Democratic Republic of the Congo and a requirement that oil and gas
companies disclose payments made to foreign governments, which a court
voided in July.
“To my mind, the SEC achieves the best results and
best fulfills its mission, when it uses its expertise, acts independently,
and defends that independence against all comers,” White said. “It is a
simple principle. And as long as I am chair, I will be guided by it.”
Judges also should respect the agency’s
independence and its ability to reach appropriate settlements with
securities law violators, she said. The agency’s settlements came under
increased scrutiny after U.S. Judge Jed Rakoff rejected a proposed agreement
with Citigroup Inc. in part because the bank didn’t admit to any misconduct.
Jensen Comment
Has the SEC ever been "independent" of Congress and the lobbying pressures that
pull the strings of Congressional puppets?
Hi Pat,
Tom Selling writes that:
It has been my position
throughout
that the FASB has come to realize that their own
individual interests, as opposed to the public interest, requires that any
changes they make to GAAP must be acceptable to Wall Street and the
bankers.
. . .
At this point, the object of the exercise should be
painfully obvious. Compared to current values, even the best possible
version of amortized cost accounting that bankers could use to save their
hides (a la Mr. Shabudin), or feather their nests (a la
the bankers who remain at large) is nothing more than a straw man.
What Tom does not point out the inconsistency of the above argument in light
of the fact that the bankers are lobbying against the amortized cost accounting
change in the three-bucket fair value standard for loan losses, the fair value
standard that's served them so well in managing their earnings since fair value
of unique troubled loans often have no value in the market or a fire-sale value
that's inappropriate.
I would contend that he should be taking on the IASB more than the FASB. The
IASB has proven that when it comes to recognizing losses on debt like Greek
Bonds, the IASB is allowing European bankers and EU lawmakers to dictate
accounting standards for loan impairments.
The FASB is also demonstrating its independence by continuing to push for
changes in lease accounting that are very unpopular in the leasing industry and
on Wall Street --- changes that are supported by almost nobody.
Tom wrote the following:
One Ebrahim Shabudin, a bank executive, has
settled with the SEC, which found that he
schemed to successfully delay the recognition of loan impairment
charges. The 2009 bankruptcy of his bank ultimately cost the
federal government $1.5 billion: 20 percent in
squandered TARP funds and the rest in costs incurred by the FDIC.
Jensen Comment
Why is the FASB responsible for a client's
delaying of impairment charges?This seems like a goof by the
auditors. To its credit, the SEC eventually punished Mr. Shabudin.
Like legislators, the FASB the FASB is
responsible for setting the rules/laws for financial reporting to
public investors. The FASB had no responsibility for examining the
terms of Mr. Shabudin's loan contract. That was the responsibility
of the external auditor and the SEC.
The analogy would be a state legislature
that set the laws regarding Ponzi schemes illegality. The
legislators do not enforce those laws. The State Attorney General
and maybe the SEC is responsible for enforcement. The SEC really
goofed (possibly due to vested inside interests) in failing to take
Bernie Madoff to task early on when a whistleblower informed the SEC
of Madoff's Massive Ponzi scheme.
Tom Selling wrote the following the following:
It has been my position
throughout that
the FASB has come to realize that their own individual interests, as
opposed to the public interest, requires that any changes they make
to GAAP must be acceptable to Wall Street and the bankers.
Jensen Comment
It would be inconsistent with Tom's
statement whenever the FASB takes a strong stand on a proposed
change in a standard when that change is "not acceptable" to Wall
Street bankers. The FASB has been independent and stuck by its guns
in insisting on accrual reserves for loan losses even though the
bankers objected loudly.
The same appears to be the case for the
proposed FAS 13 revisions on leasing that require booking of
operating leases. Almost nobody seems to be strongly supporting the
proposed Type A and Type B revisions, including the FASB's own
advisiory board. Yet the FASB does not appear to be backing down.
Throughout its history the FASB has been
independent, more independent than the SEC, on may unpopular
standards like Oil & Gas expensing of dry holes, expensing of
employee stock options, accrual amortizations of loan losses,
booking of operating leases, etc.
The FASB is "sputtering along" on leases
precisely because it has not caved in (at least not yet) on booking
of operating leases. This may well be one of those situations like
Oil & Gas where the FASB does what it thinks is proper for investors
and the SEC later caves in to political pressure and overrides the
FASB.
Tom wrote the following:
Actually, the IASB proposal for loan
impairments, from a theoretical perspective is less bad than the
FASB's.
Jensen Comment
The most shameful caving in to political
pressure in the history of standard setting (aside from the SEC cave
in on oil dry hole expensing) is the way the IASB caved in on not
having to adjust severely troubled loans like Greek Bonds to fair
value or take huge amortized losses on those bonds.
The Wall Street banks like the IASB rules
on impairments much better than having to eat huge amortized losses
on such things as Greek and Spanish bonds. having no markets. But
the FASB is standing firm against bankers' wishes on this one.
Sustainability Accounting Standards Board
The SASB apparently will have some forthcoming accounting standards by the
end of 2013. Does anybody know something useful about this accounting standards
board which got a short publicity module on Page 52 of the September 30, 2013
issue of Time Magazine?
A woman named Jean Rogers is apparently the Founder and Executive Director of
the SASB which has a home page at http://www.sasb.org/
The current Board of Directors is somewhat impressive although lacking in
directors who have contributed to the literature of accounting or its social
media ---
http://www.sasb.org/sasb/board-directors/
The curmudgeon in me makes me skeptical about the accounting expertise needed
to generate "accounting standards."
Until recently, I taught a class in sustainability
accounting, and I can tell you that it is just as fraught with big issues as
is ‘real’ accounting. Indeed, they are many of the same issues. They really
do need standards, but the problem – the same problem faced in the early
days of accounting standards – is that the businesses are very different,
and the stakeholders’ needs diverge enormously.
Elaine Cohen, author of the CSR reporting blog, is
someone I respect in the field. I have met her, and have used her material.
I do enjoy her blog. She would agree that sustainability accounting is very
different to the sort of accounting that we do, but it is important and it
does need some level of standardisation, whether done by ‘real’ accountants
or by others.
Kind regards
Ruth
September 25, 2013 reply from Bob Jensen
Hi Ruth,
In the USA, the SASB has no jurisdiction unless one of the government
agencies like the SEC takes it on like the SEC took on the FASB.
The SASB will be somewhat like the IASC in the earliest days before it
became the IASB. The IASC adopted only non-controversial milk toast
standards when compliance was only voluntary. The major factor that allowed
the IASB to take on more controversial issues was its agreement with IOSCO
that forced it to take on more controversial issues like IAS 39 ---
http://faculty.trinity.edu/rjensen/acct5341/speakers/pacter.htm
But like the IASC in its earliest days, the SASB is a start.
Insider Tips by Martha Stewart, Mark Cuban, Tom Selling, and Three Bobs (Vererrecchia,
Jaedicke, and Jensen)
Jensen Comment
I don't think the "The EBITDA Epidemic Takes Its Cue from Standard Setters."
Like Professor Verrecchia currently and my accounting Professor Bob
Jaedicke decades earlier I think the "EBITDA Epidemic" takes its cue from
investors and managers that have a "functional fixation" for earnings, eps,
EBITDA, and P/E ratios --- when in fact those metrics are no longer defined by
the FASB/IASB and may have a lot of misleading noise and secret manipulations.
Jensen Comment
If the FASB cannot define net earnings then it follows from cold logic that they
cannot define measures derived from net earnings like EBITDA.
However, virtually all private sector business firms compute net earnings and
some measures derived from net earnings like eps, EBITDA, and P/E ratios.
It's doubtful whether net earnings for two different companies or even one
company over two time intervals are really comparable.
But all that does not matter when it comes to adjudicating an insider trading
case in court even if the accused may not really be an insider.
I'm reminded of why billionaire Martha Stewart went to prison because she
acted on inside information about a company --- inside information passed on to
her by the CEO of that company. It doesn't matter that the amount of loss saved
by the inside tip involved is insignificant compared to her billion-dollar
portfolio. Evidence in the case made it clear that she did exploit other
investors by acting on the inside tip no matter how insignificant the value of
that tip to her. She was hauled off the clink in handcuffs and was released in
less than five months. But her good name and reputation were tarnished forever
---
http://en.wikipedia.org/wiki/Martha_Stewart
Flamboyant billionaire Mark Cuban is now in trial for very similar reasons,
although the alleged insider tip and the value of the alleged tip is more
obscure than in the Martha Stewart case. Like in the case of Martha Stewart the
loss avoided is pocket change ($750,000) relative to Cuban's billion-dollar
portfolio.
What Cuban failed to mention is that net earnings and EBITDA cannot be
defined since the FASB elected to give the balance sheet priority over the
income statement in financial reporting --- "The Asset-Liability Approach: Primacy does not mean Priority,"
by Robert Bloomfield, FASRI Financial Accounting Standards Research
Initiative, October 6, 2009 ---
http://www.fasri.net/index.php/2009/10/the-asset-liability-approach-primacy-does-not-mean-priority/
Abstract:
Since the 1970s, the decision-usefulness has taken center stage and our
attention has been concentrated on valuation of assets and liabilities
instead of income measurement. The concept of income, once considered the
gravitational center of accounting has lost its primacy and become a
byproduct of the balance sheet derived from the measurement of assets and
liabilities.
However, we have not been equipped with robust
conceptual foundation supporting theoretically reasoned accounting
measurement. It is not only theoretically but also practically important to
renew our seemingly waned interest in the concept of income because ongoing
reforms of accounting standards cannot be successfully implemented without a
sound understanding of the concept of income.
Be that as it may, net earnings and EBITDA are all-important because
investors change their portfolios based on net earnings and its derivatives more
than anything in the balance sheet.
"Accounting Alchemy," by Robert E. Verrecchia, Accounting Horizons,
September 2013, pp. 603-618.
Verrecchia alleges that it's not that managers have a functional fixation for
earnings metrics as it is that they believe that other managers and investors
are so fixated with earnings that it because of monumental importance not
because it is inherently a great metric but because they believe deeply that the
market itself makes this index of vital importance.
. . .
In summary, my thesis is that managers project that
others are fixated on earnings—independent of any evidence in support
of, or contrary to, this phenomenon. This leads to managers resisting the
inclusion in earnings items that fail to enhance performance, such as the
amortization of Goodwill, or measures that make future performance more
volatile, such as those based on fair value. In the absence of acknowledging
PEF and attempting to grapple with it, I continue to see confrontations over
accounting regulation along the lines of recent debates about fair value
accounting, in addition to further impediments along the path to greater
transparency in financial statements.
It's a bit like requiring calculus for undergraduate accounting courses.
Calculus probably is not essential in any undergraduate accounting course in the
curriculum, but faculty are fixated that the best accounting majors are the ones
do well in calculus. Similarly, investors change their portfolios based on
earnings, eps, EBITDA, and P/E ratios when in fact those metrics are not defined
and may have a lot of misleading noise and secret manipulations.
SUMMARY: "International accounting rule makers on Tuesday proposed
changes to corporate disclosure rules aimed at preventing companies from
overwhelming investors with useless information. The board said it hopes to
get accountants and managers away from a check-the-box mentality in
reporting financial results, and instead emphasize clarity for investors."
CLASSROOM APPLICATION: The article may be used in any financial
reporting class but focuses on covering International Financial Reporting
Standards, particularly IAS1 materiality requirements, and on comparing the
IASB and FASB approaches towards the disclosure issues discussed in the
article.
QUESTIONS:
1. (Introductory) The article describes activity by both the IASB
and the FASB to deal with problems in annual report disclosures. What is the
main concern with disclosures currently made? Hint: you will find it helpful
to click on the links in the article to the IASB survey and to the FASB
project on the Disclosure Framework, then read the Project Objectives.
2. (Advanced) The IASB proposal on amending disclosures focuses on
IAS 1. What is that standard?
3. (Advanced) Click on the link in the article to the IASB
proposal. What specific requirements in IAS 1 are being addressed?
4. (Advanced) Refer back to the FASB project objectives examined in
answering question 1 above. How does the FASB's project and proposed
statement of financial accounting concepts differ from the approach being
taken by the IASB? Form a general impression from your examination of these
source materials and cite only one or two examples to explain your answer.
Reviewed By: Judy Beckman, University of Rhode Island
International accounting rule makers on Tuesday
proposed changes to corporate disclosure rules aimed at preventing companies
from overwhelming investors with useless information.
The board said it hopes to get accountants and
managers away from a check-the-box mentality in reporting financial results,
and instead emphasize clarity for investors.
“Financial reports are instruments of communication
and not simply compliance documents,” said Hans Hoogervorst, chairman of the
International Accounting Standards Board, which sets accounting rules for
more than 100 countries. “These proposals are designed to help change
behavior, by emphasizing the importance of understandability, comparability
and clarity in presenting financial reports.”
The move is part of a global effort to make
financial statements easier to read. In a survey last year, the IASB found
that investors and analysts felt companies could better communicate the most
relevant issues in financial statements, rather than forcing them to sift
through vast amounts of data.
The IASB’s proposal suggested amendments that would
require companies to assess whether particular disclosures are material to
investors and to think closely about whether their presentation makes it
harder for investors to find the most important information. The board also
proposed that companies emphasize clarity and comparability in their
financial statement footnotes.
U.S. accounting rule makers have also been working
on a disclosure framework since 2009. Earlier this month, the Financial
Accounting Standards Board issued a proposal that suggested improvements to
the way companies present financial statement footnotes. The Securities and
Exchange Commission is also expected to tackle a “disclosure overload”
project this year.
The IASB is accepting public comments on its
disclosure framework proposal through July 23.
From the CFO Journal's Morning Ledger on September 25, 2013
‘Little GAAP’ could drive accounting simplification A push from privately held companies for simpler accounting
standards could jump-start a plan by
U.S. accounting rulemakers to remove some complexity
from GAAP, writes Emily Chasan. Concerns
from private companies that accounting standards have grown too costly and
complex pushed U.S. accounting overseers last year to establish a Private
Company Council that creates exceptions and modifications to U.S. GAAP for
private companies—essentially, a “Little GAAP” for private businesses. While
the council is still working on its first proposals to reduce complexity, it
is highlighting similar concerns for public companies as well, said Jeffrey
Mechanick, assistant director for Nonpublic Entities at the FASB. “As we
seek to bring a better cost-benefit balance within GAAP for private
companies, we’re initiating at least potential simplification for all
entities from yet another direction,” Mr. Mechanick said at an accounting
roundtable hosted by the NYU Stern School of Business. “We’ve often looked
at public companies first and here we’re looking at private companies
first.”
New Accounting History Books Worth Noting
Steve Zeff at Rice University is one of the best-known accounting historians
alive today. He's also the current Book Review Editor of The Accounting
Review. This explains, in part, why the July 2013 listing of book reviews
four scholarly reference books on accounting history. I say reference books,
because none of the four history books is light reading to pass the time on
airplanes.
SEBASTIAN BOTZEM, The Politics of Accounting Regulation:
Organizing Transnational Standard Setting in Financial Reporting
(Cheltenham, U.K.: Edward Elgar Publishing, 2012, ISBN 978-1-84980-177-5,
pp. x, 223).
Reviewer Scholar: STUART McLEAY
WOLFGANG BURR and ALFRED WAGENHOFER (coordinating editors), Der
Verband der Hoschschullehrer für Betriebswirtschaft: Geschichte des VHB und
Geschichten zum VHB (History of the VHB and Tales of the VHB)
(Wiesbaden, Germany: Gabler Verlag, 2012, ISBN 978-3-8349-2939-6, pp. xxi,
338).
Reviewer Scholar: LISA EVANS
MAHMOUD EZZAMEL, Accounting and Order (New York, NY: Routledge,
2012, ISBN 978-0-415-48261-5, pp. xx, 482).
Reviewer Scholar: SUDIPTA BASU
GARY PREVITS, PETER WALTON, and PETER WOLNIZER (editors), A Global
History of Accounting, Financial Reporting and Public Policy: Eurasia, the
Middle East and Africa (Bingley, U.K.: Emerald Group Publishing Limited,
2012, ISBN 978-0-85724-815-2, pp. xi, 249).
Reviewer Scholar: TIMOTHY S. DOUPNIK
Capsule Commentary on The Future of IFRS (London, U.K.:
Financial Reporting Faculty of the Institute of Chartered Accountants in
England and Wales, 2012, ISBN 978-0-85760-652-5, pp. 25). Downloadable at
www.icaew.com.
Reviewer Commentator: STEPHEN A. ZEFF
The accounting history classic in the set is A Global History of
Accounting, Financial Reporting and Public Policyin four volumes, the
fourth volume of which is reviewed in the above listing. The entire set is
devoted to global development of accounting, financial reporting, and public
policy in several key sovereign states. I don't think any scholarly library on
accounting history would be complete without the entire set, although accounting
professors may not invest in this set unless they are doing research in
accounting history. This is not light reading. The reviewer, Tim Doupnik notes,
that is not a book aimed at teh textbook market. Rather is "intended to be a
historical source book."
The Accounting for Order (in ancient Egypt) book by Mahmoud Ezzamel
provides more than you probably ever wanted to know about "Egyptian inscriptions
to document the role that accounting played in numerous spheres and theorizing
about how accounting helps to create and sustain order within these spheres." It
is a book that should be in every accounting history library, although
professors who buy the book are probably historians interested in ancient Egypt
society, culture, and economics. Sadipta Basu nearly always does scholarly work,
and his review of this book is well worth the read.
Most of us cannot read the Wolfgang Burr and Alfred Wagenhofer book since it
is written in German. Lisa Evans is obviously a scholar in accounting as
well as the German language and writes the following in her review:
This book is written in German and, it seems, for
an audience primarily comprising VHB members, or at least those familiar
with the discipline of Betriebswirtschaft (BWL) and with the organization of
German academe. Therefore, an explicit account of what distinguishes BWL
from related disciplines in other cultures may not have been felt necessary.
However, one of the difficulties in reviewing this book for an
English-speaking readership is the need to translate German concepts for
which there are no English language equivalents. The very terms
Betriebswirtschaft and Betriebswirtschaftslehre (the science of
Betriebswirtschaft) can be translated as, inter alia, business
administration, business management, business economics, or business
studies.
The lack of an equivalent translation is an
indication of the different histories of related disciplines in different
academic and business traditions. The different possible translations are
also a clue to the breadth of the subject matter and to difficulties in its
demarcation from related disciplines during its history. This relationship
with other disciplines is explored throughout this book.
In essence, the VHB represents interests
considerably wider than accounting and finance, and many of the famous names
(Schmalenbach, Schmidt, Mahlberg, etc.) associated with the history of BWL
were not, or not only, professors of accounting in a narrow sense. The VHB's
membership represents 16 subject areas or sub-disciplines: banking and
finance; business taxation; academic management; international management;
logistics; marketing; sustainability management; public business
administration; operations research; organization; human resources
management; production management; accounting; technology, innovation and
entrepreneurship; business information systems; and economic science (VHB
website; see also Chapter 1). The subject group for accounting was formally
constituted in 1977 and includes financial reporting, managerial accounting,
controlling, and auditing (VHB website).
Continued in the book review
The author of The Politics of Accounting Regulation: Organizing
Transnational Standard Setting in Financial Reporting, Sebastian Botzem,
is a political scientist who focuses his particular research skills to the
study of the politics of the International Accounting Standards Board. The
reviewer, stuart Mcleay, writes as follows:
. . .
n its attempt to understand the contested and
political nature of accounting standard setting, this interdisciplinary book
focuses on the structures and the procedures that enable transnational
rule-setting. The author starts with an outline of the social theory that
may explain transnational accounting standardization, noting that the shared
beliefs of professions have long been able to facilitate the social closure
that is important to self-regulation, but that professional bodies no longer
form the main loci of expertise in accounting standard setting. This is
followed by a condensed account of the IASB's emergence as the pre-eminent
international accounting standard setter. Botzem claims that, in getting to
this position, the IASB has out-competed a number of other endeavors to draw
up international accounting rules. This is a questionable interpretation, as
the two supposed competitors to the IASB (the European Community and the
United Nations) have not been greatly concerned with financial reporting
standards per se, but, respectively, with the harmonization of company law
across the member states of the European Union and the wider accountability
of multinational companies. Rather than rival initiatives, these are
components of a complex nexus of overlapping demands by social actors aimed
at constraining the behavior of firms.
The book also attempts to set the scene by drawing
links between global capitalism and the content of international accounting
standards, emphasizing the capital-market orientation embodied in fair value
accounting. This too is overly simplistic, in my view—we do not have to look
far for a counter-example in the potential usefulness of pension accounting
of employee superannuation funds.
The book continues with a reconstruction of the
organizational development of the IASB, arguing that, while the privately
run standard setter has established the necessary procedures to consult with
interested parties, it has done so without handing over too much influence.
In this respect, the author claims that the IASB has subordinated democratic
accountability to the effectiveness of expertise-based standardization. This
is a well-worn debate among accounting researchers, practitioners, and
standard setters, not only the IASB. It is particularly instructive that the
revised conceptual framework issued jointly by the IASB and FASB now limits
the range of addressees of general purpose financial reporting to investors,
lenders and other creditors, explicitly to assist them in making decisions
about providing resources to the entity. Needless to say, political
scientists should be aware that various social actors have sought to foist
their own public policy objectives onto the regulation of financial
statements, in an attempt to extend the remit of standard setting beyond
that of financial reporting. Our understanding of the IASB requires in turn
a greater appreciation of international consensus over the public policy
objectives financial statements.
Finally, the book reports on the author's own
empirical research on organizational structures and processes, by providing
an analysis of the dominant individuals and the most influential
organizations within the IASB's wider network.
Throughout the book, the IASB is portrayed as “a
successful, private, transnational, regulatory body,” whose efforts to be
outside of politics are nevertheless fundamentally political in nature.
While the IASB is often referred to as a “regulator” in this way (both in
this book and elsewhere), the broader perspective is that law-makers,
together with the financial regulators and delegated agencies that produce
“soft law,” contribute jointly to the complex framework of requirements that
are placed on the regulated. At the same time, the multinational operations
of regulated firms readily introduce legal and regulatory
extraterritorialities that muddle institutional boundaries. While Botzem
grapples with some of these complexities, and introduces the reader to
useful universal notions such as “boundary spanning” when generalizing the
diffusion of transnational standards over different social domains, a fuller
understanding of the particularities of the IASB as a regulatory body
requires a more developed appreciation of the way in which the various
institutions of corporate regulation interact in influencing financial
reporting. For instance, not only is the black letter of corporate law
transposed readily from one jurisdiction to another, so too are the formal
and informal rules and processes of accounting (as they have been since the
Middle Ages). The level of statist interaction, or emulation, was already
high before the advent of the IASB. I suspect that cultural specificity in
accounting is marginal, and that other factors, such as differences in
industrial structure, may explain not only international accounting practice
differentiation (Jaafar and McLeay 2007) but also the within-country
alliances that influence statist regulatory differentiation.
In the latter part of the book, the analysis of the
Board membership is based to a great extent on the CVs of the individuals
involved. In contrast, the analysis of the other IASB bodies that are
investigated (the Standards Advisory Council, SAC; the International
Financial Reporting Interpretations Committee, IFRIC; and the trustees)
depends greatly on the assumption that each member of these bodies is a
“representative” of their employer. While the modeling is detailed, it
builds on shaky ground in this respect. For example, a small number of
universities are listed as employing organizations (Genoa, Northwestern, São
Paulo, Tama, Unitec NZ, Waseda, and Wellington). It is difficult to believe
that these organizations are “represented” in any way on IASB committees,
and there is no obvious reason to expect that the individuals involved
necessarily act as representatives of the wider academic community.
Likewise, it is not necessarily the case that an employee of the General
Electric Company is a “representative” of GE, who is just as likely to have
been voted in by dint of other alliances or even on the basis of individual
competences. Although it may be reasonable to infer that an employee of the
Korean Accounting Standards Board is a “representative” of the KASB, or even
of standard setters in general, it is still plausible that individual
factors are as important as institutional representation in motivating
involvement with the IASB, including membership of other networks. We
require a deeper understanding of these interacting alliances formed by
individual members. Moreover, the analysis would benefit from including the
membership of the IASB's Monitoring Board, which consists of capital market
regulators.
Other aspects of the analysis in this book are
similarly underdeveloped. Speaking of one current Board member, who has
worked in India, Europe, and the United States, it is noted that “[h]e is a
member of both the Institute of Chartered Accountants of India and the
American Institute of CPAs and therefore can be considered to be the ninth
‘Anglo-American' representative on the Board” (pp. 132–133). It does seem,
here, as though an awkward fact is not allowed to get in the way of a good
story. Unfortunately, the research places too much weight on the cliché of
“Anglo-American domination.” It would be equally valid to interpret previous
employment and early training with large audit firms as direct experience of
international accounting, in transnational firms that command a global
market in accounting and audit services. For instance, at the time of
writing, just one of these firms has offices in 771 cities across 158
countries, with its employees distributed throughout Europe (34%), North
America (25%), Asia (21%) and elsewhere (20%)—see PwC's Global Annual Review
2012.
The author stretches the same point in other ways:
“in their daily work the Board members draw on a foundation of experience
rooted in an Anglo-American philosophy marked by an appreciation for private
sector self-regulation and skepticism toward state intervention” (p. 133).
Yet the 18 extracts from author interviews with IASB members (Tweedie is
quoted nine times and Whittington four times) and others (Cairns is quoted
twice, Mackintosh twice, and Mau once) provide little evidence of such
attitudes, and the hypothesis therefore remains untested. Indeed, given that
one of the main conclusions is that the IASB mode of expert-based
self-regulation is under-representative of the users of accounting
information, one might conclude that this is a very limited set of
interviewees.
Continued in article
Jensen Comment
I might add that accounting history is monumentally neglected in our North
American accountancy doctoral programs and in our academic accountancy
departments and in our top accounting research journals. Academic researchers
prefer to take the easy way out by beating purchased database pinatas with
sticks until findings, mostly uninteresting findings, fall into research
journals that are largely ignored by the profession and accounting teachers ---
http://www.cs.trinity.edu/~rjensen/temp/AccounticsDamn.htm#Essays
The Sebastian Botzem book should probably be required reading in a course
(probably an economics course) on the history and politics of regulation. Such a
course would not be common in accounting departments. Great credit should be
given to the great success that the IASB has had to date in bringing over 100
nations into the subset of nations that require IFRS totally or almost totally
as the main set of financial reporting standards for auditors and investors.
Although I'm doubtful that IFRS should replace current U.S. GAAP in the USA, my
hat is off to the great success of relentless efforts by dedicated global
accountants to succeed in the politics of IFRS. The USA is a special case, and
nobody ever thought it would be easy to bring convergence of USA and IASB
accounting standards.
The USA is a special case because of its long history of raising business
funding from equity markets that are almost non-existent in most of the 100+
nations who raise a greater share of capital from central banks and government
taxation.
The USA is a special case because of boots-on-the ground wars it has
participated in since World War II. It's not possible to enter into so many
fighting wars without polarizing the rest of the world into nations that respect
the USA's effort to bring world peace versus those that despise the USA's
political alignments and economic dominance, particularly alignments with Israel
that inflame other parts of the world.
The USA will carry a lot of political baggage to the IASB if the IASB
standards are to be deployed in the USA. Our enemies rise up against us with
both terror and with every political tool at their disposal, including the
politics of the UN that will probably be carried over into the future politics
of the IASB. This of course is Bob Jensen speaking and not repeating the more
optimistic views of Sebastian Botzem. However, it's probably inevitable that
the USA will join the IASB fold one day down the road.
Steve Zeff in this edition of TAR has a capsule commentary with a scholarly
forecast of The Future of IFRS that is much more optimistic Capsule Commentary on The Future of IFRS (London, U.K.: Financial
Reporting Faculty of the Institute of Chartered Accountants in England and
Wales, 2012, ISBN 978-0-85760-652-5, pp. 25). Downloadable at
www.icaew.com.
Reviewer Commentator: STEPHEN A. ZEFF
When people talk about independence in connection
with the FASB, they usually mean
one of several things:
Independence from the influence of powerful
stakeholders who have a vested interest in the outcome of a particular
standard-setting decision;
Independence from political
interference; or in some cases, (emphasis added)
Independence from meddling – perceived or real
–by our governing body, the Financial Accounting Foundation.
Each of these is a valid concern that, I believe,
the Board must take seriously. Independence is critical to the establishment
of high-quality accounting standards that promote decision-useful financial
reporting. But in my view, the independence of the FASB is not a right to be
exercised. It‘s a privilege to be earned – every day – through all that we
undertake.
Here's an example of how pressure is or might be placed upon accounting
standards setters, thereby threatening their "independence"
From the CFO Journal on September 16, 2013
Banks in Spain and
Italy look for relief in accounting
Italian and Spanish banks are trying to improve the
appearance of their financial health by
persuading their governments to change accounting-related rules, the WSJ
reports. In Spain, bank executives are lobbying to transform potentially
worthless tax assets into government-guaranteed tax credits that would
bolster the banks’ capital positions. And in Italy, top banking executives
are pushing for a revaluation of the Bank of Italy that would translate into
an accounting windfall for the banks and thereby inflate their capital
levels. But critics say the requested changes are sleight-of-hand maneuvers
that don’t improve the banks’ abilities to weather future losses. “If
capital-adequacy measures can be manipulated to make banks appear better
without really improving their financial health, the purpose of the
[capital] regulation is undermined,” said Anat Admati, a finance professor
at Stanford University’s business school. She described the Spanish effort
in particular as “disturbing.”
European Union banks would
have more breathing space from losses on Greek bonds if the bloc adopted a
new international accounting rule, a top standard setter said on Tuesday.
The International Accounting
Standards Board (IASB) agreed under intense pressure during the financial
crisis to soften a rule that requires banks to price traded assets at fair
value or the going market rate.
This led to huge writedowns,
sparking fire sales to plug holes in regulatory capital.
The new IFRS 9 rule would
allow banks to price assets at cost if they are being held over time.
The European Commission has
yet to sign off on the new rule for it to be effective in the 27-nation
bloc, saying it wants to see remaining parts of the rule finalized first.
Continued in article
The analogy would be proposing to your sweetheart in June without revealing
that your previous marital record until the day of the wedding in
December. Why should your new bride know early on that you had five previous
wives and eight children about to be released from reform school? The same goes
for your own secret prison record on statutory rape.
From the CFO Journal's Morning Ledger on September 13, 2013
The NYT’s Steven M. Davidoff says that the situation
with Twitter is exactly the kind of thing
opponents of the JOBS Act had warned about: A prominent company, known
around the world, has filed for what will most likely be the most
anticipated stock offering since Facebook—and we know precious little about
its business. “No selected financial data, no information about
capitalization or operations, no ‘risk factors’” or anything else you
typically find in a company’s S-1. Under the Act, companies don’t have to
make their public filing until 21 days before they launch a “roadshow,” and
the filing doesn’t obligate Twitter to set a timeline for selling its
shares, the Journal notes.
Twitter is already valued at more than $9 billion, as
judged by private sales by employees of their stock to BlackRock earlier
this year, people familiar with that transaction tell the WSJ. And if it
goes public soon, it could reap rewards from a buoyant market and a hot
period for IPOs.
Although I'm inclined to agree with
you about the decline in quality of financial reporting, but I'm not as
inclined to put as much blame on the accounting standards setters. Perhaps
we've just given standard setters an impossible job.
Much of the blame has to be placed
on the clients themselves along with their lawyers and accountants who
created contracts so filled with contingencies and incomprehensible clauses
that it's impossible to account for them, at least in our overly simplistic
double-entry system of accounting.
There were once thousands and now
ten thousands of types of complicated derivatives contracts, financial
structures, and collateralizations. We require accounting systems to mark
contracts to market when markets are thin and unstable as morning dew on
flower petals in a wind.
I think even you would be
overwhelmed if you were appointed to the IASB or IASB. I know that I would
be dumbfounded in less than a week.
As to externalities, I don't think
we will ever be able to measure the costs and benefits because of the higher
order interactions that befuddle even our best scientists. I sit up here in
the mountains and view first-hand what I think is global warming. But the
scientists who measure temperatures around the world tell us that
temperatures are declining rather than rising. There's ever so much we don't
understand in science, macroeconomics (where we are now facing complexities
we've never seen in the history of the world). and financial risk
contracting that the experts who write the contracts do not understand.
We bookkeepers clomp around in
worlds where angels fear to tread. We can't even explain why financial
statements lost predictive ability since the 1970s.
Over time, financial statements of public
corporations show more losses, intangibles, and earnings restatements, which
lower their value for predicting corporate bankruptcies.
Corporate bankruptcies, like earthquakes, are rare
events. But when they do occur, says
Maureen
F. McNichols of Stanford's Graduate School of
Business, the results can be financially devastating for investors and other
stakeholders.
An important role of financial statement
information is to permit investors to assess the likely timing and amount of
future cash flows. Recent research by McNichols and coauthors examines the
usefulness of financial statement and market data for investors who want to
ascertain the likelihood of bankruptcy. The results of that research are not
completely reassuring.
The authors — McNichols, Marriner S. Eccles
Professor of Public and Private Management;
William
H. Beaver, Joan E. Horngren Professor of
Accounting, Emeritus, at the Graduate School of Business; and
Maria Correia,
assistant professor of accounting at the London Business School — examined
40 years of financial data garnered from thousands of public corporations.
They analyzed key financial ratios, such as return on assets and leverage,
reported in filings to the
U.S. Securities and Exchange Commission, and market-related data such as
market capitalization and stock returns. Over the period they examined —
1962 to 2002 — the data became significantly less useful in predicting
bankruptcy. "Investors should be concerned and aware of this when they
assess bankruptcy risk," McNichols says.
A professor of accounting, McNichols is quick to add that financial
statement data are still highly relevant. Of the firms she and her
colleagues studied, about 1% fell into bankruptcy, and despite the
deterioration in financial-statement usefulness, financial ratios and market
data are still important tools for predicting insolvency, she says.
Nonetheless, the results are concerning enough that McNichols believes
that regulators and standards setters such as the U.S. Securities and
Exchange Commission and the
Financial Accounting
Standards Board should be aware of this issue.
Three major factors muddy the waters for investors
attempting to predict bankruptcy, the researchers found:
Over the sample period, there is increasing
evidence that management exercises discretion over financial reporting,
and that there have been increasing numbers of restatements because the
financial statements were materially misleading. "Our findings indicate
that the manipulation of reported results gives a misleading impression
of profitability and reduces investors' ability to predict bankruptcy,"
notes Correia. For example, firms recognizing revenue ahead of schedule
or fraudulently may appear profitable. As a result, the bankruptcy
prediction model is much less likely to classify bankrupt firms that
also restated earnings accurately, assigning lower risk due to their
overstated earnings.
Many firms, particularly the technology
companies listed on the
NASDAQ exchange,
are heavy spenders on research and development. R&D in itself is
certainly not a cause for concern, but because this "intangible" is not
recognized on the balance sheet, it makes various financial ratios and
data less useful.
The frequency of firms reporting losses has
increased substantially over the past 40 years. Because predicting
future earnings for firms that suffer losses involves substantially
greater uncertainty than for firms that are profitable, the bankruptcy
prediction model is less likely to accurately classify loss firms that
will go bankrupt.
Consider a firm that suffers a loss. The fact that
it has lost money is obviously not good news, but in and of itself a loss
doesn't mean a company will go bankrupt. Losses complicate the financial
picture, the researchers found, because while firms reporting a loss are
more likely to go bankrupt on average, it is harder to predict which loss
firms will do so relative to firms earning a profit.
Continued in article
Jensen Comment
Until the 1990s net earnings showed a surprising predictive power in empirical
capital market studies. I say "surprising" in the sense that we all knew
historical cost earnings based upon many arbitrary assumptions in accrual
accounting such as depreciation, amortization, and bad debt estimation.
Although net earnings was never defined very well in the old days, the FASB
and IASB pretty well destroyed any remaining definition as fair value
accounting, goodwill impairment, and many other components of earnings took away
any remaining meaning of bottom-line net earnings. The biggest bomb, in my
opinion, was the combining of unrealized fair value changes with realized
revenues on contracts.
Solution 3
Pray hard that the IASB and FASB will one day define "net earnings" in a way
that it will have predictive value. That prayer has about as much hope as
praying for world peace or a balanced Federal Budget in Washington DC.
None of the above approaches necessarily will automatically improve the
predictive value of financial statements. Our hope is that in both solutions
financial analysts will be forced to perform deeper analysis rather than simply
track bottom line net earnings that has little, if any, predictive value after
the FASB and IASB screwed it up.
At the AAA meeting in
DC, I attended a presidential address by Ray Ball and Phil Brown
regarding their seminal research paper (JAR 1968). They described the
motivation for their study as a test of existing scholarly research that
painted a dim picture of reported earnings. The earlier writers noted
that earnings were based on old information (historical cost) or, worse
yet, a mix of old and new information (mixed attributes). The early
articles concluded that earnings could not be informative, and therefore
major changes to accounting practice where necessary to correct the
problem.
Ball and Brown viewed
this literature as providing a testable hypothesis – market participants
should not be able to use earnings in a profitable manner. Stated
another way, knowing the amount of earnings that would be reported at
the end of the year with certainty could not be used to profitably trade
common stocks at the beginning of the year. Evidence to the contrary
would suggest the null that earnings are non-informative does not hold.
While the methods part
of the paper is probably difficult for recent accounting archivalists to
follow, Ball and Brown produce perhaps the single most famous graph in
the accounting literature. It shows stock returns trending up over the
year for companies that ultimately report increases in earnings and
trending down for companies that report decreases in earnings. Thus they
show that accounting numbers can be informative even if the aggregate
number is not computed using a single unified measurement approach
across transactions/events. Subsequent research would show that numbers
from the income statement have predictive ability for future earnings
and cash flows.
As I sat listening to
these two research icons, I could not help but think about some comments
I have heard recently from a few standard setters and practitioners.
Those individuals express contempt for EPS in a mixed attribute world.
They appear to wish they could jump in a time machine and eliminate per
share computations related to income. I readily admit that EPS does not
explain much of the variance in returns over periods of one year or less
( e.g., Lev, JAR 1989). However the link is clearly significant, and
over longer periods, the R2’s are quite high (Easton, Harris, and Ohlson,
JAE 1992). Can the standard setters make incremental improvements to
increase usefulness of EPS? I sure hope so, and maybe the recent paper
posted by Alex Milburn will help. But dismissing a reported number
because it is not derived from a single consistent measurement attribute
– be it fair value or historical cost – seems to revert back to pre-Ball
and Brown views that are rejected by years of research.
Jensen Comment
Given the balance sheet focus of the FASB and the IASB at the expense of the
income statement I don't see how net income or eps could be anything but
misleading to investors and financial analysts. The biggest hit, in my
opinion, is the way the FASB and IASB create earnings volatility not only
unrealized fair value changes but the utter fiction created by posting fair
value changes that will never ever be realized for held-to-maturity
investments and debt. This was not the case at the time of the seminal Ball
and Brown article. Those were olden days before accounting standards
injected huge doses of fair value fiction in eps numbers so beloved by
investors and analysts.
Sydney Finkelstein, the Steven Roth professor of management at the
Tuck School of Business at Dartmouth College, also pointed out that Bank of
America booked a $2.2 billion gain by increasing the value of Merrill
Lynch’s assets it acquired last quarter to prices that were higher than
Merrill kept them. “Although perfectly legal, this move is also perfectly
delusional, because some day soon these assets will be written down to their
fair value, and it won’t be pretty,” he said
"Bank Profits Appear Out of Thin Air ," by Andrew Ross
Sorkin, The New York Times, April 20, 2009 ---
http://www.nytimes.com/2009/04/21/business/21sorkin.html?_r=1&dbk
This is starting to feel
like amateur hour for aspiring magicians.
Another day, another
attempt by a Wall Street bank to pull a bunny out of the hat, showing
off an earnings report that it hopes will elicit oohs and aahs from the
market. Goldman Sachs, JPMorgan Chase, Citigroup and, on Monday, Bank of
America all tried to wow their audiences with what appeared to be —
presto! — better-than-expected numbers.
But in each case,
investors spotted the attempts at sleight of hand, and didn’t buy it for
a second.
With Goldman Sachs, the
disappearing month of December didn’t quite disappear (it changed its
reporting calendar, effectively erasing the impact of a $1.5 billion
loss that month); JPMorgan Chase reported a dazzling profit partly
because the price of its bonds dropped (theoretically, they could retire
them and buy them back at a cheaper price; that’s sort of like saying
you’re richer because the value of your home has dropped); Citigroup
pulled the same trick.
Bank of America sold its
shares in China Construction Bank to book a big one-time profit, but Ken
Lewis heralded the results as “a testament to the value and breadth of
the franchise.”
Sydney
Finkelstein, the Steven Roth professor of management at the Tuck School
of Business at Dartmouth College, also pointed out that Bank of America
booked a $2.2 billion gain by increasing the value of Merrill Lynch’s
assets it acquired last quarter to prices that were higher than Merrill
kept them.
“Although
perfectly legal, this move is also perfectly delusional, because some
day soon these assets will be written down to their fair value, and it
won’t be pretty,” he said.
Investors reacted by
throwing tomatoes. Bank of America’s stock plunged 24 percent, as did
other bank stocks. They’ve had enough.
Why can’t anybody read
the room here? After all the financial wizardry that got the country —
actually, the world — into trouble, why don’t these bankers give their
audience what it seems to crave? Perhaps a bit of simple math that could
fit on the back of an envelope, with no asterisks and no fine print,
might win cheers instead of jeers from the market.
What’s particularly
puzzling is why the banks don’t just try to make some money the
old-fashioned way. After all, earning it, if you could call it that, has
never been easier with a business model sponsored by the federal
government. That’s the one in which Uncle Sam and we taxpayers are
offering the banks dirt-cheap money, which they can turn around and lend
at much higher rates.
“If the federal
government let me borrow money at zero percent interest, and then lend
it out at 4 to 12 percent interest, even I could make a profit,” said
Professor Finkelstein of the Tuck School. “And if a college professor
can make money in banking in 2009, what should we expect from the highly
paid C.E.O.’s that populate corner offices?”
But maybe now the banks
are simply following the lead of Washington, which keeps trotting out
the latest idea for shoring up the financial system.
The latest big idea is
the so-called stress test that is being applied to the banks,
with results expected at the end of this month.
This is playing to a
tough crowd that long ago decided to stop suspending disbelief. If the
stress test is done honestly, it is impossible to believe that some
banks won’t fail. If no bank fails, then what’s the value of the stress
test? To tell us everything is fine, when people know it’s not?
“I can’t think of a
single, positive thing to say about the stress test concept — the
process by which it will be carried out, or outcome it will produce, no
matter what the outcome is,” Thomas K. Brown, an analyst at
Bankstocks.com, wrote. “Nothing good can come of this and, under
certain, non-far-fetched scenarios, it might end up making the banking
system’s problems worse.”
The results of the
stress test could lead to calls for capital for some of the banks. Citi
is mentioned most often as a candidate for more help, but there could be
others.
The expectation, before
Monday at least, was that the government would pump new money into the
banks that needed it most.
But that was before the
government reached into its bag of tricks again. Now Treasury, instead
of putting up new money, is considering swapping its preferred shares in
these banks for common shares.
The benefit to the bank
is that it will have more capital to meet its ratio requirements, and
therefore won’t have to pay a 5 percent dividend to the government. In
the case of Citi, that would save the bank hundreds of millions of
dollars a year.
And — ta da! — it will
miraculously stretch taxpayer dollars without spending a penny more.
I think that EU politics has always dominated the IASB and will probably
continue to do so since the future of the IASB rides so heavily upon
pleasing the many EU nations.
In the long run there is a possibility that the mice will roar like they
are now roaring in the United Nations. Enemies of the USA may combine forces
to leverage the IASB into setting accounting standards and interpretations
for purposes of hurting the USA and the rest of the free world rather than
improved accounting and transparency.
Note that a nation is not supposed to adopt IFRS if it intends to cherry pick
what standards will be enforced versus not enforced. It is not supposed to
rewrite any of the standards for its own domestic enforcements. In other words,
if a nation adopts IFRS it adopts the whole IFRS enchilada.
Congratulations Tom
"Bumps in the Road to IFRS Adoption: Is a U-Turn Possible?" by
Thomas I. Selling, Accounting Horizons Commentaries, Vol. 27, No. 1,
March 2013, pp. 155-167 ---
http://aaajournals.org/doi/full/10.2308/acch-50352
In this commentary, I address the question of
adoption of International Financial Reporting Standards in the United
States. I argue that ten claims made in support of IFRS adoption, by leading
proponents in two recent speeches, should be rejected; and consequently, the
Securities and Exchange Commission should have long ago made a “U-turn” on
its related rulemaking proposal.
. . .
WHERE WE STAND
Allow me to close with some observations about the
SEC staff's remaining IFRS adoption Work Plan announced in February 2010 and
the current convergence projects (SEC 2010, Appendix).
Let's begin with the comment letter from the CFA
Institute (2011), representing over 100,000 investment professionals
worldwide. A year and a half into the Work Plan, the CFA Institute was
compelled to point out that the staff had a responsibility to delve into all
of the potential costs and benefits of IFRS adoption, and that significant
questions remained unanswered. At that time, little had been done to:
define what “high-quality standards” means and
whether IFRS standards measure up, address whether the IASB has made needed
improvements to its infrastructure and governance, specify an enforcement
mechanism for IFRS, and specify how endorsement of IFRSs would actually take
place (and by implication lead to the ambitious goal of generating financial
statements that simultaneously comply with U.S. GAAP and IFRS).
Moreover, in a speech last December, SEC staff
member Paul Beswick (2011) acknowledged practically in passing that
constituents had expressed significant concerns that net benefits from
condorsement would not materialize, yet nothing in the staff's planning
documents provides any indication that such an analysis is in the works or
will ever be produced.
As we sit here today, more than two years after the
announcement of that work plan, we are still in about the same place, even
though the staff did issue two progress reports a couple of months ago. A
progress report produced in the Office of the Chief Accountant is a
comparison of the differences between U.S. GAAP and IFRS. Although revenue
recognition, leasing, and financial instruments were excluded, it is amazing
how many significant differences still exist! First, there are all of those
convergence projects that have been abandoned or indefinitely postponed;
second, there are the significant differences that remain from projects that
the staff is counting as converged; and third, there are the differences
that are so fundamental that the boards never bothered to put them on any
convergence agenda. Two quick examples of these are asset impairments and
inventories.
Yet, it appears that the staff has attempted to
downplay the sheer impossibility of bridging these differences, mainly by
providing a document that no commissioner would find any reason to actually
read, except perhaps as a natural and highly effective cure for insomnia.
The bulk of the report is a turgid regurgitation of differences between IFRS
and U.S. GAAP that could have easily been lifted from a pamphlet written by
any one of the Big 4. The staff also made sure to leave out any summary,
takeaways, or any indication whatsoever of the dim prospects for, and
herculean efforts that convergence will continue to entail—even under the
more moderate condorsement scenario now seen as most likely. If the Office
of the Chief Accountant intended to provide no new information or guidance,
then it succeeded admirably.
The staff paper produced in the Division of
Corporation Finance is an analysis of the use of IFRS in practice by the
subset of Global Fortune 500 companies that claimed to comply with IFRS.
This paper was actually well done. It notes a number of apparent departures
from IFRS and the inconsistent ways that IFRS has been interpreted by the
largest companies. By itself, it should explode the myth that worldwide
adoption of IFRS will result in more comparable financial statements—whether
this is due to lack of consistent enforcement, ineffective gatekeepers, or
standards that provide too much opportunity for gaming. The unavoidable and
unstated conclusion from this paper is that even if a single set of global
accounting standards were possible, there is no reason to hope that
comparable financial reporting could be the outcome. A single set of
standards without a single, consistent, and rigorous enforcement mechanism
is enough by itself to know that convergence will fail to deliver on its
promise of comparability.
As I mentioned earlier, we have come to the point
where the SEC is placing all of its hopes for any indication of significant
progress toward convergence on the revenue recognition and leasing projects.
However, the best that can be said of these projects is that two
watered-down standards could become finalized by the end of 2012. I do not
consider this to be progress, as I believe that the FASB would have been
capable of creating higher quality standards without having collaborated
with the IASB. We do have our politics here in the U.S., but recent years
have shown that they are nothing compared to the political pressures exerted
on the IASB by its many “stakeholders.”
The major project that seems most likely to be
finalized in 2012 is revenue recognition. In the revised exposure draft
issued earlier this year, the boards have abandoned any semblance of a
principled position on the asset/liability view—supposedly one of the prime
reasons the project was begun fully ten years ago. If finalized as currently
proposed, all sorts of deferred costs will populate the balance sheet.
Overall, I think it is fair to say that this
project has devolved into a desperate quest to somehow quell criticisms by
preserving current practice while at the same time replacing the rules from
200 separate pronouncements and interpretations with one cohesive document.
The unsurprising result is a draft standard that is so vague and lacking in
robust illustrative examples, I would not be surprised that we will soon
have 200 new interpretations to deal with before an effective date finally
comes to pass—which I expect to be no earlier than January 2017—that is 15
years after the project was added to the FASB's agenda.
The prospects for a high-quality lease accounting
standard are even more dismal. The boards are being pushed to whittle down
recognition of lease obligations to some crudely calculated and arbitrary
minimum amount that lessees might grudgingly accept, but is untraceable to
economic reason. The boards may have actually arrived at an impasse on the
issue of lessee expense patterns; and lessor accounting, after years of
vacillation and improvisation, is still in flux. The financial instruments
project is even less encouraging, as banking regulators wait impatiently
while the boards struggle to find common ground on the measurement of loan
loss allowances and reasonable criteria for the application of “special”
hedge accounting.
CONCLUSION
To sum up, it is clear to most that IFRS adoption
is still laden with many problems and issues. There is seemingly
overwhelming opposition to IFRS adoption, but many fear that the decision to
proceed with some form of condorsement is soon at hand.
At this juncture, I can only speak for myself: for
the sake of investor protection and the public interest, the SEC should have
long ago made a U-turn on its roadmap to IFRS adoption.
Jensen Comment Accounting Horizons, unlike The Accounting Review, has a section
devoted to commentaries. Tom's article above is a good example of an AH
commentary. Tom's article was written by Tom alone. The other two commentaries
in this March 2013 have multiple authors taken to an extreme with more authors
than pages. One of the commentaries has six authors and the other has five
authors.
The six-author commentary includes, Harry Evans, the current Editor and Chief
of The Accounting Review (TAR). That particular commentary entitled
"Testing Analytical Models Using Archival or Experimental Methods" is much more
appropriate for TAR, but TAR has not published commentaries in years apparently
because the 500+ referees will not accept commentaries in TAR ---
http://faculty.trinity.edu/rjensen/TheoryTAR.htm
We have published the
eleventh edition of our popular guide to IFRSs — 'IFRSs In Your Pocket
2012'. This publication provides an update of developments in IFRSs through
the second quarter of 2012.
This 136-page guide includes information
about:
The IASB organisation — its
structure, membership, due process, contact information, and a
chronology
Use of IFRSs around the world,
including updates on Europe, United States, Canada and elsewhere in
the Americas, and Asia-Pacific
Recent pronouncements — those
which are effective and those which can be early adopted
Summaries of current Standards
and related Interpretations, as well as the Conceptual Framework for
Financial Reporting and the Preface to IFRSs
IASB agenda projects and active
research topics
IFRS Interpretations Committee
current agenda topics
Other useful IASB-related
information
Please contact your local Deloitte
practice office to request a printed copy.
Jensen Comment
I don't know of any FASB ACS in Your Pocket counterpart for domestic standards.
It would be great if Wild West Accountants of 2012 could have a two-holster
belt for fast drawing each In-Your-Pocket Guide.
Copies are priced at £90 each, plus shipping. As an academic/student you
will be entitled to a 45%
discount off
the normal price.
If you require further information on A Guide through IFRS 2012
(Green Book) (ISBN 978-1-907877-63-6; product ID: 1713), please visit our
Web Shop
and place your order. Alternatively, download the
order form
from the shop and return it to us by email, fax or post.
eIFRS and Comprehensive subscribers can access the electronic files of A
Guide through IFRS 2012 (Green Book)
here. You
will be required to provide your login details. Comprehensive subscribers
will soon receive a copy by mail.
Jensen
Comment
This illustrates the frustration of hard copy. Getting a novel or even a fact
book in hard copy is often very satisfying. For example, looking up from a 2000
almanac of facts is not misleading as long as you know the book was published in
2000 and that for facts since 2000 you must search elsewhere.
But
accounting standards are being amended so frequently these days, the 2012 IFRS
Green and Red Books can be somewhat misleading in a matter of months. As long as
readers are diligent and highly aware that these books are in many ways obsolete
the moment they come off the printing presses, perhaps there is no big danger.
But lazy accountants and accounting teachers who grab a Green Book or Red Book
and consider the findings to be authoritative without further checking may be
revealing that they are in fact lazy.
This does not go into the detail and illustrations than the
228 page PwC summary of the differences "IFRS and US GAAP: Similarities and
Differences" according to PwC (October 2013 Edition)
http://www.pwc.com/en_US/us/issues/ifrs-reporting/publications/assets/ifrs-and-us-gaap-similarities-and-differences-2013.pdf
Note that warnings are given throughout the document that the similarities and
differences mentioned in the booklet are not comprehensive of all similarities
and differences. The document is, however, a valuable addition to students of
FASB versus IASB standard differences and similarities.
Jensen Comment
At the moment I prefer the PwC reference My favorite comparison topics (Derivatives and
Hedging) begin on Page 158 in the PwC reference
The booklet does a good job listing differences but, in my opinion, overly
downplays the importance of these differences. It may well be that IFRS is more
restrictive in some areas and less restrictive in other areas to a fault. This
is one topical area where IFRS becomes much too subjective such that comparisons
of derivatives and hedging activities under IFRS can defeat the main purpose of
"standards." The main purpose of an "accounting standard" is to lead to greater
comparability of inter-company financial statements. Boo on IFRS in this topical
area, especially when it comes to testing hedge effectiveness!
One key quotation is on Page 165
IFRS does not specifically discuss the
methodology of applying a critical-terms match in the level of detail
included within U.S. GAAP.
Then it goes yatta, yatta, yatta.
Jensen Comment
This is so typical of when IFRS fails to present the "same level of detail" and
more importantly fails to provide "implementation guidance" comparable with the
FASB's DIG implementation topics and illustrations.
I have a huge beef with the lack of
illustrations in IFRS versus the many illustrations in U.S. GAAP.
Reflections on the Last Decade of IFRS Parts 1 and 2 in the free
Australian Accounting Review
2012 Volume 22 Issue 3 Special Edition Part 1 on the last decade of IFRS
A review of the controversial International
Financial Reporting Standards (IFRS) has been sanctioned by Commissioner
Michel Barnier to start early this year, in what amounts to a major
breakthrough in a long-running campaign supported by The Daily Telegraph.
Investors from 10 leading groups – including
Threadneedle Investments, the Co-Operative Asset Management, London Pension
Fund Authority and Railpen – secretly wrote to Mr Barnier in October with a
warning that the accounting rules were harming shareholders, and
destabilising banks and the economy.
The group also wrote to Vince Cable, the Business
Secretary, but, since previous warnings to the Coalition and the
London-based International Accounting Standards Board had gone unanswered,
they appealed directly for help from Brussels.
Replying in a letter to the investors, Olivier
Guersent, the head of Mr Barnier’s cabinet, wrote that he “shared the
concerns” of investors over IFRS. He said that warnings that the rules
exacerbated the financial crisis were “legitimate questions”.
The Commission’s action is the first intervention
from Europe and looks set to leap-frog sluggish reactions from British
regulators to a raft of similar warnings. Although IFRS was introduced
across Europe, critics of the rules have maintained that the way Britain
adopted them left its banks uniquely vulnerable.
IFRS has been criticised for allowing banks to hide
risk exposure because poor loans do not appear until they have failed. The
rules, which were introduced in Britain in 2005, also allow banks to spread
losses across several years, rather than recognise them immediately.
London-based accountants have been at the forefront of trying to create a
single international accounting system, using IFRS which, critics argue, has
made many reluctant to admit that the system may be flawed.
In his letter, seen by The Daily Telegraph, Mr
Guersent said: “In 2002, the EU made its landmark decision to require all
listed companies to use IFRS. Much has been achieved since.
“However, there are legitimate questions which need
to be addressed, in particular whether the application of IFRS in the crisis
resulted in overstated profits and imprudent distributions. The Commission
services will carry out an assessment of the IAS regulation starting early
in 2013... and, if necessary, to propose complementary remediating
measures.”
In 2010, Tim Bush, a director at the investor group
Pirc, sent a letter to the Department for Business warning that IFRS was
creating “mistakes [in bank accounts] of such severity that it is difficult
to overstate”. His warnings were criticised by both British and
international accounting bodies responsible for introducing them.
In October that year, the House of Lords Economic
Affairs Committee launched a review and, in the spring of 2011, reported
that they had serious concerns about IFRS. In response, Mr Cable insisted
there was no problem. But in June last year, Andy Haldane, head of financial
stability at the Bank of England, said accounting rules were so flawed that
getting an accurate view of a bank’s assets was like trying to “pin the tail
on a boisterous donkey”.
European-Styled Avoidance of Fair Value Earnings Hits for Loan Loss
Impairments
European banks circumvented earnings hits for anticipated billions in loan
losses by a number of ploys, including arguments regarding transitory price
movements, "dynamic provisioning" cookie jar accounting, and spinning debt into
assets with fair value adjustments "accounting alchemy."
European banks resorted to a number of misleading ploys to avoid taking fair
value adjustment hits to prevent earnings hits due to required fair value
adjustments of investments that crashed such a investments in the bonds of
Greece, Ireland, Spain, and Portugal.
The Market Transitory Movements Argument
Fair value adjustments can be avoided if they are viewed as temporary transitory
market fluctuations expected to recover rather quickly. This argument was used
inappropriately by European banks hold billions in the Greece, Ireland,
Spain, and Portugal after the price declines could hardly be viewed as
transitory. The head of the IASB at the time, David Tweedie, strongly objected
to the failure to write down financial instruments to fair value. The banks, in
turn, threatened to pressure the EU lawmakers to override the IFRS 9 requirement
to adjust such value declines to market.
One of the major concerns of the is that
some nations at some points in time will simply not enforce the IASB standards
that these nations adopted. The biggest problem that the IASB was having with
European Banks is that the IASB felt many of many (actually most) EU banks were
not conforming to standards for marking financial instruments to market (fair
value). But the IASB was really helpless in appealing to IFRS enforcement in
this regard.
When the realities of European bank political powers, the IASB quickly caved
in as follows with a ploy that allowed European banks to lie about intent to
hold to maturity. The banks would probably love to unload those loser bonds as
quickly as possible before default, but they could instead claim that these
investments were intended to be held to maturity --- a game of make pretend that
the IASB went along with under the political circumstances.
European Union banks would
have more breathing space from losses on Greek bonds if the bloc adopted a
new international accounting rule, a top standard setter said on Tuesday.
The International Accounting
Standards Board (IASB) agreed under intense pressure during the financial
crisis to soften a rule that requires banks to price traded assets at fair
value or the going market rate.
This led to huge writedowns,
sparking fire sales to plug holes in regulatory capital.
The new IFRS 9 rule would
allow banks to price assets at cost if they are being held over time.
The European Commission has
yet to sign off on the new rule for it to be effective in the 27-nation
bloc, saying it wants to see remaining parts of the rule finalized first.
When people talk about independence in connection
with the FASB, they usually mean
one of several things:
Independence from the influence of powerful
stakeholders who have a vested interest in the outcome of a particular
standard-setting decision;
Independence from political
interference; or in some cases, (emphasis added)
Independence from meddling – perceived or real
–by our governing body, the Financial Accounting Foundation.
Each of these is a valid concern that, I believe,
the Board must take seriously. Independence is critical to the establishment
of high-quality accounting standards that promote decision-useful financial
reporting. But in my view, the independence of the FASB is not a right to be
exercised. It‘s a privilege to be earned – every day – through all that we
undertake.
Here's an example of how pressure is or might be placed upon accounting
standards setters, thereby threatening their "independence"
From the CFO Journal on September 16, 2013
Banks in Spain and
Italy look for relief in accounting
Italian and Spanish banks are trying to improve the
appearance of their financial health by
persuading their governments to change accounting-related rules, the WSJ
reports. In Spain, bank executives are lobbying to transform potentially
worthless tax assets into government-guaranteed tax credits that would
bolster the banks’ capital positions. And in Italy, top banking executives
are pushing for a revaluation of the Bank of Italy that would translate into
an accounting windfall for the banks and thereby inflate their capital
levels. But critics say the requested changes are sleight-of-hand maneuvers
that don’t improve the banks’ abilities to weather future losses. “If
capital-adequacy measures can be manipulated to make banks appear better
without really improving their financial health, the purpose of the
[capital] regulation is undermined,” said Anat Admati, a finance professor
at Stanford University’s business school. She described the Spanish effort
in particular as “disturbing.”
Only a few years ago,
Spain’s
banks were seen in some policy-making circles as a
model for the rest of the world. This may be hard to fathom now, considering
that Spain is seeking $125 billion to bail out its ailing lenders.
But back in 2008 and early 2009, Spanish regulators
were
riding high after their country’s banks seemed to
have dodged the financial crisis with minimal losses. A big reason for their
success, the regulators said, was an accounting technique called dynamic
provisioning.
By this, they meant that Spain’s banks had set
aside rainy- day loan-loss reserves on their books during boom years. The
purpose, they said, was to build up a buffer in good times for use in bad
times.
This isn’t the way accounting standards usually
work. Normally the rules say companies can record losses, or provisions,
only when bad loans are specifically identified. Spanish regulators said
they were trying to be countercyclical, so that any declines in lending and
the broader economy would be less severe.
What’s now obvious is that Spain’s banks weren’t
reporting all of their losses when they should have, dynamically or
otherwise. One of the catalysts for last weekend’s bailout request was the
decision last month by the
Bankia (BKIA) group, Spain’s third-largest lender,
to restate its 2011 results to show a 3.3 billion-euro ($4.2 billion) loss
rather than a 40.9 million-euro profit. Looking back, we probably
should have known Spain’s banks would end up this
way, and that their reported financial results bore no relation to reality.
Name Calling
Dynamic provisioning is a euphemism for an old
balance- sheet trick called
cookie-jar accounting. The point of the technique
is to understate past profits and shift them into later periods, so that
companies can mask volatility and bury future losses. Spain’s banks began
using the method in 2000 because their regulator, the
Bank of Spain,
required them to.
“Dynamic loan loss provisions can help deal with
procyclicality in banking,” Bank of Spain’s director of financial stability,
Jesus Saurina, wrote in a July 2009
paper published by the
World
Bank. “Their anticyclical nature enhances the
resilience of both individual banks and the banking system as a whole. While
there is no guarantee that they will be enough to cope with all the credit
losses of a downturn, dynamic provisions have proved useful in Spain during
the current financial crisis.”
The danger with the technique is it can make
companies look healthy when they are actually quite ill, sometimes for
years, until they finally deplete their
excess reserves and crash. The practice also
clashed with International Financial Reporting Standards, which Spain
adopted several years ago along with the rest of
Europe. European Union officials knew this and
let Spain proceed with its own brand of accounting anyway.
One of the more candid advocates of Spain’s
approach was Charlie McCreevy, the EU’s commissioner for financial services
from 2004 to 2010, who previously had been Ireland’s finance minister.
During an April 2009 meeting of the
monitoring board that oversees the
International Accounting Standards Board’s
trustees, McCreevy said he knew Spain’s banks were violating the board’s
rules. This was fine with him, he said.
“They didn’t implement IFRS, and our regulations
said from the 1st January 2005 all publicly listed companies had to
implement IFRS,” McCreevy said, according to a
transcript of the meeting on the monitoring
board’s website. “The Spanish regulator did not do that, and he survived
this. His banks have survived this crisis better than anybody else to date.”
Ignoring Rules
McCreevy, who at the time was the chief enforcer of
EU laws affecting banking and markets, went on: “The rules did not allow the
dynamic provisioning that the Spanish banks did, and the Spanish banking
regulator insisted that they still have the dynamic provisioning. And they
did so, but I strictly speaking should have taken action against them.”
Why didn’t he take action? McCreevy said he was a
fan of dynamic provisioning. “Why am I like that? Well, I’m old enough to
remember when I was a young student that in my country that I know best,
banks weren’t allowed to publish their results in detail,” he said. “Why?
Because we felt if everybody saw the reserves, etc., it would create maybe a
run on the banks.”
So to
sum up this way of thinking: The best system is
one that lets banks hide their financial condition from the public. Barring
that, it’s perfectly acceptable for banks to violate accounting standards,
if that’s what it takes to navigate a crisis. The proof is that Spain’s
banks survived the financial meltdown of 2008 better than most others.
The world's top accounting rulesetter unveiled
plans on Thursday aimed at buttressing its authority and independence in the
face of calls from European groups for a greater say in how new standards
are shaped.
The International Accounting Standards Board (IASB)
writes rules used in over 100 countries, giving it clout that critics say
calls for much greater accountability.
Accounting standards setting has become politically
charged since the financial crisis, as policymakers realise the reach that
rules can have - such as making banks recognise losses earlier in future,
before taxpayer bailouts are needed.
The IASB proposed on Thursday an Accounting
Standards Advisory Forum comprising 12 members from across the world.
The board currently relies on informal, bilateral
contacts with scores of national accounting bodies for input into writing
new rules but this has become unwieldy.
"The answer is to establish a multilateral forum
where representatives of the standard-setting community can come together
with the IASB," said IASB Chairman Hans Hoogervorst.
But what appears to be a modest piece of
housekeeping has already stirred political tensions, not least in Europe,
the region that gave IASB rules global momentum and now feels it should have
strong representation.
Hoogervorst proposes giving Europe three seats, the
same as for the Americas and for Asia-Oceania. It would meet for just a day
and a half, four times a year in London and, crucially, be chaired by the
IASB.
Members would have to sign up to promoting a single
set of global standards - code for no lobbying for national carve-outs - and
respect the IASB's independence.
The IASB plan is in effect an opening gambit as
national standard setters have already filed a counter proposal to the IASB
that proposes a board with up to 20 seats and far greater parity between the
IASB and national standard setters.
"Our proposal is more comprehensive, precise,
focused on the objective of partnership at all stages, not just a forum
controlled by IASB staff," said Jerome Haas, president of the French
accounting standards board ANC.
"We will have to work to find the right balance and
organisation based on the two proposals," Haas told Reuters.
The counter proposal envisages rulemaking as more
of a bottom up process based on evidence and need, rather than being imposed
by the IASB after some local consultation.
The IASB has also been locked in joint talks with
the accounting standards board from the United States, which still uses its
own rules, for a decade to align each others' rules.
But in a blow to the IASB, the United States has
deferred a decision on whether to switch to IASB rules.
The UK's Financial Reporting Council has joined
with the national standard setters of France (ANC), Germany (ASCG), Italy (OIC),
and with European standard setters' advisory group EFRAG to influence the
debate over the future of IFRS.
Global standard setter the IASB is currently
revising the conceptual framework that underpins the way the it develops and
rewrites accounting standards, with its chairman Hans Hoogervorst demanding
that it be treated as the board's "main deliverable" focus over the next
three years.
Last month, the FRC, which hiked its levy rates to
- among other things - strengthen its ability influencing the international
debates on auditing and international reporting standards, said revising the
conceptual framework was "critical" for the future of IFRS.
By collaborating with its European partners the FRC
hopes to make sure the revised conceptual framework reflects an underlying
accounting model relevant to European stakeholders.
Additionally, the standard setters have published a
joint consultation paper from the standard setters, Getting a Better
Framework, to illustrate some of the major issues that will arise in the
development of the new framework, and to encourage others within Europe to
engage in its development.
"Given the vast scope of the project, and in order
to facilitate obtaining input from European stakeholders in an open and
proactive way, the accounting standard bodies have agreed to publish
bulletins each covering a topic as well as a regular newsletter on project
updates," the FRC said.
Speaking at the IASB's September board meeting,
Hoogervorst said revising the framework was urgent because the board is
"struggling with so many basic questions in terms of measurements".
One issue that provoked controversy was the removal
of prudence from the framework to be replaced by the concept of neutrality;
a decision recently described by former UK chancellor Lord Lawson as "a
stupid thing to do".
Continued in the article
Jensen Question
Does this kind of lobbying underpin much of the SEC's reluctance to adopt
international IFRS in place of FASB-driven U.S. GAAP?
Spinning Debt Into Earnings With the Wave of a Fair Value Accounting Wand
"Euro banks' £169bn in accounting alchemy," by: Lindsey White, Financial
Times Advisor, January 19, 2009 --- Click Here
European banks conjured more than £169bn of debt
into profit on their balance sheets in the third quarter of 2008, a leaked
report shows.
Money Managementhas gained exclusive access to a
report from JP Morgan, surveying 43 western European banks.
It shows an exact breakdown of which banks
increased their asset values simply by reclassifying their holdings.
Germany is Europe's largest economy, and was the
first European nation to announce that it was in recession in 2008. Based on
an exchange rate of 1 Euro to £0.89, its two largest banks, Deutsche Bank
and Commerzbank, reclassified £22.2bn and £39bn respectively.
At the same exchange rate, several major UK banks
also made the switch. RBS reclassified £27.1bn of assets, HBOS reclassified
£13.7bn, HSBC reclassified £7.6bn and Lloyds TSB changed £3.2bn. A number of
Nordic and Italian banks also switched debts to become profits.
Banks are allowed to rearrange these staggering
debts thanks to an October 2008 amendment to an International Accounting
Standards law, IAS 39. Speaking to MM, IAS board member Philippe Danjou said
that the amendment was passed in "record time".
The board received special permission to bypass
traditional due process, ushering through the amendment in a matter of days,
in order to allow banks to apply the changes to their third quarter reports.
However, it is unclear how much choice the board
actually had in the matter.
IASB chairman Sir David Tweedie was outspoken in
his opposition to the change, publicly admitting that he nearly resigned as
a result of pressure from European politicians to change the rules.
Danjou also admitted that he had mixed views on the
change, telling MM, "This is not the best way to proceed. We had to do it.
It's a one off event. I'd prefer to go back to normal due process."
While he was reluctant to point fingers at specific
politicians, Danjou admitted that Europe's "largest economies" were the most
insistent on passing the change.
As at December 2008, no major French, Portuguese,
Spanish, Swiss or Irish banks had used the amendment.
BNP Paribas, Credit Agricole, Danske Bank, Natixis
and Societe Generale were expected to reclassify their assets in the fourth
quarter of 2008.
The amendment was passed to shore up bank balance
sheets and restore confidence in the midst of the current credit crunch. But
it remains to be seen whether reclassifying major debts is an effective
tactic.
"Because the market situation was unique, events
from the outside world forced us to react quickly," said Danjou. "We do not
wish to do it too often. It's risky, and things can get missed."
Jensen Comment
European banks thus circumvented earnings hits for anticipated billions in loan
losses by a number of ploys, including arguments regarding transitory price
movements, "dynamic provisioning" cookie jar accounting, and spinning debt into
assets with fair value adjustments "accounting alchemy."
Hans Hoogervorst, chairman of the International Accounting Standards Board,
says the board's Conceptual Framework project will finish on time. Revising the
framework is essential because the IASB is "struggling with so many basic
questions in terms of measurements," he said.
"Hoogervorst gets tough over IASB framework deadline," by Richard Crump,
Accountancy Age, October 21, 2012 ---
http://www.accountancyage.com/aa/analysis/2218655/hoogervorst-gets-tough-over-framework-deadline
Jensen Comment
Increasingly Hans has mentioned in speeches that many of the basic questions in
measurement are focused on costs versus benefits.
Phase A—Objectives and Qualitative
Characteristics
6. This phase involves consideration of the objectives
of financial reporting and the qualitative characteristics of financial
reporting information, which include relevance, faithful representation,
comparability (including consistency) and understandability, and
trade-offs between qualitative characteristics and how they relate to
the concepts of materiality and cost-benefit relationships.
Oct 23 (Reuters) - A decade-long drive backed by
world leaders to align accounting rules could go into reverse if the United
States balks at adopting global standards, a top rule-setter said.
The
G20 group of top economies called in 2009
at the height of the financial crisis for a single set of global accounting
rules to improve transparency for investors.
But differences between the International
Accounting Standards Board (IASB) and the U.S. Financial Accounting
Standards Board (FASB) pushed the initial 2011 target back to 2013. And in
its latest communiques, the
G20 has dropped all mention of a date and
only states the need for common rules.
The two sides have been holding meetings for a
decade to try to align their rules, but have become bogged down in
disagreements, in particular over how to force
banks to recognise losses earlier on bad
loans.
This was a key G20 demand to stop
banks leaving it too late and in extreme
cases needing taxpayer bailouts.
"There is a risk that, in the absence of a U.S.
decision on adoption, a decade of convergence may be followed by a new
period of divergence," said the IASB staff report released on Tuesday in
response to a July U.S. announcement.
The report responds point by point to issues raised
by the U.S. authorities, which said in July that full adoption of the IASB's
rules known as IFRSs had little support and they would stick to requiring
generally accepted accounting principles or GAAP.
"While acknowledging the challenges, the analysis
... shows that there are no insurmountable obstacles for adoption of IFRSs
by the United States," IASB Trustees Chairman Michel Prada said.
The United States is well placed to achieve a
successful transition to IFRSs and complete the objective repeatedly
confirmed by the G20 leaders, Prada added.
The IASB report said it was important to consider
whether the existing level of alignment can be maintained as both boards
plan future workloads.
IASB Chairman Hans Hoogervorst has expressed
frustration at how convergence has slowed and wants to move beyond the
seemingly permanent joint meetings with the Americans.
Countries such as
Japan, Singapore and India are watching to see
what the United States decides before fully adopting IFRSs themselves. Over
100 countries use IFRS and many believe it's now time for some of their
issues to be debated.
The IASB report seeks to ease
U.S. concerns about loss of regulatory sovereignty, saying enforcement would
remain the sole responsibility of the Securities and Exchange Commission.
Continued in article
Continued in artilce
Jensen Comment
Loss or regulatory sovereignty is not the burning issue. We always knew that the
SEC (and to some extent the AICPA) would enforce the standards in the United
States. The burning issue loss of sovereignty over the writing of the
accounting rules that would have to be enforced. It's like turning U.S.
lawmaking over to the United Nations.
Another burning issue repeatedly raised by former AAA President and Yale
Professor Shyam Sunder is that creating a monopoly in accounting standard
setting has more downside risk and upside risk.
The argument that global financial statements will be more comparable is a
leaky bucket since there may not be a whole lot of comparability in the way
clients and their auditors inconsistently apply "principles-based IFRS
standards."
Jensen Comment
Today I must leave early in the morning to take Erika to Concord for a medical
treatment. I've not yet had time to read the above draft in detail. It appears,
however, that this draft for IFRS 9 retains changes in IAS 39 that are
objectionable to me relative to what I think is better in FAS 33 as amended.
Firstly, the thrust of the IFRS 9 changes will be to add more subjectivity
(relative to FAS 133), especially in the area of hedge effectiveness testing.
For example, if a farmer has hedges a growing crop of corn, he is likely to do
so on the basis of standardized corn quality of corn futures and options trading
on the CBOT or CME. It is unlikely that the corn that he ultimately takes to
market will have the identical quality moisture content. In addition he will
have trucking costs of getting his corn from say South Dakota to the trading
market in Chicago. As a result of all this, his hedging contract acquired in
June on the CBOT or CME exchange is not likely to be perfectly effective
relative to the corn he brings to market in October. Thus there will be
hedging ineffectiveness.
There is greater likelihood that in a particular instance of hedge
ineffectiveness, the original IAS 39 would result in Client A having identical
accounting for the hedge ineffectiveness as Client B. Under the new IFRS 9 this
becomes less assured since clients are given considerable subjective judgment in
deciding how to deal with hedge ineffectiveness.
Also under FAS 133, embedded derivatives in financial contracts must be
evaluated and if the embedded derivative's underlying is not "clearly and
closely related" to the underlying in the host contract, the embedded
derivatives must be bifurcated and accounted for separately. This leads to a lot
of work finding and accounting for embedded derivatives. IFRS 9 will eliminate
all that work by not making clients look for embedded derivatives. Hence, the
risk that comes from having embedded derivative underlyings not clearly and
clossely associated with the underlyings of the host contract can simply be
ignored. I don't by into this IFRS 9 bad accounting for the sake of
simplification.
I think there are other areas of difference expected differences between IFRS
9 and FAS 133 as amended. Most of the differences lie in the subjectivity
allowed in accounting for hedging contracts under IFRS 9 that is not allowed in
FAS 133.
September 10, 2012 reply from Bob Jensen
This afternoon received a message from PwC about the IASB's proposed
changes to hedge accounting. The PwC reply is consistent with, albeit
somewhat more extensive, then my reply that I sent to the AECM early this
morning.
Note that the IASB is not really opening up these proposed hedge
accounting amendments to comments. Wonder why?
Also note that the proposed IASB's amendments diverge from rather than
converge toward U.S. GAAP under FAS 133 as amended. At this point in time I
don't think the IASB really cares about convergence of hedge accounting
rules.
My quick and dirty response is that the revised hedge accounting
standards under IFRS 9 is carte blanche for having two different clients and
their auditors account differently for identical hedge accounting
transactions because so much subjectivity will be allowed under IFRS 9. We
may even have subsidiaries of the same client accounting for identical
transactions differently.
Such is the myth of comparability one is supposed to get under
principles-based global standards.
Further more, it may challenge auditing Firm X that has one client
claiming a hedge is effective when another client would claim the hedge is
ineffective. Will auditing Firm X certify divergent accounting for the same
hedge. The answer is probably yes these days if both clients are too big to
lose.
Bob Jensen
So Much for the Myth That Accounting Standards Are Neutral in Terms of
Business Strategy (of course it did not take IFRS 9 to reveal this to us)
"Under New Accounting Standard, CFOs Could Change Hedging Strategies:
Will finance chiefs come under more pressure to adopt hedge accounting — even
though it remains entirely optional under the new standard?"
by Andrew Sawyers CFO.com, September 12, 2012
http://www3.cfo.com/article/2012/9/gaap-ifrs_hedge-accounting-ias-39-iasb-ifrs-derivatives-80-125-test-hedge-effectiveness
A new international financial reporting standard (IFRS) on hedge
accounting could prompt finance chiefs to change their companies’
hedging strategies under a more accommodating, principles-based regime
that requires less testing.
The International Accounting Standards
Board (IASB) has been pondering hedge accounting for several years in an
effort to find a way to replace the unloved standard IAS 39: so unloved
that it’s not part of the package of accounting standards endorsed by
the European Commission for listed companies. The standard has made it
tough to employ hedge accounting, which can be favorable to companies in
certain circumstances.
In
a recent podcast, Kush Patel, director in
Deloitte’s U.K. IFRS Centre of Excellence, summarized the impact of the
new rules: “More hedge-accounting opportunities,
less profit and loss volatility — so as
you’d expect, this has been well received.”
Under IAS 39, he said, “we saw a lot of companies change the way they
manage risk: we saw them reduce the amount of complex, structured
derivatives that were being used to hedge and they went for more vanilla
instruments that could [qualify for] hedge accounting more easily. Now
that IFRS 9 will remove some of these restrictions, I think it’s fair to
say risk management could change.”
Andrew Vials, a technical-accounting partner at KPMG, said in a
statement, “A company will be able to reflect in its financial
statements an outcome that is
more consistent with how management assesses and mitigates risks
for key inputs into its core business.”
Will CFOs come under more pressure to adopt hedge accounting — even
though it remains entirely optional under the new standard? “If hedge
accounting becomes easier, there may be more emphasis on them to achieve
hedge accounting — so although it’s voluntary, there is an element that
they may feel more compelled to do hedge accounting” says Andrew
Spooner, lead global IFRS financial-instruments partner at Deloitte.
The
final draft of the new hedge-accounting rules
was published on September 7 and will be incorporated into the existing
IFRS 9 Financial Instruments at the end of the year. The IASB
says it’s not seeking comments on this final draft, but is making it
available “for information purposes” to allow people to familiarize
themselves with it. The new rules will take effect from January 1, 2015,
but companies will be allowed to adopt them sooner if they wish.
Spooner and Patel note three main areas in which the new rules are
different from the old:
Changes to the instruments that qualify. It’s now
easier, for example, to use option contracts without increasing
income-statement volatility.
Changes in hedged items. It may not be possible, for
example, for a company to hedge the particular type of coffee beans a
food company buys. But it could hedge a benchmark coffee price, because
it is closely related to the item it would like to hedge. Another change
for the better: companies in the euro zone that want to hedge dollar
purchases of oil can now more easily hedge the dollar price of the oil,
then later hedge the foreign-exchange exposure without the oil-price
hedge being deemed ineffective. There are also more favorable rules for
hedging against credit risk and inflation.
Changes to the hedge-effectiveness requirements.
Under IAS 39, a company could use hedge accounting only if a hedge is
“highly effective,” meaning it must be capable of offsetting the risk by
a range of 80%–125%. But the 80–125 test has been scrapped to be
replaced by a principle-based test that is based on economic
relationship: “You have to prove that there is a relationship between
the thing you are hedging and the thing you are using,” says Patel.
Having gotten rid of the quantitative threshold, there are “more
opportunities for companies to reduce the amount of testing they do,” he
says. “It’s a welcome change.”
TOPICS: FASB, Financial Accounting Standards Board, Financial
Reporting, International Accounting Standards, International Accounting
Standards Board, SEC, Securities and Exchange Commission
SUMMARY: James Kroeker of the SEC spoke at an IFRS advisory panel
in London on Monday, February 20, 2012. He discussed the SEC's current
thinking on adoption of IFRS and the role of the FASB in that system.
According to the article, his comments were made "in terms that hinted that
he and his staff were gravitating toward a middle-ground 'endorsement'
proposal, under which IFRS would be incorporated into U.S. rules and U.S.
rule makers would retain the authority to evaluate future global rules for
U.S. use."
CLASSROOM APPLICATION: The article is useful to bring to students'
attention the current status of a U.S. shift to global financial reporting
standards (IFRS) established by the IASB with review and endorsement by the
FASB.
QUESTIONS:
1. (Advanced) Who establishes International Financial Reporting
Standards (IFRS)?
3. (Introductory) According to the article, why are "international
authorities...pushing the [U.S. Securities and Exchange Commission] to move
U.S. companies to use the global rules"? Why do accounting firms and large
multinational corporations also support this view?
4. (Advanced) What is principles-based standard setting? How is
this different from the approach generally taken under U.S. Generally
Accepted Accounting Principles (U.S. GAAP)?
5. (Introductory) According to the article, as the U.S. moves to
using IFRS, what will become the role of the Financial Accounting Standards
Board (FASB)?
SMALL GROUP ASSIGNMENT:
Access the SEC web site at
www.sec.gov. Search for the term "condorsement" through the Search field
in the upper right hand. Locate the speech by Deputy Chief Accountant Paul
A. Beswick on December 6, 2010, to the AICPA National Conference on Current
SEC and PCAOB Developments. Answer the following two questions: What does
this coined term "condorsement" mean? What role does this approach imply for
the FASB?
Reviewed By: Judy Beckman, University of Rhode Island
Regulators are edging closer to switching U.S.
companies to global accounting rules, as the Securities and Exchange
Commission's top accountant suggested Monday he was moving toward
recommending a long-discussed compromise approach.
International authorities are pushing the SEC to
move U.S. companies to use the global rules, known as International
Financial Reporting Standards, to unify companies world-wide under the same
accounting system. American corporations are watching intently for a
recommendation from the SEC's staff about whether the commission should do
so. Big accounting firms and multinational companies say a move would
simplify their accounting and make it easier for them to raise capital
around the world, while skeptics say it would be too costly and burdensome.
Most companies world-wide now use IFRS, but the
U.S. still uses its own set of rules, known as generally accepted accounting
principles. IFRS allows companies more flexibility and judgment than GAAP.
The global system is centered on applying guiding principles of accounting
rather than following GAAP's set of detailed rules.
The SEC's staff hasn't made a recommendation yet.
But on Monday, SEC Chief Accountant James Kroeker discussed the matter in
terms that hinted that he and his staff were gravitating toward a
middle-ground "endorsement" proposal, under which IFRS would be incorporated
into U.S. rules and U.S. rule makers would retain the authority to evaluate
future global rules for U.S. use.
Speaking to an IFRS advisory panel in London, Mr.
Kroeker said that the rules to be used globally "would be the standards of
the IASB"—the International Accounting Standards Board, which created
IFRS—and that the Financial Accounting Standards Board, the U.S. rule maker,
would play "an endorsing role."
Joel Osnoss, Deloitte Touche Tohmatsu Ltd.'s global
leader for IFRS, said Mr. Kroeker's remarks "clearly confirm" that he and
his staff are heading toward a recommendation that the SEC use IFRS for
American companies.
Continued in article
ASC = Accounting Standard Codification of the FASB
which
introduces the ASC. This video has potential value at the beginning of the
semester to acquaint students with the ASC. I am thinking about posting the
clip to AAA commons. But, where should it be posted and does this type of
thing get posted in multiple interest group areas?
Any thoughts /
suggestions?
Zane Swanson www.askaref.com
a handheld device source of ASC information
Jensen Comment
A disappointment for colleges and students is that access to the Codification
database is not free. The FASB does offer deeply discounted prices to colleges
but not to individual teachers or students.
This is a great video helper for learning how
to use the FASB.s Codification database.
An enormous disappointment to me is how the
Codification omits many, many illustrations in the
pre-codification pronouncements that are still available
electronically as PDF files. In particular, the best way to
learn a very complicated standard like FAS 133 is to study the
illustrations in the original FAS 133, FAS 138, etc.
The FASB paid a fortune for experts to develop the
illustrations in the pre-codification pronouncements. It's sad that
those investments are wasted in the Codification database.
Abstract
Within recent years, financial statement users have been accorded great
significance by accounting standard-setters. In the United States, the
conceptual framework maintains that a primary purpose of financial
statements is to provide information useful to investors and creditors in
making their economic decisions. Contemporary accounting textbooks
unproblematically posit this purpose for accounting. Yet, this emphasis is
quite recent and occurred despite limited knowledge about the information
needs and decision processes of actual users of financial statements. This
paper unpacks the taken-for-grantedness of the primacy of financial
statement users in standard-setting and considers their use as a category to
justify and denigrate particular accounting disclosures and practices. It
traces how particular ideas about financial statement users and their
connection to accounting standard setting have been constructed in various
documents and reports including the conceptual framework and accounting
standards. 2006 Elsevier Ltd. All rights reserved.
Joni's paper won the American Accounting Association's Notable Contribution
to the Accounting Literature Award for 2011 ---
http://aaahq.org/awards/awrd3win.htm
Jensen Comment
Accounting standard setters give primacy to providing information to investors
but really don't know a whole lot about how investors and analysts use
information. My long time complaint is that the both the IASB and FASB
Conceptual Frameworks are stronger for balance sheet items vis-a-vis income
statements.
The primary indices that investors and analysts track are earnings and
earnings-based indices such as P/E ratios. And the weakest part of both the IASB
and FASB Conceptual Frameworks is the concept of earnings, including the
inability to distinguish realized/realizable earnings from unrealized earnings
such as the way unrealized changes if fair value of financial instruments
(especially securities ultimately held to maturity) are mixed with earned
profits from sales.
For example, in May 2012 JP Morgan was lambasted in Congress and the media for
$2-$3 billion so-called "losses" on credit derivatives. And some unrealized
credit derivative losses will be booked and aggregated with realized/earned
income of the bank.
TOPICS: Financial Accounting Standards Board, Financial Statements,
International Accounting, International Accounting Standards Board, SEC,
Securities and Exchange Commission
SUMMARY: "The London-based authorities that oversee global
accounting rules said they "regret" that the U.S. hasn't made a stronger
move toward switching to the global system." The article covers
international reaction to the SEC issuance of a 120-page report on the
results of its project assessing the potential acceptance of IFRS financial
reports by U.S. domestic firms.
CLASSROOM APPLICATION: The article is useful to introduce the
obstacles facing global convergence in financial reporting in any financial
accounting class.
QUESTIONS:
1. (Introductory) What report has the SEC issued that this article
describes?
2. (Advanced) What has the U.S. Securities and Exchange Commission
(SEC) announced about plans to allow domestic companies to use International
Financial Reporting Standards (IFRS) in financial filings for publicly
traded firms?
3. (Introductory) What entities and individuals support a switch by
all U.S. firms to IFRS reporting requirements?
4. (Introductory) Who opposes such a rule?
5. (Advanced) What entities currently may use IFRS in their filings
to the SEC?
6. (Introductory) How has the international community reacted to
this announcement?
Reviewed By: Judy Beckman, University of Rhode Island
The London-based authorities that oversee global
accounting rules said Sunday they "regret" that the U.S. hasn't made a
stronger move toward switching to the global system.
The International Accounting Standards Board has
been pressing the U.S. to switch from its own set of accounting rules to
International Financial Reporting Standards, or IFRS.
But the Securities and Exchange Commission's staff,
which has considered the matter for two and a half years, indicated Friday
that any decision will be delayed still further when it issued a final
report that didn't include a recommendation for what action the agency's
commissioners should take. The recommendation will come later, and possibly
not until next year.
In a statement Sunday, the IFRS Foundation, which
oversees the IASB, said that while it recognizes the SEC's right to
determine how and when IFRS should be used in the U.S., "we regret that the
staff report is not accompanied by a recommended action plan for the SEC."
Such an action plan "would be welcome," the foundation said.
The report details the challenges that a country
like the U.S. faces in switching to IFRS, but other countries have
successfully overcome similar challenges, the foundation said. The
foundation "look(s) forward to the SEC resolving the continued uncertainty
regarding the U.S.'s commitment to global accounting standards."
IFRS supporters, such as big accounting firms and
many multinational companies, say IFRS will help simplify companies'
accounting and make it easier to raise capital across national borders. But
opponents say a switch would place too great a burden on companies,
especially smaller firms that don't have operations outside the U.S.
The SEC staff's Friday report appeared to rule out
a full-blown changeover to IFRS by the U.S., saying there was too much
concern about the cost and burden such an all-out move would pose.
Instead, the report indicated that other methods
would be used if the U.S. ultimately decides to shift to the international
rules, like a compromise "endorsement" model that would gradually
incorporate IFRS into the U.S. system of rules while maintaining the U.S.'s
authority to modify or reject any international rules if it saw fit.
Jensen Comment
Since the U.S. Congress is now gridlocked on setting the federal budget and most
other proposed laws, the United Nations deeply "regrets" that the U.S. is
unwilling to pass along the authority for this legislation to the U.N.
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The introduction of the euro and the adoption of
International Financial Reporting Standards (IFRS) in the EU and other
countries were promoted by aspirational rhetoric about gains from
uniformity. Applying uniform process or rule in diverse societies does not
yield uniform outcomes. Effective oversight and control of the process and
rule-making can become impossible and unbalanced with so many players
involved. Failure to recognise and manage the risks associated with
uniformity has driven the European Monetary Union to a critical precipice.
Similar risks apply to the efforts of the International Accounting Standards
Board (IASB), the accountancy profession and some international regulators
to bring about adoption of IFRS for global use.
The IASB and US Financial Accounting Standards
Board have committed significant resources since 2002 trying to agree on
common accounting standards. Despite their efforts, IFRS have not been
approved by the Securities and Exchange Commission for US adoption. The SEC
may never risk the political backlash from ceding control of its accounting
to a non-US body. We can learn from the euro debacle and assess not only if
the vision of one set of global accounting standards is achievable but also
if it is desirable.
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Accounting standards interact with law, commercial
codes, and social norms in different countries in many ways. The IASB has
pushed its agenda ahead taking no responsibility for recurrent unintended
consequences. The disaster of some banks depleting their capital by paying
bonuses and dividends out of false profits, generated under IFRS’s defective
mark-to-market and loan-loss provision standards, is a good example.
Abandonment of judgmental true-and-fair standards
in favour of written rules make accounting vulnerable to mis-statements
through complexity beyond the grasp of users and directors.
China, Japan, and India have yet to be persuaded to
adopt IFRS and watch from the sidelines. Within Europe, some countries view
IFRS as an Anglo-American invention, and remain sceptical of its suitability
for their own needs.
Complexity and interactivity of social systems and
markets make it all but impossible for a group of experts to divine the
“best” accounting solution that will serve divergent economies. Even if it
were feasible, it can only be developed through bottom-up evolution of
accounting and not through top-down imposition of a single method selected
by a board of “experts” with limited accountability.
The IASB’s persistent denial that the procyclical
and complex accounting model played a part in the banking crisis by
inflating profits undermines trust in its competence and intent.
The euro debacle points to prudent wariness of
Icarus-like overreaching ambition that is not underpinned in theory or
experience. Common standards, such as common currency, may appear a good
idea, particularly for international companies, regulators and audit firms.
But what did we get? A Board that issues standards that can induce false
profits in reports and drown users in complexity; that has not accepted
responsibility for the dysfunctional consequences of its standards; and has
no effective mechanisms for timely correction of defects.
Although the big players get economies of scale
from applying IFRS across their international activities, shareholders and
other stakeholders, particularly in the banking sector, have not been well
served by the outcomes of IFRS standards.
Continued in article
From The Wall Street Journal Accounting Weekly Review on June 1, 2012
TOPICS: Financial Accounting Standards Board, Standard Setting
SUMMARY: "The foundation that oversees accounting rule-making
created a panel aimed at making it easier for millions of privately held
companies to follow accounting standards. The Private Company Council will
work with the existing Financial Accounting Standards Board to carve out
exceptions and modifications to accounting rules to benefit the nation's 28
million private companies. The Financial Accounting Foundation, which
oversees the FASB, established the new panel at a meeting in Washington on
Wednesday," May 23, 2012.
CLASSROOM APPLICATION: The article is useful to discuss the
structure of the FASB organization in establishing accounting standards as
well as the changes being undertaken to better accommodate small to medium
sized entities (SMEs). NOTE TO INSTRUCTORS: DELETE THE FOLLOWING STATEMENT
BEFORE ISSUING THE SMALL GROUP ASSIGNMENT TO STUDENTS: To complete the small
group assignment #1, students can locate a timeline in the FASB final
report, Establishment of the Private Company Council (PCC) that was issued
on May 30, 2012 and is available on the FASB web site
www.fasb.org. For
assignment #2, the IASB provides a background for its efforts for SMEs on
its web site at www.iasb.org
QUESTIONS:
1. (Introductory) What is the purpose of the new Private Company
Council established by the Financial Accounting Foundation?
2. (Advanced) What is the Financial Accounting Foundation? Why is
it this group who has established the new Council, rather than the FASB
itself?
3. (Introductory) According to the description in the article, what
is the background leading up to the establishment of this Council, i.e., why
is this Council needed?
4. (Advanced) How independently will the new Council operate
relative to the FASB? To support your answer, provide detailed information
from the article.
SMALL GROUP ASSIGNMENT:
1. Investigate the historical development of the Private Company Council
beginning at the FASB website
www.fasb.org. Draw a timeline of events leading up to the establishment
of the Private Company Council. 2. Compare the structure and expected output
of the Private Company Council to the system in place in developing IFRS for
small to medium sized entities (SMEs).
Reviewed By: Judy Beckman, University of Rhode Island
The foundation that oversees accounting rule-making
created a panel aimed at making it easier for millions of privately held
companies to follow accounting standards.
The Private Company Council will work with the
existing Financial Accounting Standards Board to carve out exceptions and
modifications to accounting rules to benefit the nation's 28 million private
companies. The Financial Accounting Foundation, which oversees the FASB,
established the new panel at a meeting in Washington on Wednesday.
Private companies have long complained that
generally accepted accounting principles, the system of accounting rules
used in corporate America, are overly burdensome for them. They often don't
have the resources of larger, publicly traded companies, and some accounting
rules don't apply to them. But they still have to follow GAAP when they
prepare financial statements for lenders, bonding companies or regulators,
resulting in extra costs, they said.
That is where the Private Company Council comes in.
The panel will identify and vote on areas of the rules in which
accommodations are warranted for private companies, subject to the FASB's
endorsement. For instance, the panel might establish exceptions or
modifications for private companies in areas like how they measure the fair
value of assets and obligations, or in the requirement to bring off-the-book
entities onto the balance sheet, according to the Financial Accounting
Foundation.
The move will "give private company stakeholders
additional assurance that their concerns will be thoroughly considered and
addressed," foundation Chairman John Brennan said in a statement.
The foundation had proposed the new council last
fall, following a recommendation from a panel formed by the foundation,
state accounting boards and the American Institute of Certified Public
Accountants, the nation's largest accountants' trade group. The group had
criticized the initial proposal, saying it didn't go far enough to help
private companies and didn't give the new panel enough independence.
There are some hurdles
that have to be passed before we’re going to be comfortable making the ultimate
decision about whether to incorporate IFRS into the U.S. reporting regime.
Sticking points include the independence of the International Accounting
Standards Board and “the quality and enforceability of standards. Mary Shapiro, U.S. Securities and
Exchange Commission Chairman, January 5, 2012 --- http://www.businessweek.com/news/2012-01-06/sec-s-schapiro-says-she-regrets-loss-in-investor-access-battle.html
Jensen Comment
I interpret "enforceability of standards"to
center around the increased difficulty of issuing citations for rule breaking
under IFRS principles-based standards. The IFRS-like principle may be to "drive
safely in a school zone"
whereas the FASB bright line might be to drive under 20 mph. It is much easier
to issue citations for rule breakers who drive over the posted speed limit.
In his final act before departing the U.S.
Securities and Exchange Commission on Friday, the agency's inspector
general, David Kotz, criticized how the agency analyzes the economic impact
of some of its Dodd-Frank rules.
Kotz's criticism, contained in a report, could have
ramifications for the SEC, which has lost several court battles over the
years because of flaws in how it demonstrates that the benefits of a rule
outweigh its costs.
"We found that the extent of quantitative
discussion of cost-benefit analyses varied among rulemakings," Kotz wrote in
his report. "Based on our examination of several Dodd-Frank Act rulemakings,
the review found that the SEC sometimes used multiple baselines in its
cost-benefit analyses that were ambiguous or internally inconsistent."
Last year, U.S. business groups successfully
convinced a federal appeals court to overturn one of the SEC's Dodd-Frank
rules that aimed to empower shareholders to more easily nominate directors
to corporate boards.
In rejecting the rule, the court said the agency
failed to properly weigh the economic consequences.
Some of the business groups, such as the U.S.
Chamber of Commerce, have since raised similar concerns with other
rulemakings pending before the SEC.
Congress passed the Dodd-Frank act in 2010 to more
closely police financial markets and institutions after the 2007-2009
financial crisis. The legislation gives the SEC responsibility to write
roughly 100 new rules.
Although the SEC is not subject to an express
statutory requirement to conduct a cost-benefit analysis of its rules, other
laws do require the agency to consider the effects of its rules on capital
formation, competition and efficiency.
In addition, the SEC must also follow federal
rulemaking procedures, such as providing the public with an opportunity to
comment on its proposals.
This is the second report Kotz has issued looking
at the quality of the SEC's cost-benefit analysis.
Both reports were issued after certain members of
the Senate Banking Committee, including ranking Republican Richard Shelby,
voiced concerns about whether regulators were adequately examining the
economic impact of Dodd-Frank rules.
To determine how well the SEC is faring, Kotz's
office retained Albert Kyle, a finance professor at the University of
Maryland's Robert H. Smith School of Business, to help carry out the review.
Friday's report covered a sample of Dodd-Frank
rulemakings, including a rule allowing shareholders a non-binding vote on
compensation, several asset-backed securities rules and two proposals
pertaining to the reporting of security-based swap data.
Kotz's report was critical of the agency in a
number of areas.
In one instance, the report cites a memo in which
former General Counsel David Becker gave his opinion that the SEC should do
thorough cost-benefit analyses on rules that are not explicitly required by
Congress.
Rules mandated by Congress, however, generally
would not need the same level of cost-benefit research, the memo said.
The report suggested that the agency should
reconsider these guidelines, or else it risks "not fulfilling the essential
purposes of such analyses."
SEC management, in a written response to the
report, disagreed with that point.
"We believe Professor Kyle's opinion fails to
appreciate both the practical limitations on the scope of cost-benefit a
regulator can conduct, and the distinct roles of Congress and administrative
agencies," they said.
Continued in article
Jensen Comment
The main problem of cost-benefit analysis of rules and laws arises mainly from
externalities and interactions (covariances) that are seemingly impossible to
measure. For example, Congress can study the direct revenue and cost impacts of
dropping mortgage interest deductions in computing income tax (possibly on a
flat tax basis), but it's seemingly impossible to measure the impact of such a
tax law change will have on families, home maintenance, and retirement savings.
For example, it's naive to assume that couples who elect to rent a home rather
than to buy a home because of the loss of a tax deduction will save an
equivalent amount each month toward a retirement nest egg.
Similarly, when the accounting standard setters finally agree on a new
standard for lease accounting, there may well be tremendous externalities in
such a major shift in accounting lease and ownership contracting, employment,
the business cycle, etc.
Once you suck at rating bonds enough, obviously the
next logical step is to start predicting the progress made by a couple of
rulemaking bodies who have a solid track record of stretching out a timeline
to nowhere:
Fitch Ratings expects the U.S. will still move
forward with plans to incorporate International Financial Reporting
Standards (IFRS) into U.S. GAAP, although in a prolonged, cautious and
incremental way, according to a new report. Fitch believes a renewed
emphasis on issuing converged, 'high quality' accounting standards and
the need to re-expose updated proposals for comments has significantly
slowed the completion of many accounting projects jointly initiated by
FASB and the IASB. The major priority projects initially scheduled for a
June 2011 completion are still at various stages of completion in 2012
and some will likely extend into 2013.
[via Fitch]
January 19, 2012 message from Pat Walters
Fitch Ratings has just issued its Global Accounting
and Financial Reporting Outlook for 2012. Among other topics, the report
summarizes the various approaches to incorporating IFRS into national
standards and which option is the likely one for the SEC (and why) as well
as what the SEC's options might be IF it decides to require or permit US
companies to use IFRS.
This paper doesn't take a position about whether
this is a good idea or not. It simply presents the options on the table,
makes assessments as to the likelihood that one would be taken, and assesses
the impacts of the various options.
I find the Fitch accounting reports to be well
thought out and well written. They are certainly accessible to students.
The report also compares the three FASB models
(current, 2010, revised/expected 2012) and IFRS 9 in a nice table.
On mandatory auditor rotation, the report concludes
"The proposal stands moer of a change to become final in the E.U., while
stiff resistance by accounting firms and issuers may prove to be too
formidable for the proposal to become law in the U.S."
Enjoy,
Pat
January 19, 2012 reply from Bob Jensen
Hi Pat,
Thank you for this. I agree that it is a very good summary document and
probably makes the best guess as the way "condorsement" will take place over
many years to come.
See the attached table.
I'm bothered by the lack of definition "country-specific" in terms of
condorsement. I assume the U.S. will be able to stay on LIFO since the U.S.
Tax Code is obviously country specific.
But there's a huge gray zone that bothers me. For example consider embedded
derivatives in financial instruments. IFRS 9 says to forget about hunting
for embedded derivatives since they are ipso facto (ha ha) insignificant.
Since U.S. companies deal in possibly more financial instruments that the
rest of the world combined, my prior experience with corporate executives
who have made presentations in some of my hedge accounting dog and pony
shows is that it is both common for financial instruments to have embedded
derivatives and that the risk metrics in the embedded derivatives frequently
differ from risk metrics in the host contracts.
If U.S. companies are in fact taking advantage of the IFRS 9 loophole to
hide risk, does this make the issue "country specific??
The embedded derivatives way to hide risk is only one of many other possible
"country specific" issues. Suppose U.S. companies begin taking misleading
advantage of the softness of IFRS 9 in testing for hedge effectiveness. This
is another huge loophole that will allow for hiding of risk if auditors go
soft on client efforts to declare questionable hedges as effective.
Actually the list of gray areas can possibly go on infinitum in terms of
what become "country specific" issues.
And worse, if there is too much condorsement on "country specific" issues
departures of U.S. IFRS from London IFRS grows wider and wider and wider.
This could become self-defeating in terms of the original intent of
convergences.
And if such gray zone condorsement catches on with over 100 other nations
who turn gooey on the way they define their "country specific" departures
from IFRS, then we're back to another tower of Accountancy Babel.
It appears to me that the major goal of having one set of worldwide
accounting standards always was and will forever be an impossible dream. But
then again, those of us that have a knee-jerk hatred for monopoly power are
greatly relieved.
Thanks again,
Bob Jensen
January 19, 2012 reply by Bob Jensen
Hi Saeed,
If the condorsement track is to be taken, there are two opposing
alternatives that must also be resolved by the SEC?
Alternative 1
Is the fundamental basis of accounting to be IFRS with condorsement
(country-specific) exceptions that are to be blended in piecemeal year after
year ad infinitum? And if so, when will the foundational shift to IFRS take
place?
Alternative 2
Is the fundamental basis of accounting to be the FASB Codification database
with IFRS substitutions to take place piecemeal year after year ad
infinitum? The issue of timing is less earth shaking in this latter
alternative for clients, professors, and students.
The big international auditing firms and the AICPA prefer Alternative 1
since that alternative will abruptly lead to hundreds of millions of dollars
more in up front revenues for IFRS client training courses, IFRS consulting,
and IFRS study materials relative to Alternative 2. And there will be fewer
differences accounting rules to contend with under Alternative 1 until the
condorsement exceptions are blended in piecemeal over the years.
Client and security analyst positions on these alternatives are harder to
predict and probably more varied. Alternative 2 will have many more delayed
expenses in IFRS training and software conversions. But many of the clients
want the marshmallow principles-based standards to get around the barbed
wire of FASB rules based standards. SEC studies to date reveal that security
analysts and investors probably favor the slower Alternative 2 track.
So we wait on pins and needles until the SEC can make up its mind!
We also wait on pins and needles until we get a working definition of
"country-specific."
Respectfully,
Bob Jensen
Question
What is the most downloaded article published by the Journal of Accounting
Research?
Abstract:
We examine whether application of
InternationalAccountingStandards is associated with
higher accountingquality. The application of IAS
reflects the combined effects of features of the financial reporting system,
including standards, their
interpretation, enforcement, and litigation. We find that firms applying IAS
from 21 countries generally evidence less earnings management, more timely
loss recognition, and more value relevance of
accounting amounts than do a
matched sample of firms applying non-US domestic
standards. Differences in
accountingquality between the two groups
of firms in the period before the IAS firms adopt IAS do not account for the
post-adoption differences. We also find that firms applying IAS generally
evidence an improvement in accountingquality between the pre- and
post-adoption periods. Although we cannot be sure that our findings are
attributable to the change in the financial reporting system rather than to
changes in firms' incentives and the economic environment, we include
research design features to mitigate the effects of both.
Number of Pages in PDF File: 55
Keywords: IAS, IASB, InternationalAccountingStandards,
InternationalAccountingStandards Board,
International Financial
Reporting Standards
Jensen Comment
This article was written before changes were made in both IASB and FASB
standards. Some of these changes narrowed the differences between IASB and FASB
standards. Others widened these differences, particularly in the area of
accounting for derivative financial instruments and hedging.
"Best of 2011: Accounting: After predicting that a decision on
whether U.S. GAAP would converge with global standards would come sometime in
2011, SEC officials have punted until well into 2012," by David M. Katz,
CFO.com, January 3, 2012 ---
http://www3.cfo.com/article/2011/12/gaap-ifrs_gaapifrsaicpasecfasbiasb
Thank you Glen Gray for the heads up.
After much brooding about whether the United States
would fully meld its financial reporting with international financial
reporting standards (IFRS), the Securities and Exchange Commission ended
2011 without making its long-awaited, long-delayed decision on the issue.
In fact, after predicting that the decision would
likely come sometime in 2011, the SEC doesn't appear likely to opine on the
matter until far into 2012. In a December 5 speech before the American
Institute of Certified Public Accountants (AICPA), James Kroeker, the SEC's
chief accountant, said that the U.S. Financial Accounting Standards Board
and the International Accounting Standards Board were "many months away from
finalization of even the small group of key . . . projects" essential for
convergence.
While FASB and the IASB had made good progress on
converging leasing and revenue-recognition standards, "the prospect for a
converged solution" on accounting for financial instruments "has not been as
encouraging," said Kroeker, noting that it has been particularly tough for
the two boards to agree on a single standard for hedging transactions.
Further, the SEC's staff will need "a measure of a few additional months" to
complete its own final assessment of how it "could or should proceed with a
decision to incorporate IFRS for U.S. issuers," he said.
In the course of working on that assessment last
year, the commission's staff did, however, manage to spawn one of the
ugliest verbal coinages in recent memory: “condorsement.” Melding
“convergence” with “endorsement,” the SEC’s staff proposed that FASB could
continue to hold sway in this country over a convergence of U.S. GAAP and
IFRS during a transition period of five to seven years. But once convergence
has been achieved, FASB would merely endorse the standards the IASB
developed.
That proposal kindled a furious debate in 2011 on
the future role of FASB. Firing back against the condorsement plan, the
Financial Accounting Foundation, FASB's parent organization, proposed a
system that puts the standards board still squarely at the helm of U.S.
accounting standards.
Another hotly debated issue: the role of FASB in
setting private-company accounting standards. A group spearheaded by Barry
Melancon, president and CEO of the AICPA, called for "a separate
private-company standards board" that would be overseen by the FAF and would
"work closely" with FASB. But the board, not FASB, "would have final
authority" over changes and exceptions to U.S. GAAP targeted to private
companies. The FAF then returned the volley, proposing a system that would
make FASB the rule-maker for nonpublic companies. Below are the biggest
stories of last year.
Continued in article
No longer headed down the road less taken
Headed down the popular road of capitulation to the power of the IASB
Oops! What will be the new role of condorsers?
Will FASB condorsers be beached whales left flopping in the sand?
Will this fork in the road to IFRS speed U.S. adoption?
Oh my!
"FASB, IASB Chiefs Agree New Convergence Model is Needed," Journal of
Accountancy, December 6, 2011 ---
http://www.journalofaccountancy.com/Web/20114869.htm
The heads of the U.S. and international accounting
boards that have been working to resolve standards differences agree that
their current convergence process should be replaced by one that is more
manageable and effective.
FASB Chair Leslie Seidman said Tuesday at the AICPA
National Conference on Current SEC and PCAOB Developments that side-by-side
convergence is not the optimal model in the long run. Hans Hoogervorst,
chair of the International Accounting Standards Board (IASB), spoke
immediately after Seidman at the conference in Washington and echoed her
sentiment.
Seidman said FASB would like to work with the IASB
to complete the current priority convergence projects on revenue
recognition, leasing, financial instruments and insurance. But she said
indefinite convergence is not a viable option, politically or practically.
“As any observer can see, this process is
challenging technically and administratively,” Seidman said. “Plus, we
appreciate that the IASB, as an international body, must be responsive to
the priorities of other countries that have already adopted IFRS.”
Hoogervorst said the IASB’s convergence history
with FASB, which dates back to 2002, has been extremely useful in bringing
IFRS and U.S. GAAP closer together. But he said that two boards of
independently thinking professionals sometimes simply reach different
conclusions.
“It’s tempting to just maintain the status quo,”
Hoogervorst said. “But for the long term, the status quo is an unstable way
of decision making that inevitably leads to diverged solutions or suboptimal
outcomes.”
Hoogervorst cited the example of one part of the
financial instruments project, offsetting, where FASB and the IASB were
aligned initially but ended up in different places. Because of those
differences, he said, the balance sheets of many U.S. banks will look much
smaller than those of Asian and European banks. U.S. banks are allowed to
show net derivatives, while banks in Asia and Europe must present them in
gross.
“Through disclosures, we will try to bridge the
gap,” Hoogervorst said. “But I doubt that investors in the U.S. or elsewhere
will see it as a satisfactory outcome. At the same time, we at the IASB
believe that our conclusion is right for investors. I am sure that Leslie
would believe the same for the FASB.”
The next step for convergence could be
incorporation of IFRS into U.S. GAAP. The SEC’s long-awaited decision on
whether and how to incorporate IFRS for U.S. issuers is at least a few
months away, based on a
speech Monday by SEC Chief Accountant James
Kroeker.
The Financial Accounting Foundation (FAF), in
consultation with FASB, has sent a
letter to the SEC outlining its preferred path for
incorporating IFRS into U.S. GAAP. FAF is FASB’s parent organization.
In the letter, FAF Chairman John Brennan described
a number of recommended changes to the approach dubbed “condorsement.” The
SEC floated the condorsement concept in a work plan released in May as one
possible path to IFRS for U.S. public companies.
"The Road Not Taken" is a
poem by
Robert Frost, published in 1915 in the collection
Mountain Interval. It is the first poem in the volume and is printed
in italics. The title is often mistakenly given as "The Road Less
Traveled", from the penultimate line: "I took the one less traveled by".
"The Road Not Taken" is a
narrative poem consisting of four
stanzas of
iambic tetrameter (though it is
hypermetric by one beat - there are nine syllables per line, instead of
the strict eight required for tetrameter) and is one of Frost's most popular
works.
Wikisource has original text related to this article:
cannot be taken literally : whatever difference the choice might have
made, it could not have been made on the non-conformist or individualist
basis of one road's being less traveled, the speaker's protestations to the
contrary. The speaker admits in the second and third stanzas that both paths
may be equally worn and equally leaf-covered, and it is only in his future
recollection that he will call one road "less traveled by."
The sigh can be interpreted as one of regret or of self-satisfaction; in
either case, the irony lies in the distance between what the speaker has
just told us about the roads' similarity and what his or her later claims
will be. Frost might also have intended a personal irony; in a 1926 letter
to Cristine Yates of Dickson, Tennessee, asking about the sigh, Frost
replied, "It was my rather private jest at the expense of those who might
think I would yet live to be sorry for the way I had taken in life.
Jensen Comment
The road to U.S. adoption of IFRS up to now has been a road less taken by other
nations who had little or no say on about road construction of IFRS standards.
The U.S. wanted to help pave an uncharted road.
Now the U.S. may simply take the road more heavily traveled by by other
nations --- that road of capitulation to the power of the IASB without
insistence about putting domestic cobble stones into the road.
No longer headed down the road less taken
Headed down the popular road of capitulation to the power of the IASB
I always thought adopting IFRS was a little like getting pregnant. You either
are or are not pregnant. There's no such thing as being a little bit pregnant or
being a little bit on IFRS.
But IFRS in Russia will not be like pregnancy.
Please note that IFRSs in Russia do not replace
national financial reporting standards – preparing consolidated financial
statements under IFRSs does not lift the requirement to prepare standalone
financial statements under the Russian statutory rules.
Links from Deloitte's IAS Plus:
I wonder the SEC might adopt the same strategy for the United States.
"The Russians are Coming; The Russians are Coming"
Ernst & Young
To the Point -
Support grows for keeping US GAAP but basing future standards on IFRS
The incorporation of IFRS into the US financial reporting system was
once again a focus of discussion at the AICPA National Conference on
Current SEC and PCAOB Developments in Washington D.C. this week.
Representatives from the SEC, FASB and IASB all indicated that the SEC
could incorporate IFRS into the US financial system but retain US GAAP.
Our
To the Point publication tells you what you need to know about these
developments.
Paradox
of Writing Clear Rules: Interplay of Financial Reporting
Standards and Engineering1
Shyam Sunder
Yale School of Management
Abstract
Attempts to improve financial reporting by adding clarity to its
rules and standards through issuance of interpretations and
guidance also serve to furnish a better roadmap for evasion
through financial engineering. Thus, paradoxically, regulation
of financial reporting becomes a victim of its own pursuit of
clarity. The interplay between rules written to govern
preparation and auditing of financial reports on one hand, and
financial engineering of securities to manage the appearance of
financial reports on the other, played a significant role in the
financial crisis of the recent years. Fundamental rethinking
about excessive dependence of financial reporting on written
rules (to the exclusion of general acceptance and social norms)
may be necessary to preserve the integrity of financial
reporting in its losing struggle with financial engineering.
JEL Codes: G24; M41
Keywords: Financial Reporting; Financial Engineering; Written
Standards; Social Norms; Regulatory Equilibrium
Revised
Draft Dec. 8, 2011
1 An earlier version of this paper was presented at the
conference on Rethinking Capitalism, Bruce Initiative of the
University of California at Santa Cruz in April 2010.
Corresponding Author. Address: Yale School of Management, 135
Prospect Street, New Haven, Connecticut, 06511, USA. Telephone
+1 203 432 6160
E-mail
shyam.sunder@yale.edu.
Jensen Comment to the AECM
I am forwarding a new comment by Shyam to one of my posts on the AAA Commons.
Note that you can reply on the AECM to his comment even though you must go to
this item on the Commons to put a reply to his post on the Commons itself.
Shyam has been a long-time opponent of convergence to IFRS in the United
States but, as a highly respected researcher in economics journals as well as
accounting research journals, his objections have mainly centered around the
potential IASB abuses of its monopoly powers in the setting of global accounting
standards:
There are many objections to the mountains of standards, interpretations, and
bright line rules in both international and domestic accounting standard
setting. I think it was Paul Polanski who once noted on the AECM that, in spite
of being principles-based in theory, the IASB's standards and interpretations
are moving toward a mountain of bright line rules ---
http://faculty.trinity.edu/rjensen/Theory01.htm#BrightLines
Bob Jensen does not agree with Beresford, Sunder, and others on the issue of
bright lines and interpretations.
Firstly, I think the FASB's Codification Database (along with Comperio
from PwC) is demonstrating that modern technology allows clients and auditors to
deal more efficiently with standards complexity and bright lines.
Secondly, I think the explosion of evidence that clients and their
auditors take advantage of loopholes in standards such as the Repo 105/108
principles-based loopholes in FAS 140 that were used by Lehman Brothers and
Ernst & Young to put out deceptive financial statements. Taking away the bright
lines simply makes it easier for clients and their auditors to deceive the
public using more subjective principles-based rules. The Lehman Bankruptcy
Examiner is not at all kind to Lehman Brothers or Ernst & Young in this matter
---
http://faculty.trinity.edu/rjensen/Fraud001.htm#Ernst
Thirdly, I'm really opposed to having a contract that Client A reports
differently than Client B to a significant degree such as when Client A will
eventually use IFRS 9 to judge a hedge as being fully effective and Client B
will judge the same hedge as being too ineffective to permit hedge accounting
relief. IFRS 9 as proposed will really soften effectiveness testing for hedges
using derivative financial instruments.
As a matter of fact the leeway given to clients to test hedge effectiveness
in the proposed IFRS 9 (now delayed until 2015) is a perfect example of a
standard that will lead to great inconsistencies in how given contracts are
accounted for differently under principles-based standards.
Fourthly, Sunder, Beresford, and other proponents of reduced
complexity in accounting standards and interpretations fail to point out the
main reason for exceeding complexity in the U.S. Tax Code and its IRS and tax
court interpretations. Time and time again the build up in complexity is caused
by taxpayers who abuse what started out as as a rather simple tax rule. I think
the same thing happens when abusers like Lehman Brothers and Ernst & Young
deceptively twist a standard like FAS 140, thereby leading to further complexity
in ensuing standards and interpretations.
Time and time again the cause of complexity is what Pogo realized years ago:
"We have met the enemy and he is us."
In any case, I predict that over 99% of the subscribers to the AECM will side
with Sunder and Beresford and less than 1% will side with Bob Jensen on this
issue. But Jensen will win in the long run as simple principles-based standards
become abused even worse than bright line rules are abused.
"SEC releases reports on IFRS in practice and US GAAP-IFRS differences,"
IAS Plus, November 17, 2011 ---
http://www.iasplus.com/index.htm
The staff of the United States Securities
and Exchange Commission (SEC)
have released two additional Staff Papers as part of
the SEC's work plan for the consideration of incorporating IFRSs into the
Financial Reporting System for U.S. Issuers.
Analysis of IFRS in Practice
The first paper, An analysis of IFRS
in Practice, presents the Staff's observations regarding the application
of IFRS in practice, based on an analysis of the most recent annual
consolidated financial statements of 183 companies across 36 industries
which prepare financial statements in accordance with IFRSs. The companies
were selected from the Fortune Global 500 (the top 500 companies by revenue)
and represented all those which prepared financial statements in accordance
with IFRS in English. The 183 companies were domiciled in 22 countries, with
the majority (approx 80%) being domiciled in the European Union, but with
China and Australia also being represented with more than five companies.
The Staff Paper summarises the research
as follows:
The Staff found that company
financial statements generally appeared to comply with IFRS
requirements. This observation, however, should be considered in
light of the following two themes that emerged from the Staff’s
analysis:
First, across topical areas, the
transparency and clarity of the financial statements in the
sample could be enhanced. For example, some companies did not
provide accounting policy disclosures in certain areas that
appeared to be relevant to them. Also, many companies did not
appear to provide sufficient detail or clarity in their
accounting policy disclosures to support an investor’s
understanding of the financial statements, including in areas
they determined as having the most significant impact on the
amounts recognized in the financial statements... In some cases,
the disclosures (or lack thereof) also raised questions as to
whether the company’s accounting complied with IFRS....
Second, diversity in the application
of IFRS presented challenges to the comparability of financial
statements across countries and industries. This diversity can
be attributed to a variety of factors. In some cases, diversity
appeared to be driven by the standards themselves, either due to
explicit options permitted by IFRS or the absence of IFRS
guidance in certain areas. In other cases, diversity resulted
from what appeared to be noncompliance with IFRS... While
country guidance and carryover tendencies may promote
comparability within a country, they may diminish comparability
on a global level.
IFRS - U.S. GAAP comparison
A second paper, A Comparison of U.S.
GAAP and IFRS, to provide an assessment of whether there is "sufficient
development and application of IFRS for the U.S. domestic reporting system"
by inventorying areas in which IFRS does not provide guidance or where it
provides less guidance than U.S. GAAP. The Staff reviewed U.S. GAAP
accounting requirements and compared those requirements to equivalent or
corresponding IFRS requirements, as applicable. The Staff omitted from its
review any U.S. GAAP requirements and the IFRS equivalents that are subject
to the ongoing joint standard-setting efforts either through the Memorandum
of Understanding (MoU) joint standard-setting projects of the FASB and the
IASB, or other areas where the FASB and IASB had agreed to work together.
I looked at the article in detail, the term
“loophole” isn’t quite accurate. The issue is fair value accounting and
marking derivatives to market, which I wouldn’t call a loophole. It seems
the author considers fair value accounting a loophole because banks record
profits in their income statements before there is a hard transaction, which
is just fair value accounting. He also complained that mark to market
accounting allows banks to record assets at market value even if they can’t
be sold for that value. I found that a bit confusing because a market value
is, by definition, what the market is currently paying for assets. I could
imagine a situation where a bank held enough securities that, if sold all at
once, might depress the prices. But other than that, the market is supposed
to be the arbiter of asset values in free markets. My summary conclusion is
that the title of the article and issue raised is intentionally inflammatory
to gain readership and really, the underlying issue is old news.
December 15, 2011 reply from Bob Jensen
Hi Jim and Pat,
I think you're both correct in theory, but the problem in Europe is that
companies, especially banks, are not being symmetric in the implementation
of the fair value rules --- fair values are moved fully upward but not
necessarily fully downward. The
IASB has
objected to a degree (Tweedie
sent a ranting protest letter), but eventually the
IASB caved in
to pressures from the EU to allow over-estimations of tanking bond values
and also delayed
IFRS 9 implementation until 2015. We might allege, therefore, that
the IASB is
being somewhat complicit with corporate overstatements of earnings under
fair value accounting in an effort to keep the EU in the fold regarding the
IASB
standards and interpretations.
In the U.S., FAS
157 is somewhat loose about fair value estimation. For a variety of reasons
that sound good on paper companies can depart from mark-to-market
adjustments and use fair value (Level 3) models that are not clearly
defined. The devil is in the details, and I think companies and their
auditors can abuse the subjectivity in the rules. Of course Lehman Brothers
derivatives value estimates showed us that this could never happen (wink,
wink)!
The buzz on the Lehman bankruptcy examiner’s
report has focused on
Repo 105, for
good reason. That scheme is one powerful example of how the balance sheets
of major Wall Street banks are fiction. It also shows why Congress must
include real accounting reform in its financial legislation, or risk another
collapse. (If you have 8 minutes to kill, here is my
recent talk on the off-balance sheet problem,
from the Roosevelt Institute financial conference.)
But an even
more troubling section of the Lehman report is not Volume 3 on
Repo 105. It
is Volume 2, on Valuation. The
Valuation section is 500 pages of utterly terrifying reading. It shows that,
even eighteen months after Lehman’s collapse, no one – not the bankruptcy
examiner, not Lehman’s internal valuation experts, not Ernst and Young, and
certainly not the regulators – could figure out what many of Lehman’s assets
and liabilities were worth. It shows Lehman was too complex to do
anything but fail.
The report cites extensive evidence of valuation
problems. Check out page 577, where the report concludes that Lehman’s high
credit default swap valuations were reasonable because Citigroup’s marks
were ONLY 8% lower than Lehman’s. 8%? And since when are Citigroup’s
valuations the objective benchmark?
Or page 547, where the report describes how
Lehman’s so-called “Product Control Group” acted like Keystone
Kops: the
group used third-party prices for only 10% of Lehman’s
CDO
positions, and deferred to the traders’ models, saying “We’re not
quants.” Here
are two money quotes:
While the function of the Product Control Group was to serve as a check on the
desk marks set by Lehman’s traders, the CDO product controllers were hampered in
two respects. First, the Product Control Group did not appear to have sufficient
resources to price test Lehman’s CDO positions comprehensively. Second, while the
CDO product controllers were able to effectively verify the prices of many positions
using trade data and third‐party prices, they did not have the same level of quantitative
sophistication as many of the desk personnel who developed models to price CDOs. (page 547)
Or this one:
However, approximately a quarter of Lehman’s
CDO positions
were not affirmatively priced by the Product Control Group, but simply noted
as ‘OK’ because the desk had already written down the position
significantly. (page 548)
My favorite section describes the valuation of
Ceago,
Lehman’s largest CDO
position. My corporate finance students at the University of San Diego
School of Law understand that you should use higher discount rates for
riskier projects. But the Valuation section of the report found that with
respect to Ceago,
Lehman used LOWER discount rates for the riskier tranches than for the safer
ones:
The discount rates used by Lehman’s Product
Controllers were significantly understated. As stated, swap rates were used
for the discount rate on the
Ceago
subordinate tranches. However, the resulting rates (approximately 3% to 4%)
were significantly lower than the approximately 9% discount rate used to
value the more senior S tranche. It is inappropriate to use a discount rate
on a subordinate tranche that is lower than the rate used on a senior
tranche. (page 556)
It’s one thing to have product controllers who
aren’t “quants”; it’s quite another to have people in crucial risk
management roles who don’t understand present value.
When the examiner compared
Lehman’s marks on these lower tranches to more reliable valuation estimates,
it found that “the prices estimated for the C and D tranches of
Ceago
securities are approximately one‐thirtieth
of the price reported by Lehman. (pages 560-61) One thirtieth? These
valuations weren’t even close.
Ultimately, the examiner concluded that these
problems related to only a small portion of Lehman’s overall portfolio. But
that conclusion was due in part to the fact that the examiner did not have
the time or resources to examine many of Lehman’s positions in detail
(Lehman had 900,000 derivative positions in 2008, and the examiner did not
even try to value Lehman’s numerous corporate debt and equity holdings).
The bankruptcy examiner didn’t see enough to
bring lawsuits. But the valuation section of the report raises some
hot-button issues for private parties and prosecutors. As the report put it,
there are issues that “may warrant further review by parties in interest.”
For example, parties in interest might want to
look at the report’s section on
Archstone, a
publicly traded REIT Lehman acquired in October 2007. Much ink has been
spilled criticizing the valuation of
Archstone.
Here is the Report’s finding (at page 361):
… there is sufficient evidence to support a
finding that Lehman’s valuations for its
Archstone
equity positions were unreasonable beginning as of the end of the first
quarter of 2008, and continuing through the end of the third quarter of
2008.
And
Archstone is
just one of many examples.
The
Repo 105
section of the Lehman report shows that Lehman’s balance sheet was fiction.
That was bad. The Valuation section shows that Lehman’s approach to valuing
assets and liabilities was seriously flawed. That is worse. For a levered
trading firm, to not understand your economic position is to sign your own
death warrant.
More Detailed Differences
(Comparisons) between FASB and IASB Accounting Standards
2011 Update
"IFRS and US GAAP: Similarities and Differences" according to PwC
(2011 Edition)
http://www.pwc.com/us/en/issues/ifrs-reporting/publications/ifrs-and-us-gaap-similarities-and-differences.jhtml
Note the Download button!
Note that warnings are given throughout the document that the similarities and
differences mentioned in the booklet are not comprehensive of all similarities
and differences. The document is, however, a valuable addition to students of
FASB versus IASB standard differences and similarities.
It's not easy keeping track of what's changing and
how, but this publication can help. Changes for 2011 include:
Revised introduction reflecting the current
status, likely next steps, and what companies should be doing now (see page 2);
Updated convergence timeline, including
current proposed timing of exposure drafts, deliberations, comment
periods, and final standards
(see page 7);
More current analysis of the differences
between IFRS and US GAAP -- including an assessment of the impact
embodied within the differences
(starting on page 17); and
Details incorporating authoritative standards
and interpretive guidance issued through July 31, 2011
(throughout).
This continues to be one of PwC's most-read
publications, and we are confident the 2011 edition will further your
understanding of these issues and potential next steps.
For further exploration of the similarities and
differences between IFRS and US GAAP, please also visit our
IFRS Video Learning Center.
To request a hard copy of this publication, please contact your PwC
engagement team or
contact us.
Jensen Comment
My favorite comparison topics (Derivatives and Hedging) begin on Page 158
The booklet does a good job listing differences but, in my opinion, overly
downplays the importance of these differences. It may well be that IFRS is more
restrictive in some areas and less restrictive in other areas to a fault. This
is one topical area where IFRS becomes much too subjective such that comparisons
of derivatives and hedging activities under IFRS can defeat the main purpose of
"standards." The main purpose of an "accounting standard" is to lead to greater
comparability of inter-company financial statements. Boo on IFRS in this topical
area, especially when it comes to testing hedge effectiveness!
One key quotation is on Page 165
IFRS does not specifically discuss the methodology
of applying a critical-terms match in the level of detail included within
U.S. GAAP.
Then it goes yatta, yatta, yatta.
Jensen Comment
This is so typical of when IFRS fails to present the "same level of detail" and
more importantly fails to provide "implementation guidance" comparable with the
FASB's DIG implementation topics and illustrations.
I have a
huge beef with the lack of illustrations in IFRS versus the many illustrations
in U.S. GAAP.
I have a
huge beef with the lack of illustrations in IFRS versus the many illustrations
in U.S. GAAP.
I have a huge beef with the lack of illustrations in
IFRS versus the many illustrations in U.S. GAAP.
"Canadian regulator decides against allowing early adoption of recent
IFRSs by certain entities," IAS Plus, November 1, 2011 ---
http://www.iasplus.com/index.htm
. . .
In making its decision, the OSFI considered a
number of factors such as industry
consistency, OSFI policy positions on
accounting and capital, operational capacity and resource constraints of
Federally Regulated Entities (FREs), the ability to benefit from improved
standards arising from the financial crisis and the
notion of a level playing field with other Canadian
and international financial institutions.
OSFI concluded that FREs should not early adopt the following new or amended
IFRSs, but instead should adhere to their mandatory effective dates:
Continued
Jensen Comment
The clients, auditors, and the AICPA clamoring that U.S. firms should be able to
voluntarily choose IFRS instead of U.S. GAAP even before it has not been decided
that IFRS will ever replace FASB standards seem to ignore the problems that
voluntary choice of IFRS might cause for investors and analysts. The above
reasoning by the OSFI makes sense to me.
But then outfits like the AICPA have a self-serving interest in earning
millions of dollars selling IFRS training courses and materials.
November 2, 2011 reply from Patricia Walters
Does that mean you oppose options to early adopt standards in general,
not just IFRSs?
Pat
November 2, 2011 reply from Bob Jensen
Hi Pat,
It's hard to say regarding early adoption of a particular national or
international standard, because there can be unique circumstances. For
example, FAS 123R simply altered how to make disclosures rather than alter
the disclosures themselves since employee option expenses had to be
disclosed before the FAS 123R adoption date. But even here early adoption of
FAS 123R by Company A versus late adoption by Company B made simple
comparisons of eps and P/E ratios between these companies less easy.
There's a huge difference between early adoption of a particular standard
and early adoption of an entire system of standards like switching from FASB
accounting standards to IFRS.
I think the Canadian position of early adoption of IFRS is probably correct
because of the mess early adoption of IFRS makes with comparisons of
companies using different accounting standards and the added costs of
regulation of more than one set of standards. Also think of the added burden
placed upon the courts to adjudicate disputes when differing sets of
standards are being used.
Even though we allow IFRS for SEC registered foreign companies, I think it
would be a total mess for the SEC, the PCAOB, investors, analysts,
educators, trainers, auditing, and even the IRS (where tax and reporting
treatments must sometimes be reconciled) if our domestic corporations could
choose between FASB versus IASB standards.
There are hundreds of differences between FASB and IASB standards. Allowing
companies domestic companies to cherry pick which system they choose before
it is even known if there will ever be official replacement of FASB
standards by IASB standards would be very, very confusing. What if there
never is a decision to replace FASB standards? Do want to simply allow
companies to choose to bypass FASB standards at their own discretion?
Of course, if information were costless it might be ideal to require
financial reporting where FASB and IASB outcomes are reconciled. But clients
and auditors generally contend that the cost of doing this greatly exceeds
benefits. And teaching financial accounting would become exceedingly
complicated if we had to teach two sets of standards on an equal basis.
I would certainly hate to face a CPA examination that had nearly equal
coverage of both FASB and IASB standards simultaneously. I say this
especially after viewing the hundreds of pages of complicated differences
between the two standards systems.
Comment Letter: SEC
Staff Paper on possible method of incorporating IFRS into US financial
reporting system
Today we issued a
comment letter to the
SEC staff regarding a possible method of incorporating IFRS into the
financial reporting system for US issuers. We support the approach described
in the Staff Paper and believe it is a thoughtful and balanced way of moving
closer to achieving the ultimate goal of a single set of high-quality
globally accepted accounting standards. Although we support the approach
described in the Staff Paper, we believe it is unlikely that method would
allow US issuers (following a transition period) to assert compliance with
IFRS as issued by the IASB.
To: Dennis R
Beresford Subject: You are in the news--happy holiday
July 1, 2011, 12:29 PM ET by Emily Chasan.
International Accounting Standards Face Headwinds
The
incoming head of the board that sets international accounting standards
faces a singular challenge: convincing the world to agree on a single set of
standards before the entire movement loses steam due to political
cross-currents and bureaucratic inertia.
Just
a couple of years ago, it seemed a foregone conclusion that the world’s
largest economies would adopt International Financial Reporting Standards,
but the effort stalled amid the global financial crisis. So while Europe,
Australia, Canada and about 100 other countries have adopted IFRS, India,
China, Japan and the United States are still far off from fully committing.
IASB officials have worried recently that the set of global standards
will be significantly weakened if those countries do not join in.
And
while the U.S. isn’t likely to completely abandon IFRS, especially given
that SEC Chairman Mary Schapiro sits on the IASB’s Monitoring Board,
Schapiro herself has
said she’s not hearing a lot of enthusiasm for IFRS, and the SEC seems
determined to slow down the adoption process.
Hans
Hoogervorst, the former Dutch securities regulator who took the helm as
Chairman of IFRS on Friday, will need to draw heavily on his diplomatic
skills if he is to get those major countries back on board, and prevent
countries from diluting the standards by carving out too many exceptions.
Recent trends are against him. The U.S. Securities and Exchange Commission
abandoned an earlier roadmap that could have switched U.S. companies to IFRS
as soon as 2014, and, after delaying a decision for several years, the SEC
is set to have a
roundtable next week on the merits of “incorporating” IFRS into the U.S.
system. In
Japan, regulators are now considering postponing the mandatory adoption
of IFRS beyond its original 2015 target date, amid strong opposition from
businesses that are concerned about the hefty cost of a transition.
India, which had planned to adopt IFRS this year, recently backtracked
and is going with its own set of rules called IND-AS, which have dozens of
carve outs and differences from IFRS.
“Given the slowness of U.S. support and the fact that India and Japan and
perhaps some other countries are cooling to the idea, I’d say the IASB has
got a lot of work in front of them to convince them and other countries to
stay the course,” said Dennis Beresford, a former Financial Accounting
Standards Board Chairman, who teaches accounting at the University of
Georgia.
Ray
Ball, an accounting professor at The University of Chicago’s Booth School of
Business, says Japan and other countries want the U.S. to make a decision on
IFRS before plotting their own course.
“The
Japanese, in this case, are like the canary in the coal mine,” Ball said,
noting the U.S. is facing similar internal political concerns about the
standards. “It was a nice conceptual idea, but when you come to implement
it, it’s a lot more difficult than it seems.”
The
SEC, which is aiming to have a decision on IFRS in the next year, has been
leaning toward continuing to converge IFRS and U.S. GAAP, as well as
creating a system to simply endorse international standards in some
instances, an approach known as “condorsement.”
There are signs, though, that any progress toward convergence will be slow
going. The U.S. and International accounting boards have already missed a
June 30 deadline for important convergence projects they had already
started, amid corporate demands for a slowdown. And even after nearly a
decade of working together to converge standards, the U.S. FASB and IASB are
starting to agree to disagree. For example, the boards recently diverged on
derivatives accounting changes.
“By
unanimous votes they went in almost entirely different directions,”
Beresford said.
Three things to stress when mapping out the forest include:
1. Monopoly Evils
Monopolies are generally not a good thing. One of the first and foremost
academic accountants to warn against an
IASB monopoly on
standard setting was former AAA President
Shyam Sunder
(Yale). You might cite
Shyam's paper at
http://faculty.som.yale.edu/shyamsunder/Jamal%20Sunder%20Stds%20Dec%2014.pdf
2. Loss of Control to Uniting Smaller Uniting Nations
What we are seeing now (without saying good or bad) in the United Nations is the
rise of a power substructure of numerous smaller nations who are using the
United Nations for their own agendas (e.g. Sharia Law) that are making some
Western nations (including the United States) question their own wills to
continued belonging to and funding the United Nations. Thus far we do not have a
similar problem arising with the uniting of smaller nations to dominate standard
setting in the IASB.
However, once the U.S., Japan, India, and China become committed to
IFRS, these
uniting small nations with their own agendas could begin to rise up in the
IASB.
International accounting standards are not necessarily neutral when it comes to
global capital flows and economic development.
Also there is the problem that the IASB may increasingly ignore or dump on
financial contracts that are unique to one or several nations rather than to
all 160 nations of the world. An example is accounting for derivative contracts
that are more of a problem in the few nations having derivatives contract
trading markets. Another might be synthetic leasing that is a type of
contracting unique to U.S. tax law.
3. Self-Serving Powerful Support of
IFRS
We might question the driving support of
IFRS from the
large CPA firms and the
AICPA. These organizations are lying in wait to make hundreds of millions
of dollars selling their
IFRS software, consulting, training programs and
IFRS training
materials for the thousands of U.S. small and large companies who must, in turn,
spend hundreds of billions of dollars converting staff and software to
IFRS standards.
Think of the added consulting and software writing plums waiting to be picked.
And law firms are dreaming of sugar plum fairies for auditors and their clients
to screw up when implementing
IFRS.
Tom Selling made a plenary session presentation at the Northeast Regional AAA
meetings and received boisterous ovation for his presentation
October 28, 2011 message from Harry Howe
We had a blizzard of skepticism on IFRS adoption
courtesy of Tom Selling's outstanding plenary address at the Northeast AAA
meeting today - drifts of trenchant objections accumulating to a very
considerable depth, local rolling thunderous applause and icy blasts of
logic headed southward on I-95. In short, some of the best NE weather I can
ever remember.
Keeping up with the standard-setting activities of
the Financial Accounting Standards Board (FASB) and the International
Accounting Standards Board (IASB) (collectively, the Boards) on their many
joint projects can be challenging. But with several major projects in active
stages, it’s important that you consider the potential effects of new
standards on your company. The Boards recently revised their work plans,
announcing delays on certain projects, but are still scheduled to complete
work on many of these projects in 2011.
This publication is designed to give you a snapshot
of key developments from a US GAAP perspective each month, along with our
observations about the potential implications for companies. We also include
references to other Ernst & Young publications that provide more background
and detail on the projects and proposals. These publications are available
at ey.com/us/accountinglink.
The following discussion is based on our
observations of the standard setter meetings. The Boards are actively
redeliberating many of these projects, making tentative decisions that may
be different from earlier decisions and those in the exposure drafts (EDs).
At this point, the Boards’ decisions and our observations are all subject to
change.
Poor Leslie did not get any stars from Tom Selling (he called her the First
Goat in a series of "goats" who testified) after she testified in the Senate
Hearings about the role of the accounting profession in preventing future
economic crises in the United States (which will be even less of a role when the
FASB turns over U.S. standard setting to the international IASB) ---
http://accountingonion.typepad.com/theaccountingonion/2011/04/the-stars-and-goats-of-the-senate-hearing-on-accounting.html
The current "buzzword" among leaders is "transparency." Hardly a day goes
by that a group leader (politician, manager, or administrator) doesn’t state
that he values transparency and will provide full disclosure of his
information and actions. This project tests experimentally whether or not
leaders, when given a choice, actually reveal a preference for transparency.
Our experiment is based on a theoretical model by Komai, Stegeman, and
Hermalin (2007). Fifteen subjects are randomly assigned to five groups of
three. Each group separately participates in an investment game with three
possible return scenarios (high, average, and low) that are equally likely
to happen. Investing in the low-return scenario is not profitable to either
individual group members or the whole group. In the average-return scenario,
group well-being is maximized if all the group members invest in the
project, but full cooperation may not be achieved simply because the
dominant strategy of the individuals is to free ride on others. In the
high-return scenario full cooperation is also optimal for the group, but
subjects may or may not coordinate on full cooperation because they may fail
to coordinate their efforts with the others. We consider a leader-follower
setting. Only one member of the group (the leader) observes the scenario.
The leader moves before the rest of the group members and first decides
whether or not to invest in the project. The leader then chooses between two
information regimes: revealing his decision and the return scenario to the
rest of the group or revealing his decision but not the return scenario.
Absent any information provided by their leader, followers know only the
possible return scenarios and their likelihoods. They do not know which
scenario is assigned to their group. Given the leaders’ information choices
and investment decisions, the relevant information will be conveyed to the
followers. The followers then will separately and simultaneously decide
whether or not to invest in the project (followers do not know anything
about the different information regimes). This is realistic in many
real-world circumstances because in many business or political environments
the leaders have exclusive access to critical information and are in charge
of deciding whether or not to reveal the details of their information and
actions to their potential followers; in many circumstances it is
practically difficult for the followers to verify the real information or
the leaders’ actions.
Keywords:
Transparency, leading by example, free-riding, cooperation.
Making IFRS 9 Politically Correct
Politically Adjusted Held-To-Maturity Fair Value Choices for Banks
This may not go down well with fair value advocates
European banks may now have an IFRS 9 choice for cost versus fair value
whichever makes the financial statements look better
Don't you just hate how bankers can manipulate accounting standard setters
European-Styled Avoidance of Fair Value Earnings Hits for Loan Loss
Impairments
European banks circumvented earnings hits for anticipated billions in loan
losses by a number of ploys, including arguments regarding transitory price
movements, "dynamic provisioning" cookie jar accounting, and spinning debt into
assets with fair value adjustments "accounting alchemy."
European banks resorted to a number of misleading ploys to avoid taking fair
value adjustment hits to prevent earnings hits due to required fair value
adjustments of investments that crashed such a investments in the bonds of
Greece, Ireland, Spain, and Portugal.
The Market Transitory Movements Argument
Fair value adjustments can be avoided if they are viewed as temporary transitory
market fluctuations expected to recover rather quickly. This argument was used
inappropriately by European banks hold billions in the Greece, Ireland,
Spain, and Portugal after the price declines could hardly be viewed as
transitory. The head of the IASB at the time, David Tweedie, strongly objected
to the failure to write down financial instruments to fair value. The banks, in
turn, threatened to pressure the EU lawmakers to override the IFRS 9 requirement
to adjust such value declines to market.
One of the major concerns of the is that
some nations at some points in time will simply not enforce the IASB standards
that these nations adopted. The biggest problem that the IASB was having with
European Banks is that the IASB felt many of many (actually most) EU banks were
not conforming to standards for marking financial instruments to market (fair
value). But the IASB was really helpless in appealing to IFRS enforcement in
this regard.
When the realities of European bank political powers, the IASB quickly caved
in as follows with a ploy that allowed European banks to lie about intent to
hold to maturity. The banks would probably love to unload those loser bonds as
quickly as possible before default, but they could instead claim that these
investments were intended to be held to maturity --- a game of make pretend that
the IASB went along with under the political circumstances.
European Union banks would
have more breathing space from losses on Greek bonds if the bloc adopted a
new international accounting rule, a top standard setter said on Tuesday.
The International Accounting
Standards Board (IASB) agreed under intense pressure during the financial
crisis to soften a rule that requires banks to price traded assets at fair
value or the going market rate.
This led to huge writedowns,
sparking fire sales to plug holes in regulatory capital.
The new IFRS 9 rule would
allow banks to price assets at cost if they are being held over time.
The European Commission has
yet to sign off on the new rule for it to be effective in the 27-nation
bloc, saying it wants to see remaining parts of the rule finalized first.
Only a few years ago,
Spain’s
banks were seen in some policy-making circles as a
model for the rest of the world. This may be hard to fathom now, considering
that Spain is seeking $125 billion to bail out its ailing lenders.
But back in 2008 and early 2009, Spanish regulators
were
riding high after their country’s banks seemed to
have dodged the financial crisis with minimal losses. A big reason for their
success, the regulators said, was an accounting technique called dynamic
provisioning.
By this, they meant that Spain’s banks had set
aside rainy- day loan-loss reserves on their books during boom years. The
purpose, they said, was to build up a buffer in good times for use in bad
times.
This isn’t the way accounting standards usually
work. Normally the rules say companies can record losses, or provisions,
only when bad loans are specifically identified. Spanish regulators said
they were trying to be countercyclical, so that any declines in lending and
the broader economy would be less severe.
What’s now obvious is that Spain’s banks weren’t
reporting all of their losses when they should have, dynamically or
otherwise. One of the catalysts for last weekend’s bailout request was the
decision last month by the
Bankia (BKIA) group, Spain’s third-largest lender,
to restate its 2011 results to show a 3.3 billion-euro ($4.2 billion) loss
rather than a 40.9 million-euro profit. Looking back, we probably
should have known Spain’s banks would end up this
way, and that their reported financial results bore no relation to reality.
Name Calling
Dynamic provisioning is a euphemism for an old
balance- sheet trick called
cookie-jar accounting. The point of the technique
is to understate past profits and shift them into later periods, so that
companies can mask volatility and bury future losses. Spain’s banks began
using the method in 2000 because their regulator, the
Bank of Spain,
required them to.
“Dynamic loan loss provisions can help deal with
procyclicality in banking,” Bank of Spain’s director of financial stability,
Jesus Saurina, wrote in a July 2009
paper published by the
World
Bank. “Their anticyclical nature enhances the
resilience of both individual banks and the banking system as a whole. While
there is no guarantee that they will be enough to cope with all the credit
losses of a downturn, dynamic provisions have proved useful in Spain during
the current financial crisis.”
The danger with the technique is it can make
companies look healthy when they are actually quite ill, sometimes for
years, until they finally deplete their
excess reserves and crash. The practice also
clashed with International Financial Reporting Standards, which Spain
adopted several years ago along with the rest of
Europe. European Union officials knew this and
let Spain proceed with its own brand of accounting anyway.
One of the more candid advocates of Spain’s
approach was Charlie McCreevy, the EU’s commissioner for financial services
from 2004 to 2010, who previously had been Ireland’s finance minister.
During an April 2009 meeting of the
monitoring board that oversees the
International Accounting Standards Board’s
trustees, McCreevy said he knew Spain’s banks were violating the board’s
rules. This was fine with him, he said.
“They didn’t implement IFRS, and our regulations
said from the 1st January 2005 all publicly listed companies had to
implement IFRS,” McCreevy said, according to a
transcript of the meeting on the monitoring
board’s website. “The Spanish regulator did not do that, and he survived
this. His banks have survived this crisis better than anybody else to date.”
Ignoring Rules
McCreevy, who at the time was the chief enforcer of
EU laws affecting banking and markets, went on: “The rules did not allow the
dynamic provisioning that the Spanish banks did, and the Spanish banking
regulator insisted that they still have the dynamic provisioning. And they
did so, but I strictly speaking should have taken action against them.”
Why didn’t he take action? McCreevy said he was a
fan of dynamic provisioning. “Why am I like that? Well, I’m old enough to
remember when I was a young student that in my country that I know best,
banks weren’t allowed to publish their results in detail,” he said. “Why?
Because we felt if everybody saw the reserves, etc., it would create maybe a
run on the banks.”
So to
sum up this way of thinking: The best system is
one that lets banks hide their financial condition from the public. Barring
that, it’s perfectly acceptable for banks to violate accounting standards,
if that’s what it takes to navigate a crisis. The proof is that Spain’s
banks survived the financial meltdown of 2008 better than most others.
Continued in article
Spinning Debt Into Earnings With the Wave of a Fair Value Accounting Wand
"Euro banks' £169bn in accounting alchemy," by: Lindsey White, Financial
Times Advisor, January 19, 2009 --- Click Here
European banks conjured more than £169bn of debt
into profit on their balance sheets in the third quarter of 2008, a leaked
report shows.
Money Managementhas gained exclusive access to a
report from JP Morgan, surveying 43 western European banks.
It shows an exact breakdown of which banks
increased their asset values simply by reclassifying their holdings.
Germany is Europe's largest economy, and was the
first European nation to announce that it was in recession in 2008. Based on
an exchange rate of 1 Euro to £0.89, its two largest banks, Deutsche Bank
and Commerzbank, reclassified £22.2bn and £39bn respectively.
At the same exchange rate, several major UK banks
also made the switch. RBS reclassified £27.1bn of assets, HBOS reclassified
£13.7bn, HSBC reclassified £7.6bn and Lloyds TSB changed £3.2bn. A number of
Nordic and Italian banks also switched debts to become profits.
Banks are allowed to rearrange these staggering
debts thanks to an October 2008 amendment to an International Accounting
Standards law, IAS 39. Speaking to MM, IAS board member Philippe Danjou said
that the amendment was passed in "record time".
The board received special permission to bypass
traditional due process, ushering through the amendment in a matter of days,
in order to allow banks to apply the changes to their third quarter reports.
However, it is unclear how much choice the board
actually had in the matter.
IASB chairman Sir David Tweedie was outspoken in
his opposition to the change, publicly admitting that he nearly resigned as
a result of pressure from European politicians to change the rules.
Danjou also admitted that he had mixed views on the
change, telling MM, "This is not the best way to proceed. We had to do it.
It's a one off event. I'd prefer to go back to normal due process."
While he was reluctant to point fingers at specific
politicians, Danjou admitted that Europe's "largest economies" were the most
insistent on passing the change.
As at December 2008, no major French, Portuguese,
Spanish, Swiss or Irish banks had used the amendment.
BNP Paribas, Credit Agricole, Danske Bank, Natixis
and Societe Generale were expected to reclassify their assets in the fourth
quarter of 2008.
The amendment was passed to shore up bank balance
sheets and restore confidence in the midst of the current credit crunch. But
it remains to be seen whether reclassifying major debts is an effective
tactic.
"Because the market situation was unique, events
from the outside world forced us to react quickly," said Danjou. "We do not
wish to do it too often. It's risky, and things can get missed."
Jensen Comment
European banks thus circumvented earnings hits for anticipated billions in loan
losses by a number of ploys, including arguments regarding transitory price
movements, "dynamic provisioning" cookie jar accounting, and spinning debt into
assets with fair value adjustments "accounting alchemy."
.
From The Wall Street Journal Accounting Weekly Review on July 8, 2011
TOPICS: Financial Accounting, Financial Accounting Standards Board,
GAAP, International Accounting, International Accounting Standards Board,
SEC, Securities and Exchange Commission
SUMMARY: "Ford Motor Co. has a special room for...the staff
preparing the auto maker for a possible switch by U.S. companies to
[IFRS]....Ford supports the move...saying the company would save money by
simplifying and standardizing its accounting across all 138 countries where
Ford operates." The special room is called the company's 'IFRS Energy
Room"-staff had considered calling it the "IFRS War Room" but they "couldn't
think of who [they] were at war with." The SEC is expected to decide by the
end of 2011 whether to require U.S. listed companies to prepare financial
statements under IFRS rather than U.S. GAAP, but the change would not take
effect until at least 2015.
CLASSROOM APPLICATION: The article is useful for introducing the
U.S. perspective on convergence process towards a single set of global
financial reporting standards.
QUESTIONS:
1. (Advanced) Define in general what is meant by the terms
International Financial Reporting Standards (IFRS) vs. U.S. Generally
Accepted Accounting Principles (U.S. GAAP).
2. (Advanced) What bodies establish each of these sets of
standards? Where are the standards setters located and who comprises each of
the boards?
3. (Introductory) Summarize the points made in the article that
lead to its title phrase that the change to IFRS "pits big vs. small." Are
all small companies against the change? Explain.
4. (Introductory) Refer to the graphic on significant differences
between U.S. GAAP and IFRS. Explain the ideas of U.S. GAAP containing
"bright line rules" and IFRS being more "principles-based." Include an
example of each of these approaches from the promulgated standards.
5. (Advanced) Refer again to the graphic. U.S.GAAP permits the use
of LIFO for inventory costing but IFRS does not. When is a U.S. company
required to use the LIFO method?
6. (Advanced) What is the idea of "condorsement"? Do you think that
companies will benefit from a phased-in transition to IFRS rather than a
one-time, all inclusive change over? Support your answer.
Reviewed By: Judy Beckman, University of Rhode Island
It isn't a new hybrid car. The auto maker is
preparing for a possible switch by U.S. companies to a new set of accounting
rules already used in most of the rest of the world.
Ford supports the move to International Financial
Reporting Standards, or IFRS, saying the company would save money by
simplifying and standardizing its accounting across all 138 countries where
Ford operates.
Charts, posters and other details about how Ford
would make the switch fill the company's "IFRS Energy Room," a converted
conference room at the company's headquarters in Dearborn, Mich. "For two
days, we were thinking of it as the IFRS 'war room,"' says Susan Callahan,
Ford's manager of global accounting policies, "but we couldn't think of who
we were at war with."
The answer: companies like Hallador Energy Co., a
small Denver coal-mining company that doesn't do business outside the U.S.
and opposes moving to the international standards.
"We didn't join the metric system when everybody
else did," says W. Anderson Bishop, Hallador's chief financial officer. U.S.
accounting rules are "the gold standard, and why would we want to lower our
standards just to make the rest of the world happy?"
The clash between big and small companies is likely
to come up at a discussion session Thursday at the Securities and Exchange
Commission in Washington.
U.S. and global rule makers already have worked for
years to eliminate many of the biggest differences between IFRS and the
U.S.'s generally accepted accounting principles, or GAAP. The SEC is
expected to decide by year end whether to require U.S. companies to shift to
IFRS altogether.
If U.S. companies are required by the SEC to move
to IFRS, which wouldn't happen until at least 2015, some numbers on their
financial statements will have to be calculated differently. (For example, a
widely used method to value inventory under GAAP isn't allowed under IFRS.)
Accounting could become simpler and more flexible, since IFRS is based on
guiding principles rather than GAAP's detailed rules.
Continued in article
Jensen Comment,
In the above article (and it's picture not shown here), Rapoport only touches on
the tip of the iceberg differences between FASB and IASB rules that are hanging
up the "convergence" process between both boards. Big differences remaining
include such things as accounting for derivative financial instruments and
hedging activities where there are many unresolved disputes. Revenue recognition
agreement is still delaying the process.
And now the IASB caved into political pressure and is allowing European banks
to report investments in troubled bonds (especially Greek bonds) at amortized
costs well in excess of fair market value.
Actually I prefer more informative income statements than balance sheets.
Hence, I would love to see both the FASB and the IASB re-introduce the
alternative of "Held-to-Maturity (HTM)" as implemented in the now defunct FAS
115. This makes reported net income less of a fiction because changes in fair
value of HTM securities create pure fiction in income statements in an effort to
fair value in balance sheets that will never be realized until maturity.
GAAP has obviously failed. The evaporation of
capital in the United States over the last 3 years proves it. But the whole
Adopt-or-Else plan isn’t necessarily any better either.
In my humble opinion, it just makes the IASB look
desperate and India look awesome. For now.
Technical Line: Hedge
accounting - is convergence possible?
April 30. 2011
The FASB and the IASB have not attempted to jointly address the differences in
their proposed hedge accounting models. This week, the FASB began reviewing
responses to questions it had asked constituents about the IASB hedging
proposal. The FASB is expected to consider that input as it continues its
deliberations on its own model. Meanwhile, the IASB has moved forward separately
with its own redeliberations.
Our
Technical Line publication compares and contrasts the two hedging proposals
and explains how we believe some of the novel concepts the IASB model introduces
would work. We also offer our thoughts on how certain aspects of the proposed
IASB hedging model should be incorporated into the FASB version.
Jensen Comment
There's an old saying when cable companies are bringing fiber to households:
"The last mile costs more than all the other miles."
The FASB and IASB may well have delayed the most controversial issues in
standards convergence to the "last mile" items in that convergence like
convergence on hedge accounting standards. At the moment there are quite a few
big differences such as hedge accounting for embedded derivatives (that was
abandoned by the IASB) and hedge accounting for portfolios where hedged item
risks within a portfolio differ from hedging contract risks. These are not small
pebbles in the convergence stream.
Jensen Comment
The IASB cannot seem to distinguish between simplified accounting rules and
ambiguity as if ambiguity and subjectivity equate to greater transparency.
The fact is that financial risk and hedging contracts have become
exceedingly complex. The IASB thinks they are so complex that auditors and
their clients should be allowed to report these contracts according to
judgment/judgement rather than bright lines. This is exactly like replacing
all the speed limit signs in school zones with signs that read "Please Drive
Safely."
The best illustration of replacing "standards" with ambiguity arises is the
absurd new IFRS rules for assessing hedge effectiveness. If you want to find
illustrations of how identical contracts are accounted for differently by
auditors and their clients in financial statements, this is the best, but
certainly not the only, place to look.
The concerns that some of us have are rooted in problems unique to the United
States. Most of the nations that have adopted IFRS still rely only lightly on
equity markets for raising capital relative to using large banks to raise
capital. Large banks such as those in Germany and Japan can dictate what
financial information they want from companies and in what level of detail and
type of format. In many instances the banks are really insiders with as much
power as management to request financial and other information. Especially
in places like Japan the big banks are virtually “partners” in the companies.
The United States is much more heavily engaged in equity funding of business
capital through enormous stock exchanges like the NYSE and NASDAQ. Equity
markets disperse fund raising among millions of investors that are virtually
powerless in demanding what financial information is provided for their equity
investing. In my viewpoint this makes the United States much more dependent than
most nations on accounting standards for both stewardship and investment
decisions.
Huge equity markets in the U.S. provide corporations with enormous incentives to
get around the accounting rules in efforts to lower their costs of capital by
what we often call creative accounting, cooking the books, off-balance sheet
financing, and earnings management ---
http://faculty.trinity.edu/rjensen/theory01.htm#Manipulation
The FASB and SEC are more actively engaged in frequent and constant revision of
standards to counteract the efforts of corporations to circumvent standards ---
efforts of corporations to keep debt off the balance sheet and to manage
earnings.
When standard setting is in domestic FASB and SEC hands, the entire focus of
standard setting can be centered on making urgent changes in the standards when
corporations find ways to circumvent standards. It’s like having a leaking dike
where standard setters are constantly having to plug new leaks. Particular
areas of leakage are often in areas where IFRS is very weak, including
creative financial structures, variable-interest entities, and all sorts of
questionable ways to recognize revenue ---
http://faculty.trinity.edu/rjensen/ecommerce/eitf01.htm
For example, the FASB has an Emerging Issues Task Force (EITF) that can act very
quickly to counter revenue recognition and other fraud.
Now I will finally attempt to answer your question
Many of us in the United States are worried that we will become only one of 150+
nations dependent upon a monopolist standard setter, the IASB, that is concerned
with all 150+ nations and not just one nation, the United States, where 95%
of the creative accounting, off-balance sheet financing, and earnings management
will take place.
We worry that the IASB will not respond nearly as quickly as the FASB and SEC
to plug leaks in our dikes.
We also worry that the IASB will not give sufficient time and attention to U.S.
accounting problems that are unique to the United States capital markets and
legal system.
I admit that I’m a defeatist
when it comes to resisting the IFRS takeover of U.S. GAAP. The United States
surpasses all other nations combined in creative finance and creative accounting
to circumvent accounting standards. I just do not think the IASB will react as
efficiently and effectively as the FASB when plugging holes in the standards
dikes that are incessantly created U.S. corporations with the blessings of their
auditors.
But those of us with such
concerns have lost the battle to the lobbyists of the giant multinational
corporations and their international CPA auditing firms. Some analysts like Tom
Selling and David Albrecht are not yet as willing to concede that “Resistance is
Futile.”
The United States is doing an awful job controlling sucker punches in
governmental accounting and auditing so I will pass over this one other than to
point out where you can read about it and weep for the suckers ---
http://faculty.trinity.edu/rjensen/theory01.htm#GovernmentalAccounting
I like to think about accountancy standard setting like I think about prize
fighting or Olympic boxing. In prize fighting rules are established to prevent
such things as cheating about the weight classifications of fighters and
prevention of putting steel clamps inside boxing gloves. There are also rules to
prevent sucker punches such as hitting below the belt and before or after the
bell rings for each round. As fighters take advantages of weaknesses in the
rules, rule makers issue new rulings such as rulings on performance enhancing
drugs.
In the roaring technology firm era of the 1990s, there were many startup
companies that took advantages of weaknesses in FASB and SEC standards,
particularly weaknesses on newer ploys to mislead investors with sucker punches
in revenue accounting ---
http://faculty.trinity.edu/rjensen/ecommerce/eitf01.htm
The FASB made significant progress thus far in the 21st Century in setting
rules against some of the sucker punches that were invented in the roaring
1990s. The IASB is still trying to catch up, and delays in catching up for some
sucker punches like securitization accounting are delaying the SEC roadmap for
eliminating US GAAP and replace it with international IASB standards for
preventing sucker punches.
Some 34% of CFOs rank “convergence to IFRS” as
their No. 1 issue. Cumulatively, CFOs rank IFRS convergence higher than any
other accounting issue, according to the latest Duke University/CFO Magazine
Global Business Outlook Survey.
Yet asked to describe their companies’ “readiness
to comply with global accounting standards,” 44% said they hadn’t “begun to
address convergence,” while 39% said they were preparing, “but far from
ready.”
Corporations are “still several years away from
having to implement a plan” to comply with a converged set of standards,
says James Kaiser, U.S. Convergence IFRS leader for PricewaterhouseCoopers.
Yet, as alarming as the state of awareness without preparedness sounds, it
just about fits the current state of the regulatory outlook. “It’s important
to monitor [regulatory developments] and develop a plan, but not get out in
front of the standards until they’re finalized,” says Kaiser.
All this now begs the question of how managers of
corporations are adapting to new accounting/financing rules with
innovative sucker punches.
HOW do you pump up the value of your company in
these difficult times? One tried and tested way is to hoodwink equity
analysts, according to a new study* of 1,300 corporate bosses, board
directors and analysts.
The authors found that chief executives commonly
respond to negative appraisals from Wall Street by managing appearances,
rather than making changes that actually improve corporate governance:
boards are made more formally independent, but without actually increasing
their ability to control management. This is typically done by hiring
directors who, although they may have no business ties to the company, are
socially close to its top brass. According to James Westphal, one of the
study’s co-authors, some 45% of the members of nominating committees on the
boards of large American firms have “friendship” ties to the boss—though
this varies widely from company to company.
The tactic pays off with appreciably higher
ratings. At firms that make a strenuous effort to persuade analysts that
such board changes have boosted independence, and thus made management more
accountable, the likelihood of a subsequent stock upgrade rises by 36%, the
study concluded. The chance of a downgrade, meanwhile, falls by 45%.
Why do analysts swallow this self-interested
narrative? Respondents acknowledged that social ties could undermine
independence, but most said they do not have the time to look into such
issues. It would help if companies disclosed such relationships in their
standard company literature, suggests Mr Westphal. He thinks they should
also list shared appointments—when the boss and a director sit together on
another firm’s board.
Depressingly, these market-distorting shenanigans
are part of a pattern. An earlier study found that public companies commonly
enjoy lasting share-price gains from plans that please analysts, such as
share buybacks and long-term incentive schemes for executives, even when
they fail to follow through on announcements. Another concluded that the
further a firm’s profits fall below consensus forecasts, the more favours
its managers bestow on analysts—such as recommending them for jobs and even
securing club memberships for them—and the lower the likelihood of a further
downgrade. If investors rated analysts, those taken in by such blatant
attempts at manipulation would surely earn a “sell”.
I was thinking mostly of accrual accounting which, of course, is
not 500 years old. But as “the” basis of financial reporting, historical cost
accounting on an accrual basis has been around at least as long as the railroads
when heated arguments flared concerning depreciation accounting “rules” that
companies and auditors would follow when accounting for rails and locomotives.
When accountants commenced to argue about depreciation the focus shifted to
earnings performance reporting extensions of stewardship accounting, although
depreciation accounting also served stewardship objectives of not allowing
companies to eat their own seed corn with excessive dividends that depleted
capital.
The point is that historical cost accrual accounting, as
portrayed in the
Paton and Littleton 1941 monograph, is a bit Darwinian in terms of survival
against mutations of pro forma entry value accounting, exit value accounting,
and economic (present value) accounting. However, we can hardly argue that there
is any single basis of accounting in the 21st Century where
departures from historical cost are required in numerous GAAP rules from pension
accounting to financial instruments to personal estate accounting (that requires
exit values).
However, in the course of accounting evolution mutations have
succeeded only when there is some basis of being objectively audited with
reliability and validity. We use present value for defined-benefit pension plans
because the cash flows are contractual. We do not use present value for an older
Chrysler assembly line because there is no reliable and valid basis to audit a
totally uncertain future revenue stream attributable to an assembly line.
Exit values of components of a going concern’s assembly line are
meaningless since piecemeal liquidation is the worst possible use of the
components. Entry values are highly questionable since a new assembly line would
be radically different. The
ASU 2010-6 FASB ASU says we should aggregate non-financial asset components
into their “best use” subset for exit value reporting as a group, but I think
finding the “best use” of a Chrysler grouping of assembly line assets is like
finding pie in the sky --- certainly not something that CPA firms can audit.
Welcome to the ASU 2010-6 world of pro forma GAAP!
Both the FASB and the IASB are rushing us into replacement of
transactions-based numbers with hypothetical “value” numbers based on subjective
probabilities and cloudy assumptions to a point where we can truly answer a
client’s question about “what did I earn?” with another question “what would you
like us to show that you earned?”
Welcome to the ASU 2010-6 world of pro forma GAAP!
AC Littleton will turn over in his grave. AC always argued that
accounting really was not about valuation in the first place and felt that
investors and creditors benefitted for having accounting rooted in the audit
trail of real transactions.
Welcome to the ASU 2010-6 world of pro forma GAAP!
Personally, I think the real problem is the FASB and IASB effort
to keep accounting as one-dimensional with a single dimensional mentality
leading to a single reported eps. We should do away with reporting eps entirely
and present multi-dimensional financial statements that vary as to degree of
reliability and validity.
What was so wrong in FAS 33 by requiring that replacement cost
accounting outcomes be disclosed in supplementary schedules? Why should it have
to be “historical cost” versus “entry value” versus “exit value” versus
“economic value” in a single-dimensional financial report?
In my lifetime I’ve seen the world of traditional GAAP and the
world of pro forma going head to head. Pro forma was generally considered too
subjective and unreliable. But in the 21st century, pro forma is
winning with FASB and IASB rulings. Why does this make me happy that I’m
becoming too old to care?
I’ll let Deloitte do the caring ---
http://www.iasplus.com/dttletr/1007amortcost.pdf
There aren't
enough jokes in Accounting Land, but thanks to Joel Jameson, founder
of Silicon Economics, Inc., that has been remedied. You see, Joel
believes the FASB has a monopoly in accounting standards-setting and
thinks that violates the Sherman Anti-Trust Act.
Worse, Joel
has invented something he calls “EarningsPower Accounting,” has
applied for a patent, and claims that the FASB has infringed upon
his patent. Accordingly, he did what any blue-blood would do—he
sued the FASB.
The
complaint was filed in U.S. District Court
in San Jose on May 5, 2010. This complaint is entertaining because
it proves that legal discourse is cheap. Supply exceeds demand.
In
paragraph 10 of the complaint, Mr. Jameson states that the
Securities and Exchange Act of 1934 gives the SEC authority to set
accounting standards, but the SEC has delegated that function to the
FASB. Narancic & Katzman, attorneys for Jameson, should have told
their client about section 108 of the Sarbanes-Oxley Act, which
permits the SEC to delegate standards-setting to another appropriate
body. In a
policy statement, the SEC did in fact
re-affirm its decision to rely on the FASB, as it stated in
Accounting Series Release No. 150.
Which reminds
me: how many lawyers does it take to change a light bulb? Answer:
as many as the client can afford.
Joel Jameson
goes on to assert (paragraph 13) that FASB “is far removed from
industry participants and accounting practitioners, resulting in
low-quality standards that are often divorced from reality.”
Complete, utter nonsense, although it may be evidence that Silicon
Valley is still miffed that it has to expense employee stock
options. This argument shows that the only thing more dangerous
than an economist is a Silicon Valley economist.
He next
attacks fair value accounting and repeats old mantras about the
volatility of income numbers (paragraph 18). He errs because fair
value accounting does not induce volatility; instead, it reports the
volatility that previously had been suppressed.
Jameson then
provides a hint about his “invention,” which consists of “an
equation derived from the present value equation of finance and
credit/debit posting procedures to calculate instantaneous
end-of-period asset and liability incomes and windfalls.” This
sounds a lot like present value accounting and this has been around
a long time. Perhaps Mr. Jameson should take a trip to Stanford and
talk with Bill Beaver about Chapter 3 of Beaver’s “Financial
Reporting.”
Mr. Jameson
prefers to allow managers the ability to claim that assets will
generate so much cash flows in the future and then discount those
cash flows. He seems unperturbed about the distinct possibility
that managers might exaggerate those future cash flows and minimize
the discount rate. Further, he must not care whether these
projections are auditable. Perhaps it is better if they aren’t.
After all, society surely can reduce accounting scandals by
preventing anybody from discovering them.
The complaint
describes FASB’s alleged wrongful conduct in paragraphs 21-26, but
it is much ado about nothing. The FASB stole nothing of value.
Let’s conclude
with this observation. How many Silicon Valley entrepreneurs does
it take to change a light bulb? None; they just have to turn on the
light switch.
It is my pleasure and privilege to provide you with
an original essay from someone else besides yours truly. Michael Pakaluk
received his A.B. and Ph.D. in philosophy from Harvard University, and has
taught at Clark, Brown and CUA, among other places. Michael is currently
Professor of Philosophy at Ave Maria University and Senior Consultant and
Public Policy Analyst with AuditAnalytics. The author of six books, he is an
internationally recognized expert on Aristotle's ethics and the co-author of
a leading text on accounting ethics, Understanding Accounting Ethics (third
edition is forthcoming).
In July 2009, Michael led a seminar at the FASB on
IFRS Convergence and Accounting Professionalism. This tightly written and
logical essay is based on that seminar. Unfortunately, nothing to emanate
from the FASB subsequently indicates that anyone could have actually been
listening; of all the arguments against IFRS adoption of which I am aware,
this one is the deal breaker.
"Loss of Sovereignty and Public Interest," by Michael
Pakaluk, PhD ---
Click Here
In April 2009 I wrote a
column that suggested that Robert Herz should resign as chairman of the
FASB. Now, sixteen months later, he does in fact resign. I am not vain
enough to attribute a cause-and-effect relationship, but I want to review my
criticisms of Herz and suggest to the FAF who they should appoint to the
board.
In my column
“Herz
Should Resign,”
I stated that Mr. Herz is very knowledgeable about accounting and finance.
Indeed, if technical knowledge of accounting were all that is required, he
would be a great chair, as demonstrated in his speeches and writings.
During his tenure, beginning July 1, 2002, the FASB has dealt with a variety
of complex issues, including stock options, business combinations, pensions,
special purpose entities, and of course the ever-present issue of
derivatives. In all of these areas, Bob Herz is a master.
However, the board has faced a series of serious threats and challenges
during the last decade, and these did not call for technical solutions.
Indeed, they were outside the realm of the accountant’s black box, for they
involved primarily political threats and challenges. A good chairman would
embrace these battles and not give up without a struggle. He would not play
defense, but go on the attack and win some battles against the bad guys.
FASB members have been too genteel—too quick to compromise instead of
engaging the enemies in combat.
And who are the bad guys? First and most obvious are the bankers. In the
previous essay I called April 2, 2009 a day of accounting infamy because
that is when the FASB gave into the pressures of the banking industry and
issued a couple of FSPs that supplied bankers with considerable wiggle room
for their income statement machinations. The banking industry has fought
against fair value measurements with grim determination because they believe
that the financial crisis beginning in 2008 could have been deferred, at
least for awhile, if only they could have kept the investment community in
the dark. Fair value measurements provided the truth—and the truth was
ugly. Regardless of the consequences, the FASB should have defended
accounting truth instead of allowing bankers additional methods to hide the
truth.
What should the FASB have done? While the public was still feeling the
sting caused by the excesses and the failures of AIG and Lehman Brothers and
the mortgage-based government-sponsored enterprises, the FASB should have
written op-ed pieces for leading newspapers and online news agencies, it
should have sought out guest spots on national radio shows, and it should
have presented its case on national television shows. The board should have
taken the case to the American people and informed the world that AIG
executives and bankers and managers at Freddie and Fannie were lying in
their financial reports and wanted permission to lie some more. The
argument would have resonated with the public.
But wait—there’s more! The biggest challenge against the FASB has been the
expansion of financial engineering by investment bankers. Every time the
FASB issues a standard, bankers create ways of getting around the rules.
They may be unethical and some illegal, but if the financial engineers can
find ways to subvert good accounting practices, then managers are willing to
pay handsome fees.
Recall how Merrill Lynch enabled some of Enron’s frauds. Managers at Enron
needed to prop up the firm’s net income and cash flows in 1999, so in
December 1999 Jeffrey McMahon, then Treasurer of Enron, negotiated with
managers at Merrill Lynch to purchase an interest in Enron’s Nigerian
barges, promising to repurchase the investment in six months; moreover,
Enron guaranteed Merrill Lynch an annualized return of 22 percent. The
transaction was consummated in mid-December 1999 and was reversed in late
June 2000 when Merrill Lynch sold its investment in the Nigerian barges to
LJM2, one of the infamous special purpose entities of Enron.
The FASB needs to fight back. When a bank creates such financial
engineering, it needs to call them on it. Another example is the creation
of accelerated share repurchase programs by Wall Street. These accelerated
share repurchase programs purportedly allow firms to increase their earnings
per share without actually buying back their own shares. The FASB should
denounce such antics in the press and on television. The FASB has to attack
the bad guys and put them on the defense.
The second set of bad buys is members of Congress. Every time the FASB
attempts to do something good, some misanthrope dressed in Washington garb
writes a piece of legislation or holds hearings and castigates the
accounting profession. For example, consider Senator Enzi’s hearings on
stock option accounting. As an accountant, Enzi knew or should have known
that stock options transfer resources to managers and involve very real
costs. But he wasn’t interested in supplying truth to investors and
creditors; instead, he wanted to thwart the efforts of the FASB to better
financial reporting in this country and help those who had helped him and
hopefully would help him in the future. The FASB needs to take the offense
and point out the hypocrisy of members of Congress.
Freshman Senator Sherrod Brown (D-Ohio), on May 5,
2010, offered an amendment to S. 3217: Restoring American Financial
Stability Act of 2010. On May 7, 2010, a joint letter from seven prominent
organizations was sent to the Senate, objecting the Brown’s excursion into
accounting standard setting.
What’s going on, Prof Albrecht?
Thanks for asking. I’ll lay it out for you. Senator
Brown is a voice of reason on this issue and the seven prominent
organizations are blowing smoke.
First, let’s start with Senator Brown’s proposed
amendment, SA 3853. It is co-sponsored by Senator Edward Kaufman
(D-Delaware). It deals with the accounting for financial investments and
off-balance sheet liabilities, which has led some to speculate that Senator
Brown would be interested in chairing the FASB after Robert Herz gets done
mucking it up. SA 3853 reads:
Do you know the speed traps in your hometown? I might preface this by saying that I'm a law abiding driver who favors more and
more speed traps. Sadly, there is only one speed trap noted below within 30
miles in all directions from our cottage. But we have very little traffic in
these mountains. Our speed trap is at the south exit of Franconia Notch --- http://en.wikipedia.org/wiki/Franconia_Notch
Drivers tend to put the pedal to the metal as they emerge from the mountain
pass. I might add that the same thing happens closer to where we live at the
north exit of the Notch. But that is not listed as a speed trap. (Actually,
I found later that there are two other Notch speed traps further south around
the Lincoln exits.).
Jensen Comment In our current discussion about priorities of
accounting standard setting, it struck me that accounting and auditing standards
should be like speed traps.
As I was writing
this speed trap tidbit, it dawned on me that writing financial accounting
standards is a bit like choosing where to locate speed traps. The goals should
be focused upon where public safety is most at risk. This is not always where
violations are most likely to take place. Rather safety should be focused on
where accidents are most likely to take place because of the violations.
Accounting standards should focus on where the worst abuses of
investor/creditor safety are likely to take place. As in the case of the speed
trap on the south end of Franconia Notch, I don't think this is where safety is
at stake. The south end of Franconia Notch is in the boon docks, and drivers
pushing it to 80 mph on the four-lane I-93 in the middle of nowhere are not
pushing safety to the limit like they are pushing safety to the limit backing
their cars out of parking places in our always-overcrowded Littleton Wal-Mart. I
fear more about cars hitting shopping carts and kids in this parking lot than
accidents up on either end of the Notch.
Incidentally, drivers tend to speed where the Notch exits change to double
lanes, because they've been bottled up for miles at 45-mph on a single lane
inside the Notch. It's like they blame the drivers ahead of them in the Notch
for going so slow and want to zoom around them when there's at long last a
passing lane. But the drivers ahead of them are also speeding up to at least 65
mph such that you have to now get around them you may have to accelerate to 80
mph. I notice this time and time again at each end of the Notch. After zooming
around at 80 mph, those same drivers generally slow down to less than 70 mph
when they come to their senses.
Such is not the case for Wall Street Bankers.
They will
maintain break-neck speeds for their commissions and bonuses.
Frank Partnoy and Lynn Turner contend that Wall Street
bank accounting is an exercise in writing fiction: Watch the video! (a bit slow loading)
Lynn Turner is Partnoy's co-author of the white paper "Make Markets Be Markets" "Bring Transparency to Off-Balance Sheet Accounting," by Frank Partnoy,
Roosevelt Institute, March 2010 --- http://makemarketsbemarkets.org/modals/report_off.php Watch the video!
"To Head in the Right Direction on IFRS, the
SEC Should Make a U-Turn" --- The Accounting Onion, November 25, 2009 ---
Click Here
For what it’s
worth, my reasons for not wanting IFRS to replace U.S. GAAP are the countless
ways IFRS replaces bright line rules with carte blanche subjective and
variable (for separate and identical transactions) “principles-based” reasoning
that gives the big corporations (that are too large to lose as clients) a way to
leverage their auditors. Auditors, in turn, like principles-based standards
because they take away many bright line smoking guns like the 3% SPE smoking gun
held by Enron and Andersen. Under IFRS, Enron and Andersen might still be in
business, especially since IFRS has no variable interest entity standard for
booking or disclosure. And Andy Fastow might even be Enron’s CEO writing
Chewco’s 5,187th SPE --- http://faculty.trinity.edu/rjensen//theory/00overview/speOverview.htm
For me a school
zone needs to post “maximum speed is 20 mph” rather than “slow down for
children.”
However, we’ve
gone round and round about this one before. Those of you in favor of
principles-based standards, like our good friend Patricia, might find your
previous messages supporting principles-based standards at http://faculty.trinity.edu/rjensen/theory01.htm#BrightLines My rants against principles-based standards are also at the above site.
In the United States The roaring SEC-FASB (read that Cox-Herz)
Express Train for replacing domestic accounting
standards such as U.S. and Canadian GAAP is
analogous to letting the Federation govern
the world. Both the U.N. and the International
Accounting Standards Board have lofty
intentions, but multinational politics in the
Federation is a nightmare to behold. More on this later.
November 12, 2009 message from Bob Jensen to
the AECM listserv
Hi John,
Dave may be psychic.
One day soon the halls of the FASB will be emptied and a grateful few
(might I say “Grateful Dead”) will be transported for government work at the
SEC. At that point the authority of the SEC over Wall Street will probably
be stripped from it (the Madoff scandal at the SEC sure didn’t help) such
that all that’s left of the SEC might indeed be the Federal Accounting
Standards Board that will watch over bookkeeping practices of mom and pop
stores.
But I suspect the most thorough archiving of the Dead FASB will be
directed by Dale Flesher at the accounting history center at the University
of Mississippi. Santa Cruz prefers rock bands of the 1960s. The FASB did not
even exist until the 1970s when all the flower children were being
transformed into investment bankers.
In the grand scheme of things, accountancy makes for pretty dull history
(just kidding of course). Hippies stole for food and pot. Accountants aided
and abetted thefts of hundreds upon hundreds of billions of dollars ---
http://faculty.trinity.edu/rjensen/FraudRotten.htm
Exhibit A is Jerry Rubin ---
http://en.wikipedia.org/wiki/Jerry_Rubin
Jerry Rubin (July 14, 1938 – November 28, 1994) was a radical American
social activist during the 1960s and 1970s. He became a successful
businessman (bond salesman) in the 1980s.
Bob Jenen
Popular IFRS Learning Resources:
Check out the popular IFRS learning Deloitte link is
http://www.deloitteifrslearning.com/
Also see the free IFRS course (with great cases) ---
Click Here
Also see the Virginia Tech IFRS Course --- Send a request to John Brozovsky
[jbrozovs@VT.EDU]
The Ernst & Young
Foundation has teaching materials for IFRS (developed by faculty). They
are free and cover Intermediate I, II and Advanced Accounting. We will
be developing more this year. It is free to anyone with a .edu address.
You just need to email catherine.banks@ey.com
and she will give you a password to access the material. It is set up to
be used either as material to integrate into what you are currently
teaching or as a stand-alone course. There are lecture notes, home work
assignments, cases, etc. I hope you find it useful.
Please
feel free to contact me directly if you have any additional questions.
Ellen
IASB-FASB Convergence Efforts Hit IFRS Roadblocks and Delays
The IASB and the FASB today announced their
intention to prioritise the major convergence projects to permit a sharper
focus on issues and projects that they believe will bring about significant
improvement and convergence between IFRSs and US GAAP. Their joint statement
is as follows:
In our November 2009 joint statement, we, the
International Accounting Standards Board (IASB) and the US Financial
Accounting Standards Board (FASB) again reaffirmed our commitment to
improving International Financial Reporting Standards (IFRSs) and US
generally accepted accounting principles (GAAP) and achieving their
convergence. That Statement affirmed June 2011 as the target date for
completing the major projects in the 2006 Memorandum of Understanding (MoU),
as updated in 2008, described project-specific milestone targets, and
acknowledged the need to intensify our standards-setting efforts to meet
those targets.
We committed to providing transparency and
accountability regarding those plans by reporting periodically on our
progress. Our first report, dated 31 March 2010, described the progress we
had made to date, explained some of the challenges we face in improving and
converging our standards in certain areas, and reported changes made to
certain project-specific milestone targets.
As noted in our March 2010 progress report, we
recognise the challenges that arise from seeking effective global
stakeholder engagement on a large number of projects. Since publishing the
March progress report, stakeholders have voiced concerns about their ability
to provide high-quality input on the large number of major Exposure Drafts
planned for publication in the second quarter of this year.
The IASB and the FASB are in the process of
developing a modified strategy to take account of these concerns that would:
prioritise the major projects in the MoU to permit
a sharper focus on issues and projects that we believe will bring about
significant improvement and convergence between IFRS and US GAAP. stagger
the publication of Exposure Drafts and related consultations (such as public
round table meetings) to enable the broad-based and effective stakeholder
participation in due process that is critically important to the quality of
their standards. We are limiting to four the number of significant or
complex Exposure Drafts issued in any one quarter. issue a separate
consultation document seeking stakeholder input about effective dates and
transition methods. The modified strategy retains the target completion date
of June 2011 for many of the projects identified by the original MoU,
including those projects, as well as other issues not in the MoU, where a
converged solution is urgently required. The target completion dates for a
few projects have extended into the second half of 2011. The nature of the
comments received on the Exposure Drafts will determine the extent of the
redeliberations necessary and the timeline required to arrive at high
quality, converged standards.
The IASB and the FASB have begun discussions on
this proposed strategy with their respective oversight bodies and
regulators, including members of the IASC Foundation Monitoring Board.
It is expected that this action by the FASB and
IASB will not negatively impact the Securities and Exchange Commission’s
work plan, announced in February, to consider in 2011 whether and how to
incorporate IFRS into the US financial system.
The boards expect to publish shortly a progress
report that includes a revised work plan.
Teaching Case on the Early Bow Out of FASB Chairman Bob Herz
From The Wall Street Journal Accounting Weekly Review on August 27,
2010
TOPICS: FASB,
Financial Accounting Standards Board, International Accounting Standards
Board, Standard Setting
SUMMARY: In
a surprise announcement, FASB Chairman Bob Herz has stated he will retire on
October 1 of this year, two years before his term is up. In his chairman's
role since 2002, he has championed the use of mark-to-market accounting,
which some investors say "...brings a more realistic view to the numbers
that public companies report...," though others argue it introduces
unnecessary volatility into the reported numbers and that it exacerbated the
banking crisis. The announcement also comes during the time that the IASB is
searching for a successor to its chairman, David Tweedie, whose term ends in
June 2011.
CLASSROOM APPLICATION: The
article is useful to add current events to any introduction of the FASB's
organization and procedures in intermediate accounting or later courses
QUESTIONS:
1. (Introductory)
Describe the purpose and organizational structure of the Financial
Accounting Standards Board (FASB). Begin with the description in the
article, but go beyond those limited statements by accessing the FASB's web
site at
www.fasb.org
2. (Introductory)
How is the departure of Chairman Bob Herz expected to impact the FASB's
activities?
3. (Advanced)
The accounting standards setting process is a social science, influenced by
political and social factors. List the points in the article that speak to
this nature of accounting standards setting.
4. (Advanced)
What is the status of accounting standards in the U.S. in relation to
accounting standards set by the International Accounting Standards Board (IASB)?
In your answer, include a brief description of the IASB. Hint: to assist in
your answer, you may also access the IASB's web site at
www.iasb.org
Reviewed By: Judy Beckman, University of Rhode Island
The group that sets U.S. accounting rules said
Tuesday that its longstanding chairman would retire, causing new uncertainty
over highly contentious accounting issues that have major bearing on how
U.S. companies report their results.
The departure of Robert Herz, who has served as
chairman of the Financial Accounting Standards Board since 2002, came as a
surprise. Mr. Herz had two years remaining in his term as FASB chairman and
hadn't publicly indicated he might step down. Mr. Herz wasn't available to
comment.
Choosing Mr. Herz's successor will be particularly
important given questions about FASB's independence and the wider role of
accounting in the financial system and economy. Some bank regulators and
members of Congress believe accounting rules should work to promote
financial stability. That view can sometimes conflict with FASB's mission to
provide reliable information to investors.
Mr. Herz's departure, set for Oct. 1, also comes as
the body is enmeshed in a battle over a proposal to expand the use of
mark-to-market accounting, which requires companies to use market prices
rather than management estimates to value financial holdings.
Some investors say this practice brings a more
realistic view to the numbers that public companies report, but banks have
vigorously opposed the practice.
They say it will introduce unnecessary volatility
into results and exacerbated the financial crisis.
At the same time, Mr. Herz's departure may affect
the board's ability to complete projects designed to bring together its
rules and those set by the London-based International Accounting Standards
Board. Mr. Herz's long-stated goal was to make both accounting regimes
similar enough that U.S. public companies could abide by the international
standards.
An added wrinkle: FASB will now have to replace Mr.
Herz at the same time that the IASB is already searching for a successor to
its chairman, David Tweedie, whose terms expires in June 2011. This means
that both bodies will have new heads as they enter what could prove to be
the end game for the often-thorny process of converging two accounting
standards.
Along with Mr. Herz's departure, the foundation
that oversees FASB said it would expand the size of the board to seven
members from five, reversing a 2008 measure that reduced its size.
Jack Brennan, head of the nonprofit Financial
Accounting Foundation that oversees FASB, said the group hoped to appoint a
new chairman and board members in coming months, but wouldn't set a
deadline.
Mr. Brennan said in an interview that the decision
to step down was Mr. Herz's and that the foundation hadn't received any
pressure from the government or outside parties to replace him.
FASB is an independent standard-setting body,
although its activities are overseen by the Securities and Exchange
Commission. The board's activities are also subject to congressional
oversight hearings.
FASB member Leslie Seidman, who has sat on the
board since 2003, will serve as acting chairman from Oct 1. The chairman
post pays $750,000 a year.
The lack of a full board is likely to slow many of
FASB's projects, particularly the move to converge with international rules,
said former FASB Chairman Dennis Beresford. "They're not going to issue
anything important on the basis of having only four board members," he said,
adding that Mr. Herz's departure came as "a complete surprise."
Mr. Herz had long fought to maintain FASB's status
as an independent body whose primary constituents were investors. Over the
past year he had publicly called for a separation of accounting rules and
bank capital standards, a position opposed by some bank regulators.
Mr. Herz's biggest victory in this regard came when
he successfully shepherded new rules that required companies to expense
stock options, despite heated opposition from most of Silicon Valley and
many members of Congress.
But he also suffered what many saw as a big defeat
in the wake of the financial crisis. After Mr. Herz was browbeaten by
members of Congress during a hearing on Capitol Hill over mark-to-market
accounting, FASB subsequently changed some rules governing this practice.
IFRS Mess: The AICPA is finally looking for a
horse to pull the IASB cart
The AICPA has always put the cart before the
horse when coming out strong for replacing U.S. GAAP with IFRS before calling
for better funding of the IASB (the international standard setting body has
lower funding than the FASB). The U.S. will probably have provide the largest
share of IASB funding in a manner similar to funding of the United Nations, but
what portion will Congress agree to for carrying the IASB?
The IASB in recent years has relied heavily on
joint projects with the higher-funded FASB. Whereas the FASB can afford a
talented full-time research staff, the IASB has to rely more on volunteers and
part time helpers.
In my opinion the large international accounting
firms that all so intensely want to bury U.S. GAAP should provide a huge
endowment (maybe $100 million or more) for the IASB much like they provided
endowment funds years ago for the FASB. Since the IASB will have a world
monopoly on standard setting, it needs much more funding for support staff and
advance communications technology and worldwide educational support funding.
Barry C. Melancon, president
and CEO of the American Institute of Certified Public Accountants, speaking
at a roundtable of global accounting leaders in New York City today called
for a permanent, independent funding mechanism for the International
Accounting Standards Committee Foundation, the governing body of the
International Accounting Standards Board.
“We believe it is
imperative the foundation find a permanent funding solution for the
International Accounting Standard Board’s activities,” Melancon said at a
roundtable discussion on the IASB’s constitution. “A permanent funding
solution would ensure that the IASB has appropriate resources to carry out
its mission and would lead to world-wide confidence in the IASB’s role as an
independent accounting standard setter,” Melancon said.
Based in London,
the IASB sets global accounting rules known as International Financial
Reporting Standards and recognized in 113 countries. The U.S. Securities and
Exchange Commission is considering whether to require U.S. publicly-traded
corporations to use IFRS for financial reports in U.S. markets as soon as
2014. The IASCF has proposed changes to its constitution that seek to
establish a sustainable funding system for the board to help insulate
standard setters from short-term political pressures.
“We strongly
support the eventual use of a single set of high-quality, comprehensive
global accounting standards by public companies in the preparation of
transparent and comparable financial reports throughout the world, and thus
continue to strongly support the objectives of the IASCF and the IASB,"
Melancon said.
In the United
States, the AICPA will encourage the SEC to use part of the current levy on
U.S. public companies for accounting standard setting activities as a
permanent funding source for the IASB, Melancon said.
Background
About IFRS
International Financial Reporting Standards (IFRS) are accounting standards
developed by the International Accounting Standards Board (IASB) that are
becoming the global standard for the preparation of public company financial
statements. The IASB is an independent accounting standard-setting body that
is the international equivalent of the U.S. Financial Accounting Standards
Board in Norwalk, Conn., which sets U.S. generally accepted accounting
principles.
The IASB consists
of 14 members from nine countries, including the United States. It is funded
by contributions from major accounting firms, private financial institutions
and industrial companies, central and development banks, and other
international and professional organizations throughout the world.
In 2008, the AICPA
governing Council voted to recognize the IASB as an international accounting
standard setter, giving AICPA member CPAs the option of using IFRS for
private companies. In 2007, the U.S. Securities and Exchange Commission
approved use of IFRS for U.S. financial reports filed by foreign
publicly-held companies that use IFRS in their home country.
The AICPA has
taken an active role in helping CPAs understand IFRS. The AICPA publishes
the Web site
www.ifrs.com, the premier source for IFRS
resources in the United States. The AICPA has developed a variety of
courses, publications, articles and case studies to help Americans learn
about IFRS and understand the changes, challenges and opportunities that a
U.S. transition to IFRS will bring.
For more
information about IFRS, visit
www.ifrs.com.
Among other items, a list of frequently asked
questions explaining IFRS and its applicability in the United States is
available.
For the next several years (probably until
2014), the U.S. accounting standards are set in the FASB's Codification database
---
FASB Codification Database Supersedes All FASB Standards
Countdown to Codification Alert: FASB Alert #4, 5-22-09
What happens to U.S. GAAP literature when the Codification went live on July 1,
2009? All
existing standards that were used to create the Codification will become
superseded upon the adoption of the Codification. The FASB will no longer
update and maintain the superseded standards. Also, upon adoption of the
Codification, the U.S. GAAP hierarchy will flatten from five levels to
twoauthoritative and non-authoritative. The following table illustrates the
result:
DON’T BE CAUGHT OFF GUARD! GET READY FOR THE CODIFICATION!
The FASB is expected to institute a major change in the way accounting standards
are organized. The FASB Accounting Standards CodificationTM is
expected to become the single official source of authoritative, nongovernmental
U.S. generally accepted accounting principles (GAAP).After final
approval by the FASB only one level of authoritative GAAP will exist, other than
guidance issued by the Securities and Exchange Commission (SEC). All other
literature will be non-authoritative. While the FASB Codification is designed to make it much easier to research
accounting issues, the transition to use of the Codification will require some
advance training. These weekly “Countdown to Codification” alerts are designed
to provide tips to make that transition easier. The FASB offers a free online tutorial at
http://asc.fasb.org. A recorded instructional webcastThe Move to
Codification of US GAAP, first presented live on March 13, 2008also is
available at
http://www.fasb.org/fasb_webcast_series/index.shtml. In addition,
Codification training opportunities are offered through professional accounting
organizations such as the American Institute of Certified Public Accountants (AICPA).
Hard Copy of FASB Codification Available
FASB Codification Bound Vols. FASB Codification—Four Volumes (This bound
edition is expected to be available the week of December 21. Your credit card
will not be charged until the publication is shipped. For orders of 6 or more
sets please call 800.748.0659.)
https://www.fasb.org/jsp/FASB/Page/Store/ProductPage&subjectId=25COD
This print edition also includes the
codification of FASB Statements No. 166, Accounting for Transfers
of Financial Assets, and No. 167, Amendments to FASB
Interpretation No. 46(R), although the codification of these two
Statements has not been released in the online version as of October
31, 2009. FASB Statement No. 164, Not-for-Profit Entities:
Mergers and Acquisitions, has not been codified as of October
31, 2009 and is not included in this bound edition.
Volume 1 includes the Notice to Constituents which
provides information to aid in understanding the topical structure,
content, style, and history of the FASB Codification and also
contains the following Areas:
General Principles (Topic 105)
Presentation (Topics 205 through 280)
Assets (Topics 305 through 360)
Liabilities (Topics 405 through 480)
Equity (Topic 505).
Volume 2 includes:
Revenue (Topic 605)
Expenses (Topics 705 through 740)
Part of the Broad Transactions Area
(Topics 805 through 815).
Volume 3 includes:
The remainder of the Broad
Transactions Area (Topics 820 through 860)
Part of the Industry Area (Topics 905
through 944).
Volume 4 includes:
The remainder of the Industry Area
(Topics 946 through 995)
As of June 20, 2009 there
is still some question whether faculty, students, and colleges will get the a
free deal on the $150 basic version or the $850 professional version that
includes cross referencing.
The following message was
forwarded by David Albrecht on June 16, 2009
From: "Tracey E. Sutherland" <traceysutherland@aaahq.org>
Organization: American Accounting Association
Date: Tue, 16 Jun 2009 17:25:23 -0400
FAF and AAA to Provide FASB Codification to Faculty and Students
On July 1, 2009, the Financial Accounting Standards Board (FASB) is
instituting a major change in the way accounting standards are organized. On
that date, the FASB Accounting Standards Codification™ (FASB Codification)
will become the single official source of authoritative, nongovernmental
U.S. generally accepted accounting principles (U.S. GAAP). After that date,
only one level of authoritative U.S. GAAP will exist, other than guidance
issued by the Securities and Exchange Commission (SEC). All other
literature will be non-authoritative.
As part of its educational mission, the Financial Accounting Foundation (FAF),
the oversight and administrative body of the FASB, in a joint initiative
with the American Accounting Association (AAA), will provide faculty and
students in accounting programs at post-secondary academic institutions with
the Professional View of the online FASB Codification.
Accounting Program Access—No Cost to Individual Faculty or Students
The Professional View of the FASB Codification will be accessible at no cost
to individual faculty and students, through the AAA’s Academic Access
program, available to Registered Accounting Programs. The Professional View
will provide advanced search functions with special utilities to assist in
the navigation of content, representing the fully functional view of the
FASB Codification that will be used by auditors, financial analysts,
investors, and preparers of financial statements. All of the features that
have been available with the verification version currently at
http://asc.fasb.org are included with the Professional View.
AAA Academic Access
The AAA will provide direct services to accounting departments through its
Academic Access program; issuing authentication credentials for faculty and
students through Registered Accounting Programs, at a low annual
institutional fee of $150. Information about this program will be
forthcoming directly from AAA and on the AAA website at
http://aaahq.org/FASB/Access.cfm.
Transitional Access—From July 1 through August 31, 2009
The AAA will provide credentials to individual faculty and students, at no
charge, during the transition period before the beginning of the fall
semester when faculty and students will receive credentials for access
through their Registered Accounting Programs.
The FAF, FASB, and AAA are enthusiastic about this new initiative and
understand the value of this program to accounting education and
scholarship, in addition to its benefit to faculty and students to have
access to the advanced view of U.S. GAAP that will be used by accounting
professionals.
******************
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June 24, 2009 Update There was some doubt initially about whether the free or discounted faculty
and student access version of the FASB Codification database would be the
"Professional" version (that includes searching and cross-referencing at an $850
single user license per year).
The AAA registration site for the discounted ($150 annual discount price)
version makes it clear that accounting education departments or schools will get
the full "Professional" version at a discount, thereby saving each academic
program $700 per year savings per license. What is not yet perfectly clear is
whether this is a single-user access license. My reading is that multiple users
within a department or school can use the Codification database at the same
time. I could be wrong.
Since all future financial statements will no longer reference hard copy
sources like FAS 166 or EITF 98-1 or FIN 48, it is vital for students and
teachers and researchers to have access to the Codification database for
financial statement analysis.
All users will
have free access to the Codification database, but not the free access to the
$850 “Professional” searching and cross-referencing services.
Good News
An Accounting Education Department’s $150 license can be used by multiple
faculty members and students simultaneously, which is indeed good news.
It’s not yet clear how an accounting department will
facilitate multiple-user access, but I guess we will learn that very soon. For
example how can students and faculty off campus access the $150 professional
version of the Codification database.
Codification of the FASB standards, interpretations, and other hard copy FASB
documentation into a searchable "Codification" database, like the road to hell,
is paved with good intentions. Bits and pieces of hard copy dealing with a given
topic are scattered in many different hard copy FASB references and bringing
this all together in newly coded Codification numbered sections and subsections
is a fabulous "paving" idea.
At least Codification of FASB hard copy was a great "paving" idea until it
became evident that FASB standards most likely will be entirely replaced by IASB
international standards (IFRS). It's still uncertain when and if IFRS will
replace the FASB standards, but recent events in Washington DC suggest that the
transition will most likely happen at the end of 2014. This means that millions
of dollars and millions of professional work time hours by accountants,
auditors, educators, and financial analysts will be spent using the FASB's new Codification
database that commenced on July 1, 2009 and will most likely self destruct on
December 31, 2014. As I indicated, when and if IFRS will take over is still
uncertain and controversial, but I'm betting the shiny new FASB Codification
database will self destruct in 2014 ---
http://faculty.trinity.edu/rjensen/theory01.htm#MethodsForSetting
As a result of scheduled obsolescence, what commenced as a Codification smart
idea became dumb and dumber in 2009.
Furthermore, the Codification database has some huge limitations because it
contains only a subset of the FASB hard copy material that it ostensibly is
replacing.
FASB hard copy contains many wonderful illustrations that are, in my
viewpoint, ideal for learning about standards and their interpretations. In
fact many of the illustrations make FASB standards much easier to learn than
IFRS international standards that are illustration-lite. Sadly many of the
best FASB hard copy illustrations were left out of the Codification database
such that these illustrations cannot be located by search and cross
referencing. For example, when teaching the highly complicated FAS 133, the
most important teaching aids for my students were the illustrations in
Appendix A and Appendix B of FAS 133. Most of those wonderful illustrations
are not in the Codification database which, in turn, makes it much less
useful to accounting and finance educators. Dumb! Dumb! Dumb!
FASB hard copy contains much implementation guidance for complicated
questions raised by auditors and their clients, guidance that is not
contained or even cross-referenced in the Codification database. The
huge example here is the massive amount of implementation guidance for FAS
133 rendered by the FASB's Derivative Implementation Guidance Group (DIGG)
---
http://www.fasb.org/derivatives/
The many DIGG documents are difficult to search and cross reference.
Including them in the Codification database would be terrific --- no such
luck. Dumb! Dumb! Dumb!
Financial accounting textbooks, lecture materials, handouts, problem
assignments, and cases do not at the moment reference the Codification
database sections and subsections. Since corporate annual reports, at least
for the next five years, will now have Codification database referencing
rather than hard copy referencing, textbook publishers and educators will
have to revise all these materials. Textbook publishers are probably
ecstatic since all used books will be obsolete. Educators are not so
ecstatic about revising so much of their own teaching material Furthermore,
the financial accounting textbooks used in the 2009-2010 academic year will
be obsolete. Dumb! Dumb! Dumb!
As Pat Walters pointed out, the Codification database does not include
the Conceptual Framework hard copy. This means that the Conceptual Framework
cannot be searched and cross referenced in the Codification database. Dumb!
Dumb! Dumb!
The auditing standards make thousands upon thousands of references to
FASB hard copy references. These will have to be changed to Codification
database references until the Codification database self destructs. Dumb!
Dumb! Dumb!
Accounting firms their clients will have to change vast amounts of
materials to incorporate new Codification database referencing. For example,
PwC will have to spend millions of dollars overhauling its massive Comperio
database and for what? All this time and effort will have been wasted when
the Codification database self destructs in about five years. Dumb! Dumb!
Dumb!
Accounting firms and their clients will have to spend a lot of time and
money training employees on how to use the Codification database that will
self destruct in about five years --- Dumb! Dumb! Dumb!
Accounting software and millions of relational databases of accounting
data will have to be revised for Codification database referencing. And the
revised software will be useful for less than four years of use. Dumb!
Dumb! Dumb!
NASBA will have to revise future CPA examinations for referencing to
Codification database referencing. But when should these revisions take
place since virtually none of the financial accounting textbooks will have
such referencing for at least a year and maybe more? As far as the CPA
examination, the classes graduating in 2010 and 2011 will not have had
textbooks that incorporated the Codification references. It seems a little
unfair to hit candidates with a different referencing system than was in
their textbooks. Dumb! Dumb! Dumb!
This year early adopters of XBRL who tagged their financial statements
with FASB hard copy references will be putting out obsolete XBRL tagging.
All the U.S. standard XBRL tagging software and financial analysis software
will have to be rewritten ---
http://www.cfo.com/article.cfm/13932485/c_2984368/?f=archives
And it will be written for less than four years of use. Dumb! Dumb!
Dumb!
I’ve been
using the Codification database rather intensively on a FAS 133 project
since it became available. I can’t tell you how disappointed I am in content
of the database, the lousy illustrations, and the poor search engine. The
IASB search engine is vastly superior. Dumb! Dumb! Dumb!
The FASB will allow free access to the Codification database. But the
search and cross referencing software is only available for a single-user
license costing $850 per year. What makes electronic databases useful are
the utilities for search and cross referencing. Hence the FASB will be
raking in millions of dollars for a database that self destructs in about
five years. Smart? Smart? Smart?
The only good news is that college accounting departments can obtain
multiple-user licenses for faculty and students at a discounted $150 price.
As an accounting educator should I say thanks, but I have a hard time saying
thanks for something that is dumb, dumb, and dumb.
I'm told that the Codification database was mostly paid for with government
SOX grants. If it was bought and paid for by the government, why does the
FASB need to rake in millions more for the Codification database search and
cross referencing utilities? This is especially bothersome since the FASB
itself will probably give way to the IASB in just a few years. When that
happens the money and intellectual capital we put into the FASB Codification
database all goes down the drain. Dumb! Dumb! Dumb!
So what would've been smart for the FASB at this juncture?
Since the FASB is taking it as a given that it will virtually be out of business
in 2015 (actually it will become a downsized subsidiary of the IASB). The FASB
should forget implementation (selling) the FASB Codification database and
commence full bore into expanding it into an IASB Codification database. Then it
will be ready to roll in 2015 when the IASB standards replace the FASB
standards. FASB standards could be left codified as well such that users can
easily compare what used to be required by the FASB with what is now (after
2015) required by the IASB.
More importantly, the FASB should work 24/7 adding implementation guidelines
and illustrations into an IASB Codification database to make up for the sad
state of international standards in terms of implementation guidelines for
complex U.S. financial contracting. Tons of illustrations should also be added
to the illustration-lite international standards at the moment.
But implementing the FASB Codification database for five years or less is
dumb, dumb, and dumb!
"... This year early adopters of XBRL who tagged
their financial statements with FASB hard copy references will be putting
out obsolete XBRL tagging. All the U.S. standard XBRL tagging software and
financial analysis software will have to be rewritten..."
While there will undoubtedly be some impact to the
current USGAAP taxonomies, I expect it to be minimal. The references that
are currently in the taxonomy are largely in sync with their codification
replacements as the FAF and XBRL US have been working on this expected
transition for some time.
From a mechanical point of view it will be a fairly
simple exercise to "slip stream" in the codification references.
Askaref (which I developed with 2 others) is
designed for handheld internet devices to do that cross-referencing between
line item accounts, XBRL tags, and GAAP references (FASBs, etc). Having gone
through the database machinations to make this function work, I would say
that effort is nontrivial, but not rocket science. Until I see what a
official release of the XBRL tagging for the Codification, I would suggest
that blanket statements are premature about the ease to “slip stream”
references or the rendering of databases as useless. In any event, it will
make users and support individuals mad if this feature is delayed … like the
Boeing 787 dreamliner (the launch date keeps getting delayed and there is a
corresponding loss of value). With respect to XBRL tagging errors being
generated by the inclusion of Codification, it is difficult to get into the
mind of the user/preparer who is selecting the “best match” of a XBRL tag
with an accounting line item. I do agree that referencing the appropriate
GAAP is critical in order to select the “best match” of an XBRL tag. If this
referencing activity is made more difficult or has incomplete links, then it
is logical that more errors will occur.
With regard to textbooks, one fix that I have seen
is a cross reference table which lists textbook pages and their FASB
references with the Codification references. Hardly elegant, but it works.
Zane Swanson
June 28, 2009 reply from Bob Jensen
Hi Louis
I was influenced by the following quotation that does not make it sound
so slip stream and mechanical as firms struggle to update the XBRL tags:
Any company with a scheduled filing date
before July 22 for a quarter ending June 15 or later can opt to file its
report using the out-of-date 2008 taxonomy. The SEC, though, is
encouraging filers to use the current set of data tags. To accommodate
that request, a company with a line item affected by new FASB literature
will have to create its own extensions to the core taxonomy. Not only
would that require extra effort by companies, Hannon lamented that "a
bunch of rogue XBRL elements" not formed the same way from company to
company would inevitably hinder analyses of the effect of FASB's new
pronouncements on financial statements. David McCann, "Speed Bumps for Early XBRL Filers, Users,"
CFO.com,
June 26, 2009 ---
http://www.cfo.com/article.cfm/13932485/c_2984368/?f=archives
I hope you are correct because it will be a race to update all the
tagging software and implement these tags in corporate annual reports before
the FASB Codification archive database self destructs.
Another problem is that companies that are affected by FAS 133 often
refer to DIGG documents that will not be updated for Codification
references. This could lead to rather confusing outcomes where a footnote
quotation from a DIGG refers to Paragraph 243 of FAS 133 and the XBRL tag
refers to Section 8-15-38 of the Codification database that is not part of
the DIGG document.. It will be especially troublesome with FAS 133 since
there is so much FAS 133 hard copy that was left out of the Codification
database such that searches and references of the database cannot even find
many hard copy references originally issued by the FASB.
I don't think it's as easy as you make it sound and for what purpose with
an archival database that will most likely self destruct in such a
relatively short period of time?
Thanks,
Bob Jensen
FASB Accounting Standards Codification™—Four Volume Set ($195.00)
In order to help us determine initial print
quantities for the following FASB hard copy bound editions, please indicate
your interest in the following publications. Please note that this is for
informational purposes only. Your ‘yes’ response to any or all of the items
below is in no way an obligation to purchase the publications.
*1. FASB Accounting Standards Codification™—Four
Volume Set ($195.00)
A four-volume bound edition of the FASB Accounting
Standards Codification™ will be available at the beginning of October 2009.
Quantity pricing will be offered in addition to a 20 percent discount for
academic users.
Jensen Question
I "cheated" and copied the link above where it says DO NOT COPY THIS
LINK.
Why would the FASB put this at the end of a URL?
Will the FBI come knocking at my door?
Questions
Didn't anybody think that the FASB's new Codification transition would render
XBRL markups obsolete even before they got off the ground? What about financial
accounting textbooks for next year and the CPA examination?
Answer
I'm certain somebody thought about it, but nobody wanted to shut off this train
smoke on the Codification transition commencing July 1, 2009
There is also the issue that virtually all financial accounting textbooks
purchased by students for the 2009-2010 academic year will be obsolete (I
suspect). Such is life in the fast lane. When will the CPA examination gulp down
the Codification references?
And the Codification transition in 2009 is such a spike in cost and confusion
given that it will probably itself be obsolete around 2014 or thereabouts when
it is replaced by IFRS. Such is life in the fast lane where CEP providers and
software writers and publishers are singing (the stink being train smoke as
standard setters railroad in the changes on express trains):
Ca-chink, ca-chink,
We're getting rich on all this stink!"
A solution is said to be coming soon to a thorny
technical issue that had threatened to temporarily render electronic
financial reports tagged in eXtensible Business Reporting Language less
useful than had been hoped.
The source of the problem is the Financial
Accounting Standards Board's new codification of accounting standards, which
is set to take effect July 1. One key advantage of XBRL-prepared electronic
reports is that each data-tagged line item displays references to the
accounting and regulatory rules applicable to that item. That gives users of
the financial statements valuable context for the reported number.
But the current XBRL taxonomy — that is, the set of
tags corresponding to the line items — aligns with the pre-codification
organization of the FASB literature. That means that as of July 1, users of
data-tagged reports will see references to standards that don't match up
with the new codification. A new taxonomy incorporating references to the
newly codified accounting rules is not expected to be released until early
2010.
Neither FASB nor the non-profit entity that is
working to establish XBRL as a financial reporting format in the United
States had announced whether or when a temporary fix for the problem would
be made available. But yesterday, Mark Bolgiano, chief executive of XBRL US,
told CFO.com that one would be ready in July. The two organizations are
working together, he said, to create an extension to the existing 2009
taxonomy that will display the references correctly.
FASB, though, hedged a bit on the July timeframe. A
spokesperson told CFO.com that the accounting standards board is "shooting"
to have the fix ready by the end of the month, but there is no specific
scheduled date.
Even a short delay could affect investors, banks,
and other users of financial statements filed by any of the 500 largest
public companies with fiscal periods ending June 30 — that is to say, most
of them. And to the extent there is any confusion about the accounting
underlying the information in the reports, it could, of course, could cause
some communications problems for finance executives. The Securities and
Exchange Commission earlier this year required those 500 companies to file
financials using XBRL for periods ending June 15 of this year and later.
(About 1,800 more companies have to do so starting with quarters concluding
on or after June 15, 2010, with the rest following a year after that.)
In fact, a late-July or later release of the fix
would likely mean that most of the first wave of XBRL filings — after those
by a small group of voluntary early adopters that included Microsoft and
Pepsico — would contain the incorrect references, according to Neal Hannon,
senior consultant for XBRL strategies at The Gilbane Group, an information
technology consulting firm.
Everybody involved in the production of financial
reports, Hannon said, including software companies and financial printers,
will need some time to understand the solution and make sure it's compatible
with their products, before companies can begin to prepare financials
containng references to the codification accounting standards.
Still, Hannon called the forthcoming solution
"great news," saying he had been concerned for months that the necessary
programming might not prove doable, at least in a reasonable time frame. He
characterized XBRL-tagged financial reports without references to the
current underlying accounting literature as unacceptable. "What would be the
point?" he said.
Even if the fix were delayed, financial-report
users would still be able to locate the accounting standards relating to
specific line items, according Go tom Hoey, FASB's codification project
director. The board's codification website contains a tool that
cross-references the old organization of generally accepted accounting
principles with the new one. "It's not as though people have to be
completely lost," Hoey said, but added, "they might find it more cumbersome
for a short period."
Indeed, Hannon noted that a user would have to run
two programs simultaneously, switching back and forth between an XBRL
software reader and the cross-reference tool, which he said would be
somewhat unwieldy when performing robust analyses of financial statements.
Meanwhile, there is another speed bump for the
early days of XBRL filings: The SEC's Edgar filing database will not be
ready to accept data-tagged reports using the 2009 taxonomy, containing
several FASB rules and interpretations published this year, until July 22.
Any company with a scheduled filing date before
July 22 for a quarter ending June 15 or later can opt to file its report
using the out-of-date 2008 taxonomy. The SEC, though, is encouraging filers
to use the current set of data tags. To accommodate that request, a company
with a line item affected by new FASB literature will have to create its own
extensions to the core taxonomy. Not only would that require extra effort by
companies, Hannon lamented that "a bunch of rogue XBRL elements" not formed
the same way from company to company would inevitably hinder analyses of the
effect of FASB's new pronouncements on financial statements.
Tom’s latest blog module points out what David Raggay has told us all along
should never happen with IFRS. David rightly contends that nations should either
be on IFRS or not on IFRS as a package. They should not be able to cherry pick
what IFRS standards and interpretations will be excluded for their
jurisdictions. The EU, however, set a cherry picking precedent.
IFRS convergence won’t mean as much if the U.S. decides to go cherry picking
(like maybe those yummy Lifo Cherries).
The EU is simply too committed to perpetuating the giddy notion that financial
statements can serve investors -- and be smoothed at the same time. That's
why Ipredicted
that they would soon respond negatively and vociferously to the SEC's recent
statement
of support for a brand of convergence that would end up forcing broader
application of fair value on unwilling European financial institutions.
But, I could not have predicted that a reaction would come so soon, or so
crudely. In an article entitled "Accounting
Convergence Threatened by EU Drive,"
the Financial Times has
reported that, "in a tense meeting on future funding for the IASB," the EU's
internal market commissioner made its financial support conditional
on greater board representation for banks and their regulators.
Is this a credible threat? I think, yes. The EU has already achieved its
major objective for beating down US GAAP, which was to browbeat the SEC into
accepting financial statements prepared in accordance with IFR S. from
European issuers without reconciliation to US GAAP. Granted, that objective
has only been partially met, because the SEC still insists on the
reconciliation of differences between "IFRS as issued by the IASB" and any
provincial variation.
Nonetheless, the EU's saber rattling may not resonate well with European
companies listed in the US. They could end up facing more onerous
reconciliation requirements over time if the EU takes this issue to the
brink. What's a bank to do if US GAAP requires fair value for its assets and
liabilities, while a future watered-down version of IFRS, permitted in the
EU, does not require reporting those fair values?
The bank would either have to break ranks with its European counterparts and
reconcile to US GAAP, or terminate its US listing (including ADR
sponsorship).* Neither would be an appetizing prospect, but the indications
to this point are that the EU would dislike that scenario less than losing
its leverage over the IASB should convergence continue—and especially if the
US adopts IFRS. It seems that henceforth, the EU will be saying at virtually
every new fair value increment that it really, really
does not want to see the US adopt IFRS.
For its part, the IASB is boxed in. If it were to make a principled stand
against this blatant threat to its independence, it could he be quite easy
for Europe to abandon the IASB for some alternative standard setting
mechanism. Or, if the IASB caves to the demands of the EU, then it will lose
the US. So, either way, convergence and US
adoption of the IFRS are lost causes; obviously, the IASB cannot
afford to be abandoned by the EU.
Some at the SEC may continue to disingenuously insist that convergence is
like 'apple pie,' but this recent development should finally make it evident
that convergence has become more like an albatross around the neck of the
FASB. If the EU had their way, convergence would be nothing more than a race
to the bottom, with the interests of investors cast aside in the process.
As one friend who called the FT article to my attention put it, "it appears
the independence of the IASB is more a matter of one's imagination than
reality." It's time for the SEC to get real.
----------------------
If you are curious to know how a foreign issuer can avoid filing a Form 20-F
even though it has US shareholders, you should take a look atExchage Act Rule 12g3-2(b).
Do you think the SEC jumped the gun in allowing IFRS-Lite to be
implemented so soon?
Non-public U.S. companies may now choose IFRS-Lite (called SME)
But will they reprogram their Lifo inventory systems and other U.S. GAAP options
banned in IFRS-Lite?
U.S. companies that adopt IFRS-Lite have one huge advantage over other
companies --- they can totally ignore and need not invest in the FASB's dumb,
dumb, dumb Codification database that replaced all hard copy FASB Standards,
Interpretations, EITFs, etc.
It will be a little confusing for college faculty, CPA examiners,
students, and CPA auditors in the U.S. who have virtually no background in
IFRS-Lite. It will be interesting to watch, from the sidelines, a small local
CPA firm trying to audit an accounting system it does not understand.
Also IFRS-Lite has yet to be tested in the litigious U.S. tort system.
This will make CPA auditing firms very, very nervous!
Do you think the SEC jumped the gun in allowing IFRS-Lite to be
implemented so soon?
This is like teaching your toddler to swim by dumping the child over the
edge of the boat in a fast-moving river.
"71% of senior financial executives say that FASB should set U.S. accounting
standards, not IASB or U.S. Congress," by Kristi Grgeta, Grant Thornton, October
29, 2009
For more information, please contact:
Kristi Grgeta T312.602.8720 E
Kristi.Grgeta@gt.com
71% of senior financial executives say that FASB should set U.S. accounting
standards, not IASB or U.S. Congress
More than half of public companies still have no plans to use XBRL even
after SEC mandate
CHICAGO, October 29, 2009 – In a national survey of U.S. CFOs and senior
comptrollers conducted by Grant Thornton LLP, the U.S. member firm of Grant
Thornton International Ltd, the majority (71%) believe that the Financial
Accounting Standards Board (FASB) should set U.S. accounting standards, not
the SEC, the International Accounting Standards Board (IASB) or the U.S.
Congress.
EXtensible Business Reporting Language (XBRL) usage has picked up some
among public companies, increasing to 17 percent in September 2009 from 12
percent in March 2009; however, this increase is not as significant as one
might expect given the SEC mandate that public companies use XBRL as early
as June 2009 and no later than 2011. Even more surprising is that more than
half (52%) of public companies still report that they have no plans to use
XBRL.
Fifty-nine percent of the survey respondents report that their companies
would continue to use leases more or less in the same manner as they
currently do, even though the FASB has tentatively decided that all lease
obligations should be recognized as liabilities on the statement of
financial position with a corresponding “right of use” asset. CFOs also feel
that companies should report their own debt on their financial statements at
amortized historical cost (43%), rather than at fair value (38%) or at the
discounted amount of the expected future payments (18%).
Ideally, who should set U.S. accounting standards?
All
Public
Private
A national independent board supervised by a national regulator
(e.g., the Financial Accounting Standards Board)
71%
70%
71%
An international independent board supervised by international
entities such as the International Organization of Securities
Regulators, the World Bank and the International Monetary Fund
(e.g., the International Accounting Standards Board)
24%
23%
25%
The global accounting profession (e.g., the International Federation
of Accountants)
20%
16%
21%
A national regulator (e.g., the SEC)
16%
18%
16%
A body designated by an international entity such as the United
Nations Council on Trade and Development or the World Trade
Organization
3%
2%
3%
National legislatures (e.g., the U.S. Congress)
3%
4%
2%
Does your company currently report financial results using eXtensible
Business Reporting Language (XBRL)?
All
Public
Private
Yes
6%
17%
3%
No
94%
83%
97%
If no, when do you plan to report using XBRL?
All
Public
Private
Before 2010
1%
6%
1%
Before 2011
8%
25%
5%
After 2011
6%
18%
3%
No plans at this time
84%
52%
92%
The FASB has tentatively decided that all lease obligations should be
recognized as liabilities on the statement of financial position with a
corresponding “right of use” asset. Would a requirement to recognize lease
obligations on the statement of financial position cause you to change the
way in which you finance operations?
All
Public
Private
Yes, we would continue to use leases or lease financing, but
possibly with significant changes in the provisions of the
agreements.
12%
13%
12%
Yes, we would be less inclined to make use of lease financing.
14%
16%
13%
No, we would continue to use leases more or less in the same manner
as we currently do.
59%
57%
61%
Don’t know
15%
14%
14%
How
should firms report their own debt on their financial statements?
All
Public
Private
At amortized historical cost
43%
47%
42%
At fair value
38%
33%
38%
At the discounted amount of the expected future payments
18%
19%
18%
Other
2%
2%
2%
- ends -
About the Survey
Grant Thornton LLP conducted the biannual national survey from Sept. 21
through Oct. 2, 2009, with 846 U.S. CFOs and senior comptrollers
participating.
About Grant Thornton LLP
The people in the independent firms of Grant Thornton International Ltd
provide personalized attention and the highest quality service to public and
private clients in more than 100 countries. Grant Thornton LLP is the U.S.
member firm of Grant Thornton International Ltd, one of the six global
audit, tax and advisory organizations. Grant Thornton International Ltd and
its member firms are not a worldwide partnership, as each member firm is a
separate and distinct legal entity.
"Small Companies Criticize Switch to IFRS A panel of small-company finance
execs weighs in on moving to international financial reporting standards,"
by. Marielle Segarra, CFO.com, July 13. 2011 ---
http://www.cfo.com/article.cfm/14588474?f=home_featured
A group of CFOs and finance executives from small
public companies had little positive to say last week about a possible
switch to international financial reporting standards. Shifting to IFRS
would be painful and costly, the executives said during a Securities and
Exchange Commission roundtable.
"From our company's perspective, I see absolutely
no benefit to IFRS at all," said Shannon Greene, CFO of Tandy Leather
Factory. "All it's going to do is cost us money." Greene and other panelists
agreed that the switch would force small public companies to stretch their
staff and resources for little or no return. And since Tandy Leather
Factory, like many other small companies, has no direct competitors,
adopting IFRS would not afford the company the oft-cited benefit of greater
comparability, Greene sa
The panelists, who all agreed that the transition
to IFRS would be a challenge, also debated the ideal way to implement a
switch. The SEC initially discussed a "big bang" — a one-time, specific date
of changeover — but now appears to be leaning toward a long-term adoption
period, during which the Financial Accounting Standards Board would converge
U.S. generally accepted accounting principles with IFRS.
Most of the panelists said they would prefer a
version of the big bang, to avoid the confusion and complexity that
more-gradual approaches might invite. Prolonged implementation could cause a
distraction, constrain resources, and force "staff to spend less time on
core business purpose," said David Grubb, partner at Plante & Moran, an
auditing firm. It could also "create challenges for financial-statement
users and investors." Still, since any transition to IFRS will entail "a
period of lack of comparability," the SEC should consider a longer switch
that allows companies to opt in sooner than the mandated deadline if they
prefer, Grubb said.
Charlie Rowland, CFO of pharmaceutical company
Viropharma, would prefer to rip off the metaphorical band-aid, calling
prolonged adoption "death by increments." "It's one thing to sit in front of
your staff and say, 'For the next six months or nine months, we're going to
go through hell to redo our numbers, restate everything, get it all into the
new standards,'" Rowland said. "But if I tell them we're doing it for four
years, I'm going to have people burn out, I'll have people go find another
profession."
With the standards still a moving target, Rowland
suggested postponing a mandated switch to IFRS until the SEC decides on a
final version (even if some parts of it changed later, as GAAP rules often
do). Greene suggested ditching the mandate to switch, allowing companies to
decide whether or not to adopt the new standards.
Despite their criticisms, Greene and other
panelists acknowledged the practicality of having one set of international
standards. "Personally, I totally get it. . . . It makes sense," Greene
said. "I just can't see how to get from where we are to where we want to be
without my company spending an awful lot of money."
TOPICS: Financial Accounting, Financial Accounting Standards Board,
Standard Setting
SUMMARY: On Tuesday, October 4, 2011, the Financial Accounting
Foundation (FAF)-the board that oversees FASB and GASB operations-issued a
Request for Comment on its Plan to Establish the Private Company Standards
Improvement Council. The new Council's purpose as described by the author of
the article is to "...try to enact exceptions to generally accepted
accounting principles for private companies." Better said in the executive
summary of the Request for Comment, the Council's objective is "to improve
the standard-setting process for private companies....The PCSIC would
determine whether exceptions or modifications to nongovernmental US
Generally Accepted Accounting Principles (US GAAP) are required to address
the needs of users of private company financial statements." The Request for
Comment is available on the FASB web site at
http://www.accountingfoundation.org/cs/BlobServer?blobcol=urldata&blobtable=MungoBlobs&blobkey=id&blobwhere=1175823024715&blobheader=application%2Fpdf.
CLASSROOM APPLICATION: The article is useful to cover issues
related to small to medium sized entities (SMEs) and adoption of new
accounting standards in any financial reporting class.
QUESTIONS:
1. (Advanced) What is the Financial Accounting Foundation (FAF)?
(Hint: you may find links to this organization by accessing the FASB web
site at www.fasb.org and
clicking on the tab "About FASB").
2. (Introductory) What problems has the FASB faced in establishing
accounting standards for both large and small firms alike?
3. (Introductory) According to the wording in the article, what is
the purpose of the newly proposed Private Company Standards Improvement
Council?
5. (Advanced) What board currently serves to assist the FASB in
considering issues facing SMEs when establishing new accounting standards?
According to the article, why is the new Council needed to replace the
current system?
Reviewed By: Judy Beckman, University of Rhode Island
The Financial Accounting Foundation, an overseer of
rule making for accounting, is set to propose Tuesday a new panel aimed at
making it simpler and less costly for the nation's 28 million privately held
companies to follow accounting standards.
The Norwalk, Conn., group administers the Financial
Accounting Standards Board, which writes the accounting rules followed by
U.S. companies. Under Tuesday's proposal, a new Private Company Standards
Improvement Council would try to enact exceptions to generally accepted
accounting principles for private companies.
GAAP is the system of accounting rules used by
major U.S. corporations, but privately held companies have long complained
that the rules are too burdensome and expensive.
Many private firms don't have the financial and
management resources of larger, publicly traded companies, and some
accounting rules aren't relevant to private companies. But they still must
abide by GAAP when preparing financial statements for lenders, regulators
and some companies. Some of those costs are unnecessary, some private
companies complain.
The new panel would be "very responsive to what
we've heard from the private-company community," said FAF Chairman
John Brennan.
The FAF is seeking public comment on its proposal
through Jan. 14 and plans to hold public discussions on the proposal early
next year. If the FAF ultimately decides to set up the panel, the process of
reviewing and creating potential modifications for private companies is
expected to be in operation by mid-2012.
Tuesday's proposal could face opposition from
critics who think it doesn't go far enough, such as the American Institute
of Certified Public Accountants, the nation's major accountants' trade
group.
Under the FAF's proposal, the new panel's decisions
would be subject to ratification by FASB. In January, a panel backed by
AICPA recommended creation of a similar standards-revision process for
private companies, but the trade group wanted it to have the final say on
such changes, though it would work closely with FASB.
Barry Melancon, president and chief executive of
AICPA, said in a May speech that an independent panel for private firms is
needed to improve the current system. Unless that happens, "there may be
some bells and whistles that are added, but it's still a veto of the same
people, the same process we've had for 35-plus years," he said.
FAF President and CEO Terri Polley said the group's
new panel could carve out accommodations for private firms in areas that
include how such companies measure the fair value of assets and obligations,
as well as requirements to bring off-the-books entities onto their balance
sheet.
Already, FASB has simplified the rules on testing
the value of goodwill, an intangible asset that results from mergers and
acquisitions. That change was intended to address concerns expressed by
private companies.
FASB already has an advisory committee that
suggests rule changes to benefit private companies, though FAF and AICPA
officials have said the process hasn't worked well enough.
FAF's new panel would replace the FASB advisory
committee and be led by a FASB member. Ms. Polley said the new panel will
have more authority and be more directly involved in enacting accounting
changes.
Yesterday, a
third Commissioner of the Securities and Exchange Commission spoke out, decrying
(1) the politicization of the accounting standard setting process, and (2) the
need for a single set of global accounting standards. By so speaking she aired
her ignorance for all to see.
As reported
in a Reuters update, “SEC’s
Casey: Accounting Convergence Must Continue,” Kathleen Casey
“warned against the over politicization of accounting rules, or attempts to
pressure accounting rule makers to write rules that would favor a specific goal
sought by a particular industry.” Earlier this week, another SEC Commissioner,
Elisse Walter,
said the same thing. SEC chair Mary
Schapiro has been saying it since her confirmation hearings Not
to be left in the cold, FASB Chair Robert Herz chimed in with a
similar sentiment. Of course, they all
chant the mantra of global accounting standards.
They are
wrong. I hope everyone in the world knows it.
Here’s why
they are wrong.
Continued in article
From: The Summa [mailto:no-reply@wordpress.com]
Sent: Saturday, June 26, 2010 1:14 AM
To: Jensen, Robert
Subject: [New comment] Economic Consequences and the Political Nature of
Accounting Standard Setting
Tammy Buck said on Economic Consequences and the
Political Nature of Accounting Standard Setting June 3, 2010 at 5:19 pm Prof
Albrecht – Thanks for the thought provoking article! I would like to point
out that your statement – “First, financial statements are intended to
provide information to investors for making investment decisions.” – is
itself a value judgment of what accounting standards/financial statements
are & ought to do. If this is “true” (or rather, more desirable), then
certain accounting standards ought to be chosen over others. But if isn’t
desirable (maybe financial statements have another purpose?), then
conservatively biased standards might not be appropriate. Who decides this
focus? Investors, professors, the SEC, FASB, Fortune 500 firms? Maybe it’s
the open process of democratic process. So of course accounting standards
aren’t pure theoretical truth. But shouldn’t some independence be desirable?
Should (there I go with a value judgment!) the FASB be independent from both
the Big 4 & the big public companies? Do you really want Goldman Sachs
having a significant influence over GAAP (for instance)? Just some
questions. Maybe I just think accounting standard setter independence sounds
theoretically better, but my position is naive.
thanks,
Tammy Buck
Jensen Comment
I think independence is a goal we should strive for in standard setting, and I
think that making FASB members sever their previous financial ties with
employers is probably a good but overrated idea. One cannot so easily sever
relationships with former employers, colleagues, and friends. I was more
disturbed by the reduction of the FASB’s numbers of members such that biased
board members have much more clout. There’s a certain amount of democratic
strength in numbers on the IASB. If the FASB was not self destructing I would
work much harder to plug for a larger FASB.
Having said this, I will now give you my subjective opinion on the number one
cause of new or revised standards/interpretations that add great complexity to
accounting rules. The number one cause is the creative effort that clients use
to circumvent the spirit and intent of accounting “rules” and “guidelines.”
One needs only to look carefully at the contracts being written to find clues
about efforts to deceive. When companies (like Avis, Safeway, and all the
airlines) were forming unconsolidated lease holding subsidiaries to hide
enormous amounts of capital lease debt from their consolidated balance sheets,
the FASB rewrote the consolidation rules. In the 1980s when companies were
keeping increasing amounts (trillions) of derivative financial instruments debt
off the books (interest rate swaps were not even disclosed let alone booked),
the FASB was forced to write FAS 119, 133, and all the ensuing amending
standards and complicated DIG interpretations. When Andy Fastow, with the help
of Andersen consultants, invented ways to keep over a billion dollars worth of
debt off Enron’s books using over 3,000 SPEs, the FASB rewrote more complicated
rules for SPEs.
More recently Lehman Bros. took advantage of a loophole in the spirit of FAS
140 that allowed Lehman to mask debt with repo sales rules that have always been
inane in my viewpoint. Belatedly, Lehman’s debt masking is leading to new rules
about repo accounting “sales” that are deceptive and not really sales at all.
And, like Francine, I don’t trust the dependency of auditors on the CEOs and
CFOs of their largest clients. Just as Andersen auditors caved in to Enron’s
proposed deceptions, I think E&Y auditors caved in to Lehman’s proposed
deceptions. As Tom Selling stated, “the audit (financing) model is broken.”
However, unlike Francine, I firmly believe that public sector auditing would
exacerbate the problem. Hence I view the “independence problem” as being much
more critical with audit firms than with standard setters.
For audit firms, the long-run answer might be the replacement of assurance
with insurance, although there are many unresolved questions about insurance in
this context.
For standard setters, the long-run answer might be more research funding,
larger boards, faster turnover of board members, and more serious lobbying
rules.
Hence my conclusion is that the never-ending efforts of some clients to
deceive investors is the primary instigator of complicated new standards and
interpretations. Perhaps that’s as it should be. I’m not in favor of watering
down complicated standards on the naïve assumption that auditors will one day
get tougher, on “principle,” with the hosts that feed them. And I think that
today’s database technology is up to the task of auditing with complicated
standards and interpretations.
Perhaps the DIG should be expanded to a SIG for helping auditors and clients
with questions about any standard in problematic circumstances. One thing that
really continues to bother me, however, is how Ken Lay manipulated the SEC into
a ruling that officially allowed Enron to embark on some of Enron’s most
deceptive accounting. Can a DIG or a SIG be similarly manipulated by big
corporations?
The FASB and IASB processes of setting standards are far from perfect, but
perhaps you’re too young to remember the really bad old days of the ARB, APB,
and IASC --- historic standard setters that ducked controversial issues opposed
by audit clients and issued rulings only about milk toast issues.
Thanks to Rick Telberg at CPATrendlines, I
am now aware of
Mary Schapiro’s latest comments on accounting (to
the CFA Institute 2010 Annual Conference in Boston, Mass.). We now have
proof that the spirit of Professor Philip Barbay is alive and well inside
the beltway. You don’t remember Professor Philip Barbay? He was the fool
to Thornton Melon (played by Rodney Dangerfield) in the 1986 classic,
Back to
School. Here’s the scene I best remember:
The pictures of the SEC's Mary Shapiro and the FASB's (Lame Duck) leader Sir
David Tweedie say it all regarding why convergence of IFRS and FASB standards is
inevitable with the IASB grinding U.S. GAAP into oblivion:
I thank David Albrecht for sending Sir David's lame duck picture.
"A One-Two Accounting Punch? Next year U.S. public companies will find out
if they have to adopt international accounting standards – just as they are
implementing a host of new FASB rules," byMarie Leonem CFO.com, May
21, 2010 ---
http://www.cfo.com/article.cfm/14496195/c_14499425?f=home_todayinfinance
Will American companies have to go through a major
accounting-standards overhaul twice? Some finance executives think so. They
say the project to converge American and international standards is at odds
with the push to introduce a host of new U.S. accounting rules over the next
year, and warn that chaos could result.
That alarming prospect was raised last month during
a panel discussion at a conference held by Pace University's Lubin School of
Business. The problem will become more apparent in mid-2011, when American
companies will be digesting at least 10 major new generally accepted
accounting principles issued as joint projects of the Financial Accounting
Standards Board and the International Accounting Standards Board. The areas
covered include fair value measurement, accounting for financial
instruments, leases, and revenue recognition (see list below).
Around the same time, the Securities and Exchange
Commission is expected to announce whether public companies will have to
abandon U.S. GAAP and adopt international financial reporting standards. If
the answer is yes, it's likely that the regulator will require American
companies to make the switch in 2016, just a few years after adopting the
changes to U.S. GAAP.
Such a one-two punch would be costly and
time-consuming, noted panelist Aaron Anderson, director of IFRS policy and
implementation at IBM. Anderson hoped the SEC would allow companies to make
the switch early and avoid the GAAP changes. The computer giant already
reports results using IFRS at some of its subsidiary companies, Anderson
said.
John McGinnis, chief accountant at HSBC North
America, said that while he understood the need for "due process," he also
believed that "early adoption [of IFRS] would be very helpful." Several HSBC
subsidiaries already use IFRS, he said.
Regardless of the call from companies and foreign
regulators to allow early adoption of IFRS, the SEC is not about to rush its
decision. SEC chief accountant James Kroeker, who also spoke at the
conference, said it was "too early" to comment on the progress of the
commission's decision whether or not to abandon U.S. GAAP, although the SEC
has promised to provide periodic updates starting in October.
Other groups publicly oppose the rapid pace of
rulemaking and what a Financial Executives International committee
characterizes as the "quality versus speed trade-off." In a letter to FASB,
members of FEI's Committee on Private Company Standards said they were
worried about private-company executives becoming "overwhelmed" by poring
over exposure drafts while doing their day jobs.
Aware of the burden that both public and private
companies face, FASB is considering "staggering" the rule implementation
dates so the changes are rolled out more slowly, noted FASB technical
director Russ Golden while speaking at an April industry meeting sponsored
by the Zicklin School of Business at Baruch College.
"No one standard is an issue in and of itself,"
says Kelley Wall, senior consultant at accounting and financial advisory
firm RoseRyan. "But the timing of all of them being issued in such a short
time frame would be a significant strain on companies." Adds Jay Hanson,
McGladrey & Pullen national director of accounting, "For companies that
thought that [Sarbanes-Oxley] implementation was hard, implementing the new
FASB rules will be even worse."
But Wall isn't too concerned about switching to
IFRS after FASB issues its collection of new rules. She points out that all
10 rules currently in the exposure-draft stage are part of the IASB-FASB
joint convergence project, meaning that in most cases, the IASB would be
issuing a standard similar to the new FASB rules.
In fact, she believes the flood of new FASB rules
may be in response to the SEC's notion that convergence should be complete
before it decides whether to switch the country to IFRS. "Although
implementing a host of new accounting standards in such a short time frame
would be painful, it would make the eventual adoption of IFRS in the U.S.
easier," says Wall.
The Joint Projects Are Jumpin'
Joint FASB/IASB Projects (Final rules
due first half of 2011, unless otherwise noted)
Fair value measurement (due Q4 2010)
Consolidation: Policy and procedures
Accounting for financial instruments
Financial instruments with
characteristics of equity
Recall that Tom Selling, with the assistance of Patricia
Walters, conducted a very recent survey on academic/professional opinions
regarding the replacement of U.S. GAAP with international (IFRS) accounting
standards. I think Tom is negative about eliminating U.S. GAAP whereas Pat is
one of the strongest proponents of IFRS, especially regarding her activism in
promoting IFRS for Canada and the U.S.
The fact that the authors of the recent questionnaire
shared opposing viewpoints themselves adds to the credibility of attempting to
minimize leading questions in the survey.
This may be the most credible survey to date about how
accounting professors feel about IFRS for the U.S. and the pending SEC Roadmap
setting a conversion timetable. Being most credible to date, however, does not
mean the survey is without flaws. First and foremost, this is not a random
sample from a well-defined population of potential respondents. It commenced
with an appeal for members of the AECM to respond without having a membership
list and, accordingly, without random sampling from that list.
Secondly, there is a huge problem in any survey to date in
that many (most?) potential respondents just do not understand the issues
involved. Some understand the issues very well; others are influenced by what
others have written about the issues but have themselves really not studied the
issues in depth. Some potential respondents no doubt feel that what’s good for
the Big Four firms is good for the CPA profession in the United States. Other
potential respondents are very negative about most anything that increases the
dominance of the Big Four oligopoly. My point here is that opinions for or
against the Big Four may bias responses on what should be the IFRS Roadmap
issues irrespective of the Big Four advocacy of accelerating the IFRS
replacement of U.S. GAAP.
It really doesn’t matter how Bob Jensen feels about such
matters, but I’ve been a defeatist in this debate all along since I think it is
impossible to resist the intense and self-serving lobbying efforts of the Big
Four international auditing firms and the lies being told by the AICPA regarding
nationwide member support for elimination of U.S. GAAP, I think the AICPA is
afraid to conduct a serious member survey on this matter.
Bob Jensen has repeatedly begged for more time, at least
more 10 years, to mitigate the tremendous confusion of changing over the CPA
examination, textbooks, corporate accounting software, financial analysis
software, and the enormous problems of re-educating everybody involved in the
generation of and use of financial statements.
Both the Big Four and the AICPA are biased since they stand
to make hundreds and hundreds of millions of dollars on training CPAs and
clients about technicalities of IFRS to say nothing about the immense cost of
converting financial statements to IFRS-based standards. This, of course, is a
plus for academe since it will increase the demand for accounting graduates.
It’s a bummer for corporations in terms of cost, which is partly why a Grant
Thornton survey found 71% of the nation’s CFOs want to stay with U.S. GAAP or
that IFRS just does not yet have the depth to deal with U.S. financial
contracting and creative financing.
I'm not sure we can conclude what the underlying
motivations are for the results of the various surveys that have come out
recently, including Tom & mine. Certainly, one possibility is that the
respondents don't believe the "IASB is up to speed" as you suggest.
Another possibility is that respondents don't have
a clue what the requirements of IFRS are and don't want to know.
I also seem to be in the minority about whether or
not my side is winning. My comments recently have been along the lines of
"I'm going to wait and see what, if anything of substance, the SEC says
before I throw an adoption party."
I also know that analysts are probably the least
knowledgeable about IFRS and would be surprised if there wasn't diversity of
views on adoption.
I also believe an alternative explanation for the
FASB's speed up of convergence is because they've been told to rather than
altruism over getting the IASB "up to speed."
The bottom line is that, in my view, the surveys
only tells us what people think, not why they think it.
Pat
November 15, 2009 reply from Bob Jensen
Hi Pat,
I think what’s sad about ardent IFRS-rush convergence advocates is their
urgency to do it as fast as possible, which is a little like the why Rahm
Emanuael advocates urgency in passing liberal legislation in 2009 before
voters have time to raise serious questions about the cost consequences. We
should not “pass up a good crisis” he advocates:
http://www.youtube.com/watch?v=_mzcbXi1Tkk&NR=1&feature=fvwp
Ignorance of the professors’ and CFOs’ responses to opinion surveys works
both ways. Those favoring IFRS convergence may be as much or more ignorant
of IFRS as those who question the benefits versus costs of rushing IFRS
convergence.
Are you trying to argue that anybody having a negative opinion of IFRS or
even IFRS delays has to be ignorant of IFRS because having an IFRS world
monopoly is ipso facto the best global way to set accounting
standards?
About that there can be no debate?
Are these professors questioning IFRS convergence just ignorant? Three leading accountics professors (from MIT, Chicago, and Wharton)
question the costs versus benefits of the SEC's proposed changeover from
U.S. GAAP to international (IFRS) GAAP "Mind the GAAP: Analyzing the Proposed Switch to International Accounting
Standards," Knowledge@Wharton , April 1, 2009 ---
http://knowledge.wharton.upenn.edu/article.cfm?articleid=2192
But there are some tough questions about the move that have yet to be
answered, according to Wharton accounting professor Luzi Hail, who, with professors Christian Leuz from the
University of Chicago and Peter Wysocki of MIT's Sloan School of Management,
recently conducted research on the potential impacts of the change. They
present their findings in a paper titled, "Global
Accounting Convergence and the Potential Adoption of IFRS by the United
States: An Analysis of Economic and Policy Factors." In March, the FASB and its parent, the Financial
Accounting Foundation (FAF), sent a 132-page letter to the Securities and
Exchange Commission reflecting many of the concerns raised in the research,
which received funding from the FASB but, according to Hail, was conducted
and reported independently.
Does IFRS has to be good for everybody simply because it is good for the Big
Four and their multinational clients? What I question is the self-serving
rush-motives Big Four motives vis-à-vis some of the academic and CFO
detractors to the IFRS convergence rush, not all of whom are ignorant about
IFRS details and the gaps in IFRS vis-à-vis FASB standards..
I think what’s sad about ardent IFRS-rush convergence advocates is their
urgency to do it as fast as possible, which is a little like the why Rahm
Emanuael advocates urgency in passing liberal legislation in 2009 before
voters have time to raise serious questions about the cost consequences. We
should not “pass up a good crisis” he advocates:
http://www.youtube.com/watch?v=_mzcbXi1Tkk&NR=1&feature=fvwp
The Accounting Standards Board (ASB) of the FRC has
received in excess of 150 high quality responses to its policy proposal:
‘The Future of UK GAAP.’ The responses have been posted on its website.
The proposal was issued in August 2009 and sets out
recommendations for the future reporting requirements for UK and Irish
entities, with an emphasis on moving UK GAAP towards an international
framework.
The responses demonstrate a divergence of views on
many important issues and the ASB will have a challenging task in analysing
them and in coming to firm recommendations.
I am about to give expert evidence in a civil
matter in respect to the failure or otherwise of a company to maintain
proper records. In this particular matter the accountant, or accountants to
be more precise, cobbled together a final set of financial statements that
were wholly self-serving for the directors of the company. This entailed
significant convolution and, I would say, corruption of accounting. This has
been done shamelessly and I think that applies literally. The accountant, I
surmise, doesn’t know that accounting is not to be manipulated for self
serving ends. The lawyer is searching the (English speaking) globe for
precedent. This is proving difficult.
Simultaneously I am involved in another matter,
criminal in nature, about which I am legally constrained from giving detail.
However I think I can say that the case has a disturbing element to it. Four
insolvency practitioners and three government agencies have raked over the
embers of this particular fiasco all the while bemoaning the lack of
records. I became involved and asked if there were any general ledgers.
There were. They had existed all the time and were set out in complete
detail yet no-one bothered to look at them!
In a third matter I am the liquidator of a company
to which a bank had appointed a receiver months before. The receiver is a
chartered accountant of good reputation. When I asked for the accounting
records initially the receiver and his lawyer attempted to block me. After a
good deal of battering with the legal powers that fall to me I was provided
with the records and a confession that reconciliations had not been prepared
nor a general ledger from the time of appointment. The receiver’s lawyer’s
argument was that it was ‘convention’ to fail to maintain proper records. I
did point out that it is impossible to control receivables, for instance,
without a proper records including a GL but that is what they attempted to
do. The burden of fixing the records falls to me and what a profound mess it
is, involving bizarre goings on with respect to GST (the NZ name for value
added tax).
I am see many such instances as these.
I said to the lawyer in the first matter, partially
in jest, that I seemed to be the only person in insolvency that cared about
accounting records. He replied, in all seriousness, that was probably true.
I have thought about that since and I fear he is correct. I have begun to
have a fear that I am truly alone, a voice crying into a void. Something,
seen from my perspective, is very badly broken.
Given that I am right I think about the causes.
Leaving aside the general lawlessness that prevails amongst accountants due
to their adversarial stance to the State’s tax collectors, I believe there
are two causes: the manner in which accountants are trained and the
fragmentation of accounting due to standard setting.
NZ follows an American model in which people who
are to become accountants are ‘educated’ in Universities. There is minimal
emphasis on double entry. Most of the courses are dedicated to theory,
bullshit sociology, complex management accounting, auditing and so on. None
of this makes any sense to a student if they first do not know the basics of
accounting and that can only be gained by actually practicing the
discipline. Large numbers of accountants, to use the term loosely, are
produced who do not understand that the centrality of accounting is
double-entry and the prime record is the general ledger. In NZ accountants
insist on calling themselves ‘chartered accountants and business advisers’
as they are ashamed on being accountants alone. This disease began about the
same time as the Cogitor travesty was perpetrated.
What has happened with standards, whilst well
intentioned (the road to hell probably), has resulted in fragmentation of a
discipline that should be approached holistically. As the complexity grows
inexorably, practitioners are being left behind. Indeed the current chairman
of the government body which approves standards has spent 20 years trying to
ensure that standards only apply to big government and big business. He
wants to exclude SMEs, being closely held companies, from the scope
altogether. I understand why he wants to do this, but he suffers from an
ahistorical perspective. When limited liability was developed in Britain,
from where we get our basic law, the notion of ‘true & fair’ was developed
to ensure creditors were protected. T&F has been found, in judicial
precedent, to equate to standards. Yet 150 years later we seek to sever the
connection.
Standards are replete with vast tracts of turgid
wording much of it petty in the extreme. It is unrelated to the basic
mechanisms of accounting. It is a feat of learning and memory to cover the
whole scope. Practitioners dealing with small companies have long since
abandoned the attempt to acquire the knowledge. Even those operating large,
publicly accountable entities do not attempt to master it. In consequence
accounting has no fulcrum upon which it pivots. There is no centre. It has
become fragmented.
Words are no substitute for numbers. Having spent
20 years attempting to put standards at the centre I have had a Pauline
style conversion. I now believe that all that is necessary is a set of
principles – the conceptual framework will do for this purpose. It should
then be left to the accountant to express these principles in the mechanics
of accounting. Standard setters should be reduced to providing arithmetic
examples, at a high level, detailing how this should be done. That is the
reason why I prefer FASB to IASB. At least FASB works out how economic
events operate arithmetically before it writes its turgid, prolix nonsense.
But even then it does not show how its schemes work in double entry. I
recall many years ago working with FAS 90 (I think) in regard to acquired
mortgages. There are examples but not expressed in double entry. They are of
limited use thereby.
In America the problem is compounded due to the
fact that the most important issue in accounting, solvency determination, is
left entirely to lawyers and courts. The disintegration is complete. I truly
believe I am staring at something too awful to contemplate. Accounting
created, or helped to create, the modern economic world. Yet in its time of
crisis it is hopelessly ill-equipped to respond because it has so profoundly
lost its way.
These may be the delusions of a solitary raving
lunatic simply reflecting the psychology of the aging – being the prospect
of doom. But then I might be right.
Robert
B Walker, Chartered Accountant is a sole
practitioner undertaking insolvency work, in Wellington and Auckland New
Zealand.
Robert advises NZ Customs and Inland Revenue on
credit control and debt collection. He has provided expert witness services,
particularly with regard to the application of section 194 of the Companies
Act. He has advised a variety of Governments and NZ Government departments
and agencies on application of financial reporting law, including the
Government of Botswana, the Lesotho Revenue Authority and the National Bank
of Georgia (that country’s central bank).
Mr. Walker trained in London in a small firm,
worked for Peat Marwick Mitchell & Co at the time of the financial
revolution in the City. He then worked in shipping and, on returning back
in New Zealand, worked at the Bank of New Zealand as group accountant until
it collapsed in the last recession. He then went into audit in a small firm
that, he told me, “…was crushed by predatory pricing and the depredations of
the Auditor-General who subsequently went to prison!”
He also audited solicitors’ trust accounts.
“What a mess!” is his characterization of that period.
He then went out on his own to specialize in
financial reporting, following the enactment of a statute in that regard.
He attracted no business, sustained himself by working in Government (at the
time of the bold experiment in government accounting) and then into
insolvency where he tried to create the risk in financial reporting that was
not present in the minds of my potential clients. That is where he is
today. I recommend going to his site and reading through some of the
cases documented there. It’s an interesting
financial history of New Zealand during the past thirty years.
A guest post from Robert B. Walker:
I am about to give expert evidence in a civil
matter in respect to the failure or otherwise of a company to maintain
proper records. In this particular matter the accountant, or accountants to
be more precise, cobbled together a final set of financial statements that
were wholly self-serving for the directors of the company. This entailed
significant convolution and, I would say, corruption of accounting. This
has been done shamelessly and I think that applies literally. The
accountant, I surmise, doesn’t know that accounting is not to be manipulated
for self-serving ends. The lawyer is searching the (English speaking) globe
for precedent. This is proving difficult.
It’s every CFO’s worst nightmare: despite your best
efforts, your company’s compliance program has failed. There are credible
reports of fraud and corruption inside the company, and an initial analysis
of the situation confirms a problem. An internal investigation is necessary
to determine the magnitude of the fraud, the parties involved, and the
company’s financial and reputational exposure under government regulations.
How should you proceed? These investigations are
often high stakes, so it is important to do things the right way from the
start. In-house counsel should be involved in any situation involving
allegations or evidence of fraud. Once executives have sufficient reason to
believe the allegations are credible, they should involve outside counsel as
well. Executives’ responsibilities don’t end there: they can help find the
proper consultants to investigate the fraud, influence the fee schedule of
the outside work, and keep the investigators informed. Most important,
executives can see to it that employees cooperate with the investigators and
provide access to all relevant data and documents.
One group they will need to converse with regularly
is outside counsel. These lawyers are more likely to have broad experience
with fraud issues and related government regulations than lawyers who have
worked for only one company at a time. A more important distinction is the
clear attorney-client privilege between the company and outside counsel.
This privilege will protect the investigation and its findings, at least to
some extent.
Even when a company has done nothing wrong, the
details of its internal investigation should be kept close to the vest.
Depending on the approach government officials take to their investigation,
the company may wish to hold back the results of its own investigation. The
attorney-client privilege can provide a perfectly legal and ethical way to
do so.
In-House or Independent? Companies are often
inclined to have employees handle their fraud investigations. The advantage
to using employees is the relatively low cost to investigate, the benefit of
the employees’ knowledge of the company and its operations, and the ability
to carefully control the investigation.
However, companies are often better off using
independent investigators. Although the investigation will cost the company
more in dollars, the independence that an outsider brings to the situation
may impart more credibility to the findings, especially in the eyes of
government investigators. In addition, outside investigators may have more
experience and specialized knowledge in the area of fraud, making the
investigation more effective.
Outside counsel should make this decision, although
input from the board of directors may be important. The lawyers know the
risks related to government actions and court activity, and will be in the
best position to determine if an independent investigation is necessary.
Some of the best internal investigations I’ve seen
have had the best of both worlds. An independent investigator with a fresh
set of eyes led the investigation, while employees of the company were
liberally available to provide documentation, answer questions, and analyze
the work for additional areas of risk.
Further outside help may be needed if the apparent
fraud involves specialized issues. For example, cases involving computer
forensics should be handled by outside firms with the requisite expertise.
Other specialized needs might include familiarity with a particular foreign
jurisdiction, regulatory expertise, or knowledge of complicated accounting
or tax rules.
Continued in article
Will Yancey's helpers for compliance testing (with a focus on stratified
sampling) --- http://www.willyancey.com/
Popular IFRS Learning Resources: Check out the popular IFRS learning Deloitte link is
http://www.deloitteifrslearning.com/
Also see the free IFRS course (with great cases) ---
Click Here
Also see the Virginia Tech IFRS Course --- Send a request to John Brozovsky
[jbrozovs@VT.EDU]
The Ernst & Young
Foundation has teaching materials for IFRS (developed by faculty). They
are free and cover Intermediate I, II and Advanced Accounting. We will
be developing more this year. It is free to anyone with a .edu address.
You just need to email catherine.banks@ey.com
and she will give you a password to access the material. It is set up to
be used either as material to integrate into what you are currently
teaching or as a stand-alone course. There are lecture notes, home work
assignments, cases, etc. I hope you find it useful.
Please
feel free to contact me directly if you have any additional questions.
Ellen
PwC and Deloite comparisons
of IFRS-Lite with IFRS Heavy
In 2009
IAS Plus had 2,210,000 visitors. Thank you for
making us, once again, the #1 source on the Internet
for information about international financial
reporting. We wish you a very happy new year. Here
are a few more statistics about IAS Plus in 2009:
Total
page views: 6,810,000
Total
website file size: 1,330mb
Total
number of files: 6,619 files, including
775 HTML web pages
4,610 downloadable files (4,563 PDF, 30 ZIP,
and 17 DOC)
1,220 graphics files
31 December 2009: New IFRS e-Learning modules
in Chinese
Two
additional IFRS e-Learning modules have now been
translated into Chinese and posted on Deloitte's
CAS Plus
website – bringing the total available modules to
27:
IAS 40
Investment Property
IFRIC
12 Service Concession Arrangements
A complete
list of Deloitte's IFRS e-Learning modules in
Chinese is
Here. To download the modules (there is no
charge, but registration is required) click on the
lightbulb icon on the CAS Plus home page or
Click Here.
31 December 2009: Deloitte resources for 2009
year-ends
Presented
below are hyperlinks to the 2009 versions of three
Deloitte IFRS publications that will be useful for
2009 year-end financial statement preparation. All
are available for download on www.iasplus.com in
both PDF and Microsoft Word formats.
Deloitte's IFRS Illustrative Financial
Statements for 2009. The model financial
statements are intended to illustrate the
presentation and disclosure requirements of
IFRSs. They also contain additional disclosures
that are considered to be best practice,
particularly where such disclosures are included
in illustrative examples provided with a
specific Standard.
Deloitte's IFRS Presentation and Disclosure
Checklist for 2009. The checklist is
formatted to allow the recording of a review of
financial statements, with a place to indicate
yes/no/not-applicable for each presentation and
disclosure item.
Deloitte's IFRS Compliance Questionnaire for
2009. This questionnaire summarises
recognition and measurement requirements in
IFRSs issued on or before 30 June 2009 and may
be used to assist in considering compliance with
those pronouncements. It is not a substitute for
your understanding of such pronouncements and
the exercise of your judgment.
Deloitte's IFRS Global Office has published a
version of our illustrative IFRS financial statements for 2009 that
illustrate early adoption of IFRS 9 Financial Instruments, which was
issued in November 2009. IFRS 9 is effective 1 January 2013, but early
adoption is permitted starting in 2009. Click for
Illustrative IFRS Financial Statements Including IFRS 9
I hope that all are well. I’m still under the gun
and only have time for a quick post.
The IASC Foundation (IASCF), which is the umbrella
organisation to which the International Accounting Standards Board (IASB)
belongs, has recently issued the first batch of training material pertaining
to IFRS for SMEs. The standard itself was issued in July, 2009. These
materials include comparisons with full IFRS as well as multiple choice
questions and case studies. The materials can be freely downloaded by
clicking on the following link:
http://www.iasb.org/IFRS+for+SMEs/Training+material.htm
If you are unable to click on the link, copy
it and paste it in your browser address window.
David
With Kind Regards,
David Raggay David Raggay Managing Principal IFRS
Consultants Office: 2A Alexandra Street, St. Clair, Port of Spain, Trinidad,
W.I.
Phone/Fax: (868)-622-2217 Mobile: (868)-739-9500
Email:
david@ifrs-consultants.com
Website:
http://www.ifrs-consultants.com
IFRS Textbooks
My major criterion for evaluating a textbook is the quality of the book's end of
chapter short-answer questions, essay questions, problems, and cases combined
with other supplements such as solution's manual, test bank, student guides,
chapter videos, and spreadsheet templates. I would deem all IFRS textbooks to
date as not even good pretenders on this score.
With respect to FASB standards, textbook writers have an advantage of having
thousands of CPA examination questions available largely from commercial CPA
coaching courses ---
http://faculty.trinity.edu/rjensen/bookbob1.htm#010303CPAExam
These examination items are then adapted and customized by financial accounting
textbook authors.
Unfortunately there is no history of IFRS short-answer questions, essay
questions, problems, and cases on CPA examinations. The supply of such materials
is also very limited from Canada and elsewhere around the world.
New "textbook" pretenders are emerging for IFRS and some even have
illustrative "cases." But these are not cases complete with end of chapter
assignments and solutions manuals. I consider the following new "textbook" to be
an example of such a textbook pretender. Where are the end-of-end-of-chapter
materials, solution's manual, test bank, and student guides, chapter videos, and
spreadsheet templates.
I don't want to single out this book as being the only pretender and emerging
pretender of textbooks for IFRS. I simply want to point out that if accounting
teachers are waiting for real textbooks the wait will probably be quite long
until CPA/CA test banks are built up for textbook authors to borrow from when
writing their own IFRS textbooks.
There's also a huge problem with IFRS and FASB based textbooks. The problem
is that these standard setting bodies are making monumental changes that make
any hard copy "textbook" obsolete before the ink is dry on the pages. For
example, all of the materials of derivative financial instruments and hedge
accounting in the above Wiley IFRS "textbook" are based upon IAS 39 which is
being written out of IFRS entirely and being replaced by IFRS 9. The Wiley
coverage of this material was somewhat obsolete before the first copy of the
book was ever sold.
I'm not sure that fixed "editions" of IFRS and/or FASB based textbooks make
any sense. These textbooks should probably be available in electronic editions
that are continuously modified or at least modified three times each year. The
same goes for end-of-end-of-chapter materials, solution's manual, test bank, and
student guides, chapter videos, and spreadsheet templates.
At this point in time, I think the IFRS "textbooks" are too expensive for
what they are worth to students. I would instead recommend the quite large set
of free IFRS learning materials provided by the large accounting firms that are
doing many things to promote U.S. adoption of IFRS. Some of their excellent
resources for financial accounting teachers are linked below
Scroll down to find the resources (including cases) provided by Deloitte, KPMG,
and the other large firms.
Popular
IFRS Learning Resources:
Check out the popular IFRS learning Deloitte link is
http://www.deloitteifrslearning.com/
Also see the free IFRS course (with great cases) ---
Click Here
Also see the Virginia Tech IFRS Course --- Send a request to John Brozovsky
[jbrozovs@VT.EDU]
The Ernst & Young Foundation has teaching materials for IFRS (developed by
faculty). They are free and cover Intermediate I, II and Advanced
Accounting. We will be developing more this year. It is free to anyone with
a .edu address. You just need to email
catherine.banks@ey.com and she will
give you a password to access the material. It is set up to be used either
as material to integrate into what you are currently teaching or as a
stand-alone course. There are lecture notes, home work assignments, cases,
etc. I hope you find it useful.
Please feel free to contact me directly if you have any additional
questions.
The International Financial Reporting Standards
(IFRS), which have been described as "fatally flawed", let RBS report a core
tier one ratio for 2010 more than 4pc higher than it would have been under
the UK's old accounting rules that were replaced in 2005.
The analysis comes ahead of the publication of a
House of Lords Economic Affairs Committee report into UK accounting
practices expected to be highly critical of the IFRS system.
According to RBS's latest accounts, which were
calculated using IFRS, the bank has tangible shareholder assets of £58bn and
core tier one capital of 10.7pc.
Tim Bush, a City veteran and member of the "Urgent
Issues Task Force" that scrutinizes the work of the Accounting Standards
Board, has calculated that under pre-2005 UK GAAP (Generally Accepted
Accounting Principles) rules, which governed accounting in Britain for over
100 years, RBS would have a tangible shareholder assets of £33bn and a core
tier one capital of just 6pc.
The criticism is of the IFRS framework. There is no
suggestion RBS or any other British bank has broken the accounting rules.
The radical difference in the numbers highlights
the problems described to the Lords Committee during the course of its
investigation.
The Committee was told that IFRS, which was
introduced after the Enron scandal with the intention of producing less
subjective accounting practices, allows banks to disguise the build-up of
risks within banks because distressed loans are not reported until they
default.
In one session, Iain Richards, of Aviva Investors,
said that IFRS had had "a material cost to the taxpayer and to shareholders"
because "as a result dividend distributions have been made and bonuses have
been paid that were imprudent."
Lord Lawson, the former Chancellor who now sits on
the Committee, has asked for a list of proposals on how to overhaul what he
described as "very serious problems" with British accounting.
Fellow committee member Lord Forsyth, who was also
a Tory minister and former deputy chairman of JP Morgan, said he believed Mr
Bush's view "explains why particular banks got into difficulty" during the
financial crisis.
Separately the governor of the Bank of Ireland has
described the accounting rules for British and Irish banks as
"unsatisfactory".
September 27, 2009 message from John Anderson
On another List Server that I monitor, an American
CPA is looking for a Conventional Accounting Textbook for IFRS Accounting. I
am assuming he would want something comparable to an Intermediate Accounting
Textbook and eventually an Advanced Accounting txt.
I am imagine that today the textbook which would
perhaps come closest would be a Canadian textbook or materials transitioning
Canadian CA’s from Canadian GAAP to current IFRS, as published by the IASB.
I also wonder what success anyone may have had with
any of the ACCA’s Training or Certification Courses.
Naturally, leads on any other solid resources
besides those of the ACCA would be appreciated as well!
It was previously pointed out on the AECM that the
IFRS comparisons in the latest edition of Kieso are very superficial. At
this point it is best to Go to one of the Big Four IFRS education helpers
such as the Deloitte IFRS Learning Center helpers that have been downloaded
by over three million users.
Are there any U.K. Chartered Accountancy examination
helper books or complete prep courses available?
Many U.S. textbooks obtain question and problem material from prior CPA
examination materials provided in CPA prep courses such as the Gleim books
that contain thousands of questions and problems.
The biggest drawbacks when seeking out IFRS teaching
materials are IFRS themselves. Compared to the FASBs, the IASB standards
lack the thousands of illustrations and implementation guidelines such as
those found in the FASB standards. It is common in FASB-focused textbooks to
reproduce the FASB’s illustrations and interpretive guidelines as well as
old CPA examination material. IFRS textbook authors and course educators
must do a lot more work in creating their own illustrations and interpretive
guidelines.
It's possible in countless instances to use FASB
illustrations when teaching IFRS where those illustrations apply also to
IFRS. Sadly, many of the best illustrations found in the hard copy FASB
standards, interpretations, EITFs, etc. have been left out of the FASB’s
Codification database. Instructors are advised to Go to the original FASB
hard copy sources for many of the best illustrations.
Pat Walters won’t like me saying this, but teachers
of accounting in the U.S. like bright lines of the FASB standards. Bright
lines and explicit rules are easier to teach and easier to put on
examinations. Principles-based IFRS are more difficult to teach and examine.
What is still lacking in virtually all the popular
intermediate accounting textbooks are the materials sought after most in
textbooks --- IFRS test banks and end-of-chapter questions, problems, and
cases.
Perhaps Pat Walters or other IFRS enthusiasts can
tell us what English language IFRS textbooks have been popular around the
world in such places as the U.K., New Zealand, and Canada.
Free IEASB Standards (but not IASB Standards
themselves) The International Accounting Education
Standards Board (IAESB) has released the 2009 edition of its Handbook of
International Education Pronouncements. The Handbook contains the IAESB's
eight International Education Standards (IESs), including the IAESB
Framework for International Education Pronouncements and Introduction to
International Education Standards, as well as three International Education
Practice Statements. The handbook can be downloaded free of charge in PDF
format from the IFAC Online Bookstore
www.ifac.org/store .
Printed copies can be ordered now for shipment in early April.
Deloitte's IASB Plus, March 27, 2009 ---
http://www.iasplus.com/index.htm
In the Netherlands we teach local and IASB-rules.
IFRS is obligatory only for consolidated annual reports of listed companies.
Besides IFRS we have the commercial code and local Standards for non-listed
companies and parent companies statements only. This hodgepodge of sometimes
conflicting standards makes teaching financial accounting and reporting a
great challenge. However, it makes clear that financial accounting is a
professional activity where professional judgements are to be made. There is
no single mechanical rule that can be applied in all cases.
In my view the accounting profession can only reach
a higher level when prominent accounting scholars lead the way.
I really like this discussion and this (AECM)
listserv.
Regards,
Dick van Offeren
Leiden University the Netherlands
Deloitte IFRS curriculum materials are now
available Deloitte (United States) is making available a complete set of
IFRS course materials through Deloitte's IFRS University Consortium.
Featuring on-campus lectures and transcripts from Deloitte subject matter
leaders, actual case studies and case solutions, and other materials, the
course is available free to all colleges and universities. Course materials
are divided into eight sessions, with each session containing a unique set
of presentations, case studies, and lecture notes. The materials include a
detailed introduction to IFRS and provide an overview of the differences
between IFRS and US generally accepted accounting principles. Specific
topics covered in the Deloitte IFRS curriculum materials include:
* financial statement presentation;
* revenue, inventory and income tax;
* business combinations, discontinued
operations and foreign currency;
* intangibles and leases;
* property and asset impairment;
* provisions, pensions and share-based
payments;
* financial instruments; and
* consolidation policy, joint ventures and
associates.
The other large accounting firms have similar
helpers that are linked at the AAA Commons.
What is still lacking in the Big Four helpers are
the materials sought after most in textbooks --- IFRS test banks and
end-of-chapter questions, problems, and cases.
However, the Big Four
helpers provide quite a few illustrations of IFRS financial statements and
comparisons where IFRS differ from FASB standards.
We adopted Intermediate Accounting, 13th Edition by
Kieso, Weygandt, and Warfield effective this Fall Quarter 2009. The new
edition incorporates IFRS material in each chapter, as well as, supplemental
material provided through the book’s support website. Kieso 13th Edition
provides a comparison-contrast between US GAAP and IFRS for each topic
covered in the text. We plan to supplement the Kieso material with other
resources (e.g., Virginia Tech’s IFRS materials updated as of June 30, 2009
and materials provided by the major CPA firms).
The Canadian version of the Kieso book goes much
further, as it should. Canada is about to fully adopt IFRS.
Between now and December 2009, Wiley will publish
the US version of IFRS Primer, International GAAP Basics. The current
version of IFRS Primer by Wiecek and Young (ISBN: 978-0-470-15888-3) has a
Canadian focus. However, it includes IFRS, Canadian GAAP, and US GAAP. The
primer makes the whole process much more understandable.
The new 13th edition of Kieso also includes FASB
Codification research cases for each chapter. We registered our accounting
program with AAA and purchased faculty/student access to the new
professional version of the FASB Codification system. We will use the
professional version to complete research cases in Kieso 13th edition.
I hope this information contributes to the
conversation.
I've looked at just about every IFRS English
language textbook worldwide.
The IFRS version of Kieso is due out March 2010.
It's not the 13th edition that is out now. There is no new Canadian edition
on the Wiley.ca website.
There is a textbook out of Australia with EY
authors that doesn't cover all topics because it's out of date and was
written for the Australian market.
The ICAEW course leading to a certificate in IFRS
is also very high level. Regards In Canada, Wiley has issued an IFRS primer
that is more like a workbook than an Intermediate text, but is good. Search
wiley.com on author Irene Wieceik. This is worth buying.
On the practitioner front, my personal favorite is
also a Wiley book: International GAAP 2009. These are EY authors. Readable,
lots of examples. But not problems.
That said, the bound volume is actually
readable....again no end of chapter material.
Regards
Pat
Popular IFRS Learning Resources: Check out the popular IFRS learning Deloitte link is
http://www.deloitteifrslearning.com/
Also see the free IFRS course (with great cases) ---
Click Here
Also see the Virginia Tech IFRS Course ---
Click Here
The Ernst & Young
Foundation has teaching materials for IFRS (developed by faculty). They
are free and cover Intermediate I, II and Advanced Accounting. We will
be developing more this year. It is free to anyone with a .edu address.
You just need to email catherine.banks@ey.com
and she will give you a password to access the material. It is set up to
be used either as material to integrate into what you are currently
teaching or as a stand-alone course. There are lecture notes, home work
assignments, cases, etc. I hope you find it useful.
Please
feel free to contact me directly if you have any additional questions.
Ellen
Canadian Signs of IFRS Transitions to Come in the United States
Deloitte Canada IFRS transition newsletters, IAS Plus, January 31, 2010
---
http://www.iasplus.com/index.htm
Deloitte Canada has published the January 2010 issue
of their Countdown IFRS transition newsletter, to discuss practical
issues Canadian companies are facing in IFRS transition as well as to
provide an update on recent IFRS events. Articles in this issue include:
IFRS Predictions for 2010
iGAAP: IFRSs for Canada – the 2nd edition is
now available
The Real Deal – a focus this month on dual
reporting issues and maintaining and a shadow reporting calendar in 2010
It's official – IFRSs are now in the handbook
An update on International standard setting
activities
Some early lessons to be learned in advance when U.S. GAAP is replaced
with international IFRS standards:
"Shortcomings in IFRS transition disclosures in Canada," Canada's Ontario
Securities Commission, February 7, 2010 ---
http://www.iasplus.com/ca/1002oscifrsreview.pdf
Recently staff of the Ontario
Securities Commission conducted a review to assess the extent and quality of
International Financial Reporting Standards (IFRS) transition disclosures
made by issuers in light of the disclosure guidance provided in CSA Staff
Notice 52-320
Disclosure of Expected
Changes in Accounting Policies Relating to Changeover to International
Financial Reporting Standards
(SN 52-320).
SN 52-320 provides guidance on the
requirement in Form 51-102F1
Management’s
Discussion & Analysis
(MD&A) for an issuer’s disclosure of the expected
changes in accounting policies related to IFRS changeover for the three-year
period prior to financial years beginning on or after January 1, 2011 (the
changeover date). This disclosure is important to assist investors in
assessing the readiness of an issuer’s transition to IFRS and the impact the
adoption of IFRS may have on the issuer.
Our review focused on reporting
issuers’ IFRS transition disclosure provided in 2008 annual and 2009 interim
MD&A. We used a risk-based approach to select issuers, supplemented by a
random selection of issuers across various industries. Generally, the
criteria used in our selection process was designed to identify issuers
whose disclosure was likely to be materially improved relative to the
guidance set out in SN 52-320.
In 2008 MD&A, we expected issuers to
have discussed the status of the key elements and timing of their IFRS
changeover plan. As explained in SN 52-320, developing and implementing an
IFRS conversion plan is not just an accounting exercise, since IFRS adoption
will affect a wide variety of an issuer’s business activities. SN 52-320
directs issuers to consider how the transition to IFRS will affect all
business functions that rely on financial information and to communicate
this to investors.
We also expected issuers to have
provided a status update in their 2009 interim MD&A against previously
disclosed timelines so that readers of the MD&A could have assessed an
issuer’s transition progress.
Of the 106 reporting issuers reviewed,
60% discussed an IFRS changeover plan, while the remaining 40% did not
provide any IFRS transition disclosure. Overall, our findings suggest that
reporting issuers are not adequately discussing, in MD&A, the key elements
of their IFRS changeover plan or their progress towards achieving this plan.
We did not request, however, that issuers re-file MD&A to improve the
quality of historical IFRS transition disclosure because the focus of this
particular review was to raise awareness about the IFRS changeover and to
educate
. . .
In
2008 MD&A, we expected issuers to have
discussed the status of the key elements and
timing of their IFRS changeover plan....
Overall,
we found that issuers are not adequately
disclosing information related to their IFRS
transition efforts. A summary of our
findings is as follows:
40% of issuers
received a letter from staff questioning
whether a changeover plan was in place
as it was not evident from reading their
MD&A disclosure. Given the short time
remaining before the changeover date
this raises concerns that issuers may
not be able to comply with future filing
obligations.
Of the 60% of
issuers that discussed an IFRS
changeover plan in their 2008 annual
MD&A, approximately half simply provided
a generic description of the plan
without any direct application to their
own circumstances. The most valuable
information for investors is IFRS
transition disclosure that is specific
to the issuer.
80% of issuers
that discussed an IFRS changeover plan
failed to describe significant
milestones and anticipated timelines
associated with each of the key elements
of the plan. It is important that
issuers discuss the timing associated
with key elements so that investors can
readily assess whether the project is
progressing in accordance with the
changeover plan.
48% of issuers
that discussed IFRS transition in 2008
annual MD&A failed to provide quarterly
updates in 2009 interim MD&A on the
progress related to their changeover
plan. Investors need progress updates to
assist them in assessing the likelihood
that the issuer will be able to complete
its IFRS conversion on time.
Continued in report
Oil and Gas Accounting Under IFRS
October 16, 2009 message from Ed Scribner
Does anyone know where U.S. oil companies stand on
adoption of IFRS? Presumably their current accounting methods fall within
“the overall accounting framework established by the IASB,” so they would be
able to continue to use those methods for at least awhile.
Ed Scribner
New Mexico State University
Las Cruces, NM, USA
October 18, 2009 reply from Bob Jensen
Hi Ed,
Exxon-Mobil and other large multinational companies
want badly to bury U.S. GAAP in favor of IFRS. They are the wind beneath the
wings of the Big Four auditing firms’ advocacy of IFRS. They are also active
behind the scenes in setting IFRS they way they want IFRS. (see the
quotation below)
Actually, the large companies were not a problem when
the SEC caved in to the “oil industry” when it dropped the requirement that
dry holes be fully expensed when declared hopeless. The political heat came
from smaller wildcatting operators who would see their earnings fluctuate
from enormous losses to enormous gains year-to-year because of the impact of
one or two dry holes in some years and no dry holes in other years. A few
dry holes have negligible impact on Exxon year in and year out.
Also the big oil companies benefit when small
operations go bankrupt, because the big players can then buy up the drilling
rights of small players in the industry.
"Powerful players: How constituents captured the
setting of IFRS 6, an accounting standard for the extractive industries," by
Corinne L. Cortesea, Helen J. Irvineb and Mary A. Kaidonisa,
ScienceDirect, 2008 ---
Click Here
Abstract This paper illustrates the influence of powerful players in the
setting of IFRS 6, a new International Financial Reporting Standard (IFRS)
for the extractive industries. A critical investigative inquiry of the
international accounting standard setting process, using Critical Discourse
Analysis (CDA), reveals some of the key players, analyses the surrounding
discourse and its implications, and assesses the outcomes. An analysis of
small cross-section of comment letters submitted to the International
Accounting Standards Committee (IASC) by one international accounting firm,
one global mining corporation and one industry group reveal the hidden
coalitions between powerful players. These coalitions indicate that the
regulatory process of setting IFRS 6 has been captured by powerful
extractive industries constituents so that it merely codifies existing
industry practice.
"Private Companies Get IFRS Made Easy: At a mere 230 pages, a new
version of the international accounting standards for non-public entities may
win a big following, sooner or later," by David McCann, CFO.com, July 10,
2009 ---
http://www.cfo.com/article.cfm/14022606/c_2984368/?f=archives
U.S. private companies have a new option in
accounting standards following Wednesday's release of a simplified, vastly
slimmed-down version of International Financial Reporting Standards.
Private firms in the United States could already
choose IFRS. Yet relatively few have done so, even though the full version
of IFRS, at about 2,500 pages, is roughly a tenth the size of U.S. generally
accepted accounting principles. It remains to be seen how many companies
will find it harder to resist the new "IFRS for SMEs," which weighs in at
just 230 pages.
SME is an acronym, used widely outside the United
States, for small and medium-sized entities. However, the International
Accounting Standards Board, the promulgator of IFRS, does not include a size
test in its definition of SME. Rather, the smaller version of the standards
is reserved for entities that have no "public accountability." In other
words, it is not available to companies that publicly trade equity or debt,
or those that hold assets as a fiduciary for a broad group of outsiders as
one of their primary businesses, as is typical for banks, insurance
companies, securities broker/dealers, and mutual funds.
Adoption has the potential to be be truly
widespread. More than 95% of the companies in the world are SMEs, according
to IASB. But while U.S. private companies can start using the abbreviated
standards right away, other jurisdictions may choose not to allow it. At the
same time, some may choose to allow it even if they've previously spurned
the international standards. "IFRS for SMEs is separate from full IFRS and
is therefore available for any jurisdiction to adopt whether or not it has
adopted the full IFRS," IASB said in a press release.
Even in the Unted States, though, a broad rush to
broad adoption is hardly a given. "I will consider adopting the new standard
when the primary users of financial statements are fully educated in it and
can intelligently evaluate it," said Ron Box, CFO at Joe Money Machinery, a
Birmingham, Ala.-based regional dealer of heavy construction equipment.
Box is concerned that, for example, a bank analyst
who doesn't understand the new accounting concepts might deny a credit
request from an early adopter. "Credit markets for small businesses are
already volatile and very perplexing to most CFOs," said Box. "Prematurely
adding a new set of accounting rules to this mix could be very
counterproductive."
But Paul Pacter, IASB's director of standards for
SMEs, is not so sure the pace of adoption will be all that slow in the
United States. "It may be a little slower [than in Europe], but I think
there's going to be a lot of interest," he said.
To be sure, there aren't any rules that would
prevent a private company from switching to the new standard. The American
Institute of Certified Public Accountants last year recognized IASB as an
official accounting standard setter. With that decree, "any professional
barrier to using IFRS and therefore IFRS for SMEs [was] removed," AICPA said
on its website in response to the issuance of the shortened standards. It
also said, "Private companies may find IFRS for SMEs to be a more relevant
and less costly financial and accounting standard than U.S. GAAP."
Other major accounting organizations, including the
Institute of Management Accountants and Financial Executives International,
have also suggested that companies should at least consider switching to the
simplified standard.
It's in Europe, though, where high adoption levels
would have the most profound early impact. In the 27 European Union
countries, there are at least 55 local accounting standards in use by SMEs,
Pacter noted. A consistent, simplified standard would make it easier and
less costly to do business in multiple countries, which is common in Europe
even for tiny companies. "This will be a godsend for the millions of little
companies that trade across borders," he said.
Lenders and private investors may also benefit from
widespread adoption. "Today there is no comparability of small-company
financial statements," Pacter said.
One potential thorn could apply to the relative
handful of companies that will switch to the simpler standard and and later
be acquired by a company that uses full IFRS. In that case, some items in
the historical financials would have to be reconciled. For example, while
full IFRS requires borrowing and research and development costs to be
capitalized, in the slimmed-down version they are recorded simply as
expenses. But Pacter said that in most cases there would be only one or two
such items to worry about.
Less Is More There are several types of
simplifications of the full version of IFRS in the streamlined standards.
One type simply reduces clutter: Some topics addressed in IFRS are omitted
because they are not typically relevant to SMEs. These include earnings per
share, interim financial reporting, segment reporting, and special
accounting for assets held for sale.
Other simplifications have a more direct effect on
financial-statement preparers. Notably, various accounting-policy options in
full IFRS are replaced by simpler methods. For example, several options for
financial instruments — including available-for-sale, held-to-maturity, and
certain fair-value options — aren't included in the pared-down standard.
Neither is the revaluation model for property, plant, and equipment and for
intangible assets. For investment property, the accounting is driven by
circumstances rather than choosing between the cost and fair-value methods.
Hedge accounting (Lite) is still allowed in IFRS-Lite such that firms that
hedge most likely will not have to take value changes in hedging derivatives to
current earnings as if those derivatives were no different than speculation
derivative investments.
One of the huge problems of IFRS-Lite is that it just does not have the
guidance for when and when not to recognize revenue when compared to the history
of U.S. GAAP standards and EITFs ---
http://faculty.trinity.edu/rjensen/ecommerce/eitf01.htm
Since IFRS-Lite is principles based rather than rules-based, we are
absolutely certain to see huge inconsistencies with respect to how certain
transactions (especially revenue recognition transactions) are treaded in
Company A versus Company B that uses a different logic in applying some vague
IFRS-Lite paragraphs ---
http://faculty.trinity.edu/rjensen/theory01.htm#Principles-Based
But if a company elects IFRS-Lite just to circumvent some EITF restriction on
revenue recognition, and the auditor must buy into the IFRS-Lite carte blanche,
the U.S. court system may still drag up the EITF in a tort litigation. Hence, it
is not clear how IFRS-Lite will protect creative accounting in the U.S. courts.
July 12, 2009 reply from Gerald Trites [gtrites@ZORBA.CA]
Bob - You're quite right in saying that IFRS Lite
or otherwise is a considerable burden for small companies and practitioners.
The CICA very wisely decided to provide a lightened version of existing
Canadian GAAP for non-publically accountable companies. Not only does this
save them the burden of adopting a very differtent set of standards, it
makes their job easier by removing many of the provisions in the former GAAP
that were only of interest for public companies. They do have an option,
however, to adopt IFRS and we expect that some of the larger non-public
companies might do that to avoid looking second class to some of the debt
agencies they might deal with and also to better prepare themselves to go
public if they wish to in the future. But I expect that most non-public
companies will be happy to take advantage of the practical standards
environment that CICA has provided for them.
Jerry
July 12, 2009 reply from Bob Jensen
Hi Jerry,
The burden is heavily transitional due to possible client implementation
before U.S. CPA auditors trained in U.S. GAAP know what the heck the
difference is between what they know (U.S. GAAP) and what they don’t know (IFRS-Lite).
But it may also be more than transitional if local and regional firms
lose clients permanently to Big Four auditing firms.
Suppose that the Small Auditing Firm (SAF) in Concord, NH has been
auditing the small Yankee Leverage Company (YLC) for the last 43 years. YLC
decides to abruptly change from U.S. GAAP to IFRS-Lite before a single
employee of SAF has even heard of IFRS-Lite.
To avoid drowning in confusion, any profits that might have been made by
SAF for the next few years will be eaten alive by having to quickly hire Big
Four consultants and international consultants from places like Hong Kong
and Trinidad to fly into the Concord, NH to teach IFRS-Lite to struggling
SAF employees.
Furthermore the small local Yankee Bank (YB) finds that it must abruptly
analyze the IFRS-Lite financial statements of YLC that applied for a
business loan renewal. Yankee Bank has never seen an IFRS-Lite set of
financial statements and does not know what in the heck explains why YLC’s
revenues doubled in less than a year.
My analogy is that for SAF and Yankee Bank, the abrupt change from U.S.
GAAP to IFRS-Lite before staffs have been educated and trained in IFRS-Lite
is like throwing a small toddler over the side of the boat in a fast moving
river with its clients crying out “sink or swim!”
U.S. auditors and financial analysts have the added burden of departing
from U.S. Rules-Based Standards that they’ve become comfortable with for the
past 63 years to often vague international Principles-Based Standards where
they must flounder in a matter of weeks to audit a client that abruptly
shifts to IFRS-Lite.
The SAF auditing firm is very, very concerned that its litigation risk
exposures (to say nothing of the malpractice insurance premiums) are greatly
increased because of the increased likelihood of auditing financial
statements it does not thoroughly understand.
What will likely happen is that SAF will refuse, at least for several
learning curve years, to audit IFRS-Lite financial statements. They must
drop YLC as a client, and YLC has no choice but to pay ten times as much for
an audit by a Big Four firm out of Boston. But YLC will pay the increased
price of auditing because it wants to double its reported revenues before
going public.
This is, of course, what the Big Four hoped all along would happen as
smaller local and regional firms are too swamped by IFRS to keep clients
that hurriedly change to IFRS-Lite accounting.
Finally, what’s to happen to poor YLC that shifted from IFRS-Lite and
then two years from now decides to go public and register with the SEC? It
must then change back from IFRS to U.S. GAAP because in no way will the SEC
accept IFRS financial statements from new U.S. registrants in the next two
years.
The good news is that by going public, YLC can save on audit fees by
returning to its old local Concord, NH auditing firm provided the local firm
has not stopped doing audits altogether.
I understand the issues you raise here. I just
don't understand why you believe your scenario is credible.
Why or how would Yankee Leverage Company
management/board even know enough about IFRS themselves to spend the money
and make this switch? Not having an auditor with IFRS knowledge is their
second problem. The first problem is how will the management and directors
know what IFRS (even IFRS for SMEs) is so they could decide whether it makes
an economic sense to voluntarily make this switch. My experience from Canada
is that the smaller the company the more likely they would be looking to
their auditor for help and training (yes, independence issues).
If a company isn't an SEC registrant as you
describe YLC, I believe there are even less incentives to adopt IFRS
because, as you noted, private companies generally are concerned with
providing financial statemetns to lenders and such statements do not have be
"full" US GAAP. The smaller the company the less important are full GAAP
statements.
Could I call financial reporting by some small
private companies US GAAP-Lite?
Pat
July 13, 2009 reply from Bob Jensen
Hi Pat,
If it was not credible, why develop and market IFRS-Lite in the U.S. in
2009 and 2010?
I think it’s credible, in part, because others think it is credible ---
http://www.cfo.com/article.cfm/14022606/c_2984368/?f=archives
I think that privately owned U.S. corporations can switch to IFRS-Lite most
any time they choose to do so. What’s to stop them?
I think it is credible because some companies think they can have more
attractive financial statements under IFRS-Lite and therefore get better
credit and/or to entice rich Cousin Ed to invest big time in the family
software business.
I think it is credible because private companies can get wealthy hedge
funds to loan them money or even loan them money with convertible debt.
One thing that makes it credible are the many scenarios where companies
might report more revenues or higher earnings using IFRS-Lite than U.S. GAAP.
IFRS-Lite may be especially popular with startup tech companies that are
losing money and are trying to direct attention to revenue growth rather
than earnings. In the 1990s the startup tech companies were the most
creative in using principles-based logic to book revenue. This led to some,
certainly not all, EITF rulings that might not have to be followed under
IFRS-Lite ---
http://faculty.trinity.edu/rjensen/ecommerce/eitf01.htm
Many of the differences between IFRS and U.S. GAAP are listed at
http://www.iasplus.com/dttpubs/0809ifrsusgaap.pdf
There are many instances where IFRS allows multiple methods when U.S. GAAP
has a specific rule. For example, IAS 18 on revenue recognition shows the
looseness of IFRS revenue recognition on such things as loyalty award
programs.
The problem as I see it is that there are many US GAAP rules that are not
covered in IFRS-Lite. For example, IFRS has virtually nothing to say about
synthetics in financing that are extraordinarily popular in the United
States, such as synthetic leasing.
Do you think principles-based reasoning in place of EITF rules will lead
to 100% consistency between IFRS-Lite and every EITF ruling? I don't think
this conformity will always follow from principles-based subjectivity.
One purpose behind the push by the Big Four for a rush to IFRS was so
they could sell their training services to business firms and smaller CPA
firms. IFRS-Lite makes it possible to not have to wait for the SEC to
abandon U.S. GAAP for listed corporations.
If my scenario was not credible why would the IASB take the time and
trouble to develop IFRS-Lite to sell in the U.S. and other markets that do
not yet require IFRS-Full?
One purpose behind the IASB’s development of IFRS-Lite was to market it
to private companies that might or are already resisting transitioning to
IFRS-Full.
Bob Jensen's threads on the express train's bumpy rails toward requiring
IFRS-Heavy for public companies (Resistance is Futile) are shown below.
The Pending IASB Migrane
The IASB may be very, very sorry if and when IFRS replaces U.S. GAAP
It appears that financial innovation will not let up on the future,
downsized, Wall Street
The International Accounting Standards Board may regret the day when and if it
takes over the duties of the U.S. FASB. IFRS is way behind in dealing with
U.S.-style financial innovation, and this may be one of the biggest hurdles
facing the IASB.
Yale's Professor Robert Shiller has a September 27, 2009 article that I
will quote below, but first there are some things to consider for accounting
educators reading this tidbit.
IFRS needs huge updates on the following types of
contracting and financial engineering:
One of the huge problems that accountants, particularly auditors and
accounting standard setters, have is understanding the fluid and dynamic world
of financial innovation, especially as was and is still taking place on Wall
Street. KPMG lost the huge Fannie Mae audit largely because of the enormous
financial statement revisions caused by improper compliance with FAS 133. All
the large firms are now facing huge lawsuits due to alleged negligence in
accounting for loan loss reserves and poisonous traunches ---
http://faculty.trinity.edu/rjensen/2008Bailout.htm#AuditFirms
When will auditors learn about complexities of financial risk?
The following is an example:
The concern was focused
on potential exposure from the credit default swaps portfolio they
inherited from Wachovia. In WFC's annual report the Buiness Insider saw
limited discussion of this risk and no details of the reserves for it.
There are two possible
ways to account for the lack of discussion of Collateral Call Risk.
Either Wachovia wrote its derivative contracts in ways that don’t permit
buyers to demand more collateral or Wells Fargo is not disclosing this
risk. (A third possibility—that they don't even seem aware that they
have this risk — seems remote after AIG.)
When I read that, I saw eerie parallels with New
Century, all the more so because of the auditor connection – both Wells
Fargo and Wachovia and New Century (now in Chapter 11) are audited by
KPMG. New Century was not too transparent either and, as a result, many
people, including
some very sophisticated investors
were caught with their pants down. KPMG is accused in a $1 billion
dollar lawsuit of not just being incompetent, but of aiding, abetting,
and covering up New Century’s fraudulent loan loss reserve calculations
just so they could keep their lucrative client happy and viable.
KPMG’s audit and review
failures concerning New Century’s reserves highlights KPMG’s gross
negligence, and its calamitous effect — including the bankruptcy of New
Century. New Century engaged in admittedly high risk lending. Its
public filings contained pages of risk factors…New Century’s
calculations for required reserves were wrong and violated GAAP. For
example, if New Century sold a mortgage loan that did not meet certain
conditions, New Century was required to repurchase that loan. New
Century’s loan repurchase reserve calculation assumed that all such
repurchases occur within 90 days of when New Century sold the loan, when
in fact that assumption was false.
In 2005 New Century
informed KPMG that the total outstanding loan repurchase requests were
$188 million. If KPMG only considered the loans sold within the prior
90 days, the potential liability shrank to $70 million. Despite the
fact that KPMG knew the 90 day look-back period excluded over $100
million in repurchase requests, KPMG nonetheless still accepted the
flawed $70 million measure used by New Century to calculate the
repurchase reserve. The obvious result was that New Century
significantly under reserved for its risks.
How does the New Century situation and KPMG’s role
in it remind me of Wells Fargo now? Well, in both cases, there’s no
disclosure of the quantity and quality of the repurchase risk to the
organization. Back in
March of 2007, I wrote about the lack of
disclosure of this repurchase risk in New Century’s 2005 annual report:
There are 17 pages of
discussion of general and REIT specific risk associated with this
company, but no mention of the specific risk of the potential for their
banks to accelerate the repurchase of mortgage loans financed under
their significant number of lending arrangements….it does not seem that
reserves or capital/liquidity requirements were sufficient to cover the
possibility that one of or more lenders could for some reason decide to
call the loans. Did the lenders have the right to call the loans
unilaterally? It does say that if one called the loans it is likely that
all would. Didn’t someone think that this would be a very big number (US
8.4 billion) if that happened.
Even if a lender sells most
of the loans it originates, and, theoretically, passes the risk of
default on to the buyer of the loan, there remains an elephant lurking
in the room: the risk posed to mortgage bankers from the representations
and warranties made by them when they sell loans in the secondary
market… in bad times, the holders of the loans have been known to
require a second "scrubbing" of the loan files, looking for breaches of
representations and warranties that will justify requiring the
originator to repurchase the loan. …A "pure" mortgage banker, who holds
and services few loans, may think he's passed on the risk (absent
outright fraud). Sophisticated originators know better…When the cycle
turns (as it always does) and defaults rise, those originating lenders
who sacrificed sound underwriting in return for fee income will find the
grim reaper knocking at their door once again, whether or not they own
the loan.
But earlier, on page
114, there is a footnote to a chart representing loans in their balance
sheet that have been securitized--including residential mortgages and
securitzations sold to FNMA and FHLMC--where servicing is their only
form of continuing involvement.
Delinquent loans and net
charge-offs exclude loans sold to FNMA and FHLMC. We continue to service
the loans and would only experience a loss if required to repurchasea
delinquent loan due to a breach in original representations and
warranties associated with our underwriting standards.
So where are those
numbers? Where is the number that correlates to the $8.4 billion dollar
exposure that brought down New Century? Wells Fargo saw an almost 300%
increase from 2007 to 2008 in delinquencies and 200% increase in charge
offs from commercial loans and a 300% increase in delinquencies and 350%
increase in charge offs on residential loans they still hold. Can anyone
say with certainty that we won’t see FNMA and FHLMC come back and force
some repurchases on Wells Fargo for lax underwriting standards?
This is all we get
from Wells Fargo in the 2008 Annual Report:
The lack of disclosure of this issue here mirrors
the lack of disclosure in New Century and perhaps in other KPMG clients
such at Citigroup, Countrywide ( now inside Bank of America) and
others. How do I know there could be a pattern? Because
the inspections of KPMG by the PCAOB, their
regulator, tell us they have been called on auditing deficiencies just
like this. Do we have to wait for a post-failure lawsuit to bring some
sense, and some sunshine, to the system?
Many appear to think that the increasing
complexity of financial products is the source of the world financial
crisis. In response to it, many argue that regulators should actively
discourage complexity.
The June 2009 US Treasury
white paper seemed to say this.
The paper said that a new consumer financial protection agency be
“authorised to define standards for ‘plain vanilla’ products that are
simpler and have straightforward pricing,” and “require all providers and
intermediaries to offer these products prominently, alongside whatever other
lawful products they choose to offer”.
The July 2009, HM Treasury
white paper “Reforming Financial
Markets” similarly advocated “improving access to simple, transparent
products so that there is always an easy-to-understand option for consumers
who are not looking for potentially complex or sophisticated products.”
They do have a point. Unnecessary
complexity can be a problem that regulators should worry about, if the
complexity is used to obfuscate and deceive, or if people do not have good
advice on how to use them properly. Complexity was indeed used that way in
this crisis by some banks who created special purpose vehicles (to evade
bank capital requirements) and by some originators of complex mortgage
securities (to fool the ratings agencies and ultimate investors).
Modern behavioural economics shows that
there are distinct limits to people’s ability to understand and deal with
complex instruments. They are often inattentive to details and fail even to
read or understand the implications of the contracts they sign. Recently,
this failure led many homebuyers to take on mortgages that were unsuitable
for them, which later contributed to massive defaults.
But any effort to deal with these problems
has to recognise that increased complexity offers potential rewards as well
as risks. New products must have an interface with consumers that is simple
enough to make them comprehensible, so that they will want these products
and use them correctly. But the products themselves do not have to be
simple.
The advance of civilisation has brought
immense new complexity to the devices we use every day. A century ago, homes
were little more than roofs, walls and floors. Now they have a variety of
complex electronic devices, including automatic on-off lighting,
communications and data processing devices. People do not need to understand
the complexity of these devices, which have been engineered to be simple to
operate.
Financial markets have in some ways shared
in this growth in complexity, with electronic databases and trading systems.
But the actual financial products have not advanced as much. We are still
mostly investing in plain vanilla products such as shares in corporations or
ordinary nominal bonds, products that have not changed fundamentally in
centuries.
Why have financial products remained
mostly so simple? I believe the problem is trust. People are much more
likely to buy some new electronic device such as a laptop than a
sophisticated new financial product. People are more worried about hazards
of financial products or the integrity of those who offer them.
The problem is that financial breakdowns
come with low frequency. Since flaws in the financial system may appear
decades apart, it is hard to figure out how some new financial device will
behave. Moreover, because of the low frequency of crises, people who use
financial instruments often have little or no personal experience with the
crises and so trust is harder to establish.
When people invest for their children’s
education or their retirement, they are concerned about risks that will not
become visible for years. They may not be able to rebound from mistaken
purchases of faulty financial devices and they may suffer if circumstances
develop that create risks that could have been protected against.
Thus, to facilitate financial progress, we
need regulators who ensure trust in sophisticated products. They must work
towards clearing the way to widespread use of better products, concerning
themselves with both safety and creative ideas. They must not simply be law
enforcers against the shenanigans of cynical promoters, but also be open to
making complex ideas work that have the potential to improve public welfare.
Unfortunately, the crisis has sharply reduced trust in our financial system.
At this point in history, there has been
over-reliance on housing as an investment. It is an appealing investment as
it is simple to understand: we see the home we own every day. But in using
housing as a big savings vehicle, people have built homes that are larger
than needed and hard to maintain. This extra housing would be expected to
have a negative return in the form of depreciation.
The popular reliance on housing as an
investment, combined with the increased leverage with newer mortgage
practices, contributed to the housing bubble that has now burst, resulting
in historically unprecedented numbers of foreclosures. The fact that a
bubble could grow this large and burst is a sure sign of imperfect financial
institutions, not of overly complex institutions.
Unfortunately, people do not trust some
good innovations that could protect them better. The innovations in
mortgages in recent years (involving such things as option-adjustable rate
mortgages) are not products of sophisticated financial theory. I have
proposed the idea of
“continuous workout mortgages”,
motivated by basic principles of risk management. The privately issued
mortgage would protect against exigencies such as recessions or drops in
home prices. Had such mortgages been offered before this crisis, we would
not have the rash of foreclosures. Yet, even after the crisis, regulators
seem to be assuming a plain vanilla mortgage is just what we need for the
future.
Another example of a potentially useful
innovation is the target-date fund (also called life-cycle fund) that
invests money for people’s retirement in a way that is specifically tailored
for people their age. Such a fund plans for young people to take greater
risks and for older people to invest more conservatively. Target-date funds,
first introduced by Wells Fargo and BGI in the 1990s, are growing in
importance, but few people commit the bulk of their portfolio to such funds,
or make use of target-date funds that might make adjustments for their other
investments. It appears that people do not fully trust that these funds are
designed correctly, or would protect them from crises.
Another innovation that is underused is
retirement annuities that include protections against potential risks. There
are life annuities that protect people against outliving their wealth,
inflation-indexed annuities that protect against inflation, impaired-life
annuities that protect against having problems in old age that require they
spend more money and generational annuities that exploit the possibilities
of intergenerational risk sharing. But most people do not make use of any of
these.
Ideally, all of these protections for
retirement income should be rolled into a unified product. Such products are
not generally available yet. Certainly, people might be mistrustful of
committing their life savings to such a complex new product at first even if
it were available. So, such products are not offered and people often do
nothing to protect themselves against most of these risks.
Behind the creation of any such new retail
products there needs to be an increasingly complex financial infrastructure
so that professionals who try to create them can manage a full array of
risks. We need liquid international markets for real estate price indices,
owner-occupied and commercial, for aggregate macroeconomic risks such as
gross domestic product and unemployment, for human longevity risks, as well
as broader and more effective long-term markets for energy risks. These are
markets for the risks that were not managed as the crisis unfolded, and they
create a deeper array of possibilities for new retail financial products.
It is critical that we take the
opportunity of the crisis to promote innovation-enhancing financial
regulation and not let this be eclipsed by superficially popular issues.
Despite the apparent improvement in the economy, the crisis is not over and
so the public continues to support government-led interventions. Doing this
means encouraging better dialogue between private-sector innovators and
regulators. My experience with regulators suggests that they are intelligent
and well-meaning but often bogged down in bureaucracy. Regulatory agencies
need to be given a stronger mission of encouraging innovation. They must
hire enough qualified staff to understand the complexity of the innovative
process and talk to innovators with less of a disapprove-by-the-rules stance
and more that of a contributor to a complex creative process.
Update on IFRS and SPEs
October 12, 2009 message from Bob Jensen to the AECM
The FASB has done a part-way job in dealing with some of the
creative financing paths to date, but the FASB has miles to go before it
rests or gives up. The IASB is still asking “what’s creative finance.”
At the moment the big international accounting firms are chomping
at the bit to replace U.S. GAAP with IFRS and accounting educators in the
U.S. are gearing up to teach IFRS as if U.S. GAAP already has one foot in
the grave.
The SEC might’ve jumped on the 2014 timetable promoted by former
SEC Director Chris Cox, but the SEC is concealing its hand regarding when
and if U.S. GAAP will be lowered into the grave. My understanding is that
the major hang up is the absence of IFRS standards to deal with even the
most basic and long-standing creative finance ploys such as SPEs (that date
back to before the Enron scandal). To date international standards remain
silent on SPEs even though the FASB has the controversial FIN 141R on SPEs,
SPVs, VIEs, and synthetic leasing ---
http://faculty.trinity.edu/rjensen/theory/00overview/speOverview.htm
IFRS needs huge updates on the
following types of contracting and financial engineering:
Hence my bell weather of how badly the IASB wants to bury U.S.
GAAP is how the IASB deals with SPEs and related creative financing
vehicles. For this I requested my former student, great friend, and IASB
insider Paul Pacter to keep me posted on SPEs in the IASB. It’s not like the
IASB has been ignoring the problem, especially since the SEC is foot
dragging on the failings to date of the IASB to deal with creative financing
contracting in the U.S.
Paul is a former project leader for both the FASB and IASB and
still is very, very active in the development of international standards (he
lead the recent SME project). He does this in spite of being located in Hong
Kong with Deloitte. By the way, Paul has also been a major resource for
setting accounting standards in China. Paul is also the founder and
Webmaster if the absolutely fantastic IAS Plus ---
http://www.iasplus.com/index.htm
I would never leave home without it.
Over his years and years
of world travel, my great friend Paul Pacter must’ve taken 100,000 high
quality photographs. Paul’s photo gallery is at
http://www.whencanyou.com/index.htm
After all this preamble let me get to the purpose of this
message. The purpose is to forward a message from Paul Pacter regarding
accounting for SPEs.
The links to the two articles attached to Pauls message are can be found at
the following URLs:
Robert E. (Bob) Jensen
Trinity University Accounting Professor (Emeritus)
190 Sunset Hill Road
Sugar Hill, NH 03586
Tel. 603-823-8482 www.trinity.edu/rjensen
Reply From:
Pacter, Paul (CN - Hong Kong) [mailto:paupacter@deloitte.com.hk]
Sent: Sunday, October 11, 2009 8:22 PM To: Jensen, Robert Subject: SPEs
Bob,
From Paul Pacter on October 12, 2009
Bob
You asked me to think of you re SPEs. Attached is an excellent report on
SPEs (plus related press release). The three bullet points I highlighted
below – alone – could be a good teaching tool.
Paul
12 October
2009: Regulators' report on special purpose entities
The Joint Forum has released its Report on Special Purpose Entities.
This paper serves two broad objectives. First, it provides
background on the variety of special purpose entities (SPEs) found
across the financial sectors, the motivations of market participants
to make use of these structures, and risk management issues that
arise from their use. Second, it suggests policy implications and
issues for consideration by market participants and the supervisory
community. Regarding accounting, here are three comments made in the
report:
The ability to achieve off-balance sheet accounting
treatment is affected by the accounting regime to which the
originating or sponsoring entity is subject. Generally
speaking, off-balance sheet treatment is easier to achieve
under US GAAP than under IFRS. However, the US FASB new
accounting rules related to SPEs that are effective in 2010
will significantly reduce the ability of institutions to use
SPEs to achieve off-balance sheet treatment. As a result, US
accounting changes will significantly alter the motivations
for originators in using SPEs. These accounting changes will
also affect leverage and risk-based capital ratios, and
could have an important effect on the management of
regulatory capital adequacy requirements by firms.
European financial firms generally have less ability to
remove assets from their balance sheets by using SPEs.
However, this is offset by the fact that risk-based capital
requirements are not as closely tied to accounting in
Europe. In contrast, while US firms currently can more
easily remove assets from their balance sheets, the US
implementation of Basel I required more capital for certain
exposures than in Europe.
Some examples (but not an exclusive list) of the ways SPEs
can potentially confuse or obfuscate the financial position
of a company are:
Return on equity and return on assets can be exaggerated
if revenue flows are received from SPEs but the assets
in those vehicles are not recognised on the balance
sheet;
Sector exposure may be obscured, either deliberately or
not, by recognising some SPEs on balance sheet and not
others;
Leverage ratios may be obscured.
An appendix to the report examines, in detail, the current
accounting treatment of SPEs under IFRSs and under US GAAP. Click to
download:
The Joint Forum is a consortium of the Basel Committee on Banking
Supervision, the International Organization of Securities
Commissions, and the International Association of Insurance
Supervisors that addresses issues common to the banking, securities,
and insurance sectors, including the supervision of financial
conglomerates.
Jensen Comment: Paul gave me permission to forward the above
message. This message (including any attachments) contains confidential
information intended for a specific individual and purpose, and is protected
by law. If you are not the intended recipient, you should delete this
message. Any disclosure, copying, or distribution of this message, or the
taking of any action based on it, is strictly prohibited.
Deloitte refers to one or more of Deloitte Touche Tohmatsu, a
Swiss Verein, and its network of member firms, each of which is a legally
separate and independent entity. Please see
www.deloitte.com/cn/en/about for a detailed description of the
legal structure of Deloitte Touche Tohmatsu and its member firms.
Innovate or die. The phrase, popularized in Silicon
Valley in the nineteen-nineties, has since become a mantra throughout the
business world, and nowhere has it been more popular than on Wall Street,
which in recent years has churned out a seemingly endless stream of new ways
to manage capital and slice and dice risk. But, while Silicon Valley’s
innovations have brought enormous benefits to society, the value of Wall
Street’s innovations seems a lot less clear. (The former Fed chair Paul
Volcker has said, for instance, that the last valuable new product in
banking was the A.T.M.) The Valley gave us the microprocessor, Google, and
the iPod. The Street gave us the C.D.O., the A.B.S., and the C.D.S.—not to
mention the kind of computerized trading that enabled last week’s
stock-market nosedive. Not surprisingly, then, the whole notion of
“financial innovation” is being looked at with a gimlet eye, and Congress is
now considering various ways to rein in the banking industry’s excesses.
Given the tumult of the past few years, the barter system is starting to
look good.
Not all of Wall Street’s concoctions have been
pointless or destructive, of course. Take junk bonds, whose use Michael
Milken pioneered in the nineteen-eighties. They got a bad name when Milken
went to prison for securities fraud. But his insight that high-yield bonds
could be a good investment—that, historically, the rewards outweighed the
risks—allowed new companies, including eventual giants like Turner
Broadcasting and M.C.I., as well as countless smaller businesses, to raise
billions in capital that previously would have been out of their reach.
Today, almost two hundred billion dollars’ worth of junk bonds is sold every
year; they’re an integral part of the way Wall Street does what it’s
supposed to do: channel money from investors to productive enterprises.
There are plenty of comparable examples, as Robert
Litan, a scholar at the Brookings Institution, showed in a recent essay.
Currency and interest-rate swaps, for instance, allow global corporations to
focus on their businesses without having to worry about wild swings in
currency values. Index funds have given individual investors a low-cost way
of putting their money to work. Venture capital provides startups with
access to tens of billions of dollars every year. Raghuram Rajan, a former
chief economist at the I.M.F. and a finance professor at the University of
Chicago, says, “There’s a lot of stuff that does a lot of good that we take
for granted, because it’s just become part of our everyday financial lives.”
Unfortunately, the benefits of good financial
innovations have, of late, been swamped by the costs of the ones that went
bad. Things like “structured investment vehicles,” for instance, were
designed to evade regulations and make bank balance sheets look safer than
they were. Subprime loans, which offered lower-income Americans a rare
chance to accumulate wealth, ended up inflating the housing bubble and
leaving these same people with debts they couldn’t pay. Credit-default
swaps, which are a useful way for investors to protect themselves against
unavoidable risks, became a way for institutions like A.I.G. to make easy
money in the short term while piling up billions of dollars in potential
obligations that taxpayers ended up paying for. And securitization—the
packaging of many loans into a single complex financial product—led
investors to neglect the quality of the actual loans that were being made.
Some of these ideas, as it happens, were reasonable
ones, within limits. But limits aren’t something that Wall Street knows much
about: in recent years, it has shown an uncanny knack for taking reasonable
ideas to unreasonable extremes. The economists Nicola Gennaioli, Andrei
Shleifer, and Robert Vishny argue in a recent paper that financial
innovation often leads to financial instability: investors get interested in
a new product that seems to offer high returns, and, precisely because it’s
new, underestimate the chance that this product will eventually blow up.
They pour more and more money into the market, until things start to go
wrong, at which point they panic en masse. The complex financial engineering
that went into creating products like C.D.O.s exacerbated the problem by
making the risks of those investments opaque. If investors had known the
risks they were taking in the pursuit of greater returns, they would have
been more prepared for failure—and would presumably have put less money into
the housing market. Instead, they thought that financial wizardry had
engineered all the danger out of the system. As Rajan argued in a prescient
2005 paper, financial development, which was supposed to make the system
safer, could in fact make it riskier. The fundamental problem with
innovation was that it made investors and executives forget the need to
think for themselves.
TOPICS: FASB,
Financial Accounting Standards Board, Revenue Recognition, Software Industry
SUMMARY: The
article reports on FASB ratification of EITF Consensus positions developed
at the EITF meeting on September 9-10, 2009. Issue No. 08-1, "Revenue
Arrangements with Multiple Deliverables" is now included in Accounting
Standards Codification (ASC) Subtopic 605-25; Issue No. 09-3, "Certain
Revenue Arrangements That Include Software Elements" is now included in ASC
Topic 985. The FASB decisions related to the ASC 605-25 Subtopic
significantly expand disclosure requirements for multiple-deliverable
revenue arrangements. The decisions related to ASC Topic 985 removes
tangible products (e.g., computer hardware, smart phones, etc.) from the
scope of software revenue requirements and provides guidance on when
software included in the sale of such products is subject to software
revenue requirements (formerly documented in AICPA SOP 97-2).
CLASSROOM APPLICATION: Questions
relate to revenue recognition practices and related concepts in qualitative
characteristics of accounting information, suitable for use in an advanced
level financial accounting course.
QUESTIONS:
1. (Introductory)
The articles indicate that the FASB has "approved accounting changes." What
process actually occurred at the FASB meeting on Wednesday, September 23,
2009? (Hint: access the FASB web site at
www.fasb.org. Click on the Board Activities tab, then the Action Alert,
then the summary of Board Decisions for that date. Scroll down to the topics
reported on in this WSJ article.)
2. (Advanced)
In general, what are the current requirements when sales of technology
products, such as computers and smart phones, include both a hardware and a
software component?
3. (Advanced)
Describe how the accounting requirements described in answer to question 2
above has now changed.
4. (Introductory)
According to the article, these changes are expected to increase
profitability for tech companies. Was that the FASB's goal in approving
changes to these accounting requirements? Explain. Include in your answer
references to the qualitative characteristics of accounting information that
you believe the FASB and its EITF are considering in making these accounting
changes.
5. (Advanced)
What are multiple deliverables in a software sale? What is the residual
method for determining revenue recognition of these products? What is the
change in accounting for these sales?
Reviewed By: Judy Beckman, University of Rhode Island
Accounting rule makers approved a change that will
give a boost to technology companies and other firms by allowing them to
recognize some revenue, and profits, faster.
As expected, the Financial Accounting Standards
Board signed off on a rule that helps companies that sell goods and services
like smart phones and other high-tech devices combining hardware and
software, or home appliances that come with installation and service
contracts.
Under current accounting rules, companies often
must defer large portions of revenue from such sales, recognizing them
gradually over time, instead of immediately when the sale is made. The rule
change would give companies more flexibility in crediting more of that
revenue to results upfront.
The move wouldn't change the total revenue and
earnings a company reports over time, and the cash flowing into a company
remains the same. But companies contend the change would better align their
reported results with the true performance of their business.
Apple Inc. is expected to be one of the
beneficiaries of the new rules, because it would change how the company
reports revenue from its iPhone. Currently, Apple recognizes iPhone revenue
over a two-year period, and said recently that overall revenue and earnings
in its latest quarter would have been much higher if it didn't have to defer
revenue for the iPhone and its Apple TV product. An Apple spokesman couldn't
be reached for comment.
Apple has pushed for the change; among the other
tech companies that have publicly supported it are Cisco Systems Inc., Palm
Inc., Xerox Corp., Dell Inc., International Business Machines Corp. and
Hewlett-Packard Co.
The change will take effect in 2011 for most
companies, though they will be allowed to adopt it earlier.
"New Revenue-Recognition Rules: The Apple of Apple's Eye?
The computer company and other tech outfits are likely to cash in on
revenue-recognition changes if the new regs take on an international flavor," by
Marie Leone, CFO.com, September 16, 2009 ---
http://www.cfo.com/article.cfm/14440468?f=most_read
While Steve Jobs was preparing to introduce the new
Apple iPod nano last week, the company's chief accountant, Betsy Rafael, was
sending off a second letter to the Financial Accounting Standards Board
related to revenue recognition. At issue: how FASB might rework the rules
related to recognizing revenue for software that's bundled into a product
and never sold separately.
The rule is especially important to Apple because
it affects the revenue related to two of the company's most successful
products — the iPod and the iPhone. If FASB's time line holds to form, and
the rules are recast in 2011 the way Apple hopes they will be, the company
could be able to book revenue faster, yielding less time between product
launches and associated revenue gains. In theory, a successful launch — and
its attendant revenue — would drive up Apple's earnings, and possibly stock
price, in the same quarter the product is introduced, according to several
news reports that came out earlier this week.
Apple and other tech companies have been lobbying
for a rewrite of the so-called multiple deliverables, or bundling, rule for
quite some time. They argue that current U.S. generally accepted accounting
principles make it hard for product makers to reap the full reward of
successful products quickly. That's mainly because U.S. GAAP is stringent
about when and how companies recognize revenue generated by software sales.
"The requirements are that when you sell more than
one product or service at one time, you have to break down the total sale
value in[to] individual pieces. Establishing the individual values under
U.S. GAAP is solely a function of how the company prices those products and
services over time," PricewaterhouseCoopers's Dean Petracca told CFO in an
earlier interview. Contracts typically include such multiple "deliverables"
as hardware, software, professional services, maintenance, and support — all
of which are valued and accounted for differently.
The complex accounting rule has left many product
makers waiting for a chance to voice their displeasure at the standards, and
the most recent comment period saw such giants as Xerox, IBM, Dell, and
Hewlett-Packard — as well as relative newcomers like Palm and Tivo — make
their case to FASB. In all, 34 companies wrote to FASB during the month-long
comment period that ended in August to register their opinions on the
accounting treatment of multiple elements.
A broader revenue-recognition discussion paper was
issued by FASB and the International Accounting Standards Board in December
2008 for a six-month comment period. The boards are currently reviewing the
comments, and an exposure draft on revenue recognition, which is the
penultimate step to a new global rule, is expected out next year.
Regarding the issue of multiple deliverables, most
technology companies would like to see FASB move closer to international
standards with regard to bundled software, and drop the requirement for
vendor-specific objective evidence. Under GAAP, VSOE of fair value is
preferable when available, according to Sal Collemi, a senior manager at
accounting and audit firm Rothstein Kass.
Basically, VSOE is equivalent to the price charged
by the vendor when a deliverable is sold separately — or if not sold
separately, the price established by management for a separate transaction
that is not likely to change, explains Collemi. Third-party evidence of fair
value, such as prices charged by competitors, is acceptable if
vendor-specific evidence is unavailable. Many technology companies argue
that it is sometimes impossible to measure the fair value of a component
that is not sold separately, but rather is an integral part of the product —
as is the Apple software for the iPod series of products.
At the same time, international financial reporting
standards require companies to use the price regularly charged when an item
is sold as the best evidence of fair value. The alternative approach, under
IFRS, is the cost-plus margin, says Collemi. That is, the IFRS puts the onus
on management to value a product component based on what it costs to
manufacture the piece plus the profit-margin share built into the item.
Management usually bases its valuation on historic sales as well as current
market-established sale prices. The cost-plus margin is not allowed under
GAAP.
With respect to bundled components, the IFRS
focuses on "the substance of the transaction and the thought process and
ingredients that go into the transaction," contends Collemi, who says the
standard's objective is to make economic sense out of the transaction.
FASB's take on the subject is more conservative: the U.S. rule maker calls
for objective evidence to establish value.
Some critics say the IFRS approach invites abuse,
because it's based on management assumptions. But Collemi contends that GAAP
accounting is filled with rules and interpretations that require management
estimates, and that the burden is on management to produce the correct
numbers. What's more, auditors are in place to act as a backstop to verify
the processes used to arrive at management estimates. "If management is
following the spirit of the transaction and doing the right thing," adds
Collemi, "then it is up to auditors to challenge the estimates."
Continued in article
Deloitte Heads Up
"Reconfiguring the Scope of Software Revenue Recognition Guidance," by
Rich Paul, Ryan Johnson, Sam Doolittle, and Rebecca Morrow, Deloitte & Touche
LLP, Deloitte Heads Up, October 23, 2009 ---
http://www.iasplus.com/usa/headsup/headsup0910software.pdf
Apple’s (AAPL) fiscal third quarter earnings are due out Tuesday, July 21, and
once again the Street is focused on the big numbers — revenues, earnings and
units sold for the Mac, iPhone and iPod.
But
savvy analysts will be paying closer attention to the number that is the best
measure of a firm’s profitability: gross margin, expressed as the ratio of
profits to revenues. Or
(Revenue – Cost of sales) / Revenue
Apple’s gross margins, which have averaged 34.8% over the past eight quarters,
are the envy of the industry. Dell’s (DELL) first quarter GM, by contrast, was
17.6% and the company warned Wall Street last week that it is expecting a
“modest decline” next quarter.
In its
April earnings call, Apple low-balled its guidance numbers as usual, forecasting
a sharp drop in gross margins over the next 6 months. Specifically, it warned
analysts to expect no better than 33% in Q3 and “about 30%” in Q4.
But
Turley Muller, for one, doesn’t buy those numbers, and he should know.
Muller, who publishes a blog called Financial Alchemist, is one of a small group
of amateur analysts who track Apple closely and publish quarterly estimates that
are as good as — and often better than — the professionals’. In fact Muller’s
earnings estimates for Q2 were the best of the lot, missing the actual results
by just one penny (see here.)
For
Q3, he’s expecting Apple to report earnings of $1.35 per share on revenue of
$8.3 billion — far higher than the Street’s consensus ($1.16 on $8.16 billion).
Why
the discrepancy?
“Again
the story appears to be gross margin,” he writes. “Just like last quarter, when
Apple blew out the GM number with 36.4% (just as I had predicted) this quarter’s
GM (3Q) should be roughly the same as last quarter.
The
secret, he says, is in the profitability of the iPhone, “which is through the
roof.”
“Apple
tries to deflect that,” he says, but the evidence is right there, buried in a
chart he found in Apple’s SEC filings (see below). It shows Apple’s schedule for
deferred costs and revenue for the iPhone and Apple TV, which for legal reasons
are spread out over 24 months rather than being recorded at the time of sale.
Because Apple TV revenue is so small relative to the iPhone, this chart is a
pretty good proxy for the iPhone alone.
This
is complicated stuff, but the bottom line, as Muller points out, is that iPhone
profitability has been rising to the point where gross margins on the device are
over 50%.
Debt Versus Equity: Dense Fog on the Mezzanine Level Deloitte has submitted a
Letter of Comment(PDF 277k) on the IASB's
Discussion Paper: Financial Instruments with Characteristics of Equity. We
strongly support development of a standard addressing how to distinguish between
liabilities and equity. We do not support any of the three approaches outlined
in the
Discussion Paper, but we
believe that the basic ownership approach is a suitable starting point. Below is
an excerpt from our letter. Past comment letters are
Here. IASPlus, September 5, 2008 ---
http://www.iasplus.com/index.htm
This peek into the work of the IASB illustrates much of what is happening
within the IFRS iceberg … where 6/7th's of the activity is under the
surface, or else seemingly ignored in the US press and perhaps intentionally
under-reported by US professional organizations.
The approach was prepared by staff of the Accounting Standards Committee of
Germany on behalf of the European Financial Reporting Advisory Group (EFRAG)
and the German Accounting Standards Board (GASB) under the Pro-active
Accounting Activities in Europe Initiative (PAAinE) of EFRAG and the
European National Standard Setters.
The staff pointed out that the basic principle for the classification of
equity and liability has been established but that all other components
still represent work-in-progress.
Also:
The staff asked the Board whether there was agreement on acknowledging in
the IASB's forthcoming discussion paper that the European Financial
Reporting Advisory Group (EFRAG) had also issued a discussion paper on the
distinction between equity and liabilities. Most Board Members disagreed
with the staff's proposed wording and emphasised that the IASB should make
it clear that it had not deliberated the final version of the EFRAG
document, had therefore reached no final position on its merits and that the
acknowledgement of the existence of the EFRAG paper should not be seen as
the IASB endorsing the positions taken therein. It was decided to take the
staff proposals offline to agree a suitable wording.
Also:
The FASB document describes three approaches to distinguish equity
instruments and non-equity instruments:
·
basic ownership,
·
ownership-settlement, and
·
reassessed expected outcomes.
The FASB has reached a preliminary view that the basic ownership approach is
the appropriate approach for determining which instruments should be
classified as equity. The IASB has not deliberated any of the three
approaches, or any other approaches, to distinguishing equity instruments
and non-equity, and does not have any preliminary view.
The IASB's DP describes some implications of the three approaches in the
FASB document for IFRSs. For instance:
·
Significantly fewer instruments would be classified as equity under the
basic ownership approach than under IAS 32.
·
The ownership-settlement approach would be broadly consistent with the
classifications achieved in IAS 32. However, under the ownership-settlement
approach, more instruments would be separated into components and fewer
derivative instruments would be classified as equity.
The goal of the
Discussion Paper is to solicit views on whether FASB's proposals are a
suitable starting point for the IASB's deliberations. If the project is
added to the IASB's active agenda, the IASB intends to undertake it jointly
with the FASB. The IASB requests responses to the DP by 5 September 2008.
Click for
Press ReleasePDF 52k).
My concerns are the following:
About a year ago I understood that in IFRS most Preferred Stock would be
classified as Debt, not Equity.
There was some question about Callable and Convertible Debt.
Today, going through the IASB’ abstract of all of their meetings on this
subject, I cannot determine if the Germans in ERFAG are arguing for
Preferred Stock to be classified as Equity or not. Logically their issue of
the Loss Absorbing nature of the Security should be the determining factor
for classifications and therefore classify Preferred Stock as Equity or not.
This is critical in areas like Boston where many of our VC backed companies
would be transformed into companies having little or no Equity under IFRS.
I have seen IFRS “experts” present on Route 128 in Boston and seemingly
being unaware of this difference between US GAAP and IFRS. Similarly,
Tweedie’s stand-by illustrative company from Scotland that he loves to use
is Johnnie Walker. This would indicate to me that maybe McGreevy should
introduce Tweedie to some of the Microsoft development now performed in
Ireland, unless Johnnie Walker is about to enter the Technology Business.
As has been theme in some of my prior posts, after correctly bringing
the US position (FASB) into the discussions about a year ago, since then the
IASB seems to have its hands full dealing with the Contingencies from the
EU.
Clearly with 55 conventions in the EU, 2½ for each EU country, a key task
for the IASB is the de-Balkanization of the EU’s Accounting. During this
necessary period of consolidation within the EU, we should not be required
to mark time as the IASB planned during the EU conversion from 2005
throughout 2008. (The Credit Crunch and Financial Meltdown in September
2008 threw a monkey-wrench into these plans!)
As in their December 2008 Revenue Recognition “Discussion Paper” the IASB
seems to have their hands full now introducing these revolutionary new
concepts such as Equity Section Accounting and Revenue Recognition to their
subscribing countries. They are seemingly starting each exercise with a
blank sheet. Unfortunately this is no way conducive to their goal of
converging with us in the US. This methodology also will create excess
fatigue within the EU’s apparently limited and diffused technical resources.
Given that the IASB has been struggling with Equity Accounting since 2005
this also confirms my fear of future lack of responsiveness to newly arising
needs for new accounting regulations. We are now down to only the FASB in
this country. I shudder to consider a world with only the IASB. Could they
handle Cash in 3 months, or would this require further study?
They were quick with Derivatives in 2008 Q4 and in recent threats to us in
the US.
Apparently they can only be decisive in emotional moments of pique or fear!
Dirk Beerbaum --- Aalto University - Department of Accounting and Finance
Maciej Piechocki--- Independent
Abstract
National standard-setters continue to express
concerns over a principles-based developed IFRS taxonomy. Recent comments to
the IASB consultation on the "IFRS Taxonomy Due Process" contain more
arguments why principles-based accounting and the IFRS taxonomy are
perceived as a conceptual conflict.
A comment from the Accounting Standards Committee
of Germany: "Whilst we acknowledge that standard-setting and taxonomy
development can and should inform each other, we are concerned that
mandatorily bearing taxonomy constraints and limitations in mind when
developing standards bears the risk of the standards themselves becoming
more rules- and less principles-based. We certainly agree that the
pronouncements must be articulated clearly enough to enable appropriate
representation through the taxonomy; however, a taxonomy’s requirements
should not be the key driver for developing standards and interpretations."
Similar arguments are expressed by the Accounting
Standards Council Singapore: "We are particularly concerned that the
prescriptive nature of IFRS Taxonomy would not align well with the
principles-based IFRS."
The Swedish Financial Reporting Board wrote, "We
fear that bringing XBRL into standard setting will be detrimental to the
principles-based approach, particularly as regards the presentation of
disclosures."
The Korean Accounting Standards Board also comment,
"It should be more conspicuously clarified that the IFRS Taxonomy is not
guidance for IFRS in order not to deteriorate the principles-based
standard-setting approach."
Another commentator from a Big-4 audit firm: "There
is a risk that the design and content of a taxonomy that is intended to be
used to capture information in general purpose financial reports will, or be
perceived to, influence how those reports are prepared. Filing requirements
that used prescribed data structures could undermine principles-based
reporting requirements. We understand and share those concerns. However,
this is the very reason that the IASB should be involved with the
development and maintenance of the IFRS Taxonomy. If the IASB is not, others
will develop taxonomies and we are more concerned about the risk that those
taxonomies pose to the application of IFRS."
"EFRAG has expressed on several occasions the view
that the development of the IFRS taxonomy should not drive the IASB
standard-setting process, because it risked moving away from a
principles-based approach, in particular in the area of disclosures."
Considering the Italian Standard Setter, "However,
we reiterate our comments made with references to the Request for Views
Trustees' Review of structure and Effectiveness: Issues for the Review that
the Taxonomy should not be integrated in the IASB standard-setting process
because we see the risk that this may take the IASB away from a
principles-based approach when it develops accounting standards, in
particular in the area of disclosures. IFRS taxonomy-related issues should
be kept separate from the standard setting process as we fear that
considerations that regard the Taxonomy may have a negative impact on the
principles-based approach."
According to groundbreaking research by Richard
Mergenthaler, assistant professor of accounting at the University of Iowa
Tippie College of Business, shareholders are more likely to sue firms that
use principles-based accounting standards over rules-based standards.
Continued in article
Jensen Comment
I would have hypothesized that it would be the other way around on the basis
that it's really hard to nail Jello to a wall.
.Teaching IFRS versus Teaching USA GAAP
"Concepts-Based Education in a Rules-Based World: A Challenge for
Accounting Educators," by Kenneth N. Ryack, M. Christian Mastilak,
Christopher D. Hodgdon, and Joyce S. Allen, Issues in Accounting Education,
November 2015 ---
http://aaajournals.org/doi/full/10.2308/iace-51162
In this paper we discuss the challenges of teaching
U.S. GAAP and IFRS side by side. We then focus on one particular challenge
of teaching both the more detailed U.S. standards and the less specific IFRS:
the likelihood that students will “anchor” on the precise rules in U.S. GAAP
when applying the less specific guidelines under IFRS. As a part of this
discussion, we report on a classroom experiment designed to test for the
presence of anchoring on U.S. GAAP rules when applying IFRS in a lease
classification task. Our results indicate that students do anchor on the
U.S. GAAP bright-line values for lease accounting when classifying leases
under IFRS, primarily when U.S. GAAP rules provide an acceptable
quantification of IFRS' less precise guidelines. We do not find that
teaching order (i.e., teaching U.S. GAAP first versus IFRS first) directly
affects anchoring or lease classification. However, a moderation analysis
suggests the interaction between teaching order and anchoring may affect
lease classification. Our results suggest that, where possible, instructors
may wish to teach principles-based accounting prior to rules-based
accounting to mitigate potential anchoring by students and its effect on
their accounting judgments.
From the CFO Journal on June 6, 2013
FASB’s Seidman: Americans prefer rules to principles Outgoing FASB Chairman Leslie Seidman has had plenty of time to
tackle long-standing questions about whether accounting principles are more
desirable than specific accounting rules,
writes Emily Chasan.
The debate over whether detailed rules and bright-line exceptions are more
or less useful than broad principles that require management judgment has
dominated her past 1o years on the board. “I think it’s undeniable that we
Americans like our rules,” Ms. Seidman said at a Financial Executives
International conference in New York
on Tuesday, where she was discussing the accounting rulemakers’
soon-to-be-completed joint project on revenue-recognition accounting. She
made the comments in her final public speech as chairman of the U.S.
accounting rulemaker.
According to groundbreaking research by Richard
Mergenthaler, assistant professor of accounting at the University of Iowa
Tippie College of Business, shareholders are more likely to sue firms that
use principles-based accounting standards over rules-based standards.
Continued in article
Jensen Comment
I would have hypothesized that it would be the other way around on the basis
that it's really hard to nail Jello to a wall.
Principles-Based standards also complicate enforcement of regulations There are some hurdles that have to be passed before
we’re going to be comfortable making the ultimate decision about whether to
incorporate IFRS into the U.S. reporting regime. Sticking points include the
independence of the International Accounting Standards Board and “the quality
and enforceability of standards. Mary Shapiro, U.S. Securities and
Exchange Commission Chairman, January 5, 2012 --- http://www.businessweek.com/news/2012-01-06/sec-s-schapiro-says-she-regrets-loss-in-investor-access-battle.html
Jensen Comment
I interpret "enforceability of standards"to
center around the increased difficulty of issuing citations for rule breaking
under IFRS principles-based standards. The IFRS-like principle may be to "drive
safely in a school zone"
whereas the FASB bright line might be to drive under 20 mph. It is much easier
to issue citations for rule breakers who drive over the posted speed limit.
Pat
Walters and I have a friendly debate running over bright lines (FASBs) versus
principles-based rules (IFRS) in accountancy. I'm a bright lines guy who favors
20 mph signs in front of the schools and the historic 3% SPE outside equity
bright line that was the smoking gun that brought down Andersen and Enron. I
don't know how Pat feels about speed limit signs, but I suspect she worries that
these bright lines might encourage us old folks to press the pedal to 20 mph
when we can only safely drive in a school zone at 5 mph.
Be that as
it may, Daniel Henninger has a WSJ article that seems to take my side in
this debate. What's interesting is that new technology sometimes favors rules.
Serena Williams will pass on knowing that she indeed had a foot fault in the
2009 U.S. Open women's semifinal, because new technology records bright line
violations that are virtually impossible to dispute. The feuding Jimmy Connors
and John McEnroe will pass on never knowing for certain who was right and who
was wrong in most of their disputed calls.
If there
was no bright line for a foot fault, then Serena Williams would not have to
concede that she was wrong. In principle she may have been totally fair in her
serve. And Enron and Andersen might still be thriving. And Franklin Raines might
still be managing the earnings levels and his bonus amounts at Fannie Mae ---
http://faculty.trinity.edu/rjensen/theory01.htm#Manipulation
It’s been a decade or so since the FASB started
talking about principles-based accounting. We are not sure what caused the
impetus, but we think the first serious discussion occurred when the FASB
issued a document for public comment on October 21, 2002. It wasn’t
particularly compelling then, and it hasn’t gotten any better with age.
Given that the SEC might soon issue a statement
about registrants and whether they may employ IFRS, which supposedly are
more principles-based, we think it good to review the debate, such as it has
been. Actually, it has been more of a monologue by the FASB and the SEC,
because they refuse to listen seriously to the many dissenters.
So let’s review the initial
FASB document and the questions that were asked by
the board.
This “proposal for a principles-based approach to
U.S. standard setting” sounded good at first blush until you thought about
it. The chief impediment then was that a principles-based approach requires
people who have principles. While some managers and some accountants fit
the category, others do not. Just witness the cracks and crevices in
financial reporting during the last decade!
FASB stated that “many have expressed concerns
about the quality and transparency of U.S. financial accounting and
reporting. A principal concern is that accounting standards, while based on
the conceptual framework, have become increasingly detailed and complex.”
While true, people must remember that accounting rules attempt to map the
activities of the corporation into financial statements. As corporate
transactions grow in complexity, one should not be surprised that the FASB
created accounting rules that also grew in difficulty and intricacy. After
all, it is a bureaucracy!
But it doesn’t have to be that way! If you want to
simplify the accounting for derivatives, then just fair value all of them
and put the gains and losses in the income statement. That’s pure and
simple. If you want to simplify the accounting for special purpose
entities, require all of them to be consolidated. There is nothing
requiring the rules to be complex. See our discussion in
Accountants Behaving Badly.
In the 2002 document, the FASB quoted SEC Chairman
Harvey Pitt: “The development of rule-based accounting standards has
resulted in the employment of financial engineering techniques designed
solely to achieve accounting objectives rather than to achieve economic
objectives.”
Besides quoting somebody who didn’t understand Enron,
FASB quoted a statement that is as silly as it is
disingenuous. Managers are not going to quit engineering financial results
with the creation of principles-based accounting; indeed principles-based
accounting will enhance such financial engineering because it helps managers
to disguise the truth about their accounts.
The FASB stated that one reason for the current
complexity of accounting rules is the development of exceptions to the
principles. While that seems accurate, let’s ask ourselves what would
happen under a principles-based approach. Corporate managers would apply
the accounting principles to their situations, bending and twisting the
principles to conform to their circumstances.
Exceptions to the principles would become
applications of the principles themselves, as managers find ways to fit what
they want to do with the accounting rules. As exceptions become the
principles, accounting in practice could in fact become far more complex for
investors and creditors. The investment community would have great
difficulty in comprehending how corporate managers actually implemented the
accounting rules. Er, principles. Worse, it might make financial statements
of companies less comparable with those in the same industry. Indeed, a
recent report by the SEC seems to imply this has actually occurred in those
companies which employ IFRS (“An
Analysis of IFRS in Practice”).
In the 2002 document, the FASB said that a second
reason for the current complexity is that they must provide interpretive and
implementation guidance. In our litigious society, do we really think
managers and auditors would quit asking for such advice under a
principle-based system? Not for a second do we entertain that idea.
Continued in article
Question About Accounting for Revenues
Who had the audacity to insult IFRS by saying:
It is easy to see that in the case of multiple elements, prescribing a
principles-based accounting with guiding implications is an unattainable goal.
Answer
American Accounting Association's Financial Accounting Standards Committee (AAA
FASC): James A. Ohlson, Stephen H. Penman, Yuri Biondi, Robert J. Bloomfield,
Jonathan C. Glover, Karim Jamal, and Eiko Tsujiyama
"Accounting for Revenues: A Framework for
Standard Setting,"
American Accounting Association's Financial Accounting Standards Committee (AAA
FASC): James A. Ohlson, Stephen H. Penman, Yuri Biondi, Robert J. Bloomfield,
Jonathan C. Glover, Karim Jamal, and Eiko Tsujiyama Accounting Horizons, September 2011 http://aaajournals.org/doi/full/10.2308/acch-50027
This paper proposes an
accounting for revenues as an alternative to the proposals currently being
aired by the FASB and IASB. Existing revenue recognition rules are vague,
resulting in messy application, so the Boards are seeking a remedy. However,
their proposals replace the traditional criteria—revenue is recognized when
it is both “realized or realizable” and “earned”—with similarly vague
notions that require both the identification of a “performance obligation”
and the “satisfaction” of a performance obligation. Our framework aims for
the concreteness that yields practical accounting solutions. It has two
features. First, revenue is recognized when a customer makes a payment or a
firm commitment to pay. Second, revenue recognition and profit recognition
are combined, with profit recognition determined on the basis of objective
criteria about the resolution of uncertainty under a contract, and then
conservatively so. Two alternative approaches are offered: the complete
contract method (where profit is recognized only on the termination of a
contract) and the profit margin method (where a profit margin is applied to
recognized revenues throughout the contract as the contract profit margin
becomes clear. The latter requires resolution of uncertainty, so the
completed contract method is the default.
. . .
It is easy to see that in the
case of multiple elements, prescribing a principles-based accounting with
guiding implications is an unattainable goal. Suppose we start out with a
very simple setting in which the economics of the contract is fully certain.
This certainty does not tell us anything about how one is supposed to
allocate the total revenue to a given performance element, let alone how one
is supposed to allocate some expense to each and every element. The
allocation issues now introduce uncertainty in the income measurement, not
an appealing feature when there is no uncertainty in the first instance.
Again, of course, one can argue that argument is not fair insofar as it does
not deal with realities. That said, the point to be made here is that an
allocation on the basis of revenues (constant profit margin in case of
certainty) would seem to be of greater appeal than other alternatives.
The next point is now rather
obvious. A setting with multiple elements and uncertainties in total
contract price and total expense becomes very baffling. No wonder that GAAP
has developed standards on the basis of “types” of contracts as found across
industries. No other solution is available, as far as we are concerned.
A framework that focuses on
the decomposition of contracts into multiple performance elements cannot, in
our view, provide a solid foundation for revenue and expense measurement.10
The following prediction can be offered: if FASB and IASB retain the idea of
accounting for revenue recognition via multiple elements of performance
satisfaction, then whatever framework they come up with will lack in
operational implications when it comes down to working out specific
standards. In fact, we would argue that it is exceedingly unlikely that such
an approach can spell out useful benchmarks of how accounting should be done
in simple, baseline settings. Like Concepts Statement 5 on revenue
recognition, it will be long on some general characterizations of what
constitutes the governing ideas in revenue recognition, but short on
operational implications when it comes to the standard setting. Under these
circumstances, regulators will go on with their task without ever having to
refer to a framework that rules out certain kinds of accounting currently
prevalent. No reasonable practical precepts of accounting will be ruled out
and, thus, one can expect the occasional roles for the completed contract
method and profit margin methods.11 In sum, the idea of a standard setting
for revenue recognition without any prior constraints will remain firmly in
place.12
We should perhaps stress that
our critique of a “performance-based” accounting for revenues and related
expenses is not conceptual per se. To the contrary, we would argue that such
an approach to the accounting is sound, provided that the
performance-element is clearly observable and unambiguous as to what has
been performed, what it is worth to the contractor, and what the allocated
cost ought to be. In other words, the setting is such that one can, as a
practical matter, break the contract into smaller units without introducing
hard-to-resolve ambiguities. But this would seem to be the exception rather
than the rule, and one might reasonably argue that it is intrinsic to
contracts that they rarely can be split into objective “elements.” Customers
typically do not do so. Thus, one has to move away from
“performance-elements” and substitute the correlative, namely, customer
payments, and then address profit recognition as a matter of uncertainty
resolution. When everything is said and done, we think any accounting
standards dealing with revenue recognition will drift into this perspective
in practice.
CONCLUDING REMARKS
It is hard to avoid complex
accounting principles to the extent their dependence on transactions has to
pick up all sorts of fine print. Conversely, relatively straightforward
accounting principles require easy-to-understand events on which the rules
are based. One can think of this as reflecting a trade-off between
easy-to-understand and simple accounting, as opposed to more sophisticated
accounting that may pose considerable difficulties to implement and
appreciate. The former means that the accounting depends only on few basic
observable inputs, with a corresponding drawback that some economically
relevant aspects may be neglected by the accounting. A more sophisticated
accounting, by contrast, means that the accounting tries to pick up on a
large set of relevant features at the cost of making the accounting much
more subjective. Revenue recognition must deal with these issues, of course.
It should be fairly apparent that our tilt is toward a straightforward
accounting. We contend that a framework works best when it focuses on rules
with relatively straightforward inputs. With such a framework in place,
standard setters can proceed to address what refinements are advisable as
additional subtleties are introduced (such as industry and business models).
In sum, we believe it can be quite useful to settle certain recurring
revenue recognition issues up front in a concrete, easy-to-understand
manner.
In our
view, the FASB-IASB Exposure Draft is remiss on this dimension. It simply
does not pay enough attention to (1) what should be the basic transactions
and events on which the accounting must rest, and (2) how the input maps
into recognition and measurement rules. Discussion evolves over time, so
there is ample room for a “new-and-improved” FASB-IASB standard that differs
substantially from the current document.
The Financial Accounting Standards Board (FASB) and the International
Accounting Standards Board (IASB) recently re-exposed their joint revenue
recognition proposal, which would converge revenue recognition guidance
under US GAAP and IFRS into a single model and replace essentially all
revenue recognition guidance, including industry-specific guidance.
This industry-specific publication supplements our Technical Line,
Double-exposure: The revised revenue recognition proposal,
and highlights some of the more significant implications that the latest
revenue recognition proposal may have on the
automotive sector.
Ernst & Young comments on FASB proposals on consolidation and accounting for
investment companies and investment property entities
In our comment letter on the
consolidation proposal, we express
support for the Board's efforts to more closely align the guidance in US
GAAP with IFRS and our belief that the proposed principal-agent guidance
would alleviate many concerns investors in the asset management industry had
with FASB Statement No. 167. Given that the proposal would substantially
reduce the differences between the two consolidation models in US GAAP, we
also encourage the Board to consider moving toward a single model.
In our letter on the
investment company proposal, we express
support for the objective of amending the investment company definition to
clarify whether an entity is within the scope of Topic 946. However, we
believe more outreach with preparers and users is critical to determine
whether the proposed changes are appropriate and respond to user needs. In a
related letter, we oppose creating specialized accounting for
investment property entities and
suggest that existing diversity in practice among real estate entities would
be better addressed by refining the definition of and accounting by an
investment company. We believe that a single set of criteria for investment
entities that measure their investments at fair value with all changes in
fair value recognized in net income would be preferable.
More Detailed Differences
(Comparisons) between FASB and IASB Accounting Standards
2011 Update
"IFRS and US GAAP: Similarities and Differences" according to PwC
(2011 Edition)
http://www.pwc.com/us/en/issues/ifrs-reporting/publications/ifrs-and-us-gaap-similarities-and-differences.jhtml
Note the Download button!
Note that warnings are given throughout the document that the similarities and
differences mentioned in the booklet are not comprehensive of all similarities
and differences. The document is, however, a valuable addition to students of
FASB versus IASB standard differences and similarities.
It's not easy keeping track of what's changing and
how, but this publication can help. Changes for 2011 include:
Revised introduction reflecting the current
status, likely next steps, and what companies should be doing now (see page 2);
Updated convergence timeline, including
current proposed timing of exposure drafts, deliberations, comment
periods, and final standards
(see page 7);
More current analysis of the differences
between IFRS and US GAAP -- including an assessment of the impact
embodied within the differences
(starting on page 17); and
Details incorporating authoritative standards
and interpretive guidance issued through July 31, 2011
(throughout).
This continues to be one of PwC's most-read
publications, and we are confident the 2011 edition will further your
understanding of these issues and potential next steps.
For further exploration of the similarities and
differences between IFRS and US GAAP, please also visit our
IFRS Video Learning Center.
To request a hard copy of this publication, please contact your PwC
engagement team or
contact us.
Jensen Comment
My favorite comparison topics (Derivatives and Hedging) begin on Page 158
The booklet does a good job listing differences but, in my opinion, overly
downplays the importance of these differences. It may well be that IFRS is more
restrictive in some areas and less restrictive in other areas to a fault. This
is one topical area where IFRS becomes much too subjective such that comparisons
of derivatives and hedging activities under IFRS can defeat the main purpose of
"standards." The main purpose of an "accounting standard" is to lead to greater
comparability of inter-company financial statements. Boo on IFRS in this topical
area, especially when it comes to testing hedge effectiveness!
One key quotation is on Page 165
IFRS does not specifically discuss the methodology
of applying a critical-terms match in the level of detail included within
U.S. GAAP.
Then it goes yatta, yatta, yatta.
Jensen Comment
This is so typical of when IFRS fails to present the "same level of detail" and
more importantly fails to provide "implementation guidance" comparable with the
FASB's DIG implementation topics and illustrations.
I have a
huge beef with the lack of illustrations in IFRS versus the many illustrations
in U.S. GAAP.
I have a
huge beef with the lack of illustrations in IFRS versus the many illustrations
in U.S. GAAP.
I have a huge beef with the lack of illustrations in
IFRS versus the many illustrations in U.S. GAAP.
"Canadian regulator decides against allowing early adoption of recent
IFRSs by certain entities," IAS Plus, November 1, 2011 ---
http://www.iasplus.com/index.htm
. . .
In making its decision, the OSFI considered a
number of factors such as industry
consistency, OSFI policy positions on
accounting and capital, operational capacity and resource constraints of
Federally Regulated Entities (FREs), the ability to benefit from improved
standards arising from the financial crisis and the
notion of a level playing field with other Canadian
and international financial institutions.
OSFI concluded that FREs should not early adopt the following new or amended
IFRSs, but instead should adhere to their mandatory effective dates:
Continued
Jensen Comment
The clients, auditors, and the AICPA clamoring that U.S. firms should be able to
voluntarily choose IFRS instead of U.S. GAAP even before it has not been decided
that IFRS will ever replace FASB standards seem to ignore the problems that
voluntary choice of IFRS might cause for investors and analysts. The above
reasoning by the OSFI makes sense to me.
But then outfits like the AICPA have a self-serving interest in earning
millions of dollars selling IFRS training courses and materials.
November 2, 2011 reply from Patricia Walters
Does that mean you oppose options to early adopt standards in general,
not just IFRSs?
Pat
November 2, 2011 reply from Bob Jensen
Hi Pat,
It's hard to say regarding early adoption of a particular national or
international standard, because there can be unique circumstances. For
example, FAS 123R simply altered how to make disclosures rather than alter
the disclosures themselves since employee option expenses had to be
disclosed before the FAS 123R adoption date. But even here early adoption of
FAS 123R by Company A versus late adoption by Company B made simple
comparisons of eps and P/E ratios between these companies less easy.
There's a huge difference between early adoption of a particular standard
and early adoption of an entire system of standards like switching from FASB
accounting standards to IFRS.
I think the Canadian position of early adoption of IFRS is probably correct
because of the mess early adoption of IFRS makes with comparisons of
companies using different accounting standards and the added costs of
regulation of more than one set of standards. Also think of the added burden
placed upon the courts to adjudicate disputes when differing sets of
standards are being used.
Even though we allow IFRS for SEC registered foreign companies, I think it
would be a total mess for the SEC, the PCAOB, investors, analysts,
educators, trainers, auditing, and even the IRS (where tax and reporting
treatments must sometimes be reconciled) if our domestic corporations could
choose between FASB versus IASB standards.
There are hundreds of differences between FASB and IASB standards. Allowing
companies domestic companies to cherry pick which system they choose before
it is even known if there will ever be official replacement of FASB
standards by IASB standards would be very, very confusing. What if there
never is a decision to replace FASB standards? Do want to simply allow
companies to choose to bypass FASB standards at their own discretion?
Of course, if information were costless it might be ideal to require
financial reporting where FASB and IASB outcomes are reconciled. But clients
and auditors generally contend that the cost of doing this greatly exceeds
benefits. And teaching financial accounting would become exceedingly
complicated if we had to teach two sets of standards on an equal basis.
I would certainly hate to face a CPA examination that had nearly equal
coverage of both FASB and IASB standards simultaneously. I say this
especially after viewing the hundreds of pages of complicated differences
between the two standards systems.
Where Principles-Based Standards meet Bright
Lines
The Boards also instructed the staff to develop a principle to determine the
line between Bucket 1 and Bucket 2
From Ernst & Young's Week in Review on
September 23, 2011
Financial
instruments: impairment - The Boards instructed the staff to change
direction and pursue an absolute credit-quality approach for the
three-bucket impairment model, rather than the relative credit-risk approach
they favored in July. Under the absolute credit-quality approach, all
originated loans would be initially included in either Bucket 1 or Bucket 2,
depending on the credit quality of the loan at origination, and loans would
move between buckets based on changes in credit quality. The absolute
credit-quality approach would align more closely with existing credit risk
management practices and systems than the relative credit-risk approach,
which would put all purchased and originated loans in Bucket 1, regardless
of credit quality. The staff's outreach efforts indicated significant
concerns about operational challenges related to the relative credit-risk
approach.
The Boards also instructed the staff to consider the effect of an absolute
credit-quality method on “geographies” that primarily originate loans of
lower quality (e.g., subprime loans). Although the FASB expressed concern
with developing a separate impairment model for these types of loans, the
Board agreed to consider the staff's research.
The Boards directed the staff to consider the application of an absolute
credit-quality approach to purchased impaired loans (e.g., loans purchased
with significant discounts to their face amount). The Boards also instructed
the staff to develop a principle to determine the line between Bucket 1
(where 12 or 24 months of expected losses would be recognized) and Bucket 2
(where full lifetime losses would be recognized) rather than take a
ratings-based approach. The principle would be based on deterioration or
improvement of credit quality (e.g., collectability of cash flows) to a
particular level at each reporting period. The staff will provide additional
information about applying the principle and examples of fact patterns.
Paradox
of Writing Clear Rules: Interplay of Financial Reporting
Standards and Engineering1
Shyam Sunder
Yale School of Management
Abstract
Attempts to improve financial reporting by adding clarity to its
rules and standards through issuance of interpretations and
guidance also serve to furnish a better roadmap for evasion
through financial engineering. Thus, paradoxically, regulation
of financial reporting becomes a victim of its own pursuit of
clarity. The interplay between rules written to govern
preparation and auditing of financial reports on one hand, and
financial engineering of securities to manage the appearance of
financial reports on the other, played a significant role in the
financial crisis of the recent years. Fundamental rethinking
about excessive dependence of financial reporting on written
rules (to the exclusion of general acceptance and social norms)
may be necessary to preserve the integrity of financial
reporting in its losing struggle with financial engineering.
JEL Codes: G24; M41
Keywords: Financial Reporting; Financial Engineering; Written
Standards; Social Norms; Regulatory Equilibrium
Revised
Draft Dec. 8, 2011
1 An earlier version of this paper was presented at the
conference on Rethinking Capitalism, Bruce Initiative of the
University of California at Santa Cruz in April 2010.
Corresponding Author. Address: Yale School of Management, 135
Prospect Street, New Haven, Connecticut, 06511, USA. Telephone
+1 203 432 6160
E-mail
shyam.sunder@yale.edu.
Jensen Comment to the AECM
I am forwarding a new comment by Shyam to one of my posts on the AAA Commons.
Note that you can reply on the AECM to his comment even though you must go to
this item on the Commons to put a reply to his post on the Commons itself.
Shyam has been a long-time opponent of convergence to IFRS in the United
States but, as a highly respected researcher in economics journals as well as
accounting research journals, his objections have mainly centered around the
potential IASB abuses of its monopoly powers in the setting of global accounting
standards ---
http://faculty.som.yale.edu/shyamsunder/Jamal Sunder Stds Dec 14.pdf
There are many objections to the mountains of standards, interpretations, and
bright line rules in both international and domestic accounting standard
setting. I think it was Paul Polanski who once noted on the AECM that, in spite
of being principles-based in theory, the IASB's standards and interpretations
are moving toward a mountain of bright line rules.
Bob Jensen does not agree with Beresford, Sunder, and others on the issue of
bright lines and interpretations.
Firstly, I think the FASB's Codification Database (along with Comperio
from PwC) is demonstrating that modern technology allows clients and auditors to
deal more efficiently with standards complexity and bright lines.
Secondly, I think the explosion of evidence that clients and their
auditors take advantage of loopholes in standards such as the Repo 105/108
principles-based loopholes in FAS 140 that were used by Lehman Brothers and
Ernst & Young to put out deceptive financial statements. Taking away the bright
lines simply makes it easier for clients and their auditors to deceive the
public using more subjective principles-based rules. The Lehman Bankruptcy
Examiner is not at all kind to Lehman Brothers or Ernst & Young in this matter
---
http://faculty.trinity.edu/rjensen/Fraud001.htm#Ernst
Thirdly, I'm really opposed to having a contract that Client A reports
differently than Client B to a significant degree such as when Client A will
eventually use IFRS 9 to judge a hedge as being fully effective and Client B
will judge the same hedge as being too ineffective to permit hedge accounting
relief. IFRS 9 as proposed will really soften effectiveness testing for hedges
using derivative financial instruments.
As a matter of fact the leeway given to clients to test hedge effectiveness
in the proposed IFRS 9 (now delayed until 2015) is a perfect example of a
standard that will lead to great inconsistencies in how given contracts are
accounted for differently under principles-based standards.
Fourthly, Sunder, Beresford, and other proponents of reduced
complexity in accounting standards and interpretations fail to point out the
main reason for exceeding complexity in the U.S. Tax Code and its IRS and tax
court interpretations. Time and time again the build up in complexity is caused
by taxpayers who abuse what started out as as a rather simple tax rule. I think
the same thing happens when abusers like Lehman Brothers and Ernst & Young
deceptively twist a standard like FAS 140, thereby leading to further complexity
in ensuing standards and interpretations.
Time and time again the cause of complexity is what Pogo realized years ago:
"We have met the enemy and he is us."
In any case, I predict that over 99% of the subscribers to the AECM will side
with Sunder and Beresford and less than 1% will side with Bob Jensen on this
issue. But Jensen will win in the long run as simple principles-based standards
become abused even worse than bright line rules are abused.
Jensen still argues for bright line speed limit signs (20 mph, 45 mph, 55 mph
etc.) in place of a single principles-based law "Drive at a safe speed in this
zone."
See below.
This drive toward IFRS has been amazing because its
support consists primarily of vacuous assertions. Advocates claim that
principles are better than rules, but nobody has been able to differentiate
between principles and rules. If firms should recognize all their
liabilities on the balance sheet, is that a rule or a principle? (And if a
principle, why do we still suffer the horrors of off-balance sheet debt in
countries that have already adopted IFRS?)
Proponents of IFRS also argue that uniformity
across the world would reduce preparer and investor costs and it would
increase transparency. But, the spread of IFRS has been filled with
carve-outs, special deals, exceptions, and time-freezes; in short, countries
are adopting their own national brands of IFRS. There is significantly less
uniformity across IFRS-adopters than the promoters wish to admit. This
argument is bunk.
As business enterprises adopt IFRS, they adopt
different accounting rules and they implement them in diverse ways, even
when they present the financial report on a good faith basis. Even now it
has become difficult to compare some European firms with others even in the
same industry because of the tremendous differences across their accounting
tools.
But worst of all, IFRS is an elixir for
unscrupulous managers. These imps will be able to skim assets from their
firms and cover their tracks with such ease that critics could compare it to
the artistry of Humphrey Bogart and Bette Davis. The world of accounting and
finance would give way to theater.
It is not enough for principles to be better than
rules. Principles-based accounting produces value only when managers and
their advisers are principled men and women. Unfortunately, the past decade
contradicts such a presumption. Yes, there are some honest business people,
so we do not wish to indict everybody, but there are far too many dishonest
CEOs and dishonest CFOs and dishonest advisers to dismiss this point. IFRS
that are supposedly principles-based will not solve the fundamental
accounting problems of society until and unless the vast number of managers
become principled individuals. Sadly, hundreds and hundreds of restatements
and many SEC litigation releases and scores of lawsuits and plenty of
criminal cases prove that society does not have enough principled managers
to make it work.
Today’s accounting leaders do not remember much
from accounting history. Before the Accounting Principles Board, corporate
managers faced mostly toothless or ambiguous accounting rules, if they
encountered any accounting or disclosure rules. The great charge that began
in the 1960s was the goal to reduce manager’s accounting choices in order to
reduce the gaming in corporate reports. This goal began in the 1960s, but
did not eliminate accounting scandals as attested to by a variety of cases,
including National Student Marketing and Equity Funding. But the correct
deduction is not to allow managers a free hand in manipulating the
accounting; rather, it demonstrated that reducing managerial accounting
choices was not sufficient to improve accounting. Other things would be
required, such as an improvement in corporate governance.
So here we are with our so-called leaders in DC and
in Connecticut escorting us down this primrose path. If they continue to
inflict IFRS on the American investment community, they will find more
thorns than flowers. IFRS truly is a charade and the only ones who will
benefit are those with criminal intent.
Principles-Based versus Rules-Based Accounting Standards: The
Influence of Standard Precision and Audit Committee Strength on Financial
Reporting Decisions
Christopher P. Agoglia,
Timothy S. Doupnik, and
George T. Tsakumis
The Accounting Review 86(3), 747 (2011) (21 pages)
'Those two f-words," said Mary Carillo amid the eruption of Mount Serena in the
U.S. Open women's semifinal, "apparently led to some more." The vocabulary Mary
Carillo had in mind were not the f-words of common usage but simply, "foot
fault."
What happened next is the civilized world divided between those who believe that
rules still matter and those who think rules exist to be bent. Rules won.
But we are ahead of ourselves. Safely assuming not everyone shares a fanaticism
that requires watching two weeks of tennis into the wee hours each summer, we
need to set the scene for what is one of the most infamous moments in tennis
history.
Outplayed by Kim Clijsters, a tennis hobbyist from Belgium, incumbent Open
champion Serena Williams was serving on the precipice of a humiliating defeat
when an odd sound emerged from the sideline. It was the sound of a lines woman
yelling "foot fault." Point to Clijsters.
Whereupon, Serena snapped. Walking over to what must be the world's smallest
lines woman, Serena loudly related her willingness to place the tennis ball
inside the woman's throat, modifying both "ball" and "throat" with the world's
most famous ing word.
In the days since, sports aficionados have debated the propriety not only of
Serena's language but the lines woman's calling a foot fault within a whisper of
match point. In most championships, with one of the competitors at death's door,
the rule of thumb is "let them play."
Setting that aside, the real problem for tournament referee Brian Earley was
that Bad Serena had committed what tennis primly calls a "code violation." If
Mr. Earley called the code violation with Ms. Clijsters one-point from victory,
Serena was done. He called it.
This is why we watch sports. Not just to see the thrill of victory and the agony
of defeat, but because it is the one world left with clear rules abided by all.
Compared to sports, real life has become constant chaos. (Some esthetes would
chime in that this is why they listen to classical music. Structure rules.)
Should the lines woman have called that foot fault? Let a thousand water-cooler
debates begin. What remains is that whatever one's sport, you know what the game
is going in, and that includes the final moments of any championship, when a
season can be lost on a fatal infraction.
A pitcher balks (don't ask) with the bases loaded in baseball, and a free run
trots to home plate. Body movement along a football line before the snap can
make it first and goal. Hit a golf ball off a building and behind a tree (Phil
Mickelson, Winged Foot's 18th hole, the 2006 Open) and the gods of sanity will
abandon you. A basketball player who taps a three-point shotmaker on the wrist
may, with fouls, cost his team six points. The Austrian novelist Peter Handke
reduced the fine line separating freedom from foul to a novel's title: "The
Goalie's Anxiety at the Penalty Kick."
While we all know what the rules are in the sports, no one knows anymore what
the rules are in real life. Not in politics, law, the bureaucracies, commerce,
finance or Federal Reserve policy.
My favorite story from rule-free politics was the time in 1987 when House
Speaker Jim Wright got around a rule that a defeated vote couldn't be redone for
24 hours. Mr. Wright adjourned the House, brought it back to order in minutes,
and called it a "new" legislative day. The House clerk even said that Oct. 29
had suddenly become Oct. 30.
Boston lawyer Harvey Silverglate argues in a forthcoming book, "Three Felonies a
Day," that federal law has become such a morass that people in business
routinely violate statutes without a clue. Modern law lacks what sports provides
lucidity.
Attorney General Eric Holder's decision to let a prosecutor investigate CIA
interrogations that were ruled inbounds years ago is like a baseball
commissioner reversing a hotly disputed World Series home run. Fans everywhere
would burn down the stadium.
Which brings us to the Supreme Court. At this turn in history, the battle lines
there are drawn between Scalian originalism and Obamian "empathy." In between
stands Referee Anthony Kennedy, who gives the ball to whichever team plays by
his rules. The f-numbers 5-4 define the chaos of our era.
The war over the Court may run for a century. It must mean something, though,
that in the primal world of sports we are all strict constructionists, even as
we agree that a discreet judge would have given Serena's foot fault a pass.
From this we may conclude that the utopia most people want is a rules-based
life, with wiggle room.
Jensen
Comment
Of course it's never possible or practical to have a bright line for every rule.
Umpires must subjectively decide in each specific situation what constitutes
"unnecessary roughness," "unsportsman like conduct," "pass interference,"
"interference with a base runner," "goal tending," etc. But when bright lines
can take away the subjectivity to the satisfaction of both sides playing the
game, then I'm all for taking subjectivity out of the equation.
Jim Fuehrmeyer does not post regularly to our listservs, but he is a lurker who
quite often sends me very informative private messages.
Jim retired after 25 years with Deloitte (audit partner). He’s now an auditing
professor at Notre Dame.
I am forwarding a reply sent by Jim to the CPA-L listserv following the messages
instigated by Francine’s prisoner’s dilemma message regarding two audit clients
at PwC who came to hugely different valuations of the same credit derivatives
contracts (for payoffs owed Goldman Sachs by AIG).
From:
THE Internet Accounting List/Forum for CPAs [mailto:CPAS-L@LISTSERV.LOYOLA.EDU]
On Behalf Of Jim Fuehrmeyer Sent: Monday, February 22, 2010 11:37 AM To: CPAS-L@LISTSERV.LOYOLA.EDU Subject: FW: Asymmetry in Reporting the Same Contract Fair Value in Two
Separate Firms
This is always a tough issue for a firm: knowing that a client is on the other
side of a transaction/valuation issue/revenue recognition issue/leasing issue –
you name it.
The two audit engagement teams can’t share information with each other. In
fact, when these situations arise, if they have been discussing issues related
to their particular industry, best practices, and so on, they’ll have to stop
all communication so as to not potentially breach client confidentiality
standards. The firm’s national office will get deeply involved, but even at
that level there will be two different consultation teams handling the matter
for the two audit engagement teams. There’s likely only one or two people who
will see both sides and their task is to make sure professional standards are
followed, not that the answers are necessarily the same; and they have to walk
the fine line of not breaching client confidentiality.
This is even more difficult in an area as subjective as valuing financial
instruments where the outcomes result from estimation processes with multiple
inputs that all have reasonable ranges of their own. Just imagine what this
would be like with a so-called principles based standard that allows even more
client judgment.
It’s easy sometimes to post a blog and wonder how the auditors didn’t reach the
“right answer” immediately. I don’t think things are ever as simple as they are
portrayed sometimes.
Jim
Jensen Comment
What we are seeing is the greater bag of worms that will be opened up when IFRS
replaces FASB standards in the United States. Relative to FASB standards, IFFRs
international standards replace bright line rules with principles-based
judgments on the application of accounting standards. Whereas bright lines can
greatly constrain how far an auditor may go along with client's judgment
regarding the application of a FASB standard, IFRS standards allow much more
leeway such that it becomes much more likely that independent teams of auditors
within a given auditing firm will allow clients to value identical contracts at
greatly different values such as the actual happening for the credit derivatives
written by AIG for Goldman Sachs.
In the AIG-Goldman "prisoner's dilemma" the FASB did not have bright line
valuation standards for the broken markets. FSP 157 (4) is a principled-based
interpretation much like the principles-based IFRS standards. Hence the
inconsistency of standard application that Francine pointed out in her
prisoner's dilemma illustration may well become the "rule" (sorry about that)
rather than the exception.
With IFRS in the U.S. and what Jim explains is an absolute rule in auditing
firms that audit teams maintain independence from one another within a given
firm, I fully expect to see more and more of this type of phenomenon where
clients value absolutely identical contracts at differences in value that are
highly material in amount for clients of the same auditing firm.
Question
With tort lawyers circling the wagons, are the large international accounting
firms shooting themselves in both feet by lobbying for IFRS principles-based
standards?
The debate over whether principles-based accounting
standards are better than rules-based standards has divided many
accountants, and stymied regulators who want to move U.S. accounting toward
less-prescriptive guidance.
One argument against that nearly decade-long push
has been that moving away from bright lines and layers upon layers of rules
(as is characteristic of U.S. generally accepted accounting principles)
would lead to more class-action lawsuits from shareholders second-guessing
companies' accounting decisions. Because standards more reliant on
principles (such as international financial reporting standards, or IFRS)
give users more room to make judgment calls, observers worry that adopting
such standards will open companies up to more Monday-morning quarterbacking
by auditors, regulators, and the plaintiffs' bar.
Indeed, it's long been assumed that adopting
principles-based standards would raise companies' litigation risk. For
instance, in a 2003 report encouraging a move toward more
"objectives-oriented rules," the Securities and Exchange Commission said a
new system would carry with it "litigation uncertainty." At the time, the
commission argued that litigation exposure could be minimized by companies
and their auditors properly documenting the reasoning behind their judgment
calls under a principles-based system.
Now, three university professors have gathered
empirical evidence suggesting that litigation is indeed an issue in the
principles-versus-rules discussion. Their study, "Rules-Based Accounting
Standards and Litigation," suggests that companies that violate rules-based
standards have a lower likelihood of getting sued than those that are
accused of violating more-principles-based standards.
The professors looked at securities class-action
suits alleging GAAP violations filed between 1996 and 2005, as well as 84
restatements made during that same time frame that did not result in
litigation. Rather than judge GAAP as a whole as a rules-based system, they
considered the prescriptiveness of the standards mentioned in each case,
based on four characteristics: level of bright-line thresholds, exceptions,
implementation guidance, and detail.
The standards were measured on a "rules-based
continuum" scale running from zero to four, with zero denoting the most
principles-based standards and four indicating the most rules-based
standards. Accordingly, the standard for contingent liabilities, which
requires judgment calls, scored zero, while accounting for leases scored
four.
However, the professors shied away from concluding
whether the adoption of more-principles-based standards as a whole in the
United States would invite more lawsuits for American companies. The unique
litigation system of this country, as well as the more litigious nature of
the society, makes it difficult to directly compare the U.S. system with
that of Europe or beyond, they say.
Still, over time, IFRS could become more
rules-based if demands for carve-outs and additional guidance continue as
they have in the United States, says study co-author John McInnis, an
assistant professor at the University of Texas at Austin. "Even if we adopt
a more principles-based system, I'm not sure it would stay that way," he
says. Rather, the professors believe their study provides a building block
for U.S. regulators and other researchers to consider as the merits of
adopting IFRS continue to be weighed. (The SEC plans to decide next year
whether to require U.S. companies to make a switch to the global rules,
starting in 2015.)
For now, apparently, GAAP and its inherent
complexity give U.S. companies a defense against lawsuits by allowing them
to "shield themselves behind the rules," says McInnis. "If you follow the
rules, it appears that you are protected."
Shareholders have the burden of proving that a GAAP
violation was intentional, not an easy task when many layers of rules
provide many opportunities for mistakes. "We find that firms are less likely
to be sued when they violate standards that are more rules-based, consistent
with the view that the complexity of rules-based standards provides a
credible 'innocent misstatement' presumption," the professors wrote.
The professors acknowledge several limitations of
their research. Among them is the fact that it's not possible to observe
initial shareholder claims that lawyers drop before submitting them into the
court system. Also unanswerable is whether a more principles-based system
would lead to fewer restatements, which often trigger shareholder lawsuits
in the United States if they affect the stock price.
"Rules-Based Accounting Standards and Litigation,"
by Dain C. Donelson University of Texas at Austin - McCombs School of Business
John M. McInnis University of Texas at Austin - Department of Accounting
Richard Mergenthaler Jr. University of Iowa - Henry B. Tippie College of
Business
SSRN, April 7, 2010 ---
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1531782
In the United States we have
at a number of ways of dealing with principles-based standards that clients,
auditors, and investors are unhappy with because of just plain not knowing how
to apply the standard.
1.The standard setters paint bright lines
in their own interpretations of the standard in specific contexts. Sometimes
this is done by the standard setters themselves when issuing interpretations
to supplement standards, e.g., see FIN 46-R.
3.The standard setters build bright lines
into amended standards or new standards such as when FAS 138 added bright
lines to FAS 133.
4.A large firm, particularly PwC, paints
bright lines into a massive database used both by its clients and its own
employees, but by anybody who pays for access to the database, especially
colleges and universities that teach accountancy. In the case of PwC this
database is called Comperio ---
http://www.pwc.com/gx/en/comperio/index.jhtml
Comperio in a sense paints bright lines when a particular type of contract
just does not seem to be clearly covered in the standards and the
interpretations. Of course PwC does not have standard setting authority, but
it can issue its own guidelines that others consider following.
5.The SEC paints bright lines when the
FASB is slow to react such as now when the SEC is painting a bright line
banning debt masking using repo contracts as defined in FAS 140.
6.In the United States common law court
decisions paint bright lines that are statutes are vague or incomplete.
Anybody that defies or ignores the common law does so at risk of losing out
in a future court decision.
The IASB uses similar means of
painting bright lines into IFRS. The one that is most problematic is the common
law. When you have standard setting jurisdiction for nearly 100 nations,
problems in common law arise due to different cultures and contracting that can
differ greatly between nations. For example, some nations rely almost entirely
on capitalization with debt and almost no equity. In the United States we are
much more dependent upon equity markets.
The Financial Accounting
Standards Board (FASB) and XBRL US, the nonprofit consortium for XML business
reporting standards, announced today that they have completed the work to revise
the XBRL US GAAP Taxonomy to reflect the FASB Accounting Standards
Codification(TM) that was released on July 1, 2009. The Codification is the
single source of authoritative nongovernmental US generally accepted accounting
principles (GAAP) and is effective for interim and annual periods ending after
September 15, 2009.
In 2008, the FASB created an XBRL project team that
worked closely with the XBRL US team to release the new Codification
extension taxonomy. The FASB's XBRL project team reviewed the authoritative
references in the current taxonomy and added the related Codification
references. Public companies using the US GAAP Taxonomy to create XBRL-formatted
financial statements can now link directly from the taxonomy extension to
the specific Codification reference as posted on FASB's Codification
website. The Codification references, in conjunction with the element labels
and definitions, provide companies the information they need to select the
right element in the taxonomy to accurately reflect their financial
statements.
"The FASB Accounting Standards Codification(TM)
simplifies the process of researching accounting issues by providing a
single authoritative source of US GAAP. The work that FASB and XBRL US have
done to bring these references into the US GAAP Taxonomy further streamlines
the process of financial statement preparation for public companies," stated
Robert H. Herz, chairman of the FASB. "Incorporating the Codification into
the US GAAP Taxonomy will give preparers an easy tool that will help them
select the appropriate elements for filing their XBRL financial statements."
The Codification reorganizes the thousands of US
GAAP pronouncements into roughly 90 accounting topics and displays all
topics using a consistent structure. It also includes relevant Securities
and Exchange Commission (SEC) guidance that follows the same topical
structure in separate sections in the Codification.
The US GAAP Taxonomy was developed by XBRL US under
contract with the SEC as a comprehensive set of reporting elements that
include GAAP requirements and common reporting practices. Public companies
use this digital dictionary when creating XBRL-formatted financials. The SEC
mandated the use of XBRL for all public companies over a three year period;
the largest public companies, with a worldwide public float greater than $5
billion, began filing for interim financial statements with periods ending
on or after June 15, 2009.
"We will continue to work closely with the FASB to
align the US GAAP reporting elements with all new accounting standards.
Public company reporting must change to reflect investor and marketplace
needs. The appropriate level of support and maintenance will ensure that the
XBRL reporting elements used by public companies reflect the most current
industry and accounting standards," said Mark Bolgiano, president and CEO,
XBRL US. "Proper maintenance of the taxonomy is key to giving preparers the
tool to create consistent, high-quality financial data that gives investors
greater transparency and ultimately better accuracy in their own analysis."
Jensen Comment
It would seem that all this effort is a race against time before the FASB's
Codification might self destruct if and when international standards (IFRS)
replace all FASB domestic standards for public companies. The SEC has yet to
issue a new roadmap to IFRS, but the Big Four firms (PwC insists that IFRS is
absolutely certain to replace FASB standards) are all betting that FASB
standards will self destruct very soon (odds place the funeral in 2014).
Codification of the FASB standards, interpretations, and other hard copy FASB
documentation into a searchable "Codification" database, like the road to hell,
is paved with good intentions. Bits and pieces of hard copy dealing with a given
topic are scattered in many different hard copy FASB references and bringing
this all together in newly coded Codification numbered sections and subsections
is a fabulous "paving" idea.
At least Codification of FASB hard copy was a great "paving" idea until it
became evident that FASB standards most likely will be entirely replaced by IASB
international standards (IFRS). It's still uncertain when and if IFRS will
replace the FASB standards, but recent events in Washington DC suggest that the
transition will most likely happen at the end of 2014. This means that millions
of dollars and millions of professional work time hours by accountants,
auditors, educators, and financial analysts will be spent using the FASB's new
Codification database that commenced on July 1, 2009 and will most likely self
destruct on December 31, 2014. As I indicated, when and if IFRS will take over
is still uncertain and controversial, but I'm betting the shiny new FASB
Codification database will self destruct in 2014 ---
http://faculty.trinity.edu/rjensen/theory01.htm#MethodsForSetting
As a result of scheduled obsolescence, what commenced as a Codification smart
idea became dumb and dumber in 2009.
Furthermore, the Codification database has some huge
limitations because it contains only a subset of the FASB hard copy material
that it ostensibly is replacing. This greatly complicates XBRL tagging for some
standards and interpretations and implementation guidelines.
But the biggest problem remains that all this effort
to develop XBRL tagging for the new Codification database codes may be a waste
of time if the Big Four firms are correct in their expectations of death for
FASB standards that comprise the Codification database.
Previously one of the top experts on XBRL tagging said developing
Codification tags will be a "trivial exercise," but some of us lesser novices
cannot fathom that it will be so trivial to tag the huge Codification
referencing and cross referencing system.
There's an added problem that Louis does not address. Companies themselves
have not shown a whole lot of enthusiasm for the Codification referencing
system, in part, because they too anticipate a funeral for the Codification
referencing of FASB standards and interpretations EITFs and implementation
guidelines.
"... This year early adopters of XBRL who tagged
their financial statements with FASB hard copy references will be putting
out obsolete XBRL tagging. All the U.S. standard XBRL tagging software and
financial analysis software will have to be rewritten..."
While there will undoubtedly be some impact to the
current USGAAP taxonomies, I expect it to be minimal. The references that
are currently in the taxonomy are largely in sync with their codification
replacements as the FAF and XBRL US have been working on this expected
transition for some time.
From a mechanical point of view it will be a fairly
simple exercise to "slip stream" in the codification references.
Askaref (which I developed with 2 others) is
designed for handheld internet devices to do that cross-referencing between
line item accounts, XBRL tags, and GAAP references (FASBs, etc). Having gone
through the database machinations to make this function work, I would say
that effort is nontrivial, but not rocket science. Until I see what a
official release of the XBRL tagging for the Codification, I would suggest
that blanket statements are premature about the ease to “slip stream”
references or the rendering of databases as useless. In any event, it will
make users and support individuals mad if this feature is delayed … like the
Boeing 787 dreamliner (the launch date keeps getting delayed and there is a
corresponding loss of value). With respect to XBRL tagging errors being
generated by the inclusion of Codification, it is difficult to get into the
mind of the user/preparer who is selecting the “best match” of a XBRL tag
with an accounting line item. I do agree that referencing the appropriate
GAAP is critical in order to select the “best match” of an XBRL tag. If this
referencing activity is made more difficult or has incomplete links, then it
is logical that more errors will occur.
With regard to textbooks, one fix that I have seen
is a cross reference table which lists textbook pages and their FASB
references with the Codification references. Hardly elegant, but it works.
Zane Swanson
June 28, 2009 reply from Bob Jensen
Hi Louis
I was influenced by the following quotation that does not make it sound
so slip stream and mechanical as firms struggle to update the XBRL tags:
Any company with a scheduled filing date
before July 22 for a quarter ending June 15 or later can opt to file its
report using the out-of-date 2008 taxonomy. The SEC, though, is
encouraging filers to use the current set of data tags. To accommodate
that request, a company with a line item affected by new FASB literature
will have to create its own extensions to the core taxonomy. Not only
would that require extra effort by companies, Hannon lamented that "a
bunch of rogue XBRL elements" not formed the same way from company to
company would inevitably hinder analyses of the effect of FASB's new
pronouncements on financial statements. David McCann, "Speed Bumps for Early XBRL Filers, Users,"
CFO.com,
June 26, 2009 ---
http://www.cfo.com/article.cfm/13932485/c_2984368/?f=archives
I hope you are correct because it will be a race to update all the
tagging software and implement these tags in corporate annual reports before
the FASB Codification archive database self destructs.
Another problem is that companies that are affected by FAS 133 often
refer to DIGG documents that will not be updated for Codification
references. This could lead to rather confusing outcomes where a footnote
quotation from a DIGG refers to Paragraph 243 of FAS 133 and the XBRL tag
refers to Section 8-15-38 of the Codification database that is not part of
the DIGG document.. It will be especially troublesome with FAS 133 since
there is so much FAS 133 hard copy that was left out of the Codification
database such that searches and references of the database cannot even find
many hard copy references originally issued by the FASB.
I don't think it's as easy as you make it sound and for what purpose with
an archival database that will most likely self destruct in such a
relatively short period of time?
Of course investors will be much better off under IFRS.
It stands to reason that worldwide monopolies are better for worshippers of
consistency. This is why the United Nations should set global laws that replace
domestic laws. That way felonies in Pakistan and Mexico and Thailand will be
consistently defined with felonies in the United States. There will be no more
of this nonsense about differing laws for felonies and frauds.
But Hold on Just One Second
It stands to reason that with fewer standard setting bodies there will be less
IFRS innovation and adaptation to change due to creative accounting in one or a
few of the 140+ nations.
It's hard for global standard setters to quickly react
to each nation's innovations in financial contracting. Global accounting
standards will be especially worrisome in the U.S. where the most creative
accountants and financial engineering geniuses will be able to circumvent IFRS
global standards in a New York minute.
IFRS-FASB Convergence Will Lead to Worldwide Monopoly
Much of the economic resistance to IFRS in the American Academy stems from fear
of monopoly power as well as cultural politics.
Lest we forget
Professor Sunders stand at Yale University--- SEC's
Mandate Will Lead to a Monopoly Shyam
Sunder
Yale School of Management
Also published in the Financial Times
September 18, 2008
(Even convergence proponent Patricia Walters admitted this was one of her main
fears about convergence.)
If US
companies are required to use international accounting standards, it will
effectively create a single set of standards used around the world by taking
away the one system — US GAAP — with the influence and significance to challenge
the international rules.
According to the Securities and Exchange Commission, which has proposed a
roadmap for companies to transfer to the new international financial reporting
standards, the move would integrate the world's capital markets by providing a
common high-quality accounting language, and increase confidence and
transparency in financial reporting.
These
are lofty and desirable goals. But why mandate a monopoly? The top-down
imposition of a single set of standards will move us away from, not closer to,
the SEC's goals.
First, principles-based standards are less enforceable. By allowing more room
for judgment of managers and auditors, they introduce greater diversity and
result in fewer, not more, comparable reports.
Second, the SEC does not explain what it means by "high quality". Qualities such
as decision usefulness, reliability, timeliness, and verifiability often
conflict: expensing the value of employee stock options is a high-quality
standard for some and low for others.
Third, standard-setters try to devise new rules to account for market
innovations. Identifying which accounting rule is better calls for
experimentation. At the moment, US standard-setters can look overseas; with the
proposed worldwide monopoly of IFRS, comparisons of alternative treatments will
become impossible.
Fourth, the economic substance of business transactions depends on their legal,
commercial, market, governance and managerial environment. Even within the US,
the same set of accounting rules does not yield similar results across
industries. Greater comparability of financial reports of all public firms
across more than 100 countries is a pipedream. Within the European Union,
accountants find little comparability between the financial reports of, say,
Italian and Dutch firms - and both report under IFRS. Many Asian countries
embraced IFRS to attract foreign capital but plan to use their own
interpretations. So much for comparability.
Fifth, unlike a uniform system of weights and measures, the conduct of business
changes in response to the accounting rules applied.
The
metaphor of natural languages is more appropriate, where the meaning of words
arises from their usage, and ambiguity and multiplicity of meanings are norms,
not exceptions. Esperanto is an example of a failed effort to replace the
world's languages with a single language.
The
SEC would better protect investors by allowing two or more standard-setters to
compete for royalty revenues from companies that could choose one brand of
standards to prepare their reports. Standards competition produces efficient
results in fields such as appliances, bond ratings, higher education and stock
exchanges.
Investor or consumer self-interest, combined with some regulatory oversight,
keeps such competition from racing to the bottom. It also keeps the door open
for faster response to financial engineering and limits the complexity of the
standards.
Allowing a worldwide monopoly to a single manufacturer serves neither the public
nor the manufacturer for long. Development of IFRS is good news; a government
mandate to grant it a monopoly is not.
Shyam Sunder is James L. Frank Professor of Accounting, Economics and Finance at
Yale School of Management.
IFRS and the Accounting
Consensus1 Shyam Sunder
Yale School of Management
July 28, 2008
A broad consensus
in accounting favors principles over rules to guide creation of a uniform high
quality set of standards for use everywhere, and granting monopoly power to a
single body for this purpose. This consensus has little logical basis, and if
implemented into policy, will discourage discovery of better methods of
financial reporting, make it difficult if not impossible to conduct comparative
studies of the consequences of using alternatives methods of accounting, promote
substitution of analysis and thinking by rote learning in accounting classes,
drive talented
youth away from collegiate programs in accounting, and probably endanger the
place of accounting discipline in university curricula. The paper calls for a
re-examination of the accounting consensus.
Thanks for your recent post clarifying a number of
points about the Legal profession in the UK. This was very helpful! For
example I had previously thought a barrister was a criminal attorney and a
solicitor a civil attorney, but now thanks to your post I understand the
bifurcation of the UK Legal System across both of what we in the US know as
civil and criminal law.
Perhaps you could help some of us who are
hopelessly American understand our cousins across the sea and their
professional culture a little better than we currently do.
Frankly I feel that converging professional
cultures may be a bigger challenge than converging IFRS and US GAAP.
Can you expand upon the cultural differences
between the US and the UK on the following areas involving the Accounting
Profession:
Education – I note that in a presentation about a
year ago on Long Island for KPMG, Sir David seemed contemptuous of the need
for accountants to be college educated or waiting for US colleges to begin
teaching IFRS. Therefore, in your estimation: • What Percentage of UK
accountants were trained from the age of 14 on, through an apprenticeship
program versus, having formal college training? Is there ever a combo as in
US co-op programs? • How do these varying backgrounds play out into the ACCA
and other certifying organizations? • How does this play out in UK Public
Accounting?
Social Class – How does class play into this? Are
there still positions in the UK that the most talented cannot attain? Or,
worst case, would we say there are … and they feel this is not true, because
we have fundamental disagreements on what qualifies one for Management?
Country – Why can’t the UK standardize? How do the
Professional Standards and GAAP vary among the following: • England •
Scotland • Wales • Cornwall – Is this always grouped with Wales? • Northern
Ireland – Why are there still Standards in Northern Ireland? Why isn’t it
amalgamated with the Republic of Ireland? • The Republic of Ireland
Can a Welsh CA practice in England or Scotland?
Traditionally, before 2005, who developed UK GAAP? How did this work? My
Pro-IFRS friends tell me this doesn’t matter but these are the sorts of
cultural issues which must be considered in any proposed merger, which is
what I see convergence as. If even with our common language, we and the UK
still have major cultural disconnects, we will have even rougher sledding
with other regions. Not talking about these differences is a non-starter if
we are looking to succeed!
I haven’t forgotten about our disagreement back in
December of Cost Accounting! I will respond sometime very soon!
Best Regards!
John
John Anderson, CPA, CISA, CISM, CGEIT, CITP
Financial & IT Business Consultant
14 Tanglewood Road Boxford, MA 01921
John – here’s my answers to your questions, and no doubt someone else will
be able to improve on them. For much better info, go the ICAEW website
www.icaew.com and type ‘Divided by Common Language’ in to the search
engine. This was the title of a paper on UK v US governance and accounting
etc, which is excellent. It turned into a whole ICAEW research programme -
Beyond the myth of Anglo-American corporate
governance.
In the meantime:
What Percentage of UK
accountants were trained from the age of 14 on, through an
apprenticeship program versus, having formal college training? Is there
ever a combo as in US co-op programs?
How do these varying
backgrounds play out into the ACCA and other certifying organizations?
How does this play out in UK
Public Accounting?
As far as I’m aware, the answer is zero from age 14, as our school-leaving
age is 16 and we don’t specialise before then. Chartered accountants
generally have degrees before they go into firms to undertake the ACA
qualification. I don’t have numbers for the other qualifications.
Social Class – How does class
play into this?
Are there still positions in
the UK that the most talented cannot attain? Or, worst case, would we say
there are … and they feel this is not true, because we have fundamental
disagreements on what qualifies one for Management?
The ‘correct’ answer to your class question is that anyone can do anything,
and we can cite a load of examples of people who have made it. A pragmatic
answer is that yes, class is still a barrier, but talent does seem to
outweigh it. A glance at the electioneering that’s going on at the moment
shows that the Labour party is trying to play the class card. There was a
brilliant piece about this on the radio last night. It pointed out that
George Osborne, the Shadow Chancellor (i.e. the guy who will be in charge of
our economy if the Tories win on May 6th) is considered by most
people to be Upper class, as his father is a baronet and he went to Eton and
such. But when he was at Oxford, he was looked down upon by his upper class
peers because his father had made his money in ‘trade’!
Country – Why can’t the UK
standardize? How do the Professional Standards and GAAP vary among the
following:
England
Scotland
Wales
Cornwall – Is this always
grouped with Wales?
Northern Ireland – Why are
there still Standards in Northern Ireland? Why isn’t it amalgamated
with the Republic of Ireland?
The Republic of Ireland
The question ‘why isn’t Northern Ireland amalgamated with the Republic of
Ireland is one that led to a car bomb there in the early hours of this
morning, and there’s probably enough politics in this list without me trying
to address the Irish question here.
We can’t standardise because the UK comprises separate countries, The
Republic of Ireland is a completely different country, and even ignoring
that, within the Profession, everyone is too pig-headed to even think about
merging the 6 different accounting bodies.
England & Wales (and Cornwall, which – although Cornish nationalists will
protest – is still part of England) are together in the ICAEW. ICAS is a
separate Institute, but the standards of all of the Institutes are the same
– certainly as far as accounting goes.
Can a Welsh CA practice in
England or Scotland? Traditionally, before 2005, who developed UK GAAP?
How did this work? My Pro-IFRS friends tell me this doesn’t matter but
these are the sorts of cultural issues which must be considered in any
proposed merger, which is what I see convergence as. If even with our
common language, we and the UK still have major cultural disconnects, we
will have even rougher sledding with other regions. Not talking about these
differences is a non-starter if we are looking to succeed!
Any member of the ICAEW or ICAS can practice anywhere in the UK. Other
than the Institutes themselves, nobody cares. Indeed, I think that any
qualified accountant in the EU can practice anywhere else in the EU.
(Although I’ll take correction on that if anyone knows more.)
Our accounting standards in the UK go back to the ‘60s. (When I started my
degree we just had a handful of them to learn - bliss!) We used to have
Accounting Standards. Then Statements of Standard Accounting Practice.
Then Financial Reporting Standards. Now IFRS for larger companies. They
are all principles-based, which is the fundamental difference between UK and
US. I love the idea of principles-based, and can’t see why you guys like
rules … but I’ve been on this list long enough to know that most of you
think the exact opposite, so let’s not go there!
Our standards have always been ‘voluntary’, i.e. put out by the joint
accounting bodies rather than the government. As we all know, the EU is
trying to change that…
Hope this helps a bit
R
Our good AECM friend David Raggay reminded us that
nations adopting IFRS are not allowed to cherry pick IFRS standards (except for
nations in the EU). It's all or nothing as far as IFRS is concerned for public
companies. For private companies, nations can and do set standards that differ
from IFRS, but they must use IFRS if and when they sell equity and debt
securities to the general public. It's still not clear where nations will draw
the line for hedge fund investors since hedge funds are private investment
clubs. Some hedge funds claim to be private clubs but are about as easy to get
into as any public mutual fund.
I'm going to chuckle when civil lawsuits regarding a
particular IFRS standard are lost in one country and not lost in another country
even though the facts are identical. Having uniform standards is one thing;
having uniform enforcement is quite another.
Getting off totally free of a DWI arrest in Dimmit
County Texas is (or was for 20 years) virtually a certainty. The only traffic
judge in that county never had a trial by jury since he is (or was) not an
attorney and does not understand such trial. In Dimmit County all DWI offenders
request a trial by jury and walk away free (or so it was reported in the San
Antonio Express News when I was living in Texas). But nobody wants to be
arrested for DWI in Penobscot County in Maine even though the statutes are
virtually the same as in Texas for DWI offenses. I’m told by longtime friends in
Maine that the Hanging Judge Roy Bean still presides in Penobscot County ---
http://en.wikipedia.org/wiki/Roy_Bean
What allows UN delegates to park in any fire lane of their choosing in
NYC? We can argue from one side that having one set of world laws restricting
parking in fire lanes would eliminate such a grave danger. But we can also argue
that failure of the world legislators to agree on a set of fire lane parking
laws endangers us worse than having localized-jurisdictional laws, because then
anybody (not just UN delegates) in the U.S. could then park in fire lanes across
the entire United States.
Remember that if a nation replaces local GAAP with IFRS, that nation is not
allowed to cherry pick which IFRS standards to enforce versus not enforce or
introduce for publically traded companies. Supposedly the European carve out of
IAS 39 provisions was a phenomenon that the IASB will not allow in the future.
It’s complicated to allow multiple sets of standards/laws in a given
jurisdiction. It’s absolutely absurd to allow a given company/person to have
discretionary choice of what set to apply. The large international corporations
and CPA firms are trying to convince us that, in terms of publically traded
companies in the global economy, the definition of a “jurisdiction” is the
“world.”
I’m not totally convinced about the need for detailed world accounting
standards given the totally different importance of publically traded equity
shares in some nations vis-à-vis other nations. For example, the importance of
equity capital and creative financing (structures, synthetics, tranches, etc.)
in Germany is totally different in Germany versus the United States. Since IFRS
is most heavily rooted in European nations, this is probably why IFRS lacks
standards for creative equity financing in the United States.
It’s most confusing to have more than one set of standards in a given
jurisdiction, just as it is confusing to have more than one set of laws in one
jurisdiction. This is why I never supported the move by the SEC to allow foreign
companies to list on the NYSE under IFRS while the majority of listings (from
the U.S.) are under US GAAP. For example revenues are realized differently under
IFRS versus FASB rules. More importantly, IFRS has no standards whatsoever
covering some of the important things covered in the FASB such as accounting for
Lifo, SPEs, SPVs, VIEs, and synthetics (such as synthetic leasing).
Having two sets of accounting standards for the NYSE greatly complicates
comparability beyond the failure on a single set of standards to have perfect
comparability. It adds big noise to smaller noise in the context of
communications theory.
That is not to say that a given jurisdiction must have identical
standards/laws as other jurisdictions, especially when there are circumstantial
differences between jurisdictions. It makes sense to me to allow jurisdictions
to experiment and innovate in the setting of standards and laws within certain
fundamentals of human rights (very broad standards/laws deemed to be universal).
I don’t think that IFRS has limited itself to “broad fundamentals of investor
rights.”
Canada (and some other nations) are now facing controversies of possibly
having two sets of laws regarding murder, statutory rape, etc. --- Shiria law
for Subset A of citizens versus Canadian law for the Subset B majority of
citizens ---
http://en.wikipedia.org/wiki/Sharia
This is a very complicated issue that extends well beyond the setting of
accounting standards. One of the big complications is crossover crime, where a
person from Subset A commits a crime on a person from Subset B and vice versa.
Of course we’ve faced similar problems for years with foreign embassies not
being totally subjected to local laws. This sadly allows UN delegates to park in
any fire lane of their choosing in NYC.
Excerpt
We agree with the Board’s objective in this phase of the IASB project to
replace IAS 39 Financial Instruments: Recognition and Measurement (IAS 39)
to address weaknesses of the incurred loss model in IAS 39 that were
highlighted during the global financial crisis. An impairment loss model
that focuses on an assessment of recoverable cash flows reflecting all
current information about the borrower’s ability to repay would be an
improvement on the current approach in IAS 39 which relies on identification
of trigger events and often leads to a delay in loss recognition. However,
we have concerns about the specific requirements proposed by the IASB, in
particular those to determine, and allocate, the initial estimate of
expected credit losses on a financial asset and to use a
probability-weighted outcome approach. We believe that this approach will in
many cases be unnecessarily complex. Further, the incorporation of potential
future economic environments in estimating recoverable cash flows would be
extremely complex, costly and burdensome to apply by preparers.
The requirement in the ED to forecast future economic
environments and events without providing sufficient guidance with respect
to the level of objectivity, verifiability, or support for the underpinnings
of these inputs presents significant challenges to internal auditors,
external auditors, and regulators. Overall,
we believe that the measurement principle would not be operational if the
Board were to adopt the ED in its current form.
Jensen Comment
One huge advantage of FAS 133 over IAS 39 is the tremendous amount of
implementation guidance given by the FASB for implementation in a raft of
implementation documents, illustrations, and pronouncements from the Derivatives
Implementation Group. For educators and practitioners, the ever-increasing
complexity of IFRS should be accompanied my more illustrations and
implementation guidance. The IASB seemingly just does not have enough high
quality support staff for helping educators and practitioners.
I’m glad to see that IASB member Jim Leisenring found his rusted
spurs used when he was a FASB member. Jim’s never been one to pull his punches.
I admire his work in bringing
about
the badly needed FAS 133 and 123-R. Jim’s one of the few FASB-IASB members who
really understands derivatives and hedging.
I was glad to see Deloitte hammer down on the IASB for proposing
a totally unrealistic probability-weighted recoverable cash flow model in place
of the current trigger-event adjustment for credit risk changes of future cash
flows. At least the trigger-event gave auditors something to hang their hats on
when auditing loan loss reserves. Deloitte asserts the probability-weighted
model as non-operational and non-auditable as proposed by the IASB ED on
Financial Instruments: Amortized Cost and Impairment. I concur 100% ---
http://www.iasplus.com/dttletr/1007amortcost.pdf
Both the IASB and FASB are truly proposing low-quality and
unworkable standards in such areas as financial instruments impairment and fair
value accounting and revenue recognition. I almost threw up when I first read
the joint proposal for revenue recognition. Welcome to the world of hypothetical
revenue to accompany the hypothetical world of unrealized changes in fair value
and impairment.
Thanks Tom,
Robert E. (Bob) Jensen
Trinity University Accounting Professor (Emeritus)
190 Sunset Hill Road
Sugar Hill, NH 03586
Tel. 603-823-8482
www.trinity.edu/rjensen
From:
noreply+feedproxy@google.com [mailto:noreply+feedproxy@google.com] On Behalf
Of The Accounting Onion Sent: Monday, July 12, 2010 8:20 AM To: Jensen, Robert Subject: The Accounting Onion
I can't cite
chapter and verse for this, but experience tells me that there is a
cardinal rule for IASB and FASB members that goes something like this:
'If you can't say something nice about board deliberations, then don't
say anything at all.' Thus, I was surprised read that IASB member
James Leisenring recently
made some less-than-bland comments in regard to the quality of the
sausage spewing forth out of the IASB/FASB's high-speed grinders and
packers.
But, before I
continue, a caveat is in order. I was not in attendance when Leisenring
made the remarks that are the subject of this post. After an arduous
15-minute search I am compelled to notify readers that my only source
for his comments is a very brief news article credited to one Simon
Brown and entitled, IASB
Member Calls Lessor Accounting Discussions with FASB "Hopeless."
The report was sent to me via email by a much-respected source, who must
remain nameless. I have not even been able to discover the title of the
publication in which Brown's article appeared.
According to
Brown's report, Leisenring made colorful comments on three topics:
leases, pensions, and a disagreement among IASB members as to what
constitutes "high quality accounting standards" (which I will abbreviate
to "HQAS"). As lease accounting holds a special place in my pet-peeve
riddled heart, I'll have more to say about the lease accounting comments
at a later time. The topic for this post will be restricted to the HQAS
remark.
According to
Brown:
"Leisenring
also explained an interpretive disagreement he has with some IASB
members regarding what is meant by 'high quality standards.' He said
some consider high quality accounting standards can be standards that
are unambiguous, such that a practitioner 'can't fail to comply with
them.' An unambiguous standard, however, could still allow 'for implicit
alternatives' to the standard, Leisenring argued. He did not offer an
alternative model."
Actually, I
can't say that I even know from Simon's account what Leisenring is
specifically referring to. What grabbed my attention was simply that the
IASB members are still trying to figure out for themselves what
constitutes an HQAS, especially if it will be used as a benchmark
against which to judge the results of IFFRS/GAAP convergence. I'm also
surprised that the dialogue among the players seems to be: (1) strictly
amongs the IASB members; and (2) apparently restricted to the compliance
side of standards – as opposed to whether the numbers reported in the
financial statements actually will mean anything.
Regarding the
strictly intramural aspect of the discussion, I have
noted previously that
James Kroeker, SEC Chief Accountant has stated that the SEC would want
to determine whether convergence has resulted in demonstrably higher
quality accounting standards before moving further down the IFRS
adoption path. Leaving aside my concern that "demonstrably higher" is
neither very ambitious nor specific, the SEC's view of what HQAS means
should count for something to the IASB, assuming they actually care
about making a case for convergence.
Moreover, if
there are some doubts as to what HQAS is, the SEC's view could have been
attended to more closely at the
outset of formal
convergence efforts (October 2002); for surely the SEC had convergence
in mind when they published their congressionally mandated (see the
Sarbanes Oxley Act, Section 108(d))
report on the feasibility
of "principles-based" accounting standards in August 2003. According to
the SEC, the "objectives-oriented" standards they are looking for from a
standard setter should possess the following qualities:
"Be based on an
improved and consistently applied conceptual framework;
Clearly state
the accounting objective of the standard;
Provide
sufficient detail and structure so that the standard can be
operationalized and applied on a consistent basis;
Minimize
exceptions from the standard;
Avoid use of
percentage tests ("bright-lines") that allow financial engineers to
achieve technical compliance with the standard while evading the intent
of the standard."
Now, seven
years later, the SEC's battle plans have been subordinated during the
din and desperation of convergence wars. Are any
new standards from either board "based on an improved and consistently
applied conceptual framework"? Obviously not, for nary a
single alteration to any conceptual framework document has occurred in
the last seven years. The existing definitions for assets and
liabilities are like wooden ships sent to battle against nuclear
submarines.
Does each
new standard, or revised standard "clearly state the accounting
objective"? In a strict compliance sense, the answer could be 'yes,' but
otherwise not. Take IFRS 3R on business combinations:
"The objective
of this IFRS is to improve the relevance, reliability and comparability
of the information that a reporting entity provides in its financial
statements about a business combination and its effects. To accomplish
that, this IFRS … [establishes a bunch of new rules].
Fair enough, I
suppose. But, every new IFRS should "improve relevance, reliability and
comparability"—so what contribution does stating what should be the
objective for all
accounting standards to HQAS? For example, the IASB has an outstanding
exposure draft proposing to continue to give companies the option to
fair value financial liabilities. "The
objective of this statement is to diminish
comparability and reliability
by allowing companies to arbitrarily choose to measure some of their
liabilities at fair value, and to measure rest of its liabilities
according to the rules of this statement."
As to "minimize
exceptions to the standard," why did the IASB propose to exclude
insurance companies from the scope of its putatively "principles-based"
revenue recognition exposure draft (at earlier stages of the project,
insurance was not excluded); or to exclude extractive industries from
its leasing ED; or, again in IFRS 3R, and without exposing it for
comment, to give acquirors the option of measuring noncontrolling
interests at historic cost instead of fair value?
A High
Quality Recipe -- If I May Be Allowed to Say So Myself
Up to this
point, I have set aside my misgivings with the SEC's 2003 report, and
especially the apparent lack of monitoring to ensure that its
recommendations were adopted. I wanted to focus on my misgivings with
the IASB/FASB convergence project as a producer of HQAS; for taken as a
whole, the last seven years have done little more than to add filler and
artificial coloring to the old sausage recipes. Now, finally, here is
my very own recipe for making HQAS.
First and
foremost, for there to be a higher quality accounting standard, there
must be higher "earnings
quality," defined as the strength of association between
reported earnings and economic earnings. Higher earnings quality can,
and must, be established from standard economic logic. For example, I
believe that every post I have written in which I have suggested an
alternative accounting standard has been based on a logical link between
my proposed standard the economic earnings. On the other hand, the
Boards' leasing exposure drafts, for example, would fail this test;
because, although all leases would be capitalized, the numbers put on
the financial statements are
arbitrarily determined.
[insert link from prior post]
Second, accounting should never be determined by management's intent,
strategy, or even industry. An asset is an asset and a liability is a
liability.
Third, do not twist perfectly clear English terms into misleading
terms of art. The lump left over from IFRS 3R's additions and
subtractions is not "goodwill";
and multiplying an historic cost denominated in a foreign currency by a
current exchange rate is not "translation." A balance sheet is not a
statement of "financial position" (because of omitted economic assets
and liabilities); and a statement of recognized revenues, expenses,
gains is not an "income" statement. And, please
don't refer to a liability or a contra-asset as a
"provision" unless one is legally required to prefund a future
obligation.
Fourth, if a standard must exclude certain transactions or industries
from its scope, justification for a scope limitation should be based
only on a comparison of the cost of producing information to its value.
Why are derivatives contracts with physical settlement provisions
ignored, but net-settled derivatives are recognized and measured at
their fair values? Why should there be different revenue recognition
rules for insurance companies than for companies that issue product
warranties? I believe these are examples of political tradeoffs, as
opposed to tradeoffs made with the interests of investors in mind and
heart.
A recipe for high quality accounting standards doesn't have to be
complicated. But, it's more like baking a cake than making sausage: if
you skimp on key ingredients, it will fall flat.
Robert Walker sent an article to the CPA-L list about what a
disaster IFRS conversion has been in New Zealand. Robert sometimes sends
interesting essays on history and accounting theory to the CPA-L list.
Date: Wed, 26 Aug 2009 07:54:08 +1200
Reply-To: THE Internet Accounting List/Forum for
CPAs
Speaking at the annual meeting of the American
Accounting Association in New York on 3 August 2009, Wayne Carnall, Chief
Accountant of the Division of Corporation Finance of the US Securities and
Exchange Commission, discussed issues relating to the use of IFRSs by SEC
registrants. Among the points Mr Carnall made:
In November 2007, the SEC voted to allow
foreign registrants to use IFRSs without a reconciliation to US GAAP.
Since then, only 137 of the more than 1,000 foreign registrants have
chosen to use IFRSs.
The number of foreign registrants in the
United States has been declining over the past few years, including a
two-thirds drop in European registrants. Mr Carnall attributed the
decline primarily to cost-benefit reasons.
In November 2008, the SEC invited comment on a
proposed Roadmap for the Potential Use of Financial Statements
Prepared in Accordance with International Financial Reporting Standards
by US Issuers, Mr Carnall pointed out that the draft Roadmap was
'far from being a proposal' and, at this point, there is 'no date
certain' regarding use of IFRSs by US domestic registrants. Mr Carnall
expressed disappointment that the SEC received fewer than 250 comments
on a proposal that could signficantly affect all 12,000 SEC registrants.
In November 2008, concurrent with the proposed
Roadmap, the SEC also proposed to permit voluntary early adoption for a
limited group of large US registrants (based on industry and size) for
periods ending after 15 December 2009 (filings in 2010). Mr Carnall said
the responses 'did not indicate much support for the option'.
Mr Carnall noted that there continue to be
'significant and fundamental differences between IFRSs and US GAAP' both
in terms of the written standards and how the standards are implemented.
He expressed concern that IFRSs might become
regionalised or localised by differing local interpretations or
modifications. The goal, he said, should be one common standard around
the world.
Mr Carnall noted that there is no SEC
prohibition for a US registrant to publish IFRS financial statements in
addition to US GAAP statements – yet no company is doing that. If the
market demanded it, or if companies saw that IFRS financial statements
might improve their access to capital, they would likely be publishing
IFRS financial statements voluntarily. He noted a reluctance of
companies to invest resources into IFRSs (systems, training, etc) until
the SEC gives a date certain.
Are accounting educators and standard setters commencing to bury their
heads in the sand?
Meanwhile, FASB chairman Robert Herz, also on the
panel, drew a distinction between "avoidable" and "unavoidable" complexity
in financial reporting. Some complexity is a given because "the world of
business and finance is not simple, and not getting any simpler, and you've
got to have reporting that faithfully tries to report that; you can't just
dumb it down."
"Companies Exasperate SEC Accounting Chief: He chides
them for citing accounting standards that "few people understand" in their
financials and for their puzzling apathy on IFRS," CFO.com, July 17, 2009 ---
http://www.cfo.com/archives/directory.cfm/2984368
That is how innovation often proceeds — by learning
from errors and hazards and gradually conquering problems through devices of
increasing complexity and sophistication.
Yale Professor Robert Shiller, "Financial Invention vs. Consumer
Protection," The New York Times, July 18, 2009 ---
http://www.nytimes.com/2009/07/19/business/economy/19view.html?_r=1
JAMES WATT, who invented the first practical steam
engine in 1765, worried that high-pressure steam could lead to major
explosions. So he avoided high pressure and ended up with an inefficient
engine.
It wasn’t until 1799 that Richard Trevithick, who
apprenticed with an associate of Watt, created a high-pressure engine that
opened a new age of steam-powered factories, railways and ships.
That is how innovation often proceeds — by learning
from errors and hazards and gradually conquering problems through devices of
increasing complexity and sophistication.
Our financial system has essentially exploded, with
financial innovations like collateralized debt obligations, credit default
swaps and subprime mortgages giving rise in the past few years to abuses
that culminated in disasters in many sectors of the economy.
We need to invent our way out of these hazards,
and, eventually, we will. That invention will proceed mostly in the private
sector. Yet government must play a role, because civil society demands that
people’s lives and welfare be respected and protected from overzealous
innovators who might disregard public safety and take improper advantage of
nascent technology.
The Obama administration has proposed a number of
new regulations and agencies, notably including a Consumer Financial
Protection Agency, which would be charged with safeguarding consumers
against things like abusive mortgage, auto loan or credit card contracts.
The new agency is to encourage “plain vanilla” products that are simpler and
easier to understand. But representatives of the financial services industry
have criticized the proposal as a threat to innovations that could improve
consumers’ welfare.
As the story of the steam engine shows, innovation
often entails tension between safety and power. We need to foster inventions
that better human welfare while incorporating safety mechanisms that protect
the public. Could the proposed agency accomplish this task?
The subprime mortgage is an example of a recent
invention that offered benefits and risks. These mortgages permitted people
with bad credit histories to buy homes, without relying on guaranties from
government agencies like the Federal Housing Administration. Compared with
conventional mortgages, the subprime variety typically involved higher
interest rates and stiff prepayment penalties.
To many critics, these features were proof of evil
intent among lenders. But the higher rates compensated lenders for higher
default rates. And the prepayment penalties made sure that people whose
credit improved couldn’t just refinance somewhere else at a lower rate, thus
leaving the lenders stuck with the rest, including those whose credit had
worsened.
This made basic sense as financial engineering — an
unsentimental effort to work around risks, selection biases, moral hazards
and human foibles that could lead to disaster.
This might have represented financial progress if
it weren’t for some problems that the designers evidently didn’t anticipate.
As subprime mortgages were introduced, a housing bubble developed. This was
fed in part by demand from new, subprime borrowers who now could enter the
housing market. The bursting of the bubble had results that are now all too
familiar — and taxpayers, among others, are still paying for it all.
Continued in article
Jensen Comment
Accounting theorists and standard setters are constantly being bombarded with
complaints that financial statements and accounting standards are just too
complicated for professional analysts as well as "ordinary" investors. Certainly
there are complexities that can be simplified without great loss in investor
protection. However, some standards become more complex rather than simple
simply because financial innovations become increasingly complex as described
wonderfully in the above article by Professor Shiller.
There's no turning back.
We just cannot replace the fleet of modern aircraft in the U.S. Air Force with
"simple" World War I biplanes. We just cannot replace a 2009 Mercedes and all
its computers with a Model T Ford that my father could tear into pieces, scrape
the head, and put all the pieces together when he was 12 years old in an Iowa
farm barn. My father could've spent the rest of his life just learning how to be
a F-16 or Mercedes mechanic and then, at best, only be an expert on one of many
components on such complex machines.
Similarly, we cannot return to simple accounting standards for complex
derivative financial instruments or complicated financing contracts that defy
simple partitions into debt versus equity. We should keep seeking ways to
simplify as many accounting standards as possible, but in total if we truly want
to protect investors from increasingly complex financial innovations like
Shiller is talking about, we will need increasingly complex accounting standards
to deal with those increasingly complex financial contracts.
What I worry about is that many accounting educators and standards setters
are willing to bury their heads in the sand rather than learn to understand and
track the financial innovations taking place around the world.
Here's one example of a financial innovation.
What is debt? What is equity? What is a Trup?
Banks are going to create huge problems for accountants with newer hybrid
instruments From Jim Mahar's Blog on February 6, 2005 ---
http://financeprofessorblog.blogspot.com/ My guess is that 99.9% of accounting educators have
never studied a Trup!
Now to the big controversy where "Resistance in
Futile"
Sadly we in 2008 we had a Chair of the
SEC who was willing to abuse his powers in favor of
large international accounting firms without giving other stakeholders a voice
in the debate!
Cox tried to force this thing through
quickly before being ridden out of town after the November 2008 election. However, cooler heads have since prevailed to delay, but not derail, the
changeover of US GAAP to International GAAP.
The big news is the apparent sidetracking
of the Herz-Cox Express Train for replacing U.S. accounting standards (FASB
rules) with international standards (IFRS) in 2014. The rush to re-educate and
retrain accountants in the United States is now give a more reasonable time
frame. The rush filing gaps in international GAAP has been give a more
reasonable time frame. There is now more time for the International Accounting
Standards Board to obtain better funding and to improve its infrastructure,
especially its research budget and staff.
Some of the modules below are out of date, but I'm
leaving them for historical references. The Cox-Herz Express Train aimed at
elimination of U.S. GAAP has been delayed from 2014 estimates to possible delays
until after 2020. This greatly alleviates the crisis of rushing to educate
current students and re-educate and train U.S. accountants in IFRS.
Demski’s
(1973) article, ‘‘The General Impossibility of Normative Accounting Standards,’’
reinforced academic reluctance to weigh in on how practice ‘‘ought’’ to proceed.
What quantitative, management accountants read into Demski’s article was that
the accounting standard-setting process was hopelessly and inevitably pointless—
impossible, even—and that it did not deserve any further effort from them.
Academicians began backing off from involvement in standard setting, which
caused further separation of teaching from research, but also exacerbated the
separation of research from practice. In fact, polls revealed that the most
quantitative journals—thus, those least accessible to practitioners—were
perceived to have the highest status in the academy (Benjamin and Brenner 1974).
Glenn Van Wyhe, "A History of U.S. Higher Education in Accounting, Part II:
Reforming Accounting within the Academy," Issues in Accounting Education, Vol.
22, No. 3 August 2007, Page 481.
Three leading accountics professors (from MIT, Chicago, and
Wharton) question the costs versus benefits of the SEC's proposed changeover
from U.S. GAAP to international (IFRS) GAAP "Mind the GAAP: Analyzing the Proposed Switch to
International Accounting Standards," Knowledge@Wharton , April 1, 2009 ---
http://knowledge.wharton.upenn.edu/article.cfm?articleid=2192
But there
are some tough questions about the move that have yet to be
answered, according to Wharton accounting professor
Luzi Hail, who, with professors
Christian Leuz from the University of Chicago and Peter
Wysocki of MIT's Sloan School of Management, recently
conducted research on the potential impacts of the change.
They present their findings in a paper titled, "Global
Accounting Convergence and the Potential Adoption of IFRS by
the United States: An Analysis of Economic and Policy
Factors." In March, the FASB and
its parent, the Financial Accounting Foundation (FAF), sent
a 132-page letter to the Securities and Exchange Commission
reflecting many of the concerns raised in the research,
which received funding from the FASB but, according to Hail,
was conducted and reported independently.
Jensen Comment
Since the large international accounting firms are four-square behind this
transition, I still conclude that U.S. GAAP is in its dying days ---
http://faculty.trinity.edu/rjensen/theory01.htm#MethodsForSetting
Academic arguments at this point are ... well . . . er . . .well . . . academic.
"Companies Exasperate SEC Accounting Chief: He chides them for citing
accounting standards that "few people understand" in their financials and for
their puzzling apathy on IFRS," CFO.com, July 17, 2009 ---
http://www.cfo.com/archives/directory.cfm/2984368
The Securities and Exchange Commission's new top
accountant took a pair of swipes today at the corporate community, showing
frustration over the response to two major accounting standards initiatives.
The SEC's Division of Corporation Finance has been
receiving a "surprisingly" large number of questions recently on the new
codification of accounting standards, noted Wayne Carnall, the division's
chief accountant. What most people want to know, he said, is whether they
have to amend existing filings, so that references to specific standards
using the old numbering system are replaced with references to their new
groupings by topic under the codification, which took effect July 1.
The answer is that they don't. Only filings made
for periods ending after September 15 must refer to the standards as they're
newly codified. But what Carnall finds bothersome is that the question needs
to be asked at all. "You should not be making references to specific
standards that very few [users of financial statements] understand," he
said. Disclosures can be greatly improved and simplified by clearly
expressing the concept the preparer is trying to communicate, as opposed to
citing a standard.
Cornall spoke during a panel discussion of
complexity in financial reporting hosted by the American Institute of
Certified Public Accountants. He said that when it comes to simplifying
financials, while "standard setters and regulators can do a lot," the onus
is also on individual filers and their auditors. "Don't write documents just
to protect yourself from litigation or to satisfy a regulator," he said.
"Think about the user."
His second beef had to do with the number of
comment letters filed about the SEC's roadmap for U.S. adoption of
International Financial Reporting Standards after its release last November.
A total of 240 letters were received, about half of them from registrants.
Cornall called that level of response "disappointing."
"Only about 1% of the companies in the United
States that would be impacted by this change, if we were to adopt it,
decided to comment. I thought that was a surprisingly low number," he said.
He noted that a pair of FASB staff positions issued
in March on what he called a "relatively small, narrow item" — valuing
assets in illiquid markets — got 700 comments in a 15-day comment period.
"Yet on a proposal to change the reporting framework in the United States we
got 120 comments" from public companies during a 120-day comment period.
Meanwhile, FASB chairman Robert Herz, also on the
panel, drew a distinction between "avoidable" and "unavoidable" complexity
in financial reporting. Some complexity is a given because "the world of
business and finance is not simple, and not getting any simpler, and you've
got to have reporting that faithfully tries to report that; you can't just
dumb it down."
But, he added, there's plenty of needless
complexity built into accounting rules because of "particular needs, biases,
special treatments, exceptions, options, and different models for similar
things."
Herz's counterpart on the Canadian Accounting
Standards Board, Paul Cherry, said there's no doubt that clearer, simpler
standards can be written, but a myriad of conflicting interests stand in the
way. "Whether [less complexity] will prove acceptable to the business and
regulatory communities is a huge and important question that won't be
answered for years,"
The module below is out of date, but I'm leaving
them for historical references. The Cox-Herz Express Train aimed at
elimination of U.S. GAAP has been delayed from 2014 estimates to possible
delays until after 2020. This greatly alleviates the crisis of rushing to
educate current students and re-educate and train U.S. accountants in IFRS.
Hi David,
When it comes to resisting the rush to IFRS in the U.S., there are a
number of very rational tacks to take
1. My best argument is that the SEC caved in too soon before making a
very good deal. This is the last moment in history where the U.S. has
considerable leverage over the IASB when deciding whether to abandon U.S.
GAAP. Firstly, the U.S. could've held out for an IASB with a lot more
endowment to cover additional operating expenses for things like a research
staff, cheaper or free publications, and a better Web site. Secondly, the
U.S. could've held out for a better infrastructure in terms of full time
board members and full time staff.
2. Since the large international accounting firms and corporations so
badly want IFRS, the SEC could've insisted they put up tens of millions in
an endowment fund for IFRS. The time will never be better to leverage more
out of the large international firms.
3. As Jim Leisenring points out the convergence could've been slower
rather than a big bang such that some of the controversial converged
standards could be tested in the U.S. courts. He points out that one of the
key advantages of the FASB standards is that they've be wrung out in the
litigious U.S. tort system.
4. The SEC could've held off longer to force the IASB to take up some of
the important areas already covered in the FASB standards for which there
are no IASB standards such as in the areas of FIN 46 and FAS 140. Similarly,
the SEC should insist on better IASB standards on revenue realization.
5. The SEC coould've granted at least a decade to avoid chaos in U.S.
colleges, the CPA examination and review process, the re-writing of
accounting software, and the training of virtually all accountants in
industry and in CPA firms.
6. Don't forget Shyam Sunder's argument against having a standard setting
monopoly. Firstly, monopolies generally stifle innovation. Think of where
electronic communications would be today if AT&T had remained the only phone
company all these years. Secondly, the regulatory monopolies in Europe,
IOSCO, and elsewhere in the world have a rather poor record as Chris Cox
very cogently, and perhaps mistakenly, argued recently ---
http://profalbrecht.wordpress.com/2008/10/08/shyam-sunder-ifrs-critic/
6. The SEC could've waited until the economies of the world recover
before creating huge uncertainties in financial analysis and investment
during an economic crisis that may last for years. During those years the
recovery may be extremely fragile.
7. Lastly the whole rush to convergence does not pass the smell test. The
only thing I smell is train smoke from the Herz-Cox Express.
Now is a great time
for the major players (multinational corporations and the Big Four auditing
firms) who desperately want to dump US GAAP to step forth with tens of millions
of dollars for the endowment of the IASB. Having more resources for research and
the ability to quickly provide guidance on how to account for specific kinds of
contracts such as new securitization and synthetic instruments and variable
interest entities and weird kinds of “revenue” contracting would greatly enhance
IFRS to a point where IFRS standards actually look more comprehensive than FASB
and ASR standards.
My complaint all
along with the Cox-Herz IFRS Express was that the IASB is not yet properly
funded and does not have a suitable infrastructure to become the world’s
monopoly accounting standard setting body. Hopefully, the Express Train will be
sidelined until massive funding that makes the FASB and SEC look puny. The
recent pledge of the EU for funding is a good start, but it falls way short of
what is really needed for a monopoly power.
In the U.S., the
EITF and the DIG have always had great intentions but they’ve been on the cheap.
Let’s fund the IASB big time and create an IETIF and an IDIG that makes their
U.S. counterparts look cheap.
Of course I’m still
bothered by Professor Sunder’s argument against monopolies, but nations are and
probably will continue to selectively opt out of IFRS sections that they don’t
like. You can read about Shyam’s arguments at
http://faculty.trinity.edu/rjensen/theory01.htm#MethodsForSetting
IFRSs from a financial analyst's viewpoint
The cover story of the Winter 2009 issue of
The Investment Professionalpresents a range of
viewpoints – primarily those of professional investors and analysts – on the
benefits and shortcomings of requiring IFRSs for all US SEC registrants. The
Investment Professional is the quarterly journal of The New York Society of
Security Analysts, Inc (NYSSA). The article,
The Hard Sell – SEC in a Quandary over Its Push for IFRS (PDF 551k),
is copyright 2009 by NYSSA and is posted on IAS Plus with
their kind permission. Here is a brief excerpt:
Deloitte's IAS Plus, March 9, 2009 ---
http://www.iasplus.com/index.htm
Free and Low-Cost Online Access to IFRS and Other IASB Files
In April 2009, the IASB
for the first time provides free downloads for its core international standards
---
http://www.iasb.org/IFRSs/IFRS.htm
This renders some of the messaging below obsolete. However, since only the core
standards are available for free from the IASB, some of the information
below is relevant for other IASB documents.
Pat Walters informed me of a heck of a good deal that provides free online
access to online IASB documents (including standards and interpretations) to
members of KPMG's IAAER. Annual dues are $25 with a $5 discount to students.
There are other helpful education materials available to IAAER members. Become a
member at
http://www.iaaer.org/join/index.htm
You will receive a password via email
Some other recent communications regarding IFRS education materials are shown
below:
Deloitte IFRS curriculum materials are now available Deloitte (United
States) is making available a complete set of IFRS course materials through
Deloitte's IFRS University Consortium. Featuring on-campus lectures and
transcripts from Deloitte subject matter leaders, actual case studies and
case solutions, and other materials, the course is available free to all
colleges and universities. Course materials are divided into eight sessions,
with each session containing a unique set of presentations, case studies,
and lecture notes. The materials include a detailed introduction to IFRS and
provide an overview of the differences between IFRS and US generally
accepted accounting principles. Specific topics covered in the Deloitte IFRS
curriculum materials include:
* financial statement presentation;
* revenue, inventory and income tax;
* business combinations, discontinued operations and foreign currency;
* intangibles and leases;
* property and asset impairment;
* provisions, pensions and share-based payments;
* financial instruments; and
* consolidation policy, joint ventures and associates.
I am very pleased to share with you that the Ernst
& Young Academic Resource Center (EYARC), a $1.5 million investment
sponsored by the Ernst & Young Foundation, has just released Phase II of our
IFRS curriculum materials. Phase II materials complement the Phase I
curriculum made available earlier this year. We now offer you full coverage
of the three most common financial accounting and reporting courses:
Intermediate I, Intermediate II and Advanced Accounting.
Created through a virtual collaboration of faculty
and Ernst & Young professionals, our curriculum is designed to be flexible
and comprehensive enabling you to integrate IFRS with US GAAP in a manner
unique to your teaching style.
. . .
Our curriculum, along with other useful faculty
resources, is available to you through a private password-protected site at
www.ey.com/us/arc . If you do not have account
access or if you have any questions regarding the EYARC, please contact
Catherine Banks, EYARC Program Director, at +1 206 654 7793 or
catherine.banks@ey.com .
In the event that you are attending the AAA
national convention in New York next month, we welcome you to attend our
EYARC hosted concurrent session on IFRS integration on Tuesday, August 4
from 10:15 – 11:45 a.m. We are confident that this curriculum will be
helpful to you and your academic program. We look forward to continuing to
support you with resources from our EYARC!
You might want to
check out my wiki on IFRS, located at
http://ficpa-ifrs.wikispaces.com/
i hope
that you and all AECM interested parties will join the website and
contribute to our joint learning.
Roger Debreceny
pointed out to me that Hong Kong has adopted IFRS with no exceptions
from IFRS as published by the IASC and the IASB. Although they have
changed the numbering a bit, the regulations are word for word and
available for free at their website. See the preface to the material
for copyright information.
http://www.hkicpa.org.hk/hksaebk/HKSA_Members_Handbook_Master/volumeII/preface.pdf
Additionally, the
2008 IFRS XBRL taxonomy is available for free download from
www.iasb.org A handy viewer is located here:
http://xbrl.iasb.org/xbev/viewer/presentation/index.html
Since the IFRS taxonomy follows the bound volumn
regualtions paragraph by paragraph, the viewer is an excellent way for
discovering by topic treatment of accounting issues in IFRS. The viewer
exposes a presentation view, a calculation view and a item view. Also
included is a handy look-up tool that students could easily use.
I think these online tools
and the ones already mentioned create a wealth of material for bringing
IFRS into ANY level accounting course. Anyone want to help documenting
this idea?
Neal
January 21, 2009 reply from Bob Jensen
Hi Neal,
Since Paul Pacter resides in Hong Kong but
is still a key player in the IASB, perhaps he will enlighten us about
whether we can count on this Hong Kong freebie to continue.
Thank you for pointing out this Hong Kong
Website that has IFRS content available for free.
I’m inclined to think that the free public
access to Hong Kong Volume II
(
http://www.hkicpa.org.hk/ebook/HKSA_Members_Handbook_Master/volumeII/contentpage.pdf
) is a Website oversight since the Master Volume is only available to
members of the Hong Kong CPA Institute. Now that information is leaking out
about this Volume II freebie to the world it’s a question of how long this
can remain free to the world.
What we are testing here is an efficient
markets hypothesis. If the IASB is dependent upon revenue from sales of its
standards and interpretations it can hardly allow any Web server to offer up
free content that is identically verbatim with content that is not free from
the IASB (aside from slight and obvious changes in numbering). I guess the
same can be said for the currently free 2008 IFRS XBRL available from the
IASB itself.
It would be great for academe if Hong Kong
and the IASB continue these backdoor freebie alternatives, but I would not
count on it for your students. Many college libraries either do or will soon
subscribe to Comperio from PwC. This is allows faculty and students to have
free online access to FASB Standards, IASB Standards, and a wealth of other
database information with the powerful Comperio search engine ---
http://www.pwc.com/Extweb/aboutus.nsf/docid/58B3A4A2F1C2053680256E2800357A82
But Comperio is not cheap. Perhaps an argument can be made with campus
librarians that Comperio has become more essential in the period of
transition from U.S. GAAP to IFRS since students must worry about both sets
of standards during the transition period and Comperio is very helpful in
this regard.
But who can argue with a Hong Kong freebie
as long as the IASB allows this leakage to the world?
In preparation for a May 14th
talk at Florida State, i have assembled a wiki,
http://ficpa-ifrs.wikispaces.com/ where i have
posted several recent articles about the SEC IFRS roadmap. Please feel free
to visit, join the wiki and contribute to the materials assembled. Thanks,
Neal Hannon
Free IEASB Standards (but not IASB Standards themselves) The International Accounting Education Standards Board
(IAESB) has released the 2009 edition of its Handbook of International Education
Pronouncements. The Handbook contains the IAESB's eight International Education
Standards (IESs), including the IAESB Framework for International Education
Pronouncements and Introduction to International Education Standards, as well as
three International Education Practice Statements. The handbook can be
downloaded free of charge in PDF format from the IFAC Online Bookstore
www.ifac.org/store .
Printed copies can be ordered now for shipment in early April.
Deloitte's IASB Plus, March 27, 2009 ---
http://www.iasplus.com/index.htm
IFRS standards (usually referred to as the "bound
volume") are only available for a fee because sales of publications is one
of the IASB's primary revenue streams.
That said, academics can get an on-line
subscription to the IASB (ability to download the standards, etc) for
(the dues fee of ) $25 if you join the IAAER and your
students can get a subscription for their dues fee of only $20.
In the Netherlands we teach local and IASB-rules.
IFRS is obligatory only for consolidated annual reports of listed companies.
Besides IFRS we have the commercial code and local Standards for non-listed
companies and parent companies statements only. This hodgepodge of sometimes
conflicting standards makes teaching financial accounting and reporting a
great challenge. However, it makes clear that financial accounting is a
professional activity where professional judgements are to be made. There is
no single mechanical rule that can be applied in all cases.
In my view the accounting profession can only reach
a higher level when prominent accounting scholars lead the way.
I really like this discussion and this (AECM)
listserv.
Regards,
Dick van Offeren
Leiden University the Netherlands
I am
obviously not European, but I know a little bit about what has been
happening around the world.
The
ACCA, a body that qualifies accountants, primarily in Europe, Asia and
the Caribbean has for some years now, allowed candidates to focus in
their exams, on the IFRSs. The texts produced for the exams are
therefore, IFRS-friendly. Following is a link to the site of one
learning material provider:
“Applying International Financial Reporting Standards,
published in December 2006 by John Wiley and Sons (Australia). The focus
of this 1,236-pagetextis
on the interpretation, analysis, illustration, and application of IFRSs.
The textbook has been written for intermediate and advanced financial
reporting courses, at both undergraduate and postgraduate level, and
aligns with the knowledge expectations of the accounting profession.
Paul's co-authors are KeithAlfredson,
former chairman of the Australian Accounting Standards Board (AASB);
Ruth Picker, IFRIC member and a technical partner of Ernst & Young; Ken
Leo and Jeannie Radford, both of Curtin University of Technology; and
Victoria Wise of Victoria University. Here is the
Book's Home Page, for more information and
on-line purchasing. Or, for international orders, emailcustservice@johnwiley.com.au”
“UNDERSTANDING
INTERNATIONAL FINANCIAL REPORTING STANDARDS IS THE FIRST BOOK TO MAKE
IFRS ACCESSIBLE TO STUDENTS. IT COVERS THE PRINCIPLES AND APPLICATION OF
ALL IFRS AND INCLUDES:
SUMMARIES (INCLUDING FLOWCHARTS) OF THE KEY POINTS OF EACH IFRS
EXAMPLES SHOWING THE APPLICATION OF THE PRINCIPLES IN EACH IFRS
EXTRACTS FROM THE PUBLISHED FINANCIAL STATEMENTS OF COMPANIES THAT
USE IFRS
BRIEF EXPLANATIONS OF HOW IFRS PRINCIPLES DIFFER FROM NATIONAL
PRINCIPLES
DISCUSSION AND EXAMINATION QUESTIONS
YOU CAN PURCHASE UNDERSTANDING IFRS FROM THEPEARSON
WEBSITE” (ISBN 0273679007)
Full
disclosure: I know and speak to both Paul Pacter and David Cairns but am
in no way associated with them or their publications. I do, however,
recommend these publications.
With Kind Regards,
David Raggay
Managing Principal
IFRS Consultants
Offices: 625 Link Road, Lange Park Chaguanas, Trinidad, W.I.
& 67 Tragarete Road, Port of Spain Trinidad, W.I.
Among those mounting a grassroots movement to slow
the rush to IFRS are Analyst's Accounting Observer newsletter editor
Jack Ciesielski, former FASB member Ed Trott, and Bowling
Green State University professor David Albrecht (who has compiled the arguments
of seven IFRS critics, including Niemeier and himself, on his blog
The Summa).
Among their arguments: preliminary research from Europe shows that the
international "standards" in fact afford investors little comparability among
financial statements, one of the key reasons given for U.S. convergence.
Niemeier is also leery of letting the International Accounting Standards Board (IASB)
be the standards-setter for the world, given its recent capitulation to pressure
from European Union authorities to loosen fair-value accounting for banks.
Alix Stuart, "Which One When? A roundup of key accounting deadlines,
developments, and detours to watch for in 2009," CFO Magazine, January 1,
2009 ---
http://www.cfo.com/article.cfm/12834698?f=search
It’s foolish not to book and maintain derivatives at fair value since in the
1980s and early 1990s derivatives were becoming the primary means of
off-balance-sheet financing with enormous risks unreported financial risks,
especially interest rate swaps and forward contracts and written options.
Purchased options were less of a problem since risk was capped.
Tom’s argument for maintaining derivatives at fair value even if they are hedges
is not a problem if the hedged items are booked and maintained at fair value
such as when a company enters into a forward contracts to hedge its inventories
of precious metals.
But Tom and I part company when the hedged item is not even booked, which is the
case for the majority of hedging contracts. Accounting tradition for the most
part does not hedge forecasted transactions such as plans to purchase a million
gallons of jet fuel in 18 months or plans to sell $10 million notionals in bonds
three months from now. Hedged items cannot be carried on the balance sheet at
fair value if they are not even booked. And there is good reason why we do not
want purchase contracts and forecasted transactions booked. Reason number 1 is
that we do not want to book executory contracts and forecasted transactions that
are easily broken for zero or at most a nominal penalties relative to the
notionals involved. For example, when Dow Jones contracted to buy newsprint
(paper) from St Regis Paper Company for the next 20 years, some trees to be used
for the paper were not yet planted. If Dow Jones should break the contract, the
penalty damages might be less than one percent of the value of a completed
transaction.
Now suppose Southwest Airlines has a forecasted transaction (not even a
contract) to purchase a million gallons of jet fuel in 18 months. Since it has
cash flow risk, it enters into a derivative contract (usually purchased option
in the case of Southwest) to hedge the unknown fuel price of this forecasted
transaction. FAS 133 and IAS 39 require the booking of the derivative as a cash
flow hedge and maintaining it at fair value. The hedged item is not booked.
Hence, the impact on earnings for changes in the value would be asymmetrical
unless the changes in value of the derivative were “deferred” in OCI as
permitted as “hedge accounting” under FAS 133 and IAS 39.
If there were no “hedge accounting,” Southwest Airlines would be greatly
punished for hedging cash flow by having to report possibly huge variations in
earnings at least quarterly when in fact there is no cash flow risk because of
the hedge. Reported interim earnings would be much more stable if Southwest did
not hedge cash flow risk. But not hedging cash flow risk due to financial
reporting penalties is highly problematic. Economic and accounting hit head on
for no good reason, and this collision was avoided by FAS 133 and IAS 39.
Since the majority of hedging transactions are designed to hedge cash flow or
fair value risk, it makes no sense to me to punish companies for hedging and
encouraging them to instead speculate in forecasted transactions and firm
commitments (unbooked purchase contracts at fixed prices).
The FASB originally, when the FAS 133 project was commenced, wanted to book all
derivative contracts and maintain them at fair value with no alternatives for
hedge accounting. FAS 133 would’ve been about 20 pages long and simple to
implement. But companies that hedge voiced huge and very well-reasoned
objections. The forced FAS 133 and its amending standards to be over 2,000 pages
and hellishly complicated.
But this is one instance where hellish complications are essential in my
viewpoint. We should not make the mistake of tossing out hedge accounting
because the standards are complicated. There are some ways to simplify the
standards, but hedge accounting standards cannot be as simple as most other
standards. The reason is that there are thousands of different types of hedging
contracts, and a simple baby formula for nutrition just will not suffice in the
case of all these types of hedging contracts.
First, I picked my OilCo example because it was
also accounted for as a ‘hedge’ of an anticipated transaction—just like your
Southwest example. I hope you agree that OilCo was speculating. As to
Southwest, you say that Southwest was hedging, but I say they were
speculating. If fuel prices had gone south instead of north, Southwest would
have been at a severe cost disadvantage against the airlines that did not
buy their fuel forward (and they would have become a case study of failure
instead of success). In essence, the forward contracts leveraged their
profits and cash flows. That’s not hedging, it’s speculating.
FAS 133 has been an abject failure, as have all
other ‘special hedge accounting’ solutions that came before it. There will
always be some sort of mismatch between accounting and underlying economics,
but ‘special hedge accounting’ is not the way to mitigate that. You say that
some companies would have been unfairly penalized by entering into hedges
without hedge accounting. I say, with current events providing evidence,
that much more value was destroyed because special hedge accounting provided
cover for inappropriate speculation. To managers, it has been all about
keeping risks off the balance sheet and earnings stable; reducing
(transferring) economic risks that shareholders may be exposed to is an
afterthought. And, besides, most of the time shareholders can reduce their
risks by diversification. As we have seen the hard way, transaction risk
reduction (what FAS 133 requires) can be more than offset by increases in
enterprise risk. On a global scale, FAS 133 (and IAS 39) has done much more
to enable managers to use derivatives as instruments of mass economic
destruction than help them manage economic risks. And of course, instead of
2000 pages of guidance (and the huge costs that go along with it), we’d have
20 pages.
Although I did not mention it in my blog post, I
could be reluctantly persuaded to allow hedge accounting for foreign
currency forwards, but that’s as far as I would go.
Best,
Tom
June 30, 2009 reply from
Bob Jensen
Hi Tom,
Southwest Airlines was hedging and not speculating when
they purchased options to hedge jet fuel prices. If prices went down, all
they lost was the relatively small price of the options (actually there were
a few times when the options prices became too high and Southwest instead
elected to speculate). If prices went up, Southwest could buy fuel at the
strike price rather than the higher fuel prices. If Southwest had instead
hedged with futures, forward, or swap derivative contracts, it is a bit more
like speculation in that if prices decline Southwest takes an opportunity
loss on the price declines, but opportunity losses do not entail writing
checks from the bank account quite the same as real losses from unhedged
price increases.
In any case, Southwest's only possible loss was the
premium paid for the purchase options and did not quite have the same
unbounded opportunity losses as with futures, forwards, and swaps. In
reality, companies that manage risks with futures, forwards, and swaps
generally do not have unbounded risk due to other hedging positions.
What you are really arguing is that accounting for most
derivatives should not distinguish “asymmetric-booking” hedging
derivative contracts from speculation derivative contracts. I
argue that failure to distinguish between hedging and speculation is very,
very, very, very misleading to investors. I do not think FAS 133 is an
"abject failure." Quite to the contrary (except in the case of credit
derivatives)!
I have to say I disagree entirely about “derivatives”
being the cause of misleading financial reporting. The current economic
crisis was heavily caused by AIG’s credit derivatives that were essentially
undercapitalized insurance contracts. Credit derivatives should’ve been
regulated like insurance contracts and not FAS 133 derivatives. Credit
derivatives should never have been scoped into FAS 133.
The issue in your post concerns derivatives apart from
credit derivatives, derivatives that are so very popular in managing
financial risk, especially commodity price risk and interest rate
fluctuation risk. Before FAS 119 and FAS 133 it was the wild west of
off-balance sheet financing with undisclosed swaps and forward contracts,
although we did have better accounting for futures contracts because they
clear for cash each day. Scandals were soaring, in large measure, due to
failure of the FASB to monitor the explosion in derivatives frauds. Arthur
Levitt once told the Chairman of the FASB that the FASB’s three biggest
problems, before FAS 133, were 1-derivatives, 2-derivatives, and
3-derivatives ---
http://faculty.trinity.edu/rjensen/FraudRotten.htm#DerivativesFrauds
When you respond to my post please take up the issue of
purchase contracts and non-contracted forecasted transactions since these
account for the overwhelming majority of “asymmetric-booking” derivatives
contracts hedges being reported today. Then show me how booking changes in
value of a hedging contract as current earnings makes sense when the changes
in value of the hedged item are not, and should not, be booked.
Then show me how this asymmetric-booking reporting of
changes in value of a hedging contract not offset in current earnings by
changes in the value of the item it hedges provides meaningful information
to investors, especially since the majority of such hedging contracts are
carried to maturity and all the interim changes in their value are never
realized in cash.
Show me why this asymmetric-booking of changes in value
of hedging contracts versus non-reporting of offsetting changes in the value
of the unbooked hedged item benefits investors. Show me how the failure to
distinguish earnings changes from derivative contract speculations from
earnings changes from derivative hedging benefits investors.
What you are really arguing is that accounting for such
derivatives should not distinguish hedging derivative contracts from
speculation derivative contracts. I argue that failure to distinguish
between hedging and speculation is very, very, very, very misleading to
investors.
Derivative contracts are now the most popular vehicles
for managing risk. They are extremely important for managing risk. I think
FAS 133 and IAS 39 can be improved, but failure to distinguish hedging
derivative contracts from speculations in terms of the booking of value
changes of these derivatives will be an enormous loss to users of financial
statements.
The biggest complaint I get from academe is that
professors mostly just don’t understand FAS 133 and IAS 39. I think this
says more about professors than it does about the accounting. In fairness,
to understand these two standards accounting professors have to learn a lot
more about finance than they ever wanted to know. For example, they have to
learn about contango swaps and other forms of relatively complex hedging
contracts used in financial risk management.
Finance professors, in turn, have to learn a whole lot
more about accounting than they ever wanted to know. For example, they have
to learn the rationale behind not booking purchase contracts and the issue
of damage settlements that may run close to 100% of notionals for executed
contracts and less than 1% of notionals for executory purchase contracts.
And hedged forecasted transactions that are not even written into contracts
are other unbooked balls of wax that can be hedged.
There may be a better way to distinguish earnings
changes arising from speculation derivative contracts versus hedging
derivative contracts, but the FAS 133 approach at the moment is the best I
can think of until you have that “aha” moment that will render FAS 133 hedge
accounting meaningless.
I anxiously await your “aha” moment Tom as long as you
distinguish booked from unbooked hedged items.
Bob Jensen
"The New Role of Risk Management: Rebuilding the Model," Interview with Wharton
professors Dick Herring and Francis Diebold, and also with John Drzik, who is
president and chief executive officer of Oliver Wyman Group, Knowledge@wharton,
June 25, 2009 ---
http://knowledge.wharton.upenn.edu/article.cfm?articleid=2268
Question
Why then does the company still use forward contracts to "immunize" its
operations?
Jensen Comment
I disagree with Tom Selling's comment that hedging is just another form of
speculation. It is true that companies that hedge cash flows, fair value, or
foreign currency are missing out on opportunity gains and losses, but the
reasons for speculation versus hedging are usually entirely different. A company
like Timken wants to make money in manufacturing and does think it has the
expertise or desire to take on speculation risks in foreign currency markets.
http://faculty.trinity.edu/rjensen/caseans/000index.htm
And posting changes in fair value of hedging
contracts to current earnings creates fictional volatility in current
earnings for unbooked hedging contractors. Firms that try not to speculate
with hedges are hammered with "speculating" volatility.
Teaching Case from The Wall Street Journal Accounting Weekly Review on
October 22, 2010
SUMMARY: "The slumping U.S. dollar is opening new sales opportunities
abroad for American manufacturers, who are worried about a sputtering
economy but also concerned about how to cope with a volatile currency
market. Many U.S. companies...are seeing stronger demand in Europe and Asia
as the weak dollar makes U.S. goods cheaper there." Three cases in this
article provide examples for use of forward or futures contracts to sell
currencies, forward or futures contracts to purchase currencies, and
contracts to hedge net investments in overseas operations.
CLASSROOM APPLICATION: The opening statement allows instructors to
emphasize that any size operation may need expertise in handling foreign
currency exchange. Questions also ask students to understand the nature of
the current volatility in foreign exchange markets; the reasons why a weaker
dollar helps U.S. producers; and the various uses of forward exchange
contracts.
QUESTIONS:
1. (Advanced) What economic factors are influencing overall volatility in
today's currency markets? What factors are influencing the fall of the U.S.
dollar in particular?
2. (Advanced) Explain why a fall in the value of the dollar helps make
products, such as Consol Energy's coal and natural gas, cheaper relative to
others trading in world markets.
3. (Introductory) Andrew Logan is president of his namesake company which
operates in Cleveland and makes clutches for industrial and marine
equipment. What did he do to begin selling his products overseas? How did
that strategy turn out?
4. (Introductory) What factors influence whether Mr. Logan's potential
customers will decide to select him as a vendor?
5. (Advanced) Assume that Logan Clutch Corp. makes sales denominated in
currencies of the countries in which the customer is located. How will the
value of the dollar influence these transactions? What types of foreign
exchange contracts might this company enter inGo to manage these sales?
6. (Introductory) Consider the case of Terex Corp. the large, Connecticut
based producer of manufacturing equipment. How does this company use forward
contracts? Why does its CEO, Ron DeFeo, say that the "last thing he wants to
see is a 'yo-yo situation'," or excessive volatility in currency values,
regardless of his use of forward contracts?
7. (Advanced) Consider the case of Timken Co which makes roller bearings and
other industrial goods in many worldwide locations. Why does that structure
mean that currency swings do not have a big impact on sales? Why then does
the company still use forward contracts to "immunize" its operations?
Reviewed By: Judy Beckman, University of Rhode Island
The slumping U.S. dollar is opening new sales
opportunities abroad for American manufacturers, who are worried about a
sputtering economy but also concerned about how to cope with a volatile
currency market.
Many U.S. companies—from coal miners to a producer
of tugboat clutches—are seeing stronger demand in Europe and Asia as the
weak dollar makes U.S. goods cheaper there.
Economists say the dollar's swoon, which started in
mid-September following a summer rally, will provide a modest boost for U.S.
exports, but they caution that it means American consumers and businesses
will pay more for imported goods and raw materials.
The weak dollar is helping Consol Energy Inc., a
big Pittsburgh-based coal and natural-gas producer, compete with South
African and Australian miners for coal sales to the key Chinese market, says
Bob Pusateri, Consol's executive vice president for marketing. To improve
its export prospects, Consol opened offices this year in Shanghai, Beijing,
Seoul, Tokyo and Zug, Switzerland, through a partnership with a trading
firm.
The timing of the dollar's drop has been especially
favorable for Consol. China is showing a renewed interest in building up
[its] commodity inventories," Mr. Pusateri says. Consol's coal sales to
China are likely Go total nearly three million tons both this year and in
2011, up from 500,000 tons in 2009, he says. The sagging dollar also is
helping Consol in Europe and Latin America.
Last week, the Commerce Department reported that
U.S. imports grew much more rapidly than exports in August, widening the
trade deficit and further damping the dollar. Expectations that the Federal
Reserve will create more currency to buy bonds also are driving down the
dollar's value.
The rapidity of the dollar's drop has some
companies on edge. "The volatility is what really kills manufacturing," says
Ron DeFeo, chief executive of Terex Corp., a big maker of cranes, excavators
and other construction equipment, based in Westport, Conn. "We can plan for
a certain bandwidth of currency variation," he says.
For instance, the company uses forward contracts,
which lock in currency-exchange rates on certain future dates, and it buys
parts in a variety of currencies. "We're fine for now," Mr. DeFeo says, as
currency rates haven't reached "extremes." But a further, sustained drop in
the dollar would force Terex to rethink where it buys some of its parts and
where it makes certain products. The executive says the last thing he wants
to see is "a yo-yo situation," with currencies bouncing up and down.
A strong dollar tends to help Terex, making it
easier to sell machinery it makes in Europe to U.S. customers. But Terex
also exports machinery from the U.S. With plants in both places, Mr. DeFeo
says, to some extent "we have a natural hedge" against currency swings.
But Mr. DeFeo says governments shouldn't see a
weaker currency as a cure for their economies: "Currency weakness is not an
export strategy, in my opinion." Though a weak currency can help exports, at
least in the short run, he would rather see a strong dollar "because it's a
reflection of the U.S. economy" and its overall health.
Despite the weak dollar, Joshua Shapiro, chief U.S.
economist for MFR Inc., an economic advisory firm in New York, expects U.S.
export growth to slow to a range of 4.5% to 5% next year from an estimated
8.4% in 2010 because buyers of manufactured goods have largely rebuilt
depleted inventories.
Ken Matheny, a senior economist at Macroeconomic
Advisers LLC in St. Louis, is more bullish. He says the recent drop in the
dollar will help keep export growth robust in the next couple of years and
help buoy overall U.S. economic growth.
Andrew Logan, president of Cleveland-based Logan
Clutch Corp., a maker of clutches for industrial and marine equipment,
including tugboats and snow-removal equipment, began carting its products to
trade shows in Asia and Europe 18 months ago. His efforts paid off. Exports
at the family-owned company this year are running at about 20% of sales,
nearly double the rate last year, Mr. Logan says.
"When the dollar started to slide and stay there,
we had more European customers interested in our products," says Mr. Logan.
Some overseas customers believe the dollar will stay weak for a long spell,
and that means "they're more willing to make a commitment" to buying Logan
clutches, which are designed to cut energy costs, he says.
With oil priced in dollars, one risk is that oil
producers could push up their prices to compensate for the decline in the
dollar value of their products, says Joseph LaVorgna, chief U.S. economist
for Deutsche Bank AG in New York. Higher energy costs could shatter American
consumers' already-fragile confidence, and thus drag down manufacturers,
which also would be hurt by higher energy costs.
Business confidence already is wavering amid signs
the economy remains anemic. A Business Council survey of CEOs, released last
week, showed one-third expect improving business conditions over the next
six months, down from two-thirds in May.
Despite the gloom, says Larry Kantor, global head
of research for Barclays Capital in New York, the weak dollar "is a net plus
for the U.S. economy." In the absence of free-trade agreements,A weaker
dollar "is one of the few ways you can get exports going," says Mr. Kantor,
who thinks many U.S. energy, industrial and agricultural companies will
benefit.
For global companies based in the U.S., the impact
of currency swings can be muted because they have factories in many
countries and costs in a variety of currencies. At St. Paul, Minn.-based 3M
Co., whose products ranging from dental supplies to films used in computer
screens, the weaker dollar provides only a small boost, says Steven Winoker,
an analyst at Sanford C. Bernstein & Co. He recently lifted his forecast of
3M's 2011 earnings to $6.20 a share, compared with his forecast of $5.54 in
2010. The 2011 forecast is about three cents more than it would have been
without the dollar's drop.
A 3M spokeswoman declined to comment.
"We tend to manufacture where we sell our
products," says Glenn Eisenberg, chief financial officer at Timken Co. The
Canton, Ohio-based maker of roller bearings, gear boxes and other industrial
goods has manufacturing plants in 12 countries. As a result, he said,
currency swings "tend not to be a big issue," but the company does try to
"immunize" itself against them by using forward contracts. In the first half
of 2010, Timken says, currency fluctuations added about 1% to its global
sales in dollar terms.
For some smaller companies, the dollar's weakness
offers greater potential benefits because they are growing from a small
base. Ron Overton, president of Overton Industries Inc., a tool-and-die
company in South Mooresville, Ind., recently hired a marketing company in
ChicaGo to help find more buyers in Japan and elsewhere in Asia.
With the dollar on the ropes, "We have a little bit
of a price advantage," says Mr. Overton, whose company traditionally has
relied on North American for nearly all its sales.
At Webco Industries Inc., a maker of metal tubes
based in Sand Springs, Okla., the weak dollar helps in another way. Along
with spurring exports, it makes its products less expensive than imports. It
is "going to help us be insulated against foreign competition," says Mike
Howard, chief financial officer.
TOPICS: Foreign Currency Exchange Rates, Operating Income SUMMARY:
Nintendo keeps large amounts of cash balances generated from its worldwide
revenues in those foreign currencies rather than converting them to
yen"....Nintendo's 2.1 billion yen ($24.8 million) loss for the half [year]
through September [30, 2010] largely was because of ...losses on its
foreign-currency reserves. Of those reserves, $3.4 billion was in dollars
and €billion ($3.76 billion) was in euros. The company posted an operating
profit of 54.23 billion yen...." CLASSROOM APPLICATION: The article is
useful to introduce foreign currency transactions, foreign currency
translation, and hedging. QUESTIONS: 1. (Introductory) Why does Nintendo
have cash holdings ("reserves") in so many currencies?
2. (Introductory) Explain how the rising value of the yen relative to
other currencies has resulted in losses to be recorded on Nintendo's
financial statements. (Note: In your answer, you may consider accounting
requirements for these foreign currencies under IFRS rather than having to
investigate Japanese national accounting practices since, in December 2009,
the Japanese Financial Services Agency (FSA) began permitting at least some
Japanese companies to apply IFRSs for fiscal years ending on or after March
31 2010. It is the case, however, that the company prepares its financial
statements under Japanese accounting standards.)
3. (Advanced) Why are these currency losses considered to be "paper
losses"?
4. (Advanced) "Nintendo does some, but much less [than other similar
companies]-hedging to lock in fixed foreign-exchange rates." What type of
foreign currency hedge transaction would Nintendo have to enter inGo to
offset the losses seen in the company's September 2010 interim financial
statements?
5. (Advanced) How does Nintendo's strategy of holding foreign currencies
reflect a long-term rather than short-term viewpoint?
6. (Advanced) Given the fact that the company posted an operating profit
of 54.2 billion yen, where in the income statement do you think the foreign
currency losses are shown?
Reviewed By: Judy Beckman, University of Rhode Island
Like many Japanese companies, Nintendo Co. recently
reported a big hit to its financial results from the strong yen.
But unlike its brethren, reduced exports weren't
the main cause of Nintendo's first interim net loss in seven years. The
bigger problem for the home of Super Mario was the company's unusually large
$7.4 billion pile of cash held in foreign currencies at the end of its
fiscal first half, representing nearly 70% of Nintendo's total cash
holdings.
A strong yen affects all Japanese exporters when
overseas sales of cars, electronics and other products are translated into
the Japanese currency, and Nintendo is no exception. The companies do
whatever they can to combat the strength of the yen, which is trading near
15-year highs against the dollar. On top of hedging to lock in fixed
foreign-exchange rates, which Nintendo does on a limited basis, many are
slashing costs to squeeze out profits. Like many other Japanese companies
operating globally, Kyoto-based Nintendo also makes as many overseas
payments as possible with dollars to offset the currency impact.
But Nintendo stands out from the pack by keeping
large amounts of revenue in foreign currencies rather than converting it to
yen. In recent years, the company has generated an unusually high 80% or
more of its revenue outside Japan, largely thanks to the popularity of its
Nintendo Wii game console and the DS hand-held game system. With
foreign-currency reserves among the highest for Japanese exporters, that has
exposed Nintendo to bigger paper losses on reserves when the yen
appreciates.
Nintendo's 2.01 billion yen ($24.8 million) loss
for the half through September largely was because of 62.1 billion yen in
appraisal losses on its foreign-currency reserves. Of those reserves, $3.4
billion was in dollars and €2.7 billion ($3.76 billion) was in euros. The
company posted an operating profit of 54.23 billion yen, but that was down
48% from a year earlier.
Nintendo justifies its foreign-currency strategy as
a way to take advantage of higher interest rates overseas while saving on
the commissions required for exchanging foreign currencies. The policy also
reflects Nintendo's distinctive long-term thinking: The value of its foreign
cash may be down this year because of the yen's strength, but it could rise
in coming years, resulting in appraisal gains. Since fiscal 2000, Nintendo
has been alternating every few years between appraisal gains and losses on
its foreign currency holdings, though it has consistently posted net profits
for its fiscal years. For the current year, which runs through March,
Nintendo has forecast a net profit of 90 billion yen.
The company occasionally converts some of its
foreign cash into yen "whenever the rates are favorable," said Nintendo
spokesman Ken Toyoda. "There are some payments we have to make in yen, such
as taxes, so we make sure we always have enough yen to cover those." Because
Nintendo holds many currencies other than the dollar and the euro, it can
selectively convert the currencies that are relatively strong against the
yen.
Nintendo also uses either 33% of its group
operating profit or 50% of its net profit, whichever is higher, for its
total dividend payout. That allows the company to keep its dividend
relatively strong—and keep investors satisfied—even when foreign-exchange
losses weigh on the bottom line.
"I think Nintendo's management philosophy is quite
different from most other companies," said Tokai Tokyo Research Center
analyst Yusuke Tsunoda. Nintendo's currency strategy indicates that, instead
of focusing on short-term results, Nintendo measures its performance over a
longer period, perhaps taking a few years at a time, he said. "Some retail
investors may occasionally complain, but this is just how Nintendo is," he
said. Institutional investors generally are aware of and accept the
company's currency policy.
Sony Corp. Chief Financial Officer Mamoru Kato said
his company wouldn't consider adopting Nintendo's currency policy, though he
didn't pass judgment on his rival's choice. Sony's cash deposits in foreign
currencies are small and any gains or losses on them have little impact on
its earnings, the company said. Panasonic Corp. also said its foreign cash
deposits have almost no impact on its bottom line.
"Nintendo has its own way of thinking, maybe much
longer-term thinking," Mr. Kato said.
Nintendo nevertheless is considering making
adjustments to its singular stance as interest-rate differences between
Japan and other major countries have narrowed and foreign-exchange rates
have become increasingly volatile. "We may be at a point where we need to
reassess the advantages and disadvantages of holding money in foreign
currencies," Nintendo President Satoru Iwata said at the company's annual
meeting in June. "In the long run, the most effective method is to hold all
the key currencies in a well-balanced manner."
Let’s quit
wishing for a world that doesn’t and won’t ever exist. That’s a child’s
game. Let’s engage the enemy in the world we have. The FASB has
something to contribute to the investment community, and its work is too
important to whine about the tactics of the enemy. Let’s take the fight
to the public. If the FASB did this, I think it would win. And we
would all be better off.
Speaking before the National Press Club, FASB
chairman Robert Herz recently denounced the politicization of accounting. He
correctly stated, "The investing public expects and deserves unbiased and
transparent financial information." Herz also correctly pointed out that
special interests can undermine the usefulness of financial reports by
advocating inferior accounting methods and disclosures. However, wishing
special interests to go away will never eliminate them or their pleas for
bastardized accounting.
Interference by the Congress and the SEC is not a
new thing. Accounting for the investment tax credit in APB Opinion No. 2 was
overturned by Congress, which by law permitted a different method
(subsequently and begrudgingly conceded by the APB in Opinion No. 4). The
FASB opted for successful efforts accounting in FAS 19 only to see it
overturned by the SEC in ASR 253. And recently Congress threatened to
intervene unless the FASB provided some relief with respect to fair value
accounting.
In addition to these instances, the FASB and its
predecessors have faced intense lobbying over a number of accounting issues,
including leasing, restructuring of troubled debt, pensions, business
combinations, and special purpose entities. Whenever the FASB deals with an
important issue, one that will produce “losers”, one should expect aggrieved
parties to express themselves and to resort to the SEC or to Congress for
help.
Previous leaders of the FASB, including Armstrong,
Kirk, and Wyatt, have acknowledged the presence of political factors and how
they prevent standard setters from finding technical solutions to technical
problems. And they yearned for a world in which standard setting would be
insulated from politics. Alas, such a world does not exist.
Leaders of the FASB would be much better off if
they just accepted the world as it is instead of bemoaning the one they
face. Then they should embrace the political challenges and take the
offense, as staying on defense is almost always a losing proposition. And
they should not wait until the political pressures are too great when little
or nothing can be done.
For example, immediately after the collapse of
WorldCom, the FASB should have seized the moment. Investors and creditors
were yelling and screaming for justice after the implosions of Enron and
WorldCom, so much so that the almost economically comatose White House woke
up, the Congress went from almost killing Sarbanes-Oxley to speeding up and
ensuring its passage, and even Harvey Pitt found religion. The FASB should
have taken immediate action to require the expensing of stock options. It
also should have taken steps to change the accounting for special purpose
entities. And, in the process, it could have dared anybody to prevent them
from mandating more truthful and more transparent accounting.
Last year was another golden opportunity that the
FASB let pass. The board members should have known that politicians were
going to step in and force the hand of the FASB. Bankers have lobbied
Washington mercilessly for over a year. Did the FASB really expect our
national politicians to ignore the hands of those who feed them?
The German
Parliament has passed the Act to Modernise
Accounting Law (in German:
Bilanzrechtsmodernisierungsgesetz). A goal of
the legislation is to reduce the financial reporting
burden on German companies. The accounting
requirements under the Act are described as an
alternative to International Financial Reporting
Standards for small and medium-sized companies that
do not participate in capital markets. In announcing
the new law, the German Federal Ministry of Justice
(which administers the Commercial Code (ComC) in
Germany) said:
The
modernised ComC accounting law is also an
answer to the International Financial
Reporting Standards (IFRS), published by the
International Accounting Standards Board (IASB).
The IFRS are geared to suit capital market
oriented enterprises; in other words, they
also serve information needs of financial
analysts, professional investors and other
participants in the capital markets.
By far the majority of those German
enterprises that are required by law to keep
accounts and records do not take part in the
capital market at all. For this reason,
there is no justification for committing all
the enterprises that are required to keep
accounts and records to the cost-intensive
and highly complex IFRS. Also the draft
recently discussed by the IASB of a standard
IFRS for Small and Medium-Sized Entities
is not a good alternative for drawing up an
informative annual financial statement.
Practitioners in Germany have strongly
criticised the IASB draft because its
application – compared with ComC accounting
law – would still be much too complicated
and costly.
The law exempts 'sole
merchants' (prorietorships) with less than €500,000
turnover and Euro 50,000 profit from any obligation
to keep accounts and records. Small companies (less
than 50 employees, assets of €4.8 million, and
annual turnover of €4.8 million) need not have an
audit and may publish only a balance sheet.
Medium-sized companies (less than 250 employees,
assets of €19.2 million, and annual turnover of
€38.5 million) have reduced disclosure requirements
and may combine balance sheet items. Among the new
accounting provisions of the ComC:
Companies
will be permitted to capitalise internally
generated intangible assets, while getting an
immediate tax deduction for the costs.
Financial
institutions will measure financial instruments
designated as 'held for trading' at fair value,
with value changes recognised in a 'special
reserve'. The Ministry of Justice press release
states: 'This special reserve has to be built up
from part of the enterprise's trading profits
when times are good and can then be used to
offset trading losses when times get worse.
Hence this special provision has an anticyclical
effect. Here the necessary steps have been taken
in order to respond to the financial markets
crisis.'
Special
purpose entities that are controlled must be
consolidated.
The new law takes
effect 1 January 2010, with early application for
2009 permitted. Click for
In the land of historic fair value theory, some differences between Dutch
accounting and IFRS seem a bit surprising. For example, the Dutch still require
pooling-of-interests in some circumstances. Also Dutch standards still amortize
goodwill on a historical cost basis).
One of the early contributors to value theory in accounting was Theodore
Limperg from Holland.
The social responsibility of the auditor: A basic theory on the auditor's
function by Theodore Limpberg ((Hard to Find, but no doubt Steve Zeff
has a copy. Steve is an expert on accounting in The Netherlands)
Aug. 20 (Bloomberg) --
How many legs would a calf have if we called its tail a leg?
Four, of course. Calling
a tail a leg wouldn’t make it a leg, as
Abraham Lincoln famously
said.
Nor does calling an
expense an asset make it an asset. This brings us to the odd accounting
rules for the insurance industry, including
Lincoln National Corp., which uses Honest Abe as
its corporate
mascot.
Look at the asset side of
Lincoln National’s
balance sheet, and you’ll see a $10.5 billion item
called “deferred
acquisition costs,” without which the company’s
shareholder equity of $9.1 billion would disappear. The figure also is
larger than the company’s stock-market value, now at $7 billion.
These costs are just that
-- costs. They include sales commissions and other expenses related to
acquiring and renewing customers’ insurance-policy contracts. At most
companies, such costs would have to be recorded as expenses when they are
incurred, hitting earnings immediately.
Because it’s an insurance
company selling policies that may last a long time, however, Lincoln is
allowed to put them on its books as an asset and
write them down slowly -- over periods as long as 30 years in some cases --
under a decades-old set of accounting
rules written exclusively for the industry.
Rule Overhaul
Those days may be
numbered, under a unanimous decision in May by the U.S. Financial Accounting
Standards Board that has received little attention in the press. The board
is scheduled to release a proposal during the fourth quarter to overhaul its
rules for insurance contracts. If all goes according to plan, insurers no
longer would be allowed to defer policy-acquisition costs and treat them as
assets.
One question the board
hasn’t addressed yet is what to do with the deferred acquisition costs, or
DAC, already on companies’ books. While there’s been no decision on that
point, it stands to reason that insurers probably would have to write them
off, reducing shareholder equity. The board already has
decided such costs aren’t an asset and should be
expensed. If that holds, it wouldn’t make sense to let companies keep their
existing DAC intact.
The impact of such a
change would be huge. A few examples: As of June 30,
Hartford Financial Services Group Inc. showed DAC
of $11.8 billion, which represented 88 percent of its shareholder equity, or
assets minus liabilities. By comparison, the company’s stock-market value is
just $7.3 billion.
MetLife, Prudential
MetLife Inc. showed $20.3 billion of DAC,
equivalent to 74 percent of its equity.
Prudential Financial Inc.’s DAC was $14.5 billion,
or 78 percent of equity.
Aflac Inc. said its DAC was worth $8.1 billion as of June 30, which was
more than its $6.4 billion of equity.
Genworth Financial Inc. listed its DAC at $7.6
billion, or 76 percent of net assets. That was more than double the
company’s $3.4 billion stock-market value.
The rules on insurance
companies’ sales costs are a holdover from the days when the so-called
matching principle was more widely accepted among
accountants and investors.
At life insurers, for
example, it’s common to pay upfront commissions equivalent to a year’s worth
of policy premiums. By stretching the recognition of expenses over the
policy’s life, the idea is that companies should match their revenues and
the expenses it took to generate them in the same time period.
The problem with this
approach is that deferred acquisition costs do not meet the board’s standard
definition of an asset. That’s because companies
don’t control them once they have paid them. The money is already out the
door. There’s no guarantee that customers will keep renewing their policies.
No Recognition
Even the industry’s normally friendly state
regulators don’t recognize DAC as an asset for the purpose of measuring
capital, under
statutory accounting principles
adopted by the National Association of
Insurance Commissioners.
To be sure, the FASB’s decisions to date are
preliminary.
How to treat acquisition costs is one of many issues the
board is tackling as part of its broader insurance project. Others include
the question of how to measure insurers’ liabilities for obligations to
policy holders.
Meanwhile, the London-based International
Accounting Standards Board is working on its own insurance
project and has said it would take a more accommodating approach to
policy- acquisition costs.
Insurers would be required to expense them
immediately. However, the IASB has said it would let companies record enough
premium revenue upfront to offset the costs. That way, they wouldn’t have to
recognize any losses at the outset. So far, the U.S. board has
rejected the IASB’s method.
Congress Wild Card
The wild card in all this is Congress. Last
spring, the insurance industry joined banks and credit unions in getting
U.S. House members to
pressure the FASB to change its rules on debt securities, including
those backed by toxic subprime mortgages, so that companies could keep large
writedowns out of their earnings. Because the FASB caved before, it’s a safe
bet the industry would go that route again.
With so much riding on the outcome, we should
expect nothing less. What’s at stake isn’t the real value of the industry’s
assets, but investors’ perceptions of how much they’re worth.
Honest Abe wouldn’t be fooled.
August 20, 2009 reply from Bob Jensen
the current conflict about rules for insurance company accounting
bring to light once again the conflict between income statement versus
balance sheet priorities accounting standard setting.
The matching concept based on historical cost accrual accounting was
always favored the income statement in place of the balance sheet, because
deferred costs were considered obsolete and often arbitrary on the balance
sheet. Payton and Littleton provide one of the best theoretical arguments in
favor of the matching concept where revenues deemed realized are matched
with expenses (or price-level adjusted expenses) used in generating those
revenues ---
http://faculty.trinity.edu/rjensen/theory01.htm#FairValue
Also see mention of Payton and Littleton in
"Research on Accounting Should Learn From the Past," by Michael H.
Granof and Stephen A. Zeff, Chronicle of Higher Education, March 21,
2008
In the 1970s, the matching concept lost favor in accounting when the FASB
decided the balance sheet was to be the primary financial instrument of
concern in standard setting. This was heavily influenced at the time by when
the FASB declared war on off-balance sheet financing that companies were
using to hide financial risk. The FASB subsequently became concerned with
earnings management, but the priority of the balance sheet was never
questioned by the FASB.
Today the thrust of the FASB and the IASB into fair value accounting is
primarily in the interest of making balance sheets more informative to
investors. In the process, fair value accounting greatly confuses the income
statement by mixing realized versus unrealized earnings components in the
bottom line. This has led some powerful accounting
leaders like the current Director of the FASB (Bob Herz) to argue that
perhaps income statement components should not be aggregated by
companies or auditors into bottom line net income ---
http://faculty.trinity.edu/rjensen/theory01.htm#ChangesOnTheWay This is analogous for pharmacies to declare that
certain drugs are too dangerous to sell in one pill, but they will sell 100
ingredient pills that you can pick and choose from to get a combined effect.
The current heated debate on what unrealized earnings can be diverted to
Comprehensive Income (OCI) instead of being posted to current earnings is
rooted in the unresolved problem of what types of unrealized income to keep
out of current earnings. This is the black hole of fair value accounting
apart from the even more serious problem of how to make fair value estimates
cost effective (e.g., having real estate formally appraised every year would
not be cost effective for large international hotel or restaurant chains).
the current conflict about rules for insurance company accounting
bring to light once again the conflict between income statement versus
balance sheet priorities accounting standard setting.
The
Declaration on Strengthening the Financial System
(PDF 137k) issued by the leaders of the Group of 20
(G20) following their meeting in London on 2 April
2009 calls on the accounting standard setters to
improve standards for determining the fair values of
financial instruments in illiquid markets and to
take other actions regarding complexity of financial
reporting, provisioning, and off balance sheet
financing, among other matters:
Accounting standards
We have agreed that the accounting standard
setters should improve standards for the
valuation of financial instruments based on
their liquidity and investors' holding
horizons, while reaffirming the framework of
fair value accounting.
We also welcome the FSF
recommendations on procyclicality that
address accounting issues. We have agreed
that accounting standard setters should take
action by the end of 2009 to:
reduce the complexity of accounting
standards for financial instruments;
strengthen accounting recognition of
loan-loss provisions by incorporating a
broader range of credit information;
improve accounting standards for
provisioning, off-balance sheet
exposures and valuation uncertainty;
achieve clarity and consistency in
the application of valuation standards
internationally, working with
supervisors;
make significant progress towards a
single set of high quality global
accounting standards; and
within the framework of the
independent accounting standard setting
process, improve involvement of
stakeholders, including prudential
regulators and emerging markets, through
the IASB's constitutional review.
The IASB has responded to the G20 leaders'
recommendations and, at the same time, to
Recent Decisions taken by the US Financial
Accounting Standards Board (FASB). Here are
excerpts:
The IASB's response to the G20:
'The IASB is committed to taking action
on each of the items recommended by the
G20 by the end of 2009, the target date
suggested by the G20, in order to ensure
globally consistent and appropriate
responses to the crisis.'
The IASB's response to the FASB
actions: 'Initial reports regarding
new or additional divergences between
IFRSs and US GAAP being created by these
FSPs appear to be overstated. A
preliminary review of the FASB's
decisions by IASB staff indicates that
FASB�s objectives and approach on the
application of fair value when a market
is not active appear to be broadly
similar to those in IFRSs.'
"Critics Pan New Financial Statements: A long-planned overhaul
of financial statements gets a rough reception from preparers at its initial
unveiling, particularly from banks. Meanwhile, a survey says a large majority of
CFOs don't even know about the proposal," by Tim Reason, CFO.com, April
24, 2009 ---
http://www.cfo.com/article.cfm/13561804
It's been called the most dramatic overhaul of
financial statements since the cash flow statement was introduced more than
two decades ago. But when the comment period closed last week on the ideas
for radically changing financial statements, the proposed design from the
world's accounting standard setters had been called a few other things too:
"poorly defined," "confusing," cluttered, "information overload,"
"inconsistent with management's internal reporting," and, frequently,
"costly."
In October 2008, the Financial Accounting Standards
Board and the International Accounting Standards Board jointly issued a
discussion paper laying out their preliminary ideas for changes to financial
statements that would fundamentally alter the way information is presented
on the financial statements. Comments were due last week.
The two boards said their goal was to tie the
different financial statements more closely together, provide deeper dives
into financial numbers that are often aggregated at a very high level, and
also provide a heavy emphasis on cash and liquidity. A key feature of the
proposal is that managers would separate a company's actual business
activities from its financing or funding activities. As a result, each of
the three statements — balance sheet, income statement, and cash-flow
statement — will be divided into two major sections: business and financing.
The financing section will include those activities
that fund a company's business. For nonfinancial institutions, that would
primarily include cash, bank loans, bonds, and other items that arise from
general capital-raising efforts.
The business section — which would be further
subdivided into operating and investing categories — would focus on what a
company does to produce goods and provide services. The operating category
will include primary or "core" revenue and expense-generating activities,
and the investing category will include activities that generate a return
but are not "core."
Many preparers, particularly banks, commented that
FASB and IASB needed to do more to clearly define 'operating' and
'investing' activities. "They're using the same terminology that we use in
FAS 95 for cash flows," Grant Thornton partner John Hepp told CFO.com, "But
they have completely different meanings from what they meant [in FAS 95]."
Indeed, Hepp's sentiments are echoed in Grant Thornton's official comment
letter, which notes not only that the distinction between the operating and
investing sections is "very confusing," but also that "the [discussion
paper] itself uses three different descriptions."
"I don't think FASB or IASB is real clear on what
these terms mean, so I don't know how management would apply them," Hepp
added.
Some of the debate, of course, may come down to
FASB's and IASB's desire to have management itself define what activities it
considers to be part of their company's business model for adding to
shareholder value, versus simple investment returns.
"Users of financial statements analyze how a
company creates value separately from how it funds that value creation,"
said FASB senior project manager Kim Petrone in a webcast at the beginning
of this year. "So we want to separate the creating activities from the
financing activities." Petrone explained that companies will begin by
classifying assets and liabilities based on how they are used by management.
"That management approach is going to be very important because it allows
[the accounting] to apply to many different entities. It's been asked if
this will apply to banks, and it will apply to banks."
But banks themselves were less than thrilled with
that portion of the proposal. While conceding that it might be useful for
investors of non-bank institutions to see financing activities separated
from business activities, the American Bankers Association said "this kind
of breakout will have little or no value to users of financial statements of
banking institutions. . . . In essence, both investing activities and
financing activities normally are operating activities at a bank."
"The nature of the banking industry would lead, in
our opinion, to the vast majority of activities being presented within the
business activities (operating category)," concurred the British Bankers
Association, adding that, for financial institutions, "we do not believe
that the separation of business activities from financing activities will
provide users with information that is more decision-useful than the current
presentation method."
While banks might find it impossible to distinguish
between financing and operating activities, it is interesting to think that
some of the distinctions proposed might have helped banks highlight the
difference between actual losses and the writedowns that many were forced to
take as a result of changes in fair value. Indeed, that's what at least one
analyst, not speaking specifically about the banking industry, suggested
just over a year ago. "As we see more fair value coming through the
financial statements, those statements need to do a better job of showing
where the changes are coming from; this would help a lot," Janet Pegg, a
senior managing director and an accounting analyst at Bear Stearns, told CFO
magazine in Feb 2008.
Continued in article
David Albrecht pointed out the following related links:
SUMMARY: "International accounting rule makers on Tuesday proposed
changes to corporate disclosure rules aimed at preventing companies from
overwhelming investors with useless information. The board said it hopes to
get accountants and managers away from a check-the-box mentality in
reporting financial results, and instead emphasize clarity for investors."
CLASSROOM APPLICATION: The article may be used in any financial
reporting class but focuses on covering International Financial Reporting
Standards, particularly IAS1 materiality requirements, and on comparing the
IASB and FASB approaches towards the disclosure issues discussed in the
article.
QUESTIONS:
1. (Introductory) The article describes activity by both the IASB
and the FASB to deal with problems in annual report disclosures. What is the
main concern with disclosures currently made? Hint: you will find it helpful
to click on the links in the article to the IASB survey and to the FASB
project on the Disclosure Framework, then read the Project Objectives.
2. (Advanced) The IASB proposal on amending disclosures focuses on
IAS 1. What is that standard?
3. (Advanced) Click on the link in the article to the IASB
proposal. What specific requirements in IAS 1 are being addressed?
4. (Advanced) Refer back to the FASB project objectives examined in
answering question 1 above. How does the FASB's project and proposed
statement of financial accounting concepts differ from the approach being
taken by the IASB? Form a general impression from your examination of these
source materials and cite only one or two examples to explain your answer.
Reviewed By: Judy Beckman, University of Rhode Island
International accounting rule makers on Tuesday
proposed changes to corporate disclosure rules aimed at preventing companies
from overwhelming investors with useless information.
The board said it hopes to get accountants and
managers away from a check-the-box mentality in reporting financial results,
and instead emphasize clarity for investors.
“Financial reports are instruments of communication
and not simply compliance documents,” said Hans Hoogervorst, chairman of the
International Accounting Standards Board, which sets accounting rules for
more than 100 countries. “These proposals are designed to help change
behavior, by emphasizing the importance of understandability, comparability
and clarity in presenting financial reports.”
The move is part of a global effort to make
financial statements easier to read. In a survey last year, the IASB found
that investors and analysts felt companies could better communicate the most
relevant issues in financial statements, rather than forcing them to sift
through vast amounts of data.
The IASB’s proposal suggested amendments that would
require companies to assess whether particular disclosures are material to
investors and to think closely about whether their presentation makes it
harder for investors to find the most important information. The board also
proposed that companies emphasize clarity and comparability in their
financial statement footnotes.
U.S. accounting rule makers have also been working
on a disclosure framework since 2009. Earlier this month, the Financial
Accounting Standards Board issued a proposal that suggested improvements to
the way companies present financial statement footnotes. The Securities and
Exchange Commission is also expected to tackle a “disclosure overload”
project this year.
The IASB is accepting public comments on its
disclosure framework proposal through July 23.
"Effect of Principles-Based Versus Rules-Based Standards and Auditor Type
on Financial Managers' Reporting Judgments," Karim Jamal (University of
Alberta) and Hun-Tong Tan Nanyang (Technological University), SSRN, July
21, 2008 ---
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1165442
Abstract:
Managers sometimes implement accounting standards (such as the lease
standard) opportunistically to move debt off balance-sheet. Regulators are
under pressure to adopt principles-based accounting standards to reduce such
opportunism. However, there are lingering concerns about whether
principles-based standards can be properly implemented and enforced. We
report results of an experiment where highly experienced financial managers,
with incentives to structure a transaction off balance sheet, take a
reporting position on how a lease is to be disclosed. We manipulate the type
of GAAP (principles-based, rules-based) and the type of auditor
(client-oriented, principles-oriented, or rules-oriented). Our results show
that when the auditor is client-oriented, the nature of GAAP does not
matter, and that a move towards more principles-based standards is likely to
result in improved financial reporting quality only when there is a
corresponding shift in auditors' mindsets towards beings more
principles-oriented.
Something Bad About the IASB There was markedly less harmony between the two panelists when it came to
International Financial Reporting Standards. Hewitt said there's no doubt that
creating a single worldwide set of accounting rules is the correct thing to do.
It reflects the reality that nations depend on one another for imports and
exports, and that U.S. companies would have greater access to overseas capital.
Turner, though, cuffed the International Accounting Standards Board for bowing
to pressure from France president Nicolas Sarkozy and other European Union
leaders to relax fair-value accounting rules. Since last October, IASB has come
under fire for sidestepping due process to rush out a rule allowing financial
institutions to reclassify some loans as a way of avoiding marking those assets
to market and avoid losses generated by a drop in asset value. "IASB has not
shown that it can develop high-quality standards without political
interference," Turner said. "Until it can, IFRS is not ready for prime time."
David McCann, "Former SEC Chief Accountant Blames FASB for Meltdown He credits
auditors and financial statement preparers for successfully fighting fraud,"
CFO.com, March 5, 2009 ---
http://www.cfo.com/article.cfm/13234318/c_13234460
Thank you to Glen Gray for this link.
Something Good About the FASB "IASB has not shown that it can develop high-quality
standards without political interference," Turner said. "Until it can, IFRS is
not ready for prime time." Turner indicated that even then he would not support
IFRS for U.S. companies, rejecting Hewitt's notion that the nature of
international business today demands it. In fact, IFRS would make American
companies less competitive, he insisted. "If we make our markets look like
everyone else's, and they're only as transparent as everyone else's, there's no
reason for [investors] to allocate their money to U.S. markets," he said. "But
if our markets have, as they always have had, greater transparency, and
investors get the information to make better decisions, then there is a reason."
David McCann, "Former SEC Chief Accountant Blames FASB for Meltdown He credits
auditors and financial statement preparers for successfully fighting fraud,"
CFO.com, March 5, 2009 ---
http://www.cfo.com/article.cfm/13234318/c_13234460
Bob Jensen's threads on the FASB vs. IASB issue are at
http://faculty.trinity.edu/rjensen/theory01.htm#MethodsForSetting
Jensen Comment
The implication here has to be that Lynn Turner does not that IASB standards in
the U.S. will provide the same level of transparency as FASB standards, at least
not until we see some dramatic improvements in IASB standards.
Something Bad About the FASB Actually, Turner said he gives credit to "practicing
accountants" — financial-statement preparers and auditors — for overseeing a
dramatic falloff in financial fraud cases compared to the years immediately
following the Enron and WorldCom scandals. "There's a change from 10 years ago,
and accountants do deserve some credit," he said. "Certainly some of the audit
firms get a lot of credit for what they've done in standing behind fair value
and trying to get the numbers right." He had no such praise for FASB. Although
the board is currently rewriting FAS 140 to eliminate QSPEs, it has "done an
absolutely miserable, abysmal job, especially in the balance sheet area."
David McCann, "Former SEC Chief Accountant Blames FASB for Meltdown He credits
auditors and financial statement preparers for successfully fighting fraud,"
CFO.com, March 5, 2009 ---
http://www.cfo.com/article.cfm/13234318/c_13234460
Jensen Comment
Whereas the FASB at least tackled the SPE problem and lost, the IASB on the
international front has had its head completely in the sand.
A November 3, 2008 clarification of my position of the controversy of
replacing U.S. accounting standards with international accounting standards.
Notwithstanding
Shaum Sunder’s excellent argument against an IASB monopoly and my preference for
bright line rules, I’ve viewed all along that “resistance is futile” in trying
to prevent the ultimate replacement of U.S. domestic accounting standards with
international standards.
At this point
I’m merely trying to prevent both a premature Big Bang (Mary Barth’s wording) or
a bunch of Little Bangs (Pat Walter’s wording) prematurely. By prematurely, I
mean having at least until 2018 to evolve into this in an orderly manner for
business firms, auditors, accounting educators, textbook writers, students, and
CPA examiners. Cox is rushing this thing too fast at the SEC, and I think the
FASB is trying to avoid having to rewrite FASB standards, interpretations, and
guidelines to be consistent with IFRS.
I think we’ve
given the FASB sufficient resources to rewrite U.S. GAAP in an evolutionary
manner that will greatly enrich the illustrations and implementation guidelines
that are sorely lacking in the present IASB standards. In other words I would
like to have FASB Standards and a greatly improved FASB Codification Database
after 2018 even if IFRS is virtually written into U.S. GAAP. And yes, I will
concede to removing most of the bright line rules! Sigh!
I also think the
U.S. should maintain its leverage by not fully committing to IFRS until the IASB
is better able to handle the enormous U.S. economy in terms of a better IASB
infrastructure, greatly increased IASB research funds, many more IASB full-time
members, and a demonstration that it is not under the thumb of the EU
politicians and bankers.
I also agree
fully with Mary Barth that our academy’s accounting researchers worldwide should
play a greater role in making IFRS better able handle its eventual monopoly on
all accounting standards for the free world.
I would also
like time to let the smell to dissipate concerning how Chris Cox, while Director
of the SEC, abused his authority by trying for force international standards
down our throats too suddenly in a chaotic Big Bang.
As to GAAS, I just don’t think we’re
ready for International GAAS until we have better international law, especially
international law regarding bribery, corruption, white collar crime enforcement,
and international civil litigation procedures. Bill Ellis forwarded a link comparing
U.S. GAAS with international GAAS ---
Click Here
Bright
Lines Versus Principles-Based Rules
Pat
Walters and I have a friendly debate running over bright lines (FASBs) versus
principles-based rules (IFRS) in accountancy. I'm a bright lines guy who favors
20 mph signs in front of the schools and the historic 3% SPE outside equity
bright line that was the smoking gun that brought down Andersen and Enron. I
don't know how Pat feels about speed limit signs, but I suspect she worries that
these bright lines might encourage us old folks to press the pedal to 20 mph
when we can only safely drive in a school zone at 5 mph.
Be that as
it may, Daniel Henninger has a new WSJ article that seems to take my side in
this debate. What's interesting is that new technology sometimes favors rules.
Serena Williams will pass on knowing that she indeed had a foot fault in the
2009 U.S. Open women's semifinal, because new technology records bright line
violations that are virtually impossible to dispute. The feuding Jimmy Connors
and John McEnroe will pass on never knowing for certain who was right and who
was wrong in most of their disputed calls.
If there
was no bright line for a foot fault, then Serena Williams would not have to
concede that she was wrong. In principle she may have been totally fair in her
serve. And Enron and Andersen might still be thriving. And Franklin Raines might
still be managing the earnings levels and his bonus amounts at Fannie Mae ---
http://faculty.trinity.edu/rjensen/theory01.htm#Manipulation
'Those two f-words," said Mary Carillo amid the eruption of Mount Serena in the
U.S. Open women's semifinal, "apparently led to some more." The vocabulary Mary
Carillo had in mind were not the f-words of common usage but simply, "foot
fault."
What happened next is the civilized world divided between those who believe that
rules still matter and those who think rules exist to be bent. Rules won.
But we are ahead of ourselves. Safely assuming not everyone shares a fanaticism
that requires watching two weeks of tennis into the wee hours each summer, we
need to set the scene for what is one of the most infamous moments in tennis
history.
Outplayed by Kim Clijsters, a tennis hobbyist from Belgium, incumbent Open
champion Serena Williams was serving on the precipice of a humiliating defeat
when an odd sound emerged from the sideline. It was the sound of a lines woman
yelling "foot fault." Point to Clijsters.
Whereupon, Serena snapped. Walking over to what must be the world's smallest
lines woman, Serena loudly related her willingness to place the tennis ball
inside the woman's throat, modifying both "ball" and "throat" with the world's
most famous ing word.
In the days since, sports aficionados have debated the propriety not only of
Serena's language but the lines woman's calling a foot fault within a whisper of
match point. In most championships, with one of the competitors at death's door,
the rule of thumb is "let them play."
Setting that aside, the real problem for tournament referee Brian Earley was
that Bad Serena had committed what tennis primly calls a "code violation." If
Mr. Earley called the code violation with Ms. Clijsters one-point from victory,
Serena was done. He called it.
This is why we watch sports. Not just to see the thrill of victory and the agony
of defeat, but because it is the one world left with clear rules abided by all.
Compared to sports, real life has become constant chaos. (Some esthetes would
chime in that this is why they listen to classical music. Structure rules.)
Should the lines woman have called that foot fault? Let a thousand water-cooler
debates begin. What remains is that whatever one's sport, you know what the game
is going in, and that includes the final moments of any championship, when a
season can be lost on a fatal infraction.
A pitcher balks (don't ask) with the bases loaded in baseball, and a free run
trots to home plate. Body movement along a football line before the snap can
make it first and goal. Hit a golf ball off a building and behind a tree (Phil
Mickelson, Winged Foot's 18th hole, the 2006 Open) and the gods of sanity will
abandon you. A basketball player who taps a three-point shotmaker on the wrist
may, with fouls, cost his team six points. The Austrian novelist Peter Handke
reduced the fine line separating freedom from foul to a novel's title: "The
Goalie's Anxiety at the Penalty Kick."
While we all know what the rules are in the sports, no one knows anymore what
the rules are in real life. Not in politics, law, the bureaucracies, commerce,
finance or Federal Reserve policy.
My favorite story from rule-free politics was the time in 1987 when House
Speaker Jim Wright got around a rule that a defeated vote couldn't be redone for
24 hours. Mr. Wright adjourned the House, brought it back to order in minutes,
and called it a "new" legislative day. The House clerk even said that Oct. 29
had suddenly become Oct. 30.
Boston lawyer Harvey Silverglate argues in a forthcoming book, "Three Felonies a
Day," that federal law has become such a morass that people in business
routinely violate statutes without a clue. Modern law lacks what sports provides
lucidity.
Attorney General Eric Holder's decision to let a prosecutor investigate CIA
interrogations that were ruled inbounds years ago is like a baseball
commissioner reversing a hotly disputed World Series home run. Fans everywhere
would burn down the stadium.
Which brings us to the Supreme Court. At this turn in history, the battle lines
there are drawn between Scalian originalism and Obamian "empathy." In between
stands Referee Anthony Kennedy, who gives the ball to whichever team plays by
his rules. The f-numbers 5-4 define the chaos of our era.
The war over the Court may run for a century. It must mean something, though,
that in the primal world of sports we are all strict constructionists, even as
we agree that a discreet judge would have given Serena's foot fault a pass.
From this we may conclude that the utopia most people want is a rules-based
life, with wiggle room.
Jensen
Comment
Of course it's never possible or practical to have a bright line for every rule.
Umpires must subjectively decide in each specific situation what constitutes
"unnecessary roughness," "unsportsman like conduct," "pass interference,"
"interference with a base runner," "goal tending," etc. But when bright lines
can take away the subjectivity to the satisfaction of both sides playing the
game, then I'm all for taking subjectivity out of the equation.
"New York CPAs Slam IFRS Roadmap: The international standards
are of dubious quality, the SEC is vague on how it will judge them, and the
benefits of adoption are contradictory, the accountants charge," by David
McCann, CFO.com, March 6, 2009 ---
http://www.cfo.com/article.cfm/13254066/c_13252677?f=home_todayinfinance
Pat Walters forwarded the above link.
A prominent accountants group filed a comment
letter with the Securities and Exchange Commission yesterday displaying deep
skepticism about the workability of the current roadmap for requiring U.S.
public companies to use International Financial Reporting Standards.
The New York State Society of Certified Public
Accountants registered a broad range of concerns, addressing the quality of
the international standards; conversion costs; an alleged contradiction
between the two main benefits of adopting IFRS put forth by the SEC;
eligibility criteria for early adopters; and a forthcoming version of the
standards for use by private companies.
The roadmap calls for the SEC to vote in 2011
whether to move forward with mandatory adoption, which under the existing
plan would be phased in from 2012 to 2014. It also allows a limited number
of large U.S. companies to adopt the international standards as early as
this year.
The quality issue is foremost to the New York
accountants. "The SEC Roadmap does not present, in sufficient detail, the
methodology and criteria expected to be applied ... in assessing the
adequacy of IFRS," they wrote in their comment letter.
Apples and Oranges?
In their letter, the New York accountants seemed to
question whether the SEC is doing enough to make sure financial reports that
use IFRS will be comparable with one another.
Any assessment of the international standards, the
NYSSCPA wrote, should consider whether they are consistent with the
Financial Accounting Standards Board's Concepts Statements. They singled out
Statement No. 1, which says that financial reports should provide
information investors and creditors can use to make informed decisions, and
Statement No. 2, which says comparability and consistency are important
characteristics of financial statements.
The New York accountants also questioned whether
the decision-making process of the International Accounting Standards Board,
which promulgates IFRS, "is conducive to setting future high-quality
standards."
They criticized the IASB for its move last fall to
let companies retroactively reclassify assets so they could "cherry pick"
ones with significant losses and remove them from net-income calculations.
In doing so, the international board gave in to pressure from the European
Commission, the accountants suggested, saying they are concerned about "the
influence of various national regulators, users, and others who promote the
interests of their specific constituencies, as opposed to the needs of the
worldwide community."
Further, the NYSSCPA said the supposed main
benefits of adopting IFRS — comparability with non-U.S. reporting entities
and allowing management greater judgment in preparing financial information
— may both be desirable but appear inherently contradictory.
"The comparability of financial statements prepared
in conformity with IFRS may be overstated," the comment letter said. "IFRS
does not seem to be consistently applied from country to country, as the
number of allowable options is conducive for the regulatory agencies in each
country to interpret IFRS pursuant to their respective needs and business
environments."
Comparability is further reduced, the letter added,
by the tendency of preparers and auditors, "because of their habits of
mind," to apply IFRS in a manner that is as similar to their current or
former national accounting standards as possible. "When using
principles-based standards, reasonable people arrive at materially different
results after applying their judgments to a given set of facts and
cirucmstances," the New York accountants wrote.
When and Who?
The letter also questioned the prudence of the
conversion to IFRS when the depth and duration of the financial crisis are
hard to predict. "It would be reasonable to conclude that the monetary and
human capital costs of the transition could be burdensome to entities with
limited resources and prohibitive for some smaller entities, even over a
period of many years."
An alternative, the NYSSCPA suggested, would be for
FASB and IASB to vigorously pursue efforts to converge the American and
international standards, which it said would produce the best-quality global
standards and help minimize conversion costs for U.S. companies when IFRS
adoption does finally become mandatory.
At the same time, though, the society said it fully
supports allowing early adoption of IFRS, and in fact the eligibility
criteria should be expanded.
The roadmap suggests that the proposal to limit
early use of IFRS to the 20 largest companies in so-called "IFRS industries"
is grounded in an assumption that larger companies will be more likely to
have sufficient expertise and resources to carry out the adoption.
"We disagree," the accounting society members
wrote. "In fact, IFRS adoption experience in Europe has shown that smaller
entities may need less time to complete the IFRS transition, while large
companies with numerous subsidiaries in different countries may take as long
as five years."
U.S. companies that are among the 20 largest
worldwide in "IFRS industries" — ones like oil and gas and some retail
sectors in which IFRS is the most-often-used financial reporting system —
are eligible to adopt the international standards as early as this year. The
SEC has estimated there are at least 110 such companies.
Continued in article
AICPA Supports SEC Proposed
Roadmap for Transitioning to IFRS for Public Companies ---
Click Here
However, no mention is made of any survey of the membership on this issue.
How to account for inventory loans with clawback provisions?
From The Wall Street
Journal Accounting Weekly Review on April 30, 2009
SUMMARY: Chrysler
and GM auto dealers are facing worries over slow sales and possible debt
calls on their inventory loans due to falling values of these U.S. auto
makers' brands. This discussion of the domino-effect of U.S. automakers'
bankruptcies focuses on the impact on car dealers' financing of vehicle
inventories.
CLASSROOM APPLICATION: The
article can be used in financial or managerial accounting courses covering
inventories and current liabilities, from the introductory level up.
QUESTIONS:
1. (Introductory)
What are 'wholesale loans' or 'floorplan financing' arrangements for car
dealerships? From where do car dealerships obtain these loans?
2. (Advanced)
Are these inventory-financing loans short-term debt or long-term? Support
your answer.
3. (Introductory)
Why does the looming bankruptcy of the U.S. car makers Chrysler LLC and
General Motors Corp. lead to potential calls for immediate repayment, in
full or in part, of loans owed by car dealership companies?
4. (Advanced)
Why might such debt repayment be required in the case of bankruptcy
proceedings? In your answer, provide an overview of the overall bankruptcy
process that might lead to this result.
Reviewed By: Judy Beckman, University of Rhode Island
For Chrysler LLC and General Motors Corp.
dealerships, slow sales are just part of their worries. Now they're bracing
for possible auto-maker bankruptcy filings that could trigger repayment of
their inventory loans.
The two auto makers have about 10,000 dealers in
the U.S., with the bulk of them carrying considerable debt, mainly from the
money they borrow to buy cars that sit on their lots. If Chrysler or GM were
to file for bankruptcy protection, the banks extending that credit could
immediately begin calling dealer loans, demanding a good portion of the
money back and refusing to extend any more inventory financing.
U.S. taxpayers, meanwhile, could be called to the
rescue.
At issue are loans for inventory, known as
"wholesale" loans or "floorplan" financing, that are primarily given by GMAC
LLC and Chrysler Financial to dealers so they can buy vehicles to stock
their showrooms. These loans are typically backed by the vehicles that are
being financed by the dealer and paid back when the vehicles are sold.
Chrysler Financial and GMAC, run independently and
answering to different shareholders, have "clawback" provisions that allow
the finance companies to demand at least partial payment of the loans in the
event of a bankruptcy because the value of the vehicles being used as
collateral would plummet. Other lenders are believed to have similar
provisions.
Last week, the National Automobile Dealers
Association met with the Treasury's task force on the auto industry to talk
about the issue, particularly as it pertains to Chrysler, but walked away
without a solution, NADA Chairman John McEleney said.
"It's a huge problem that we don't have the answer
to," Mr. McEleney said in a telephone interview late last week. "I feel a
little better because the task force seems to understand."
Mr. McEleney said NADA is looking for some
guarantees from the Obama administration that would help prevent dealer
failures that could result from the clawback provisions.
An Obama administration official briefed on the
meeting said "it was a good discussion and a thoughtful exchange, but
certainly there was no commitment.
On Monday, GM President and CEO Fritz Henderson is
scheduled to present an update on the company's revised viability plan. Mr.
Henderson is expected to announce further reductions of plants and brands,
including the iconic Pontiac brand, and GM could launch a debt-for-equity
exchange with unsecured bondholders who are owed about $28 billion. The
exchange must commence Monday in order to avoid default on a $1 billion loan
that is due for payment June 1.
GM also needs to make progress on cutting hourly
labor costs, and reducing the amount of cash it owes United Auto Worker
retirees for future health-care obligations.
The administration is faced with a balancing act in
how it should help the thousands of dealers selling GM and Chrysler
vehicles, just as it does with auto-parts makers..
On the one hand, bankruptcy would be a way to help
the two U.S. companies outmaneuver uncompetitive supply contracts with parts
makers and onerous state franchise laws that protect underperforming dealers
from being closed down.
Just as Treasury officials have demanded major
concessions from the UAW and bondholders, they are also calling for a sharp
decrease in the amount of dealers and suppliers connected to GM and
Chrysler.
But completely ignoring their plight could lead to
a unintended collapse of the whole network of companies dependent on the two
companies, and that could lead to tens of thousands of job losses in coming
months at the auto-parts companies, and dealers. Auto suppliers received a
$5 billion aid package from Treasury in March. Treasury officials also
designed a government warranty program for GM and Chrysler dealers so that
buyers would feel safer buying cars from two companies on the edge of
collapse.
Traditionally, three-quarters of the dealers at
both Chrysler and GM finance their inventories through GMAC or Chrysler
Financial because those companies typically make wholesale loans the top
priority when it comes to auto-industry lending, and because credit is
typically extended at a discount rate.
A person familiar with Chrysler Financial's
position on the clawback provision said the company will work with each
dealer on a case-by-case basis.
GMAC alone currently extends over $20 billion in
wholesale financing to U.S. dealers for inventory purposes.
GM, in documents filed in February with the
Treasury , said direct financing to dealers for inventory could end up
costing taxpayers between $2 billion and $14 billion over the course of the
company's stay in bankruptcy, should a Chapter 11 filing come to pass.
Chrysler's projection on the matter is unclear.
As of the end of the first quarter, GM and Chrysler
dealers had 1.1 million vehicles of unsold inventory on their lots. The two
companies sold 660,000 vehicles during the entire first quarter, and there
is little indication that an uptick in sales will help clear the inventory.
The administration's auto task force has been
considering indirect ways of helping dealers, such as measures that would
allow GM and Chrysler to once again offer leases on new vehicles, something
they stopped doing last summer, people familiar with the matter said. They
are also looking at how the auto makers can trim dealer networks.
Principles-Based Accounting Standard Question
FASB accounting standards are more rule-based than their international IASB
counterparts that are more principles-based. The above case is an excellent test
of whether principles-based standards will lead to more consistency in how to
account for such inventory loans when the rules-based standards are somewhat
difficult to apply. In other words, would international standards lead to more
consistency regarding how automobile manufacturers and dealers account for
inventory loans with "clawback" provisions?
"Pension time bomb: The shadow hanging over GM's turnaround," The
Washington Post, August 27, 2010
PRESIDENT OBAMA has a riposte for
critics of his decision to rescue
General Motors and Chrysler: You can't argue with
success. And much good news has emanated from Detroit of late, especially
from GM. Having wiped out almost all of its debt through an
administration-orchestrated bankruptcy process, slashed excess plants and
streamlined operations, GM is once again
turning a profit: $2.2 billion so far in 2010.
Sales are up; promising new models are coming to
market. GM's aggressive
new management is
planning a public stock offering, which would let
the Treasury Department start unloading the 61 percent stake it bought for
nearly $50 billion. U.S. officials speak of escaping with modest losses -- a
small price for averting industrial catastrophe.
All true -- up to a point. But
the company's stock prospectus points to several reasons for caution,
including such obvious ones as the sluggish U.S. economy and overcapacity in
global auto manufacturing. And then there's a threat that the
Obama-supervised bankruptcy did not address: the precarious condition of
GM's immense pension plans.
With almost $100 billion in
liabilities, GM's defined-benefit plans for U.S. employees (one covers a
half-million United Auto Workers members, another, 200,000 white-collar
personnel) are the largest of any company in America. Yet they were
underfunded by $17.1 billion as of the end of
2009, and the underfunding had only slightly lessened, to $16.7 billion, as
of June 30. (Chrysler has a similar problem, on a smaller scale.) Having
been filled with borrowed money before Chrysler's bankruptcy, the funds can
limp along for a couple of years. But, as GM's prospectus acknowledges,
federal law will require it to start pumping in "significant" amounts by
2014 if not sooner. GM does not say exactly how much, but an April
Government Accountability Office report suggested
that a $5.9 billion injection might be required initially, with larger ones
to follow. In other words, any investor who buys GM stock is buying stock in
a firm whose revenue is already partially committed to retired workers.
When companies go bankrupt, their
underfunded pensions often are taken over by the Pension Benefit
Guaranty Corp. (PBGC), a government-run,
industry-funded insurance agency, which then pays retirees a fraction of
what they were owed. But that didn't happen in the GM-Chrysler bankruptcy.
The UAW resisted what would have been a huge reduction in the generous
benefits of its members, especially the many who retire before age 65. And
the Obama administration chose not to push back.
The net effect is that the
pension time bomb is still ticking. If GM earns robust profits, even more
robust than it is making now, the bomb won't detonate. Otherwise -- well, in
a worst-case scenario, GM winds up back in bankruptcy, with PBGC
intervention both unavoidable and more expensive than it would have been
last year. And that could necessitate a bailout from Congress, because of
the PBGC's own deficits.
We're not offering investment
advice -- just a dash of realism about a still-troubled industry, and a
warning that its dependence on taxpayers may not be ended so easily.
Tom Selling explains the timing of the SEC issuance of
the IFRS Roadmap in "G-20 Conference Provides Cover for the SEC to Issue
Its IFRS Roadmap," The Accounting Onion Blog on November 15, 2008 ---
http://accountingonion.typepad.com/
November 16, 2008 letter from Bob Jensen Go tom Selling
Hi Tom,
Thanks for
providing a link to the Roadmap for unconditional surrender of U.S. GAAP. We
lost the war, but resistance was futile from the time Chris Cox took over as
the Director of the SEC. I surrendered some time ago but was hoping for 2018
rather than 2014 ---
http://faculty.trinity.edu/rjensen/Theory01.htm#MethodsForSetting
I think the U.S. could've bargained for more, especially for a better
infrastructure and funding of the IASB and a much larger permanent research
staff at the IASB.
Like everything
else associated with IFRS, this SEC Roadmap is an illustration of being
“Principles Based.” The milestones are very soft with no bright lines ---
http://www.sec.gov/rules/proposed/2008/33-8982.pdf
The SEC Roadmap
sets 2014 as the date of unconditional surrender, but leaves the door very
slightly ajar for delays in this date depending upon whether certain
“milestones” are met. But true to principles-based standards there are no
definitive benchmarks for accomplishing the milestones. To me these
milestones are more for show than for real. It’s best to assume 2014 is a
done deal. Educators and CPA examiners and CPA review courses and students
are going to be in a state of turmoil. As for the publishers --- they’re
probably dancing in the streets. Cox just killed the used book market. Cox
just killed the CPA exam review materials.
This will affect
textbooks at all levels. LIFO has to be expunged from Principles textbooks.
Fair value fantasies have to be added to the textbooks. All the bright line
rules in Intermediate and Advanced accounting textbooks have to be plucked
out and replaced by IFRS principles-based replacements. All basic and
financial accounting instructors have to be retooled ---
http://faculty.trinity.edu/rjensen/Theory01.htm#FairValue
Training firms
(including the AICPA, IMA, and large accounting firms) are dancing in the
streets. Virtually all business firms that have public accounting audits as
well has the public accounting audit firms themselves will have to spend
hundreds of millions of dollars on hurried training.
Let’s conclude
by admitting we’ve been Coxed into 2014 this in the waning days before Chris
Cox gets fired or is forced to resign. He abused his authority in this just
like he abused his authority in deciding not to monitor Wall Street’s
Investment Banks before their collapse (Cox admits he made a grave mistake
here) ---
http://faculty.trinity.edu/rjensen/2008Bailout.htm#SEC
I’m willing to
surrender unconditionally but not until 2018. However, I doubt that anything
short of nuclear war will slow down this Herz-Cox Express Train. Sadly, the
Big Four that really got us into this roadmap (Cox is just a front) may not
be around in 2014 to enjoy their successful lobbying effort ---
http://faculty.trinity.edu/rjensen/2008Bailout.htm#AuditFirms
As pointed out by the FEI financial blog, the
chairman of the FAF has sent a
FAF letter to President Bush, G-20 prior to
the G-20 summit asking him to preserve accounting standard setting. Here are
a few highlights from the letter:
In a letter posted on the Financial Accounting
Standards Board (FASB) website today, Robert Denham, President of the board
of Trustees of the Financial Accounting Foundation (FAF) (which oversees the
FASB), sent a letter to U.S. President George W. Bush on Nov. 13, asking
President Bush to share the letter with members of the G-20 attending the
Summit on Financial Markets and the World Economy taking place today and
tomorrow in Washington, DC. Following are some of the points in the FAF
letter to President Bush, G-20:
We understand that current issues relating to
international accounting standards will be discussed at this [G20] meeting
as part of a comprehensive examination of the global financial crisis. The
FAF believes that the complex task of setting accounting standards is best
done by the experts who comprise the FASB and International Accounting
Standards Board (IASB). We are very concerned about recent efforts in the
United States and abroad that contemplate political solutions to perceived
flaws in certain accounting standards. Political pressures have been brought
to bear on the IASB to urgently review and revise its standards,
particularly relating to 'mark-to-market' (fair value) accounting. The IASB
has already departed from its normal due process to make one such revision
in response to this pressure and is being asked by the European Commission
to further review its standards for certain financial instruments and to
complete its deliberations in time for year-end financial reporting.
High-quality accounting standards are best achieved when the
standard-setting process is independent and free of political influence. We
believe that any legislative outcome that would permit accounting standards
to be overturned through a political process will create uncertainty,
greatly undermine investor confidence, and dangerously compromise the
credibility of financial reporting at a time when the capital markets are
under great duress and in need of greater transparency. We encourage the
G-20 to support independent standard setting via a robust due process free
from political interference. This support will do more to restore confidence
in the capital markets than legislating accounting standards in a way that
reduces the reliability and transparency of financial information presently
available to investors. How can giving an understaffed, under-funded,
politically influenced board be a good thing for international accounting,
let alone US accounting? The Wall Street Journal (see
http://online.wsj.com/article/SB122662346962726733.html ),
in an editorial about the G-20 summit talked about the push for a new
international regulator (a natural follow-on to global IFRS) in the
following terms: Given the dominant American role in global finance, a new
international regulator is one more way for the Lilliputians to tie down
Gulliver. We're all for nations working together for common standards that
improve business efficiency across borders. But Europe has all too often
used its regulatory standards to punish American companies -- witness its
antitrust assaults on Microsoft and GE.
Seems to me that there is an abundance of
scepticism to harness against giving up on FASB as the US accounting
standard setter.
IASB Chairman Sir David Tweedie told a group of
British members of Parliament that he considered resigning his post after
going toe Go toe with the European Commission [EC] over the use of fair
value accounting methods and warned that further interference in accounting
rules could destroy the effort to adopt a unified set of standards,
according to a story in the Financial Times on Nov. 12. The IASB reportedly
agreed to the change only to avoid a worse alternative -- the EC's threat to
carve out sections of the IFRS relating to fair value practices.
The CFA Institute's Centre for Financial Market
Integrity opposes the IASB's change, calling it a step backward because it
doesn't improve the quality of financial reporting. The CFA would like to
see a broader application of fair value into categories where it's currently
not required, such as loans and receivables, says Patrick Finnegan, director
of the Financial Reporting Policy Group at the Centre.
"If you think we have problems with transparency of
balance sheets now, just wait for what's coming [under IFRS]," warns Kenneth
Scott, a senior research fellow at the Hoover Institution and a professor at
Stanford University's law school. Reclassification of financial assets
"doesn't add anything to asset value. It just fixes the books."
It's odd that something promoted as beneficial to
investors should be called into question for potentially lowering the
quality of reporting standards and in turn, preventing investors from
analyzing what a company's assets are really worth.
The key difference between U.S. Generally Accepted
Accounting Principles [GAAP] and IFRS is that U.S. standards are based on
explicit rules while the international standards' reliance on principles
gives companies more room to use their judgment in deciding how to recognize
revenue and other key metrics. Adoption of IFRS would also probably trigger
a big tax hike for U.S. companies, which would no longer be able to use the
last-in-first-out [LIFO] inventory accounting method, which doesn't exist
under the international standards. The LIFO method assumes that goods
purchased most recently are sold first and that the remaining items have
been purchased at earlier periods, yielding a lower gross profit during
high-inflation periods than the first-in-first-out accounting method.
Don't Sue Me
The debate over switching to accounting standards
based on something less explicit than rules comes down to questions about
whether the less explicit standard will provide adequate protection against
lawsuits, says James Leisenring, director of technical activities in
research at the FASB. "You can't understand
the debate about gratuitous vs. obligatory guidance [within IFRS] until you
understand the litigation system in the U.S.," where companies are more
concerned about getting sued than in other parts of the world, he says.
"What it's really about is safe harbors. What [IFRS skeptics] really want to
know is 'If I do it in a particular way, am I home free or not?'"
The explicit rules under GAAP may appear to offer
safety, but the downside is there are so many of them that the odds of
missing one or two are greater, he says. From Leisenring's perspective, the
big accounting firms that are drawn to IFRS believe they'll get sued less
since it will be harder to point to their mistakes. White agrees that some
companies like the freedom allowed under IFRS to interpret standards to suit
their convenience, which undercuts auditors' ability to prohibit certain
accounting choices.
The most strident critics of migration to IFRS
argue that the primary goal of the SEC and U.S. Treasury Dept. is attracting
capital to U.S. markets, rather than ensuring that the highest quality
accounting standards prevail. While attracting more capital to the U.S. "is
a valid business objective, it's not clear we can do that by going to
international financial reporting standards," says Ashwinpaul Sondhi,
president of A.C. Sondhi Associates in Maplewood, N.J., who has served on
CFA Institute committees.
Paul Miller, a professor of accounting at the
University of Colorado, would prefer to have competing standards, since the
only standards all countries would be able to agree on would be very weak
ones. He also believes a unified set of standards, rather than being
helpful, would stifle much-needed innovation given that most of the existing
accounting standards are more than 60 years old. (This is also
consistent with Shayum Sunder's research paper ---
http://profalbrecht.wordpress.com/2008/10/08/shyam-sunder-ifrs-critic/
)
Loss of Information
Some investment advisers, including Sondhi, believe
investors have already lost valuable information with the SEC's elimination
last year of the reconciliation between GAAP and the non-U.S. GAAP standards
used in foreign companies' financial reports. "Reconciliation gave me
information and told me about [non U.S. companies'] cash flow generating
ability that I didn't have from their financial statements alone," Sondhi
says.
The fact that many analysts in the U.S. and
overseas used to rely on the reconciliation suggests they found the
differences between GAAP and foreign standards very useful, says Sondhi. He
agrees that competition between different sets of standards might result in
better information. "I don't know that either side has achieved a level of
standard setting that would lead me to say we can do with one," he says.
Many investment professionals, however, support
migrating to a single set of standards, as long as they are of the highest
quality. Finnegan at the CFA Institute questions whether the IASB and the
FASB can act truly independently given the pressure each has been subjected
to by regulators over the past several months as a result of the financial
crisis. "When you have that kind of pressure and intervention, you have the
possibility of movement to lower-quality standards that's going to appease
certain interests at any one point in time, and that's not healthy," he
says.
Criticism of fair value accounting has been no less
vehement in the U.S. The SEC has resisted pressure to suspend the standard,
but Section 132 of the TARP gives the SEC broad authority to suspend the use
of SFAS 157 by issuer class or category of transaction [BusinessWeek.com,
10/14/08].
Who Feeds the Watchdogs?
The fact that IASB is funded by corporate
contributions also compromises its independence, critics say.
Until 2003, the FASB was funded under the same arrangement for 30 years.
That changed with the passage of Sarbanes-Oxley, which required the board to
be funded by mandatory contributions from the Public Company Accounting
Oversight Board [PCAOB], which Congress created to provide better regulatory
oversight of the accounting industry.
Miller at the University of Colorado says a better
source of funding for a standards board would be stock exchanges, which
could charge a fee to buyers and sellers who use the exchanges to do
transactions and presumably are users of financial statements. "I would far
rather see money going to an international board from users of financial
standards than those who prepare them," he says.
Another concern is whether the SEC would continue
to have regulatory oversight if U.S. companies adopt IFRS. Says Miller: "The
big issue is that sending it offshore diminishes our control, and in a time
of crisis where accounting has played a part, I don't think it's especially
wise to create a new system that diminishes U.S. control over accounting
standards."
Is that to say that FASB is beyond political (and
other) interference?
David
December 18, 2008 reply from Bob Jensen
Hi David,
Of course the FASB is not beyond politics.
But it was successfully formed to further distance standard setting from
politics. In fact the FASB was formed because a very serious threat from
Moss and Medcalf that the SEC would become the U.S. accounting standard
body, thereby giving the executive and legislative branches of
government more control over accounting standards and appointments of
standard setters ---
http://faculty.trinity.edu/rjensen/theory01.htm#AccountingHistory
Moss and Metcalf came very close to
removing the accounting profession from standard setting. The FASB was
intended to be an in-between “independent” standard setting body. There
are many times when the FASB really demonstrated independence under
threatened legislation to overturn such standards as FAS 123-R and FAS
133 (both of which Silicon Valley lobbyists fought hard to overthrow).
The SEC, however, has always had powers to overturn the FASB, and it did
so with oil and gas accounting after the drilling industry put the SEC
in a vice. That episode served to illustrate how political standard
setting would’ve become in the hands of the SEC. To it’s credit, the SEC
has mostly distanced itself from such standard overrides for more than
three decades.
If I were to criticize FASB independence
it might be that the powers on the Board were and still are heavily
influenced by executive partner alumni of the largest accounting firms
whose alumni generally led the FASB. I don’t want to imply ethics
violations in this regard. I do want to imply that the most powerful
FASB members had close ties with research partners in their former CPA
firms. I think that the research going on within the big firms caught
the attention of the FASB more than any other input to FASB
deliberations. In many, many instances this was a good thing since our
academy utterly and shamefully failed the FASB.
After 1933, the AICPA and the SEC seriously attempted to generate
accounting standards, enforce accounting standards, and provide academic
justification for promulgated standards.
ASRs of the SEC
In a 3-2 vote the SEC followed George
O. May's efforts to mandate external audits of securities traded
across state lines in the U.S.
1939-1959 A.D.: Accounting standards
were generated by the AICPA's Committee on Accounting Procedure
(CAP) that issued Accounting Research Bulletins (51 ARBs) --- but
the tendency was to overlook controversial issues such as
off-balance sheet financing, public disclosure of management
forecasts, price-level accounting, current cost accounting, and exit
value accounting. Controversial items avoided by the CAP included
management compensation accounting, pension accounting,
post-employment benefits accounting, and off balance sheet financing
(OBSF). The CAP did very little to restrain diversity of reporting.
1960-1972 A.D.: Accounting standards
in the U.S. were generated by the AICPA's Accounting Principles
Board (APB) that had more members than the CAP and a mandate to
attack more controversial reporting issues. The APB attacked some
controversial issues but often failed to resolve their own disputes
on such issues as pooling versus purchase accounting for mergers.
1972-???? A.D. Accounting standards
in the U.S. were, and still are, being generated by the Financial
Accounting Standards Board (FASB) that has seven members, including
required members from industry, academe, and financial analysts in
addition to members from public accountancy. FASB members must
divorce themselves from previous income ties and work full time for
the FASB. The formation of the
FASB was a desperation move by CPA's to stave off threatened
takeover of accounting standards by the Federal Government (there
were the Moss and Metcalf bills to do just that under pending
legislation in the U.S. House and Senate). Unlike the CAP and APB,
the FASB has a full-time research staff and has issued highly
controversial standards forcing firms to abide by pension accounting
rules, capitalization of many leases, and booking of many previous
OBSF items (capital leases, pensions, post-employment benefits,
income tax accounting, derivative financial instruments, pooling
accounting, etc.). The road has been long and
hard on some other issues where attempts to issue new standards
(e.g., expensing of dry holes in oil and gas accounting and booking
of employee stock options) have been thwarted by highly-publicized
political pressuring by corporations.
The funding history of the FASB is
interesting in itself until government funds started flowing because of
the Sarbanes-Oxley legislation. Like the IASB, some funding came from
sales of publications, but the FASB also had a seeded endowment.
Since the big accounting firms want IFRS so desperately in a rushed time
frame, I think these international firms should also give millions for
an endowment of IASB research and publication and Website
communications.
As far as our academy goes, most faculty
listened to the accountics researchers who attempted to divert academic
thinking away from standards setting.
Academic Accounting
Researchers Dropped Out and Failed the FASB
Demski’s
(1973 around the time the FASB was being formed)
article, ‘‘The General Impossibility of Normative Accounting
Standards,’’ reinforced academic reluctance to weigh in on how practice
‘‘ought’’ to proceed. What quantitative, management accountants read
into Demski’s article was that the accounting standard-setting process
was hopelessly and inevitably pointless— impossible, even—and that it
did not deserve any further effort from them. Academicians began backing
off from involvement in standard setting, which caused further
separation of teaching from research, but also exacerbated the
separation of research from practice. In fact, polls revealed that the
most quantitative journals—thus, those least accessible to
practitioners—were perceived to have the highest status in the academy
(Benjamin and Brenner 1974).
Glenn Van Wyhe, "A History of U.S. Higher Education in Accounting, Part
II: Reforming Accounting within the Academy," Issues in Accounting Education,
Vol. 22, No. 3 August 2007, Page 481.
Professor Demski continues to steer us
away from the clinical side of the accountancy profession by saying we
should avoid that pesky “vocational virus.” (See below).
The
(Random House) dictionary defines "academic" as "pertaining to areas of
study that are not primarily vocational or applied , as the humanities
or pure mathematics." Clearly, the short answer to the question is no,
accounting is not an academic discipline. Joel Demski, "Is
Accounting an Academic Discipline?"
Accounting Horizons, June 2007, pp. 153-157
Statistically there are a
few youngsters who came to academia for the joy of learning, who are yet
relatively untainted by the vocational virus.
I urge you to nurture your taste for learning, to follow your joy. That
is the path of scholarship, and it is the only one with any possibility
of turning us back toward the academy. Joel Demski,
"Is Accounting an Academic Discipline? American Accounting Association
Plenary Session" August 9, 2006 ---
http://faculty.trinity.edu/rjensen//theory/00overview/theory01.htm
Too many accountancy doctoral programs
have immunized themselves against the “vocational virus.” The problem
lies not in requiring doctoral degrees in our leading colleges and
universities. The problem is that we’ve been neglecting the clinical
needs of our profession. Perhaps the real underlying reason is that our
clinical problems are so immense that academic accountants quake in fear
of having to make contributions to the clinical side of accountancy as
opposed to the clinical side of finance, economics, and psychology ---
http://faculty.trinity.edu/rjensen/theory01.htm#DoctoralPrograms
My honest opinion is that many leading
accountics researchers are not avoiding the clinical side of accounting
out of snobbery. The problem is that clinical research in accountancy is
much more difficult than economics and behavioral research. Clinical
problems in accountancy are systemic and intractable.
"The SEC in
2008: A Very Good Year? A terrific one, the commission says, tallying a
fiscal-year record in insider-trading cases, and the second-highest number of
enforcement cases overall. But what would John McCain say?" by Stephen Taub and
Roy Harris, CFO.com, October 22, 2008 ---
http://www.cfo.com/article.cfm/12465408/c_12469997
Sadly, Chris Cox will leave office with both U.S. capital markets and the
U.S. financial accounting/auditing systems in disarray. It's not so much that
he's a bad person. It's just that he was too trusting of the oligopolies when
allowing them free hand in policing themselves.
That did not work
all well as we're now writing into the histories of disasters.
As a departing (hopefully soon) Director of the SEC, the legacy of Chris Cox
will not be commendable in spite of a
record number of successful recent SEC court cases against financial fraud.
John McCain announced during his campaign that, if elected President of the
U.S., one of his first acts would be to fire Chris Cox. In spite of some great
leadership against specific targets of fraud, Chris Cox failed to see the
dangers in allowing oligopolies to control two industries. In the case of Wall
Street, Commissioner Cox decided not to exercise the SEC's power and
responsibility of oversight of investment banks. And Wall Street investment
bankers took advantage of lax SEC oversight to a point of self-destruction.
In the case of the accounting industry, Chris Cox decided to allow the
oligopoly of the largest international accounting firms to dictate, for all U.S.
accounting firms and U.S. industry, abandonment of our rich heritage of U.S.
accounting principles in favor of an incomplete set (compared
to U.S. GAAP standards) of international accounting standards (IFRS).
Although this might be a commendable goal in a couple of decades after the
International Accounting Standards Board has the resources and infrastructure
and standards in place to take on the giant U.S. economy, the large-firm
oligopoly seemingly moved too quickly to make this transition. Possibly the
large accounting firms rushed us into IFRS this year because they had Chris Cox
under their thumbs. Tom Selling on October 8, 2008 now reveals some of the
politics being played by the big firms in this regard and predicts that the new
SEC Director will not be so favorably inclined toward a rush to abandon U.S.
accounting standards.
"Speaking Out Against IFRS Adoption? Welcome to the "Loud Minority," by
Tom Selling, The Accounting Onion, October 8, 2008 ---
http://accountingonion.typepad.com/
As I mentioned in a previous post, PCAOB member
Charles Niemeier delivered a tour de force critique of U.S. efforts to adopt
IFRS, at a recent New York State Society of CPAs (NYSSCPA) educational
event. To its credit, the NYSSCPA's e-zine covered Niemeier's remarks a few
days later. On the other hand, the PCAOB sure took its sweet time (weeks) to
post the text of his speech on its website.
Perhaps one reason the PCAOB appears to have
dragged its feet is that Niemeier was equally critical, if not more so, of
two other "global initiatives" in the financial reporting arena: "reliance
on non-U.S. regimes for auditor oversight, and converging U.S. auditing
standards to those developed by the International Federation of
Accountants." These thoughts were completely overlooked in the NYSSCPA's
coverage, and given short shrift by almost everyone else it seems.
Evidently, few care whether the PCAOB willingly gores its own ox; but
opposing IFRS adoption is like standing between hungry pigs and their
troughs.
IASC to Niemeier: You're Loud and We're Right ('Cuz
We Said So)
With respect to IFRS adoption, NYSSCPAs' coverage
of Niemeier was fair, and gets kudos from me for reporting this key
reaction:
"'The impression I got and the reaction from the
audience was: it's about time somebody said something about this,' said
conference Chair George I. Victor, who is also immediate past chair of the
NYSSCPA's Accounting and Auditing Oversight Committee. 'It's David and
Goliath and David stood up to Goliath here. Just about everybody in the room
agreed with most if not all, of what he said.'" [emphasis supplied]
You can bet that a Goliath would want the last
word, and preferably with no David to contend with. So, the NYSSCPA
accommodated Goliath a week later in the person of Philip Laskawy,
vice-chairman of the International Accounting Standards Committee Foundation
(IASCF), new chairman of Fannie Mae, and former head of Ernst & Young (1994
– 2001). Not all of the questions posed to Laskawy were softballs; however,
there can be no denying that numerous disingenuous answers were allowed to
prevail with nary a token of protest.
If a straight-shooting David were present, maybe
the encounter would have gone something like this:
NYSSCPA: The 22 trustees of the IASCF are
responsible for the governance, oversight and funding of IASB and the
rigorous application of International Financial Reporting Standards (IFRS).
Philip A. Laskawy retired as the chairman and CEO of Ernst & Young in 2001,
a position he had held since 1994. In addition to his service as a trustee,
he currently serves on the boards of several U.S. and foreign-based
companies and non-profits.
David: Another pertinent fact, which may affect
your assessment of Mr. Laskawy's credibility, is that he presided over E&Y
during a time when, as evidenced by unprecedented sanctions, E&Y committed
some of the most blatant independence violations by an international firm
since the enactment of the federal securities laws:
[In 2004, an] SEC administrative law judge fined
E&Y $2.164 million (including $1.7 million disgorgement) and bars the firm
from accepting any new clients in the U.S. for six months, after finding
that the firm acted improperly by auditing PeopleSoft Inc. -- a company with
which it had a profitable business relationship. … According to The New York
Times, the administrative law judge said the firm "committed repeated
violations of its auditor independence standards by conduct that was
reckless, highly unreasonable and negligent." (Floyd Norris, "Big Auditing
Firm Gets 6-Month Ban on New Business," April 17, 2004) … The SEC alleged
that E&Y violated the auditor independence requirements in connection with
E&Y's audits of PeopleSoft Inc.'s financial statements from 1994 through
2000. … [Available at http://www.crocodyl.org/wiki/ernst_young; emphasis
supplied]
NYSSCPA: More than one study has reported that
companies show higher earnings under IFRS versus GAAP. Can anything be done
to smooth the contradictory data investors will be relying upon as IFRS is
phased in for more companies in the years ahead?
Goliath: I have no basis of knowing whether any of
those studies are right or wrong. Anyway, that gets adjusted in the market
place, but more importantly you'll be able to compare two companies from
different countries who are in the same business to see how they're doing.
David: It sounds like you're not even interested in
knowing the answer to these questions. Evidently, the numerous studies cited
by Niemeier, and by Professor Teri Yohn in her testimony to Congress amount
to an inconvenient truth you would prefer to ignore. Yes, I know you're
Goliath, so I'll humor you and pretend that the totality of research on this
topic is actually inconclusive. How can you say on the one hand that the
market adjusts for differences in accounting, rendering differences between
IFRS and GAAP inconsequential; and then say on the other hand that market
participants will benefit from enhanced comparability! You seem to be saying
that accounting doesn't matter now, but it will when everyone adopts IFRS.
NYSSCPA: Are you concerned that comparability
across companies will decrease if the U.S. conducts a phased-in transition
to IFRS?
Goliath: Nope. U.S. companies aren't comparable
anyway, because GAAP changes so darn much. And, I don't think there have
been any examples where it's been that impactful on stock prices. Even
today, investors are not using GAAP earnings necessarily as a way of
determining their recommendations on companies.
David: Once again, the evidence contradicts your
wishful thinking. Those same folks I just mentioned cite evidence that
investors do prefer GAAP, and GAAP is more closely associated with stock
prices – i.e., investors putting their money where their mouth is.
Besides, lack of comparability due to changes in
GAAP is way overstated; all significant changes to GAAP require retroactive
restatements to assure comparability over earlier periods. Also, are you
actually saying that once the U.S. takes the plunge on IFRS, there will be
the equivalent of world peace, and for the first time since the days of the
Old Testament, accounting standards won't change? Unless that's what you are
saying, then IFRS won't result in comparability either; you have just thrown
comparability, your biggest selling point for global accounting convergence,
under the bus.
NYSSCPA: If the transition goes as expected, the
U.S. will be basically giving up control of financial standards to an
international body by 2016. We're surprised more people haven't been talking
about it.
Goliath: You really would have to ask them.
David: "You really would have to ask them" is
exactly what the IASCF and SEC should be doing more often and more better –
if the goal of U.S. adoption of IFRS is to make a change that investors
actually want and can benefit from. Instead of blatantly shilling for IFRS,
Goliaths should be spending their time looking for real answers. For
example, figure out how to encourage broad-based investor feedback so that
rigorous studies by impartial investigators can provide reliable answers to
high-stakes questions.
NYSSCPA: We're also surprised that you haven't
gotten more comment letters on the constitution review from stakeholders who
would want to weigh in on the oversight of IASB. What's your opinion on
that? Do you think all the stakeholders are really paying attention at this
point, or maybe it's too far off?
Goliath: With most things in life there's a very
loud minority, and Charles Niemeier truly is part of that minority—very
small—who make a lot of noise, but the vast silent majority just goes about
and does its thing, and I think that's what's happening here. And by the
way, I don't think the presidential election is going to affect the
transition to IFRS.
David: I don't know which insult makes me want to
shoot you with my slingshot more: your arrogant disrespect of a man of
obvious intelligence and integrity; or channeling Richard Nixon and Spiro
Agnew with their infamous Vietnam-era "silent majority" ("vast," no less)
schtick. Either way, there can be no denying Niemeier is in the company of
some other very smart people: among them, Ed Trott, former FASB member is
now speaking out about the questionable political agendas motivating the
SEC's proposed roadmap and the EU's adoption of IFRS; Floyd Norris of the
New York Times doing pretty much the same; and Shyam Sunder of Yale, who
believes that U.S. adoption of IFRS would lead to a mandated monopoly,
thereby creating more chaos than order to accounting standards. And, don't
forget the reaction of Niemeier's audience at the NYSSCPA program: it sounds
like he is the one preaching to the majority choir.
As to "loud," that better describes the Big Four
et. al., and the AICPA with their unabashed promotion of their own
self-interest. Now that current events are forcing the SEC to refocus on
investor protection, the long-awaited document proposing a "roadmap" to IFRS
seems to have disappeared (along with my 401(k) account). That seems to have
had no effect on your rhetoric – or that of your former firm. I received an
invitation from E&Y to watch a webcast on IFRS 2 (share-based payment) with
the following come on:
"International Financial Reporting Standards (IFRS)
is becoming the dominant language of financial reporting worldwide. With the
pending release of the SEC's proposed IFRS Roadmap, IFRS adoption in the US
is almost official. The question now remains a matter of when will adoption
be required and how will companies make the transition. For many, the key
will be early preparation and these businesses are developing their
transition plans now." [bold and italics in original; underline is mine]
Given recent events, that sounds awfully loud to
me! Other work prevented me from watching the webcast, but I'm betting that
there was more of the same hyperbole: probably some useful tips designed to
lead to fees for assisting management should they desire to re-engineer
their own compensation schemes to get the most out of IFRS in their
financial statements. But wait. I forgot that, according to you, the "market
adjusts" for these things. I'm also betting that a lot of investors' money
will be headed out the window when management figures out how to manage its
compensation under IFRS.
As to the outcome of the elections, don't be
surprised if "loud minority" leader Niemeier becomes the next SEC chair!
Even though he is a Republican, and Barack Obama is the likely victor,
Niemeier has the integrity, experience and profile that the SEC desperately
needs at this critical juncture. With three Democrats and a Republican chair
who owes nothing to his party, IFRS adoption in the U.S. will be history.
The bottom line, Goliath, is that the footnotes to
Niemeier's speech by themselves were more compelling and interesting than
what essentially boils down to your blind eye, blind faith or vested
interest responses for the sole objective of selling IFRS. My father taught
me to watch out for people, like you and the SEC's John White, who weave
"truly" into pompous rhetoric like "loud minority" and "vast silent
majority." The reliability of such utterances are usually anything but.
And by the way, I'm sure you're going to do a truly
great job for me at Fannie Mae.
At least six accounting professors have been trying to actively derail the current
SEC Chairman's abusing of his power to rush the replacement of rule-laced U.S.
accounting standards with mushy "principles-based" international standards that
allow business firms much greater flexibility (read that "subjective judgment")
in accounting for earnings and risk. But our efforts to derail or at least
postpone the Cox-Herz IFRS Express Train are utterly futile ---
http://faculty.trinity.edu/rjensen/theory01.htm#MethodsForSetting
As Chairman of the SEC, Christopher Cox should've instead been paying more
attention to preventing fraud and preventing the Men in Black (bankers) from
bullying their auditors into understating their bad debt reserves for faltering
mortgaged-backed securities (e.g., at Bear Stearns) and sinking credit default
swaps (e.g., at AIG). Mixing the metaphor here, we might say that Nero was
fiddling while Rome was burning.
The chairman of the Securities and Exchange
Commission, a longtime proponent of deregulation, acknowledged on Friday
that failures in a voluntary supervision program for Wall Street’s largest
investment banks had contributed to the global financial crisis, and he
abruptly shut the program down.
The S.E.C.’s oversight responsibilities will
largely shift to the Federal Reserve, though the commission will continue to
oversee the brokerage units of investment banks.
Also Friday, the S.E.C.’s inspector general
released a report strongly criticizing the agency’s performance in
monitoring Bear Stearns before it collapsed in March. Christopher Cox, the
commission chairman, said he agreed that the oversight program was
“fundamentally flawed from the beginning.”
“The last six months have made it abundantly clear
that voluntary regulation does not work,” he said in a statement. The
program “was fundamentally flawed from the beginning, because investment
banks could opt in or out of supervision voluntarily. The fact that
investment bank holding companies could withdraw from this voluntary
supervision at their discretion diminished the perceived mandate” of the
program, and “weakened its effectiveness,” he added.
Mr. Cox and other regulators, including Ben S.
Bernanke, the Federal Reserve chairman, and Henry M. Paulson Jr., the
Treasury secretary, have acknowledged general regulatory failures over the
last year. Mr. Cox’s statement on Friday, however, went beyond that by
blaming a specific program for the financial crisis — and then ending it.
On one level, the commission’s decision to end the
regulatory program was somewhat academic, because the five biggest
independent Wall Street firms have all disappeared.
The Fed and Treasury Department forced Bear Stearns
into a merger with JPMorgan Chase in March. And in the last month, Lehman
Brothers went into bankruptcy, Merrill Lynch was acquired by Bank of
America, and Morgan Stanley and Goldman Sachs changed their corporate
structures to become bank holding companies, which the Federal Reserve
regulates.
But the retreat on investment bank supervision is a
heavy blow to a once-proud agency whose influence over Wall Street has
steadily eroded as the financial crisis has exploded over the last year.
Because it is a relatively small agency, the S.E.C.
tries to extend its reach over the vast financial services industry by
relying heavily on self-regulation by stock exchanges, mutual funds,
brokerage firms and publicly traded corporations.
The program Mr. Cox abolished was unanimously
approved in 2004 by the commission under his predecessor, William H.
Donaldson. Known by the clumsy title of “consolidated supervised entities,”
the program allowed the S.E.C. to monitor the parent companies of major Wall
Street firms, even though technically the agency had authority over only the
firms’ brokerage firm components.
The commission created the program after heavy
lobbying for the plan from all five big investment banks. At the time, Mr.
Paulson was the head of Goldman Sachs. He left two years later to become the
Treasury secretary and has been the architect of the administration’s
bailout plan.
The investment banks favored the S.E.C. as their
umbrella regulator because that let them avoid regulation of their
fast-growing European operations by the European Union.
Facing the worst financial crisis since the Great
Depression, Mr. Cox has begun in recent weeks to call for greater government
involvement in the markets. He has imposed restraints on short-sellers,
market speculators who borrow stock and then sell it in the hope that it
will decline. On Tuesday, he asked Congress for the first time to regulate
the market for credit-default swaps, financial instruments that insure the
holder against losses from declines in bonds and other types of securities.
The commission will continue to be the primary
regulator of the companies’ broker-dealer units, and it will work with the
Fed to supervise holding companies even though the Fed is expected to take
the lead role.
The Fed had already begun regulating Wall Street
firms that borrowed money under a new Fed lending program, and the S.E.C.
had entered into an agreement under which its examiners worked jointly with
Fed examiners, an arrangement that is expected to continue.
The S.E.C. will still have primary responsibility
for regulating securities brokers and dealers.
The announcement was the latest illustration of how
the market turmoil was rapidly changing the regulatory landscape. In the
coming months, Congress will consider overhauls to the regulatory structure,
but the markets and the regulators are already transforming it in response
to events.
Still, the inspector general’s report made a series
of recommendations for the commission and the Federal Reserve that could
ultimately reshape how the nation’s largest financial institutions are
regulated. The report recommended, for instance, that the commission and the
Fed consider tighter limits on borrowing by the companies to reduce their
heavy debt loads and risky investing practices.
The report found that the S.E.C. division that
oversees trading and markets had failed to update the rules of the program
and was “not fulfilling its obligations.” It said that nearly one-third of
the firms under supervision had failed to file the required documents. And
it found that the division had not adequately reviewed many of the filings
made by other firms.
The division’s “failure to carry out the purpose
and goals of the broker-dealer risk assessment program hinders the
commission’s ability to foresee or respond to weaknesses in the financial
markets,” the report said.
The S.E.C. approved the consolidated supervised
entities program in 2004 after several important developments in Congress
and in Europe.
In 1999, the lawmakers adopted the
Gramm-Leach-Bliley Act, which broke down the Depression-era restrictions
between investment banks and commercial banks. As part of a political
compromise, the law gave the commission the authority to regulate the
securities and brokerage operations of the investment banks, but not their
holding companies.
In 2002, the European Union threatened to impose
its own rules on the foreign subsidiaries of the American investment banks.
But there was a loophole: if the American companies were subject to the same
kind of oversight as their European counterparts, then they would not be
subject to the European rules. The loophole would require the commission to
figure out a way to supervise the holding companies of the investment banks.
In 2004, at the urging of the investment banks, the
commission adopted a voluntary program. In
exchange for the relaxation of capital requirements by the commission, the
banks agreed to submit to supervision of their holding companies by the
agency.
Jensen Comment
In other words the Men in Black did indeed submit themselves to supervision, but
they probably knew full well that their man in charge of the SEC was going to be
focusing more on matters other than the shenanigans of the Men in Black
(bankers). Belatedly Cox now admits he should have paid more attention to what
he was supposed to be supervising.
Cox is going to be fired by either John McCain or Barack Obama. But in the
few remaining days before he leaves office he's trying to force the replacement
of rule-laced U.S. accounting standards with mushy "principles-based"
international standards that allow business firms much greater flexibility (read
that "subjective judgment") in accounting for earnings and risk. Efforts to
derail or at least postpone the Cox-Herz IFRS Express Train are utterly futile
---
http://faculty.trinity.edu/rjensen/theory01.htm#MethodsForSetting
I’m about to
give up on the FASB and the SEC. This is where you can find me, where the
air is clear and free of train smoke ---
http://hk.youtube.com/watch?v=C-F3vSrJIUQ
I
have three questions that I really want Christopher Cox to consider before
being fired:
1. Why the rush to commit
in 2008 (now) the United States to IFRS on an express train schedule? From a
strategy standpoint here in the U.S. it would seem better to wait and hold a
carrot in front of the IASB so that the IASB gets its infrastructure and
funding in place to handle the job of setting standards for the U.S. and all
the rest of the planet.
2. Why should our local Presby Construction Company that has audits to
maintain a line of credit at a local bank have to rush to change over to
IFRS global standards on such an express schedule by 2011? There just does
not seem to be enough time for this company to change over all its
accounting software (e.g., eliminate the LIFO inventory system), rewrite
leasing contracts, train employees, etc.
3. Why should so many accounting educators in the U.S., who cannot possibly
be up to speed to teach IFRS and FASB standards jointly by 2011, be forced
to do so without more time to prepare for this complete overhaul of the
courses, the curriculum, and the CPA Examination. NASBA has not yet
committed itself to an all-IFRS exam by 2011. Our accounting educators will
have the burden of teaching both FASB and IASB standards simultaneously when
preparing students for the CPA examination. I’m glad I’ve retired from
teaching!
Oxymoron? Principles-Based Revenue Recognition Standard
"Revenue Recognition: Will a Single Model Fly? Elements unique to
long-term contracts pose a challenge for FASB and IASB in their bid to create
one standard covering all customer relationships" by David McCann, CFO.com, July
2, 2009 ---
http://www.cfo.com/article.cfm/13941548/c_2984368/?f=archives
Can U.S. and international accounting
standard-setters realize their dream of fashioning a single
revenue-recognition standard that would apply to all customer contracts?
While the answer won't be known for some time, it's safe to say there are
hurdles on the road ahead.
In a joint discussion paper issued last December in
which the Financial Accounting Standards Board and the International
Accounting Standards Board proposed a model for a lone standard, they
acknowledged that an alternative approach could be needed for some
contracts. The almost 200 letters they received in a comment period that
ended June 19 did nothing to remove any doubts about whether having one
standard will be viable.
Most of the letters agreed that the standards
boards' goals are laudable. One main objective is to simplify and clarify
FASB's revenue-recognition rules, which currently are scattered among more
than 100 standards. Another is to offer more guidance than what's contained
in IASB's broadly worded revenue-recognition principle.
In meeting those twin objectives, the boards would
be advancing their overarching goal of converging U.S. and international
standards. The major goals aside, however, many commenters registered alarm
at specifics of the proposed model — especially concerning how revenue
should be recognized under long-term contracts.
Today, entities typically recognize revenue when
it's realized or realizable and the "earnings process" is substantially
complete. The new model instead would direct the entity to record the gain
when it performs an obligation under its contract, such as by delivering a
promised good or service to the customer. (The contract need not be written;
even a simple retail transaction involves an implicit contract in which the
customer agrees to provide consideration in return for an item.)
In a simple example, if the entity had agreed to
provide two products at different times, it would recognize revenue twice,
even if the contract stipulated that payment would not be made until the
second product was delivered. The discussion paper mentions several
permissible bases on which revenue could be allocated to the different
performance obligations. But the paper says the revenue should be in
proportion to the stand-alone selling price of the good or service
underlying a performance obligation. And for an item that's not sold
separately, a stand-alone price should be estimated — something that the
standards boards acknowledged could be hard to do.
A main purpose of the performance-obligation
approach is to iron out many of the disparities in how businesses account
for revenue, which the boards say make financial statements less useful than
they should be. The discussion paper gave the example of cable television
providers, which under FAS 51 account for connecting customers to the cable
network and providing the cable signal over the subscription period as
separate earnings processes. By contrast, under the Securities and Exchange
Commission's SAB 104, telephone companies account for up-front activation
fees and monthly fees for phone usage as part of the same earnings process.
"The fact that entities apply the earnings process
approach differently to economically similar transactions calls into
question the usefulness of that approach [and] reduces the comparability of
revenue across entities and industries," the discussion paper stated.
Long Engagements Perhaps the thorniest issue
arising from the standards boards' proposal involves long-term construction
or production contracts. Historically, under many such arrangements the
company recognizes revenue using the "percentage-of-completion" method — if
it's a three-year project with costs of $3 million, and $1 million of that
is expended in the first year, one-third of the revenue is reflected for
that year.
The single-model proposal, on the other hand, says
that revenue should be recognized as an entity "transfers control" of goods
and services to the customer. But many comment letters noted that the
discussion paper did not clearly define what constitutes a transfer of
control.
A company that is constructing a building for a
customer may regard the materials and labor being provided as a continuous
transfer of goods and services, which under the proposed model could be
construed as allowing them to continue to recognize revenue over the
duration of the contract. But if the standard setters hold that "transfer of
control" occurs when the building is completed and turned over to the
customer, all of the revenue would have to be recognized in the final year
of the contract.
Lynne Triplett, a partner and revenue-recognition
expert at Grant Thornton, told CFO.com that the way the discussion paper is
written, "There could be questions as to whether there is continuous
transfer of control, and to the extent there's not, there is going to be a
significant difference between the way revenue is recognized today versus
how it might be recognized in the future."
That would create misleading financial statements,
according to some of the comment letters. "The most concerning area of the
discussion paper is the potential change to the accounting for long-term
contracts," wrote Financial Executives International Canada. "Creating a
model which results in 'lumpy' revenue recognition ... with a waterfall
effect in one accounting period at the very end, is not useful to the
readers of financial statements."
Continued in article
Jensen Comment
Most of the argument centers on timing of revenue recognition such a in
long-term contracts. But the important issues concern whether or not some
transactions should be recognized as revenue. Much of this debate was left in
many EITF dead ends that need to be explicitly resolved ---
http://faculty.trinity.edu/rjensen/ecommerce/eitf01.htm
But the track record of the IASB is not very strong about explicit
resolution of problems. Instead the IASB likes principles-based standards that,
in my viewpoint, leaves too much to subjective judgment. This is one of the
reasons why the revenue recognition standards to date issued by the IASB
arguably constitute the greatest weakness in IFRS.
Is it possible to teach this transaction from an IFRS perspective?
Denny Beresford made a helpful suggestion that one way to teach IFRS is to
first look at the transaction itself and then reason out how to account for it
under IFRS standards and interpretations. So here's a challenge for your
advanced-level accounting students: How would you account for this one
under IFRS?
What this illustrates is the type of thing that the IASB will have to tackle
all alone, without a FASB research staff, when the U.S. depends upon the IASB
for its accounting standards. I don't think the IASB fully understands what it
is getting into by so desperately wanting to set accounting standards for U.S.
companies.
From the financial rounds blog on December 29, 2008
How Do You Use Credit Default Swaps (CDS) To Create "Synthetic Debt"?
There's been a lot of talk in recent months about
"synthetic debt". I just read a pretty good explanation of synthetics in
Felix Salmon's column, so I thought I'd give a brief summary of what it is,
how it's used, and why.
First off, let's start with Credit Default Swaps (CDS). A CDS has a lot of
similarities to an insurance policy on a bond (it's different in that the
holder of the CDS needn't own the underlying bond or even suffer a loss if
the bond goes into default).
The buyer (holder) of a CDS will make yearly payments (called the
"premium"), which is stated in terms of basis points (a basis point is 1/100
of one percent of the notional amount of the underlying bond). The holder of
the CDS gets paid if the bond underlying the CDS goes into default or if
other stated events occur (like bankruptcy or a restructuring).
So, how do you use a CDS to create a synthetic bond? here's the example from
Salmon's column:
Let's assume that IBM 5-year bonds were yielding 150 basis points over
treasuries. In addition, Let' s assume an individual (or portfolio manager)
wanted to get exposure to these bonds, but didn't think it was a feasible to
buy the bonds in the open market (either there weren't any available, or the
market was so thin that he's have to pay too high a bid-ask spread). Here's
how he could use CDS to accomplish the same thing:
First, buy $100,000 of 5-year treasuries and
hold them as collateral
Next, write a 5-year, $100,000 CDS contract
he's receive the interest on the treasuries,
and would get a 150 basis point annual premium on the CDS
So, what does he get from the Treasury plus writing
the CDS? If there's no default, the coupons on the Treasury plus the CDS
premium will give him the same yearly amount as he would have gotten if he's
bought the 5-year IBM bond, And if the IBM bond goes into default, his
portfolio value would be the value of the Treasury
less what he would have to pay on
the CDS (this amount would be the default losses on the IBM bond). So in
either case (default or no default), his payoff from the portfolio would be
the same payments as if he owned the IBM bond.
So why go through all this trouble? One reason might be that there's not
enough liquidity in the market for the preferred security (and you'd get
beaten up on the bid-ask spread). Another is that there might not be any
bonds available in the maturity you want. The CDS market, on the other hand,
is very flexible and extremely liquid.
One thing that's interesting about CDS is that (as I mentioned above), you
don't have to hold the underlying asset to either buy or write a CDS. As a
result, the notional value of CDS written on a particular security can be
multiple times the actual amount of the security available.
I know of at least one hedge fund group that bought CDS as a way of betting
against housing-sector stocks (particularly home builders). From what i
know, they made a ton of money. But CDS can also be used to hedge default
risk on securities you already hold in a portfolio.
To read Salmon's column, click
here, and to read more about CDS, click
here
Credit Default Swap (CDS)
This is an insurance policy that essentially "guarantees" that if a CDO goes bad
due to having turds mixed in with the chocolates, the "counterparty" who
purchased the CDO will recover the value fraudulently invested in turds. On
September 30, 2008 Gretchen Morgenson of The New York Times aptly
explained that the huge CDO underwriter of CDOs was the insurance firm called
AIG. She also explained that the first $85 billion given in bailout money by
Hank Paulson to AIG was to pay the counterparties to CDS swaps. She also
explained that, unlike its casualty insurance operations, AIG had no capital
reserves for paying the counterparties for the turds they purchased from
Wall Street investment banks.
What Ms. Morgenson failed to explain, when Paulson eventually gave over $100
billion for AIG's obligations to counterparties in CDS contracts, was who were
the counterparties who received those bailout funds. It turns out that most of
them were wealthy Arabs and some Asians who we were getting bailed out while
Paulson was telling shareholders of WaMu, Lehman Brothers, and Merrill Lynch to
eat their turds.
25 December 2008: 12 IASB pronouncements
await EU endorsement
The European Financial Reporting Advisory Group (EFRAG) has updated its
report showing the status of endorsement, under the EU Accounting
Regulation, of each IFRS, including standards, interpretations, and
amendments. Click to download the
Endorsement Status Report as of 23 December 2008 (PDF 89k).
Currently, there are 12 IASB pronouncements are awaiting European
Commission endorsement for use in Europe (including 3 awaiting EFRAG
advice and 8 awaiting an ARC recommendation), as follows:
Standards
IFRS 1 First-time Adoption of IFRS – Restructured standard
(2008)
IFRS 3 Business Combinations (2008) Interpretations
IAS 39 Amendments for Reclassification of Financial Assets
24 December 2008: IFRS e-Learning in
Spanish
The many visitors to IAS Plus for whom Spanish
is their first language may be interested to know that Deloitte
is in process of translating our IFRS e-Learning into Spanish.
Approximately 20 of the current 37 modules have been translated.
These are under review and we are hopeful that they can be
released in the first quarter of 2009. Translation of the
remaining 17 modules has begun, but it's a bit premature for us
to suggest a likely release date. Like the English language
version, Deloitte's Spanish IFRS e-Learning will be made
available to the public without charge.
Here’s a negative externality of the wipeout of FASB
standards, interpretations, implementation guides, illustrations, etc. A vast amount of openly shared accounting education tutorials, videos,
spreadsheets, software, and free textbooks will disappear.
A lot of accounting cases from Harvard, Stanford, ECCH, and elsewhere will
disappear.
Note that FASB referencing must change even if content changes only slightly
(such as expunging of some bright lines)
From:
Richard Campbell [mailto:campbell@rio.edu] Sent: Monday, December 08, 2008 6:46 AM To: Jensen, Robert Subject: My nomination for "Sharing professor of the week"
I featured
Susan’s free accounting videos some time back editions of both New Bookmarks
and Tidbits. Since then I’ve maintained links to her videos and other free
videos, textbooks, spreadsheets, and other free course materials at
http://faculty.trinity.edu/rjensen/ElectronicLiterature.htm#Textbooks
The
changeover to IFRS is going to mess up a lot of the free stuff, especially
in intermediate accounting. There will also be things that have to be
changed in basic financial and managerial accounting such as extraction of
LIFO as an acceptable valuation alternative for inventories. Basic
accounting instructors assume that the IFRS changes are minimal for the
basic courses, but if you look at the available open shared videos,
tutorials, test banks, spreadsheets, and free textbooks there are countless
other changes that have to be made. For example, Tom Selling correctly
points out that IAS 17 is basically a clone of the amended FAS 13 lease
accounting with the bright lines fuzzied up. But everywhere that the open
shared materials reference FAS 13, the references and maybe quotations have
to be changed to IAS 17.
In other
words, even in places where the substance does not change, the references
change. Those professors who think that basic accounting lecture materials
and other course materials won’t change much, just have not thought this
out. Every little place where a reference to a FASB standard,
interpretation, EITF, etc. is mentioned (even in a footnote) has to be
changed to reduce confusion for students.
Either
students and faculty have to give up on using open share materials or the
providers like Susan have to redo most of their videos, tutorials, test
banks, spreadsheets, and free textbooks. The changeover to IFRS did not will
not being doing those of us that openly share hundreds of files any favors.
Will Susan remake all her free videos? Will Jensen remake all his free
videos? Think of the open shared accounting materials that have to be
changed at
http://faculty.trinity.edu/rjensen/ElectronicLiterature.htm#Textbooks
We expect
the authors of commercial materials to take the time and trouble to change
their textbooks and textbook supplements. It’s asking a lot, however, to
expect authors of free open sharing books, videos, tutorials, and test banks
to redo there openly shared materials because of changes due to the
replacement of US GAAP with IFRS.
At first I
breathed a sigh of relief that most of my open sharing tutorials, videos,
glossary, and other materials on accounting for derivative financial
instruments actually point out differences between FAS 133 and IAS 39. This
technically means less updating for me. But after I thought about it, these
materials add a lot of noise for users who will no longer give two hoots
learning how FAS 133 differs from IAS 39. They will only want to learn IAS
39 as efficiently as possible, and IAS 39 is a whole lot easier to learn
than FAS 133 since IAS 39 completely ignores a lot of the hard stuff,
especially stuff taken up for FAS 133 by the Derivatives Implementation
Group ---
http://www.fasb.org/derivatives/
Will I pull all the DIGs out of my FAS133/IAS39 free online glossary? I
doubt it ---
http://faculty.trinity.edu/rjensen/acct5341/speakers/133glosf.htm
We assume
that publishers of current textbooks will persuade the authors to rework
their textbooks. But I wonder is those repositories of individual teaching
cases (Harvard, Stanford, ECCH, etc,) have considered all the changes to
content and references that must be changed in the teaching cases and
teaching notes that reference FASB literature. In some cases, the authors of
these cases are no longer living or have long since retired or have zero
interest in reworking old cases. A lot of such cases will no longer be
available for use in accounting courses.
The shift to International Financial Reporting
Standards (IFRS) is both appropriate and, in any event, ineluctable. It is
appropriate because our markets today, more than ever before, are truly
global. Investors worldwide need to be able to compare companies across the
board, and disparities in accounting conventions will only create major
traps for the unwary. It is ineluctable because the SEC has wisely
recognized the need for a uniform global standard and has paved the way
toward the achievement of such a standard.
Before we actually arrive at this promised land,
however, major questions will need to be answered about the roles that the
Securities and Exchange Commission, the Financial Accounting Standards
Board, and, ultimately, the U.S. judiciary, will play during the transition
period, and once all public companies are required to report under an IFRS
regime. Given the ineptitude and generally high level of dissatisfaction
with FASB, the weakened political position of the SEC and the incentive to
move quickly in the waning days of the Bush administration, steps along the
road to adoption of IFRS may occur more quickly than otherwise might be
expected. Companies should begin to prepare for the process of abandoning
U.S. GAAP and adopting IFRS within the next several years, even while
bearing in mind that many details remain to be ironed out.
The Lay of the Land
IFRS is a simplified, principles-based, system of
accounting standards. Instead of relying upon the rules-based approach
reflected in GAAP, under which every possible type of transaction needs to
be separately addressed, IFRS provides a set of principles applicable to the
economic substance of various transactions, and then relies on
professional and independent auditors to interpret those principles and
apply them to the specific economics of each transaction. As a result of
this principles-based approach, the entire IFRS canon consists of only 2,000
rules, as opposed to GAAP, which has over 25,000 rules (and still fails to
address some significant issues). Concomitant with this relative regulatory
simplicity come both flexibility and a potential lack of comparability. Two
different reporting entities may account for comparable transactions
differently under IFRS, depending upon the opinion of each entity and the
professional judgment of their auditors.
IFRS has been developing and evolving since 1966,
and has benefitted from inclusion of the best elements of existing
accounting systems. Since 2002, FASB and IASB have worked toward convergence
of IFRS and GAAP. Not surprisingly, conceptual differences have hampered the
process. The initial effort proceeded rule-by-rule, and attempted to
reconcile each one. Unfortunately this approach foundered on irreconcilable
philosophical differences between the approaches underlying the two
standards, and in any event would have taken decades to achieve (all the
while new rules were being promulgated). Recently, the effort has been
slimmed down and limited to several finite areas, including lease
recognition, financial statement presentation, and revenue recognition. The
hope is to complete these projects by 2011.
The movement toward IFRS is gaining considerable
momentum in the United States. On Aug. 7, 2007, the SEC issued a concept
release asking for comments on allowing U.S. companies to adopt IFRS in lieu
of GAAP, and on Nov. 15, it abandoned its long-standing requirement that
foreign private issuers reconcile their IFRS-based financial statements to
GAAP, so long as those statements initially are prepared in accordance with
IFRS. SEC Chairman Christopher Cox has made convergence one of his top
priorities. Industry comments have been favorable on a conceptual level,
although there has been much comment on specific issues that need to be
resolved prior to the adoption of IFRS. Federal Reserve Chairman Ben
Bernanke and Treasury Secretary Henry Paulson have been supportive of the
concept as well. Earlier this summer John White, director of the SEC’s
Division of Corporation Finance, indicated that a roadmap for convergence,
possibly including a timetable for proposed rule-making, would be
forthcoming once the SEC is back to its full complement of five
commissioners—which has now happened—and the new commissioners have had an
opportunity for input into the process.
Outstanding Issues
While generally supportive of the proposal to move
to IFRS, many comment letters point out issues that need to be resolved
prior to full-scale adoption. These include, predictably, the need for
judicial clarity, the need to define the changed roles of the SEC and FASB,
and the method by which the transition from GAAP to IFRS will be
accomplished.
Switching to IFRS will require U.S. auditors to be
comfortable abandoning the judicially tested, relatively well-defined,
rules-based approach and entering the uncharted waters of auditors’
judgment. It is unlikely that any legislative relief will be attempted and
unreasonable to expect that even if attempted, such relief would emerge
expeditiously from the current quagmire bogging down tort reform. Auditors
and companies will have to assume the risk that courts, in the perfect
clarity of 20/20 hindsight, may decide that judgments made at the time of a
transaction were incorrect, that the transaction was, therefore, improperly
recorded, and, finally, that the company and the auditors should be punished
for the accounting lapse. Despite the inherent uncertainty in this new
approach, the missteps and near-bankruptcy of accounting firms under the
current rules-based regime make for a compelling argument that pursuit of
another alternative is in order. Auditors and companies may come to realize
that the grass is no less green and potentially greener on the other side of
the accounting standards’ fence.
The move from detailed prescriptive rules to
principles-based accounting will also change the nature of enforcement
actions. Regulators will no longer be able to measure financial reporting
against bright line rules. Instead, they will have to become fluent in
economic reasoning and application of broad principles. It will also make
after-the-fact revisions—such as the change in finite reinsurance rules—more
difficult. Juries will have to make judgments based upon intent, which may
be a welcome change from recent decisions, which required jurors to delve
into the world of arcane accounting rules and resulted in some perverse
outcomes.
If IFRS is to become and remain the international
standard, the role of the SEC will need to change. The SEC presently wields
considerable influence over the substantive content of GAAP, through its
issuance of Staff Accounting Bulletins, initiation of enforcement
proceedings, and its effective control over the membership and funding of
FASB. The SEC can neither hope nor expect to have anywhere near that much
influence with IASB. To be sure, the SEC will have a powerful voice, but it
will be one of many, capable of being either overridden or made stronger, by
other regulatory bodies. Many Europeans fear the SEC will attempt to take
over IASB and move IFSR toward GAAP. While the SEC, under Chairman Cox has
shown admirable worldwide cooperation, subsequent administrations might
espouse a more parochial approach. A xenophobic agenda could significantly
set back both international finance and the United States’ position in the
international financial community.
The PCAOB will be a critical player in this
evolving drama. The Sarbanes-Oxley Act created the PCAOB to oversee the
auditing profession. In that role, it examines U. S. auditors and sets forth
minimum standards that auditors must follow during the course of their
audits. The International Auditing and Assurance Standards Board (IAASB) is
the IFRS’s equivalent of the PCAOB. Will the PCAOB, which was established
only six years ago, be willing to share its power so soon after its
creation? The PCAOB and the IAASB could exist independently, but this would
be awkward and eventually might lead to a different version of IFRS in the
United States, thereby undermining one of the primary rationales for IFRS.
The more pragmatic and, ultimately, more effective, approach will require
cooperation, with the PCAOB acting as the U.S. representative on the IAASB.
Such a limited role for the PCAOB could irritate some regulators and
legislators.
FASB will clearly assume a role subsidiary to IASB.
It will become the United States’ representative on IASB, but will no longer
have the ability to set accounting rules by itself. To a certain extent this
is an ignominious end to a rich part of U.S. financial history, but it is an
end that is largely dictated by the damage self-inflicted by FASB’s
consistent inability to address adequately the critical issues that have
arisen during globalization of the capital markets. Bodies such as IASB,
seeking to become the sole global source for regulation in a given sphere,
would do well to study the history of FASB in order to avoid similar
mistakes.
One final issue is the method by which the
transition from GAAP to IFRS will be accomplished. Most other countries have
managed the transition by providing a grace period, during which companies
and their auditors had an opportunity to adjust their financial processes
and to adapt to IFRS, with IFRS reporting implemented at the end of the
period. Another alternative is to allow an interim period during which
companies could elect to report using either IFRS or GAAP as they move
toward IFRS at their own speed, but with a deadline by which the use of IFRS
would be required. Under either of these approaches, full implementation of
IFRS in the United States is likely in less than five years.
Critics of an interim approach complain that,
during the interim, there may be disparities between companies in the same
industry that utilize GAAP or IFRS. While this is regrettable, the reality
is that it will likewise be possible that two companies in the same industry
will report differently under IFRS. Investors and regulators will have to
adjust to life under this new regime, and there is no time like the
present—or at least the near future—to start getting used to it.
What Companies Should Do Now
Companies should be endeavoring to get ahead of the
inevitable transition to IFRS. It will offer benefits of international
consistency of approach and simplification of application. Unfortunately
with these benefits there also will be upfront costs—potentially quite
significant ones—as there were with Sarbanes-Oxley. This time, at least,
U.S. companies are not the guinea pigs for a whole new process, but are
merely adopting an approach that has already been tested in Europe and much
of the rest of the world.
In order to make the transition to IFRS as smooth
and painless as possible, U.S. companies should consider the following
steps:
The Early Bird Catches the Worm.
Companies should start planning now. International accounting firms
already have in-house expertise in moving companies to IFRS. If
companies act now, they can benefit from that expertise, before someone
else steps in to monopolize it.
Use Outside Advisors. It is
inevitable that you will need outside advisors to make the switch. Don’t
be penny-wise and pound-foolish. Money spent judiciously early in the
process will facilitate a smooth transition and save money in the long
run.
Promote Transparency. The
switch to IFRS necessarily will eliminate or change some of the key
metrics that investors rely upon to track the progress of companies. To
consider exactly how companies will be affected, utilization of outside
advisors can help companies determine how to include these metrics in
their reporting materials, introduce investors to new metrics and
explain the difference between the old and the new ones, so that
investors will be comfortable with, and able to anticipate, the change.
Speak Up. There will be
numerous opportunities for companies to make their voices heard on the
matter of IFRS and its implementation, and to influence the outcome of
events. Those that actively engage in the process are likely to find the
outcome far more palatable than those that make no effort to make their
opinions known.
A Friend in Need Is a Pest.
After the SEC finalizes its IFRS-related rules, the die will be cast. As
companies offer comments or suggestions on the rules proposals, it will
also be an opportune time to establish relationships with the
regulators, to learn whom you can call with questions when IFRS becomes
the standard. The SEC Staff needs information now, to inform its
analysis and help in the formulation of specific proposals. Providing
such input today will pay exponential dividends in the future.
Keep Your Equilibrium. There
will be difficult times as companies transition to IFRS. For example,
the recent revisions to Financial Accounting Statement 5—concerning
contingent liabilities—require more expansive disclosures concerning
contingent liabilities than previously required under GAAP. This was
done, in part, to bring FAS 5 in line with IFRS’s requirements. Needless
to say, FASB’s proposed changes are raising concerns about discovery and
other issues. Unfortunately there will be many similar surprises—some
good, some bad—as companies transition to IFRS. Companies would do well
to bear in mind, though, that all other U.S. companies, even their
competitors, are going through the same process and that this too shall
pass, with IFRS eventually becoming the status quo.
Retain Flexibility. While the
SEC has devoted a great deal of public comment to IFRS, there is no way
of knowing when actual proposals will materialize, how long the
proposals will take to move from the proposal stage to final rules, and
how much might change in the interim. Companies must remain flexible and
avoid going so far in one direction that it is difficult to reverse
field if the lay of the regulatory landscape changes.
Be Patient and Communicate.
U.S. audit partners and their teams are also learning IFRS. It will be
important to have ongoing, open communications, so that companies
identify key areas of uncertainty or differences in approach and develop
mutually acceptable solutions. The first time through needs to be a
collaborative effort, not a confrontational one.
There’s No Time Like the Present.
Companies should hire or train someone in IFRS, and it isn’t too soon to
start. A successful transition will depend upon the development of
in-house resources that can help manage the process. This is an ideal
role for cultivating junior staff with potential and initiative.
Cultivate New Investors.
IFRS-based financial statements will open your company to all the
world’s investors. Open a dialogue to determine what metrics they would
find most useful in evaluating you and your competitors and then work to
ensure that your implementation of IFRS includes those metrics.
The transition to IFRS offers exciting
possibilities for U.S. companies. Abandoning rules-based GAAP in favor of
principles-based IFRS should eventually simplify lives and accounting
statements. In addition, comparably prepared statements should expand the
worldwide investor pool for U.S. companies. There undoubtedly will be
transition costs, inconsistencies, and uncertainties, to say nothing of
significant dislocations, but overall it is an important step toward an
integrated global financial system. Once the details work themselves out,
everyone will be in a better place.
November 28, 2008 message from Bob Jensen
I still think those of you advocating principles-based standards because
they sound better in theory (who can argue with good auditor judgment?) are
forgetting the entire history of why the FASB kept adding bright line rules
to what started out as principles-based standards.
In countless instances, companies with the helpful nods of their
less-than-independent auditors were getting around standards by writing
ever-increasingly complex contracts to keep debt off the balance sheet and
to manage earnings and to inflate revenues. It was, I grant you almost a
game, because as the standards added more bright lines the contracts became
increasingly complex such as is now the case when trying to decide whether
financial obligation is debt, equity, mezzanine, or entirely off balance
sheet. Efforts are constantly being made to shrink the reported debt with
incomprehensible contract clauses.
In theory principles-based standards will mean that brilliant auditors of
all the large accounting firms will independently follow a path of logic and
all arrive at the same conclusion under IFRS standards as to how each
contract should be booked and reported. If you really believe this then you
also believe in the tooth fairy. Bright line rules are not perfect, but at
least they make the companies work harder to manage reported earnings,
assets, and liabilities.
Note that I’ve never argued that rules-based standards eliminated
creative accounting. But I do think they forced the creative accountants to
become more innovative, because the bright line rules were specifically
designed to make abuses that came to light less abusive. There’s probably no
better illustration of creative accounting versus Emerging Issues Task Force
rule adoption than in the area of revenue recognition ---
http://faculty.trinity.edu/rjensen/ecommerce/eitf01.htm
It’s inevitable that bright line rules will be added at exponential rates
as the IASB becomes aware of how U.S. companies are abusing their
principles-based standards with creative contracts and huge inconsistencies
in how some contracts are accounted for in practice. In the meantime a whole
lot more U.S. investors will be hurt under IFRS than FASB standards, at
least for the next decade or so. You all hope this will be so, but the IASB
has not yet encountered creative accountants and lawyers in the United
States. There’s a reason we have 80% of the world’s supply of lawyers.
Bob Jensen
Question
What recent 3-2 FASB vote riles the feathers of Tom Selling with innuendos that
the banking industry and large accounting firms had too much influence on a vote
that was not in the best interests of accounting transparency for investors?
A "Who Done It?"
"FSP EITF 99-20-1: Dissenting Board Members Hit the Nail on the Head," by Tom
Selling, The Accounting Onion, January 14, 2009 ---
http://accountingonion.typepad.com/theaccountingonion/2009/01/fsp-eitf-99-20.html
Jensen Comment
I perform the despicable deed of (almost) revealing the ending of his mystery to
those who've not yet read the mystery. What must our students think?
About Those Brave Dissenters
And, who were those masked men (or woman)? If I
give you a list of the current FASB members along with a brief description
of their backgrounds, I'm betting you can guess correctly, even without
knowing anything else about them:
* Robert Herz -- former ...
* Thomas Linsmeier -- former ...
* Leslie Seidman -- former ...
* Marc Siegel -- a recognized ...
* Lawrence Smith -- former ...
They are X and Y, of course -- the only two who did
not spend the bulk of their careers serving corporate clients. And
incidentally, they are the two most recent additions to the FASB.
The likes of X and Y give me some hope for the
future of standard setting following the second major financial reporting
crisis of the decade. If we could somehow get just one more on the board
like them, the SEC's recommendations to the FASB can become a reality long
before the IASB gets its act together.
Like most accounting issues, reasonable people can
disagree on the best accounting for this situation. For example, I refer
readers to comment letter 7 on this FASB project written by yours truly. The
letter agrees with the majority FASB position and further explains why the
current "other than temporary impairment" model ought to be reconsidered by
the FASB. The SEC staff took a similar position in its recent report on fair
value accounting.
Not to disparage Tom's well considered views on
this matter, but I would also observe that those disagreeing with the output
of the process might have more influence on the process by expressing their
views directly to the FASB or other standard setting body.
Denny Beresford
January 18, 2009 reply from Bob Jensen
I do understand that the FASB is well intended, but I did hate to see it
reduce such power to three people no matter what the issue.
I think where I agree with Tom is the strong wording of the two that
dissented this time.
1 - Whether new standards should require a larger
number of board members or a higher number of votes before becoming
effective.
2 - Whether the dissenters present more compelling
arguments (in your view) for their position than do the assenters for the
final position taken by the FASB.
As you know, the size of the FASB was reduced to
five members last year after having been comprised of seven members from the
beginning of the Board. The FAF Trustees made this change after due process
and there were arguments for and against. I was in favor of the change
primarily because it allows the Board to be more efficient and reach
conclusions more quickly rather than the past practice of working on some
issues "forever." I also note that, with only five members, the present
members from the user and academic community have more influence (2 of 5
votes) than they did under the old system (2 of 7 votes).
The voting requirement has changed several times -
majority vs. super majority. I served under both regimes and don't believe
that it made much difference. In almost all cases I can remember, the Board
would have acted on a final standard regardless of the voting requirement.
The bare majority rule just allowed one more member to get on his/her
soapbox and express a personal view that often didn't affect the overall
conclusion but rather one or more of the technical details.
So my question to you and others is should the
Trustees reconsider the composition of the Board to change the size again,
change the voting requirement again, or change the composition of the Board
by choosing members with different backgrounds? I know there has been a fair
amount of research on the effect of voting requirements but I'm not aware of
any such research that presents a compelling reason for one approach or the
other. The size of the Board is a new development and, again, I'm sure there
are research opportunities available. And, of course, individuals can always
weigh in with their personal opinions on these matters regardless of
supporting research.
On the second point above about whose opinions
should prevail, that seems to be the purpose of a standard setting process
that has been thoroughly considered and agreed to by those with interest in
the process. In other words, once interested parties have bought into the
idea that having standards is likely to improve the quality of financial
reporting and that the system for developing those standards is reasonable,
then those parties should be willing to accept the results of the system.
I'm a pragmatist and always felt that the financial markets were better
served by having some accounting standards even if those standards aren't
perfect (and who can judge that?). Thus, I only dissented a couple of times
during my time as Chairman. And even in those cases I thought it was better
that the Board issued a new standard than not, even if I would have
preferred a different approach. Since leaving the Board over 11 years ago I
have continued to write comment letters because I am passionate about
financial accounting and have personal views on most of the topics. Often
I've disagreed with the Board but I'm happy to have at least had the chance
to participate and I can cite at least a few cases where changes were made
as a result of my (and others') comments on a particular issue.
I've always been surprised that so few academics
participated in the FASB's process and I wrote about that at least a couple
of times while at the Board. And the situation is actually a bit better
these days as the AAA financial reporting committee and some individual
professors do contribute. But there is plenty of room for further
improvement.
Sorry for getting a little carried away on this. I
need to get back to my weekend reading.
I hope I am not interrupting your reading with this
email. But, I really, really want to respond to some of your points.
Before I do that, however, and speaking of reading,
I did finally finish Alice Schroeder's 800-page authorized biography of
Warren Buffet. It was rather long, but quite enjoyable throughout – in large
part because it was so well-written. I hope to have more to say about it in
a blog post coming soon.
Coincidentally, I read Katharine Graham's
(“Personal History") memoirs about 10 years ago. Graham was the publisher of
the Washington Post (Ben Bradlee, Woodward, Bernstein, Pentagon papers,
etc.), and was a long time and close friend of Buffet. I would highly
recommend her autobiography as well for both enjoyable reading and her
perspective on the politics and "great personalities" of her time.
Also, more or less by coincidence, the book I read
after the Buffett biography was "Outliers: The Story of Success," by Malcolm
Gladwell. I read Gladwell's previous book, "Blink", and found it to be
interesting but not compelling. However, "Outliers" is an absolute must-read
for educators who want to understand more about what makes their students
tick. I think so highly of the book that, unusual for me, I plan to re-read
it. And just this weekend, I started Paul Krugman's book, "The Return of
Depression Economics and the Crisis of 2008." Already, it looks like it will
be an easy and informative read.
As to your comments pertaining to the size and
processes of the FASB, here are my reactions:
· So far, it does not appear that the Board has
become more efficient after having been pared down from seven to five
members. Perhaps the most egregious case is the financial statement
presentation project which I wrote about recently on my blog. The Board
could have resolved matters quickly but instead chose to combine forces
with a 14-member IASB with the result being, among other things, that we
still don't have a direct method statement of cash flows. We should also
be asking why the amendments to FAS 140 and FIN 46R are taking so long.
And, how come a five-member board has not fixed the blatantly bad
effects of pension and OPEB accounting on the income statement?
· While it may appear that the two members from
the user and academic communities have more influence, I don't believe
it to be the reality. Greater proportion representation does not mean
more influence. The chair now exclusively controls the agenda. FSP EITF
99-20-1 provides a strong indication that he or she who controls the
agenda now has a much greater influence on outcomes. I highly doubt that
Bob Herz would have put this project on the agenda, and indeed on a fast
track, unless he already had two other board members in his pocket.
Notwithstanding any arguments as to the quality and appropriateness of
the FSP, resistance from the other board members and dissenting commenters was futile; the FSP was a done deal after that.
· Considering the views of "those with
interests in the process" is not an appropriate or necessary role of the
FASB. While there may be many stakeholders in the FASB’s decisions, the
only voices that should count in the FASB's deliberations are those
advocating the interests of investors. I believe the SEC has finally
acknowledged this unequivocally in its recent report to Congress. So,
why do we have former auditors and preparers on the FASB? It would seem
that some believe they are there to represent the interests of auditors
and preparers, but I believe they are there only to provide technical
and practical perspectives. OTTI accounting does not benefit investors,
and the changes made to OTTI accounting by the FSP also did not benefit
investors.
· As to why so few academics participate in the
FASB's process, I can provide three possible reasons pretty much off the
top of my head. First, as always, is incentives, or in this case, lack
thereof. Comment letters to the FASB or the SEC do not count as
"publications" by academic administrators. Second, academics prefer
models to politics; no matter how valid a point and academic may have to
make, unless you're a big name advocating the majority position, the
impact of your painstakingly written letter will amount to, at best,
just a tick mark in the "pro" or "con" column. (And, by the way, I KNOW,
that Board members read my blog; I doubt if the same would be true of my
comment letters.) Third, disincentives. The large accounting firms are
not appreciative of contentious comments; why should one go through all
the effort with the only certain outcome being a bite to a hand that
could feed you. Abe Briloff was ostracized, and I know of at least one
other case where a local partner of a Big Four firm complained to a
university about opinions publicly expressed by one of its faculty.
The big questions that remain are as follows:
How does an auditing firm
dance to the differing “tones at the top” of differing clients?
How do textbook writers and classroom teachers choose a tone to teach?
The large
international auditing firms want to replace bright line rule with professional
judgment which, inevitably, will lead to inconsistencies in the way virtually
identical transactions are accounted for in practice.
What makes the
U.S. unique in the world of financial markets is that the U.S. has 80% of the
world supply of lawyers combined with an even higher percentage of creative
accountants. The FASB is battle weary from having to continuously plug leaks in
U.S. GAAP’s bag of standards --- which is probably why there are so many more
bright lines and explicit rules in U.S. GAAP.
For example,
note the timeline of standard-plug, standard-plug, interpretation-plug, EITF-plug,
standard-plug in the following links:
Although a clear path toward adoption of
International Financial Reporting Standards in the United States hasn’t been
established, the largest public companies are already mulling their approach
toward converting to a new accounting system.
Given the massive complexities such a conversion is
likely to involve—especially when moving from the highly prescriptive U.S.
Generally Accepted Accounting Principles to a more flexible,
principles-based IFRS—it’s no wonder companies are looking at the full
spectrum of options for how to arrive at the end result.
Danita Ostling, a partner at Ernst & Young and the
firm’s Americas IFRS leader, says several theories of how to make the
conversion have already emerged. The most dramatic approach: start with a
clean sheet of paper. “With the clean sheet of paper, companies are looking
at the once-in-a-lifetime opportunity to step back and challenge the way
things are done from the perspective of accounting policies and practices,”
she says.
For those who want a less daunting path, Ostling
says they can also simply try to minimize the differences between IFRS and
GAAP reporting. Companies can take stock of how accounting under the two
systems is done, note where the differences arise, and then enact changes to
reduce and eventually eliminate those gaps.
“It’s likely to be a less-complex, less-time
consuming, less-expensive exercise than taking the clean-sheet-of-paper
approach,” she says. “But companies that take that approach will miss the
once-in-a-lifetime opportunity to fundamentally reconsider their accounting
policies and practices.”
Paul Munter, an audit partner at KPMG and an
IFRS expert, says minimizing differences has some validity because IFRS
allows companies to exercise more judgment about accounting items; that
would give them latitude to decide how a certain item in GAAP would appear
if reported under IFRS. The approach “uses
GAAP as an anchor, and says we’re only going to make changes where
absolutely necessary,” he says.
Conversely, Munter continues, starting with a clean
sheet of paper means companies are not anchored to GAAP as a starting point.
“They’ll develop IFRS policies in a fashion most representative of the
business activities and will provide the best financial reporting for the
business activities,” he says. “That philosophical decision will drive a lot
of the activities and priorities within the company’s conversion process.”
As such, the decision about which approach to take
should be made at the highest level of the company, Munter says. The CEO,
primary officers, and the audit committee should all be involved.
A third possible approach is to hum along under
GAAP, but make topside adjustments at the end of the reporting process to
convert the finished financial statements to IFRS. That was a common
technique in Europe when the European Commission first required IFRS
adoption in 2005, says David Schmid, a partner at PricewaterhouseCoopers.
That’s not to say Schmid supports such an approach,
though. “Those companies tended to have challenges, because you tend to miss
things,” he says. The topside approach would likely raise many red flags
about internal control over financial reporting; in Europe, it left some
corporate managements unable to speak in the same reporting language as the
users of financial statements.
Dave Kaplan, PwC’s international accounting leader,
says the United States should take a lesson from Europe’s experience with
topside adjustments under a scrambled implementation—namely, think carefully
before you do it.
“To be most effective, the best way to go through
the conversion process is to embed the basic IFRS accounting into systems,
processes, and controls,” he says. “It will result in a much more
well-controlled organization and will minimize the potential risk of errors
in the long run.”
Chris Wright, managing director at consulting firm
Protiviti, says companies may be considering the topside adjustment approach
because they’re accustomed to the process already if they operate under
different accounting systems in different countries. They may see topside
adjustments as a short-term solution, or as a means of progressing from one
system to another.
Life in the Long Term
Wright also believes that as IFRS and GAAP
differences are reduced over time, the need to keep separate books and then
topside adjustments will fade as well. “Topside adjustments as a long-term
solution would seem to defeat the purpose of moving to IFRS,” he says.
Albarelli Rebecca Albarelli, of the consulting firm
Jefferson Wells, says the “topside approach” will ultimately complicate
conversion to IFRS and consume more time and resources. For example, she
says, the topside approach would not capture the right data for measuring
inventory or making fair-value measurements, which can cause internal
control problems. “Build it the right way in the first place, and in the
long run you will build in efficiency,” she says.
Implementing IFRS throughout an organization will
require companies to get down to the gritty details of accounting policies,
according to Hans-Peter Rudolf of the auditing firm Crowe Chizek. Companies
will need to develop a conversion framework that examines financial
statements line by line, he says, and ensure that framework is applied
consistently throughout the business.
And what should that framework examine? How
transactions are accounted for under GAAP, how they might differ when
accounted for using IFRS, and how IFRS will be applied within the
organization to best reflect the economics of the business, Rudolf says. In
pension accounting, for example, the company would need to make decisions on
issues such as whether to accelerate pension expense under IFRS, then
confirm that everyone in the company (as well as outside service providers
and specialists) follow the same policies.
Joel Osnoss, leader of Deloitte’s global IFRS
offerings services group, says companies
need to establish their own judgment frameworks to assure a successful
implementation
(of IFRS).. The
Securities and Exchange Commission’s Committee for Improvements to Financial
Reporting might provide some guidance on that front, he says. CIFR has urged
the SEC and the Public Company Accounting Oversight Board to consider
developing judgment frameworks, so companies might use that recommendation
to help them develop judgment frameworks of their own.
“Most big decisions around how to account for
something would happen at the corporate level,” Osnoss says. “There needs to
be tone at the top
laid out for the rest of the company.”
Jensen Comment
When thousands of companies have their own "judgment frameworks" regarding
implementation of IFRS it would seem that the challenge facing accounting
educators is daunting indeed. For example, FAS 133 is now replete with
illustrations and implementation guidelines ---
http://www.fasb.org/derivatives/ These serve to
offer a consistent set of guidelines for textbooks and classroom educators
presenting FAS 133 accounting.
Today, once a U.S. accounting educator understands the basics of FAS 133,
it's relatively easy to teach from the myriad of illustrations in FAS 133 and
the DIG
Pronouncements. When IAS 39 takes its place there are almost no
illustrations and almost no implementation guidelines. When thousands of audit
clients establish their own judgment frameworks and implementation guidelines
for FAS 133, what set or implementation guidelines should accounting educators
make students learn?
Based upon what
leaders in the large international accounting firms are saying to us, IFRS
allows companies to march to their own tunes (tones) and their own drummers!
What tunes should we play in college? Unlike the football field's marching
band, it's doubtful that we will do synchronized marching to the extent that we
were synchronized under U.S. GAAP.
IFRS (or maybe just the EU) Accounting Rule
Flexibility in Action
"Accounting Changes Help Deutsche Bank Avoid Loss,"
Reuters, The New York Times, October 30, 2008 ---
Click Here
New accounting rules
allowed Deutsche Bank to dodge a loss in the third quarter, the company said
Thursday as it also announced heavy losses in proprietary trading.
Josef Ackermann, the chairman of Deutsche, which is
Germany’s flagship bank and once was seen as having escaped the worst of the
market turmoil, declared a year ago that the financial crisis for his bank
was over.
On Thursday, however, Mr. Ackermann departed from
the optimism that had led him to declare seeing the light at the end of the
tunnel several times over.
“Conditions in equity and credit markets remain
extremely difficult,” he said, warning that the bank could cut its dividend
to shore up capital in a “highly uncertain environment.”
Also Thursday, Germany’s finance minister, Peer
Steinbrück, said that a number of German banks were expected to turn to
Berlin for help. Mr. Steinbrück appeared to make a veiled reference to
Deutsche Bank when he told a newspaper that those seeking help could include
banks that had publicly opposed taking it in the past. Mr. Ackermann
recently was quoted as saying he would be “ashamed” to take taxpayer money.
Deutsche Bank made a pretax profit of 93 million
euros ($118.5 million) in the third quarter, a result possible only because
of changed accounting rules. These allowed it to cut write-downs by more
than 800 million euros, to 1.2 billion euros, during the period.
The new rules, sanctioned by Brussels lawmakers,
soften the old system that demanded all assets reflect market prices.
Deutsche Bank, for example, has more than 22
billion euros of leveraged loans — commitments often made to private equity
investors to lend money to buy companies.
Farming out these loans had become difficult as
worried investors retreated to safe havens and their value had fallen. The
new accounting rules allow Deutsche to hold some of these loans on their
books at a fixed price.
Like all other banks, Deutsche is grappling with a
freeze in interbank lending. Banks around the world have largely stopped
lending to one another after the Wall Street investment bank Lehman Brothers
collapsed in mid-September.
The crisis prompted the German government to start
a rescue fund of 500 billion euros, under which it can give guarantees for
banks seeking financing on this market or by issuing bonds, for example.
Beware, believing what's reported in the press as truth. Reporters
generally do not study accounting as part of the academic experience.
To the best of my knowledge, the recent change made by the IASB was to
converge with US GAAP in permitting companies to re-classify financial
assets from held for trading to available for sale. This move does not
permit these assets to be held at other than fair value. It does report the
change in fair value to equity, rather than in income.
This change was made specifically to create a level playing field across
Europe and the US. The same change was made in Canada for the same reason.
Do I regret they made this change? Yes. I suspect they do too, but the
alternative was to let the European Commission "do their own thing" in this
crisis.
Actually, as I understand it the IASB change allows
companies to reclassify securities out of the mark to market through income
category (i.e., trading) to held to maturity in which case the securities
will be carried at cost. Further, the change can be made retroactive to July
1 before most of the market disruption occurred. U.S rules allow this only
in "rare" circumstances.
But isn’t it interesting banks are suddenly reclassifying their
portfolios seemingly to avoid reporting losses? Is this good judgment based
upon principles-based standards or earnings management under flexible
accounting standards?
Surely the reporters are all wrong and these reputable banks are merely
using good judgments under principles-based standards. Certainly they would
not use flexible accounting rules to manage earnings!
Are we making a mockery out of accounting “standards?” What you are
saying Pat is that the IASB would rather change an accounting standard under
political pressure from the EU than to face up to another EU carve out of
IFRS. Surely this is a mockery since the change in IFRS to suit the EU (and
U.S.) affects all other nations using IFRS who are not in the EU and the
U.S.
What you are really telling us Pat is that IFRS adapts to threats from
the EU when you stated:
Do I regret they made this change? Yes. I
suspect they do too, but the alternative
was to let the European Commission "do their own thing” . . .
Pat Walters
I call this making a mockery out of the conceptual framework that
dictates that accounting standards are to be based upon what is the best
accounting for investors. Instead the IASB acted in fear that the EU would
“do-their-own-thing” accounting standards for banks. Of course there’s some
history of this in the U.S., notably dry hole accounting for oil and gas.
But the FASB has a better record of going nose-to-nose with Congress on FAS
133 and FAS 123-R.
FASB standards are sometimes flexible to a fault as well. Surely Franklin
Raines would not (ha, ha) reclassify just enough macro mortgage portfolios
under FAS 133 rules to meet the e.p.s target (to the penny) to get his bonus
before he was fired as CEO of Fannie Mae ---
http://faculty.trinity.edu/rjensen/theory01.htm#Manipulation
How can those of you teaching ethics and intermediate accounting and
auditing look your students straight in the eye?
Should accountancy be reclassified in the Literature Department since
financial reports are becoming more flexible fiction than fact?
The following statement
by Pat is not fully correct:
“…the recent change made by the IASB was to
converge with US GAAP in permitting companies to re-classify financial
assets from held for trading to available for sale. This move does not
permit these assets to be held at other than fair value. It does report
the change in fair value to equity, rather than in income.”
The revisions to IAS 39 (and FAS 133)
permit loans and receivables that were being measured
at fair value to be reclassified to “held to maturity”, if the entity does
not intend to sell them in the “foreseeable future” (whatever the heck that
means). Thus, fair value accounting would cease for these assets. Moreover,
there would be a new rule for measuring impairment on these assets, which
diverges from GAAP.
Best,
Tom Selling
November 3, 2008 reply from Bob Jensen
Hi Tom,
What the reclassification to “held-to-maturity” means in these times is
that nobody else (now not even our government) is foolish enough to buy this
hopeless dog that the bank can’t possibly unload. Paulsen’s new bail out
plan entails buying into bank equity rather than buying up the
banks’dog/junk mortgages. The trick now is to get these dogs on the books at
historical cost as “held-to-maturity” rather than, choke, fair value.
Interestingly, this is precisely what Fannie Mae’s CEO, Franklin Raines,
was doing when cherry picking which investments to designate as
“held-to-maturity” in his earnings management scheme to pad his bonus ---
http://faculty.trinity.edu/rjensen/theory01.htm#Manipulation
Think of the irony. The good mortgages that perhaps increased in value
with declining interest rates are marked upwards to fair value as
“available-for-sale” or “trading” securities. The dogs that should be
unloaded are instead designated as “held-to-maturity.”
A clever professor here could design a case where all the good mortgages
are sold for profit, the enormous executive bonuses are paid, and the
shareholders are left with the “held-to-maturity” dog kennel that is grossly
overvalued on the balance sheet. What’s even worse is that this is possible
under FASB and IASB accounting standards. Our standard setters are now
telling us there’s nothing wrong with being left with the dog kennel.
The
shareholders’ class action lawyers think otherwise.
Is this what we call making investors our number one concern when setting
accounting standards?
My problem here is that in theory I can and do in my FAS 133 seminars
make a darn good case for not marking up HTM securities to fair value. But
then I never envisioned the dog kennel problem.
I think the IASB is a bit tougher than the FASB on a decision to sell HTM
investments before maturity. In IFRS it’s a bit like breaking the honor
code. You may sell an insignificant sick puppy on occasion from the HTM dog
kennel, but you must never sell a valuable dog before its maturity date
without putting the other sick HTM dogs in the kennel up for sale as well.
Selling them all might result in huge losses under the new IASB/FASB rulings
allowing for the placement of very sick dogs in an HTM kennel to avoid
recognizing huge losses in their value. Thus when Deutsche Bank put a lot of
sick dogs in the HTM kennel to shore up 2008 reported earnings (actually to
avoid a huge reported 2008 loss), Deutsche Bank better be prepared on its
honor to keep virtually all of them in the kennel until they expire.
The following is a direct quotation from IAS 39.
B.19 Definition of held-to-maturity financial
assets: 'tainting'
In response to unsolicited tender offers,
Entity A sells a significant amount of financial assets classified as
held to maturity on economically favourable terms. Entity A does not
classify any financial assets acquired after the date of the sale as
held to maturity. However, it does not reclassify the remaining
held-to-maturity investments since it maintains that it still intends to
hold them to maturity. Is Entity A in compliance with IAS 39?
No. Whenever a sale or transfer of more than an
insignificant amount of financial assets classified as held to maturity
(HTM) results in the conditions in IAS 39.9 and IAS 39.AG22 not being
satisfied, no instruments should be classified in that category.
Accordingly, any remaining HTM assets are reclassified as
available-for-sale financial assets. The reclassification is recorded in
the reporting period in which the sales or transfers occurred and is
accounted for as a change in classification under IAS 39.51. IAS 39.9
makes it clear that at least two full financial years must pass before
an entity can again classify financial assets as HTM.
IASB amendments permit reclassification of financial
instruments
The International Accounting Standards
Board (IASB) today issued amendments to IAS 39
Financial
Instruments: Recognition and Measurement
and IFRS 7
Financial Instruments: Disclosures
that would
permit the reclassification of some financial instruments. The amendments to
IAS 39 introduces the possibility of reclassifications for companies
applying International Financial Reporting Standards (IFRSs), which were
already permitted under US generally accepted accounting principles (GAAP)
in rare circumstances.
The deterioration of the world’s
financial markets that has occurred during the third quarter of this year is
a possible example of rare circumstances cited in these IFRS amendments and
therefore justifies its immediate publication. Today’s action enables
companies reporting according to IFRSs to use the reclassification
amendments, if they so wish, from 1 July 2008.
These amendments are the latest in a
series of steps that the IASB has undertaken to respond to the credit
crisis. The IASB has worked with a number of other regional and
international bodies, including the Financial Stability Forum (FSF), to
address financial reporting issues associated with the credit crisis. In
responding to the crisis, the IASB notes the concern expressed by EU leaders
and finance ministers through the ECOFIN Council to ensure that ‘European
financial institutions are not disadvantaged vis-à-vis their international
competitors in terms of accounting rules and of their interpretation.’ The
amendments today address the desire to reduce differences between IFRSs and
US GAAP in a manner thatproduces high quality financial information for
investors across the global capital markets.
Sir David Tweedie, Chairman of the IASB, said:
In addressing the rare
circumstances of the current credit crisis, the IASB is committed to
taking urgent action to ensure that transparency and confidence are
restored to financial markets. The IASB has acted quickly to address the
concerns raised by EU leaders and others regarding the issue of
reclassification. Our response is consistent with the request made by
European leaders and finance ministers; it is important that these
amendments are permitted for use rapidly and without modification.’
For more information about the IASB’s
response to the credit crisis, see the Website at
http://www.iasb.org/credit+crisis.htm.
Reclassification of Financial Assets (
Amendments
to IAS 39 Financial Instruments:
Recognition and Measurement and IFRS 7
Financial Instruments:
Disclosures)
is available for eIFRS subscribers from today. Those
wishing to subscribe to eIFRSs should visit the online shop or contact:
IASC Foundation Publications
Department,
30 Cannon Street, London EC4M 6XH, United Kingdom.
Tel: +44 (0)20 7332 2730 Fax +44 (0)20 7332 2749
Email:
publications@iasb.org
Web:
www.iasb.org
The following table illustrates how
reclassification will be dealt with following this announcement by IFRSs
when compared with US GAAP.
US GAAP
Amended IAS 39
Reclassification of securities out of the trading
category in rare circumstances
Permitted
Permitted (as amended)
Reclassification to loan category (cost basis) if
intention and ability to hold for the foreseeable future (loans) or
until maturity (debt securities)
Permitted
Permitted (as amended)
Reclassification if fair value option previously
elected
Jensen Comment
In fairness, the IASB did a commendable job crafting IAS 39, although there's no
doubt it could not have done so without the help of the FASB and other help from
the FASB. IAS 39 was hammered out under great pressure from the U.S. SEC to get
an international standard out on derivatives accounting before the SEC would
even consider adopting IFRS for foreign registrants. You can read about the
evolving history of derivative instrument accounting scandals and the evolution
of IAS 39 and its amendments at
http://faculty.trinity.edu/rjensen/FraudRotten.htm#DerivativesFrauds
Especially revealing about the early history of IASC/IASB standards, and IAS 39
in particular, is Paul Pacter's presentation at
In its early history, the IASB was extremely influenced by lobbying forces in
industry and politics. This is because conformance with the IASB's international
standards was virtually voluntary in all member nations, and the large
industrial nations were not even members. Then, in its efforts to get its
standards recognized or required by the major stock exchanges (see
IOSCO), the IASB generated some tougher standards. Winning over the European
Union is the biggest feather in the IASB's hat to date, and currently the IASB
is working harder than ever to win over the SEC, the FASB, and the NY Stock
Exchange. Sadly, it has had to revert to political concessions both before and
during the 2008 economic crisis to win over banks in the EU and the US. In
fairness, however, the FASB also made an uncharacteristically fast cave-in to
the banking industry during the 2008 economic crisis.
Actually, as I understand it the IASB change allows
companies to reclassify securities out of the mark to market through income
category (i.e., trading) to held to maturity in which case the securities
will be carried at cost. Further, the change can be made retroactive to July
1 before most of the market disruption occurred. U.S rules allow this only
in "rare" circumstances.
Although most accountants are not particularly happy with the bull crap
coming out of Washington and Brussels these days, most of us have no choice but
to accept what is happening in this worldwide economic crisis ---
http://faculty.trinity.edu/rjensen/2008Bailout.htm#FairValueAccounting
As far as the big bang versus the evolution in the conversion of U.S. GAAP to
international standards, here is my stance for what it's worth:
Notwithstanding
Shaum Sunder’s excellent argument against an IASB monopoly and my preference for
bright line rules, I’ve viewed all along that “resistance is futile” in trying
to prevent the ultimate replacement of U.S. domestic accounting standards with
international standards.
At this point
I’m merely trying to prevent both a premature Big Bang (Mary Barth’s wording) or
a bunch of Little Bangs (Pat Walter’s wording) prematurely. By prematurely, I
mean having at least until 2018 to evolve into this in an orderly manner for
business firms, auditors, accounting educators, textbook writers, students, and
CPA examiners. Cox is rushing this thing too fast at the SEC, and I think the
FASB is trying to avoid having to rewrite FASB standards, interpretations, and
guidelines to be consistent with IFRS.
I think we’ve
given the FASB sufficient resources to rewrite U.S. GAAP in an evolutionary
manner that will greatly enrich the illustrations and implementation guidelines
that are sorely lacking in the present IASB standards. In other words I would
like to have FASB Standards and a greatly improved FASB Codification Database
after 2018 even if IFRS is virtually written into U.S. GAAP. And yes, I will
concede to removing most of the bright line rules! Sigh!
I also think the
U.S. should maintain its leverage by not fully committing to IFRS until the IASB
is better able to handle the enormous U.S. economy in terms of a better IASB
infrastructure, greatly increased IASB research funds, many more IASB full-time
members, and a demonstration that it is not under the thumb of the EU
politicians and bankers.
I also agree
fully with Mary Barth that our academy’s accounting researchers worldwide should
play a greater role in making IFRS better able handle its eventual monopoly on
all accounting standards for the free world.
I would also
like time to let the smell to dissipate concerning how Chris Cox, while Director
of the SEC, abused his authority by trying for force international standards
down our throats too suddenly in a chaotic Big Bang.
As to GAAS, I just don’t think we’re
ready for International GAAS until we have better international law, especially
international law regarding bribery, corruption, white collar crime enforcement,
and international civil litigation procedures.
Bob Jensen
Far more dangerous is what is happening around the world to destroy capital
markets and create government dominance in the allocation of capital and
resources in the world. Both FASB and IASB standards may soon be irrelevant
footnotes in our history books. We may soon all be government accountants. Won't
that be fun?
One of the advantage of adopting IFRS is that it
will create strong enforcement.
No, I think you are saying something else.
You are saying that one of the advantages of strong
enforcement is that it matters not whether the rules are U.S. GAAP or IFRS,
companies will be forced Go toe the line.
I disagree. Although enforcement is stronger in
Canada and the U.S. than practically anywhere else in the world, whether or
not it is strong is a matter of considerable debate. Enforcement in the U.S.
has historically been so weak, that companies for years have not complied
with many requirements of GAAP. Auditing has been so weak that creation of
PCAOB was deemed necessary.
Tom Selling make an excellent point that even with
strong auditing and SEC enforcement, it will be difficult to get companies
to account fairly for results of operations because companies will be given
much more flexibility under IFRS. Ed Ketz agrees.
Given that the large CPA firms are so hungry for
windfall revenues from the anticipated IFRS transition (and a decrease in
litigation cost), it is easy to see that they are not concerned in the least
by a gigantic conflict of interest. If the CPA firms cannot resist
temptation and are running through this conflict of interest, what makes
anyone think they can do a good job of auditing once IFRS standards hit?
Strength or effectiveness of enforcement is
relative. We can debate at length the relative "strength' of enforcement in
varying countries. I believe that one can look at SOX & creation of the
PCAOB as evidence of stronger enforcement initiatives to curb abuse than
occur in other jurisdictions where these types of constraints have not been
put in place. Of course, these are empirical questions. If you can point me
to any research on relative enforcement of securities laws, I'm always open,
that would indicate the laws in the US or Canada are relatively weaker than,
say, Italy, China, Russia, etc., I would be delighted to consider it.
Whether or not IFRS is more "flexible" than US GAAP
is also an empirical question. Any test of IAS as created by the IASC as
opposed to the current standards as amended and improved by the IASB would
be out of date in my view. So pointed to research results based on data from
the 1990s is not helpful to the current debate.
You, Tom, and others choose to believe that the
standards are more flexible. I do not believe they are. Nor do I believe
they are vague. I am not alone in my belief.
I also believe that the disclosures on a wide
variety of issues are superior to what we currently get in US GAAP. But,
also, an empirical question.
I believe that we would necessarily need to
identify a set of companies that apply the both IFRS & US standards
correctly in order to test our various hypotheses on this issue. It is still
an empirical question.
I would love to see some evidence from high
quality, research on these issues. If you have any at your disposal to
share, I would love to read it. Otherwise, we are each entitled to maintain
our view based on our separate sets of anecdotal evidence, until such
research findings are forthcoming.
Neither claims of flexibility nor counterclaims are
evidence. Just claims. Nor does a list of believers on either side of the
debate create evidence of the validity of their respective claims.
And, yes, one of my beliefs is that it matters not
what the underlying standards are. Without systems to encourage adherence or
punishments for failure to do so, no set of high quality standards will meet
its objective to provide information on which investment and credit
decisions can be based.
Regards, Pat
October 21, 2008
reply from Bob Jensen
Hi Pat,
I will reply later on with some illustrations about both flexibility and
enforcement. I will have to mostly comment at the moment off the top of my
head from a Boston hotel.
There is little doubt that IFRS is much more flexible with respect to the
amount and timing of revenue recognition. This has led to some problems that
I will cite later on.
IAS 39 is much more flexible than FAS 133 in allowing macro hedges that
do not hedge all maturity date risks in the macro hedge.
But the most important failing of IFRS is that it says virtually nothing
about some of the really vexing problems covered by some FASB standards,
most notably those in FIN 46 on such items as synthetic leasing around which
an entire industry has been built in the U.S. Certainly saying nothing about
the FIN 46 items leaves a lot of flexibility for nations that buy into IFRS
lot stock and barrel when IFRS is silent on many types of SPEs and synthetic
leases.
Asking for empirical evidence of enforcement issues of IFRS in the U.S.
is a bit premature since U.S. SEC registrants are not yet allowed to use
IFRS. Certainly some firms will avoid civil suits because it is more
difficult to sue bad judgment than it is rule violation.
Thank you for getting to some specifics. These are
issues I think we can have reasonable debates about.
First, I have never said IFRS is perfect, but then
neither is US GAAP. They are both constantly moving targets. Ideally, moving
each other forward to better overall financial reporting. I, of course,
judge "better" from the user perspective.
That is why I do have a concern about eliminating
the competition (as I have mentioned.)
Yes, I do know that the Big 4 use flexibility as a
marketing tool. Since I've spent close to 14 years involved with IFRS, what
the Big 4 think doesn't really influence me one way or another. I try
(sometimes successful) to draw my own conclusions on the merits of a
particular accounting treatment based on how I think it will enhance a
user's ability to make good investment or credit decisions. My agenda and
the Big 4's agendas are not often the same. Just because the Big 4 say it's
so, doesn't make it so.
Now for my questions: Is flexibility inherently
"bad"? (which I infer is the implication by the IFRS opponents). If so, then
we would need to address areas of flexibility within US GAAP, that may not
exist in IFRS, to have a clear picture about relative flexibility in the
"set"? When might flexibility be warranted? My view would be to provide the
necessary distinctions between different economics, and not to permit or
encourage arbitrary decisions by management. I also admit that might be hard
to do. And when is flexibility (choice) not a problem for users? Perhaps the
LIFO/FIFO/Weighted Average or Depreciation methods would be a case when
we've all learned how to handle flexibility.
On the specific issues you cite:
Leases: The IASB recognizes that lease accounting
is an problem IAS 17 on leases is very old and users have been asking the
IASB (and its predecessor) to get to work on this standard since the
mid-90s. I certainly did with the other members of the analyst delegation at
the IASC. Accounting for leases is on the work plan. A discussion paper on
leases is due the Q4 2008. That would be the time to provide reasoned input
to the IASB, in the same way one would to the FASB to move the global
playing field on financial reporting forward. I am also cognizant that the
leasing industry has a very powerful lobby, not limited to pressuring the
IASB.
I will be the first to complain about IAS 39 and
accounting for financial instruments (as I know I've mentioned in previous
emails). This issue is part of the Memorandum of Understanding with the FASB
and part of a longer term project. From my point of view, the FASB hasn't
done a stellar job in this area either. In fact, the recent move by the IASB
and the Canadian accounting standards board to permit reclassification of
financial instruments from held-for-trading to available for sale after
initial recognition (what I would call increasing flexibility) was done to
converge to what the FASB already permitted. I would like to hear people's
views on whether converging with the FASB on this issue was a good idea or
not. I personally was saddened.
I also admit I'm not a financial instruments guru,
but I try. With respect to permitting macro hedging as you describe below: I
would be most interested in people on the list having a discussion about
whether this type of hedge accounting is a good idea or not. What are the
unintended consequences of permitting or prohibiting special accounting for
such hedges? How should hedge accounting reflect the economics of hedge
transactions?
On enforcement: I agree with you. But that is one
of my points in this discussion. I don't find it useful to make claims that
we cannot investigate effectively. When we make such claims, we are all just
stating our views based on our personal experiences. I admit to making some
of these claims myself, but I want to avoid them in our discussion
for/against IFRS adoption by the US.
And, it's always the nitty-gritty accounting issues
I find most compelling anyway.
Sometimes, in reading the emails, I perceive the
IFRS discussion is more about "who has the right (accounting) religion"
rather than the relative merits of two systems of accounting that are both
flawed (being created by humans) in their own unique ways. I don't believe
we can have effective discussions about the "right religion" question. We
can debate the relative merits of accounting treatments on specific issues
and, hopefully, communicate our views to the people who will ultimately make
these decisions going forward.
Regards,
Pat
October 21, 2008 reply
from Bob Jensen
Hi Pat,
I think the IASB is destined to become the accounting standard setter for
the planet earth. But as I’ve pointed out repeatedly, neither the current
set of IFRS nor the IASB itself will be able to do that effectively for two
decades or more.
Contracting in the U.S. in particular as become so complex with financial
structures, tax complications (FIN 48), synthetics and VIEs (Fin 46), and
complicated mezzanine instruments, and enormous issues of revenue
recognition that are not yet covered in IFRS. IFRS presently is only a
subset of FASB standards and interpretations. Why not wait until FASB
standards are a subset of IASB standards?
The IASB has neither a research budget nor a staff of researchers
anywhere close to the research infrastructure of the FASB that deals with
very complicated accounting issues peculiar to U.S. business enterprises. At
present the IASB relies heavily on the FASB for research, but there is
question in my mind why the U.S. should continue to bear the brunt of doing
so much research for the benefit of the IASB, especially when many nations
do not want the United States to be overly influential in setting IASB
standards.
The IASB really falters when it comes to implementation guidance. Firstly
compare the dearth of illustrations in IASB standards relative to FASB
standards. Then look at the implementation guidelines issued by the IASB on
complicated derivative contracts relative to the rich set of implementation
guidelines available from the FASB’s Derivatives Implementation Group ---
http://www.fasb.org/derivatives/
Business firms around the globe have to look to the FASB for implementation
guidance on contracts never mentioned by the IASB anywhere.
I’m all for rethinking the transition to IASB standards when the IASB
obtains far more resources than were ever available to the FASB, and the
IASB standards are virtually all re-written with tons of illustrations and
detailed implementation guidelines for virtually all the international
standards. I’m for re-thinking the transition to IASB standards when
international standards are available for all contracts covered in FASB
standards, e.g., FIN 46 and 48.
Until the IASB has the infrastructure, resources, illustrations,
guidelines, and a more complete set of base standards, my question was and
still is: Why the rush? The answer to this question lies in my suspicions
that the largest international accounting firms and their clients are
looking for more flexible and in many instances weaker standards that will
make audits easier and less vulnerable to lawsuits. It’s much easier to
defend bad judgment in court than to defend against violation of specific
rules such as when Enron got caught sneaking over bright lines such as the
3% SEC rule for SPEs.
What’s the rush? Why not force the IASB to get better resources and
standards by refusing to transition from FASB standards to IASB standards
until those added resources and standards and implementation guidelines are
in place?
Bob Jensen
Some evidence of revenue recognition flexibility is given in the research
paper “Revenue Recognition under IFRS Revisited - Conceptual Models, Current
Proposals and Practical Consequences,” by Jens Wüstemann and Sonja Kierzek,
University of Mannheim, Accounting in Europe, Vol. 2, pp. 69-106, 2005
---
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=990888
Abstract:
Since 2002, the FASB and the IASB have been undertaking a joint project on
the revision and convergence of U.S. GAAP and IFRS revenue recognition. Even
though the outcome of the project is still open, the project's course as
well as trends in recently published IFRS and other current IASB projects
suggest that existing earnings-based and realisation-based IFRS revenue
recognition criteria are likely to be replaced by a radically new approach.
This paper demonstrates the inconsistencies in current IFRS revenue
recognition that have triggered the project and then presents and discusses
three conceptually different revenue recognition models that are
internationally debated at present. The paper concludes that a major
revision of existing IFRS revenue recognition as proposed by the FASB and
the IASB is not required. It is argued that the perceived deficiencies
should rather be solved on the basis of current transaction-based IFRS
revenue recognition criteria.
Also it is not clear how IFRS would even apply to some of the revenue
recognition problems resolved by the Emerging Issues Task Force ---
http://faculty.trinity.edu/rjensen/ecommerce/eitf01.htm
IFRS just does not cover some of these thorny revenue recognition problems.
I’m reminded of when I was ten years old and living
near the Riverview Cemetery in Algona, Iowa. I was one of five little boys
in tin helmets hiding behind gravestones while taking on an approaching
German Panzer Division. I think you,
Tom Selling,
Shyam Sunder,
Ray Ball,
Ed Ketz, and me are little boys in tin helmets taking on a
Big Four Panzer Division that
closed its ranks to debate in 2008.
In those days women did not engage in combat, but
we had three very young nurses behind us willing to tend our wounds in
Riverview Cemetery. I'm pleased that several women have come forth lately on
the AECM to help save us David.
Resistance is futile David. But it’s nice to have
fantasies and fun for good causes.
The American Accounting Association Commons contains, for AAA members, documents
supplied by accounting firms to help accounting educators make the transition
from domestic accounting standards to international accounting standards ---
https://commons.aaahq.org/signin
Bob Jensen defines IFRS as International Fleecing of
Responsible Standards
International auditing firms are seeking a judgmental (read that softer) set
of standards under lobbying pressure from their large multinational clients.
Bright lines led to $billions of losses in litigation in the U.S. because a
client, with the blessing or incompetence of an auditor, crossed a line such as
the old SPE 3% line that was a huge factor in the demise of Andersen and Enron
---
http://faculty.trinity.edu/rjensen/Fraud001.htm
I’m
presently doing a funded research study comparing FAS 133 with IAS 39. FAS 133
has lots of bright lines and lots of examples, especially
DIG examples, of
how to account for complicated hedges. IAS 39 is like driving down a mountain
road on a moonless night without any headlights, road signs, or guard rails.
With over a thousand variations of financial instrument derivative contracts and
thousands of types hedging strategies, IAS 39 lets clients manage earnings most
any way they like without detailed rules of the road and bright lines that give
them and their auditors guidance.
Question
The FASB had some troubles passing new standards with seven board members.
How do you think the IASB will function efficiently with 16 members?
Deloitte has submitted
a
Letter of Comment
(PDF 176k) on the IASCF Discussion Document Review of the IASC Foundation
Constitution: Public Accountability and the Composition of the IASB:
Proposals for Change. Below are excerpts from our letter.
Past comment letters are
Here.
We believe that in
a number of areas the need for urgent action has meant that the
Trustees may not have developed fully the detailed operations of
the revised structure, or at least have not articulated these
clearly in the proposals. Consequently, they are potentially
ambiguous.
Monitoring group:
We support the creation of a monitoring group as a way of
creating a direct link between the IASC Foundation and very
senior levels of official institutions with a legitimate
interest in accounting standard-setting and transparency in
financial reporting. However, the role of the monitoring group
should be more clearly defined than it is in the discussion
document.
IASB size and composition:
With respect to the proposals affecting the IASB directly,
we are
not inclined to support increasing the size of the IASB from 14
to 16 members, but are willing to support such an increase to
accommodate more part-time members. We do not
believe that the Trustees have presented a convincing case to
increase the size of the IASB and are concerned that the current
size of 14 members is at the extreme upper end of operational
efficiency. Nor do we support the introduction of any
geographical formulation, quotas or other such limits.
Jensen Comment
It may not be long until IASB member nations clamor for 192 board members.
Welcome to the United Nations of Accounting Standard Setters (UNASS).
Will they get diplomatic immunity for crimes
committed (notably shoplifting and parking violations) in London?
Will the new tall UNASS building be near the
Tower of
London?
For the few who might possibly be interested, there is a summary on Paul
Pacter's blog:
http://www.iasplus.com/index.htm , of discussions held at an IASB
meeting on September 16 pertaining to recommended improvements to IFRS.
These specific improvements are meant to address issues pertaining to the
credit crisis.
Actually
Resistance is Futile.
On this issue we are confronting the tightly-knit worldwide establishment
that closed ranks and shut off debate on this railroad. Maybe it's just sour
grapes, because our academy was completely left out when Cox-Herz caved in
to the wishes of the largest international auditing firms.
Don’t you smell just a bit of train smoke on this very
important watering down of U.S. GAAP?
Bob
Jensen, Tom Selling, David Albrecht, and Shyam Sunder are finding it a lonely place back at the
Debate Depot. Thus far I don’t think many of our friends in the academy are
resisting even though I think many don’t like the stench aboard this
speeding train --- at
http://faculty.trinity.edu/rjensen/theory01.htm#MethodsForSetting
I’m about to
give up on the FASB and the SEC. This is where you can find me, where the
air is clear and free of train smoke ---
http://hk.youtube.com/watch?v=C-F3vSrJIUQ
Bob Jensen
For Me the IFRS Transition Just Does Not Pass the Smell Test
Saga of the Replacement of a Strong Set of FASB Accounting Standards With a
Weaker Set IFRS International Standards in the United States
By the 1990s, auditing services of CPA firms were becoming less and less
profitable and professional. Auditing was viewed by clients as a necessary
evil for which they were willing to accept the lowest bidder irrespective of
audit quality. In fact for many companies like Enron, bad or "cooperative"
auditing firms were sought after as preferred auditors. In order to cut
costs of service, CPA firms either dropped auditing services or they
replaced more and more substantive testing with inferior analytical reviews
in auditing ---
http://faculty.trinity.edu/rjensen/fraud001.htm#Professionalism
Auditing firms were increasingly being sued for poor quality audit
services ---
http://faculty.trinity.edu/rjensen/fraud001.htm
This made auditing services even more risky and less profitable.
The auditing firms created expanding consulting services that bolstered
profitability far more than auditing services. The AICPA promoted newer
types of assurance services such as WebTrust, SysTrust, Elder Care,
etc. ---
http://en.wikipedia.org/wiki/Assurance_services
The AICPA promotions of assurance services peaked out when strong advocate
Bob Elliott was President and Vice Chair of the AICPA. Bob even appeared in
a special edition of the PBS television program Nightly Business Report on
May 31, 1999 just before Enron and Worldcom commenced to melt down ---
http://www.aicpa.org/pubs/cpaltr/jacpa.htm
He always stressed how auditing was becoming less and less profitable and
that expanded consulting/assurance services were essential for the survival
of CPA firms.
Bob Elliott's best analogy in the 1990s was his comparison of the
auditing industry with the railroad industry. He stress how the railroads
failed to adapt to newer forms of technology and transportation services
(e.g., the likes of mergers with airlines, FedEx, UPS, etc.). His message
was that, to avoid being like a failed railroad industry, auditing firms had
to change with technology and exploit the auditing firms' major asset ---
a reputation for integrity.
Sadly, the reputation for integrity of auditing firms took a huge
hit at the dawn of the 21st Century. It was revealed how the auditing firm
of Andersen was earning as much from consulting in Enron as it was from
auditing. Andersen was in fact auditing systems that it helped install,
including Enron's felonious SPEs. You can view one of the thousands of these
fraudulent SPEs at
http://faculty.trinity.edu/rjensen//theory/00overview/speOverview.htm
You can read about the Enron and Worldcom scandals at
http://faculty.trinity.edu/rjensen/FraudEnron.htm
The poor services of auditing firms became a focal point in the U.S.
Congress when equity markets appeared of the verge of collapse due to fear
and distrust of the financial reporting of corporations dependent upon
equity markets for capital. The Roaring 1990s burned and crashed. In a
desperation move Congress passed the Sarbanes-Oxley Act (SOX) of 2002 ---
http://en.wikipedia.org/wiki/Sarbanes-Oxley_Act
SOX was a shot in the arm for the auditing industry. SOX forced the
auditing industry to upgrade services with SOX legal backing that doubled or
even tripled or quadrupled fees for such services. Clients continue to
grumble about the soaring costs of audits, but in my opinion SOX was a small
price to pay for saving our equity capital markets.
Unlike many other nations that either did not have national accounting
standards or had weak and incomplete sets of standards, the FASB over the
years produced the best set of accounting standards in the world (although
there is no such thing a perfect set since companies are always writing
contracts to circumvent most any standard). The FASB standards were heavily
rule-based due to the continual battles fought by the FASB in the trenches
of U.S. firms seeking to manage earnings and keep debt of the balance sheet
with ever-increasing contract complexities such as interest rate swaps
invented in the 1980s, SPE ploys, securitization "sales," synthetic leasing,
etc.
The experiences of those frazzled
executives in charge of reducing risks in the credit derivatives
market are starting to resemble Alice’s adventures in Wonderland.
Alice shrank after drinking a potion, but was then too small to
reach the key to open the door. The cake she ate did make her grow,
but far too much. It was not until she found a mushroom that allowed
her to both grow and shrink that she was able to adjust to the right
size, and enter the beautiful garden. It took an awfully long time,
with quite a number of unpleasant experiences, to get there.
Aline van Duyn, "The adventure never ends in the derivatives
Wonderland," Financial Times, September 11, 2008 ---
Click Here
While Lehman Brothers was fighting for
its life in the markets today, it was also battling in a Senate
panel's hearing on whether the company and others created a set of
financial products whose primary purpose is to dodge taxes owned on
U.S. stock dividends. The "most compelling" reason for entering into
dividend-related stock swaps are the tax savings, Highbridge Capital
Management Treasury and Finance Director Richard Potapchuk told the
Senate's Permanent Subcommittee on Investigations. Lehman Brothers (nyse:
LEH - news - people ), Morgan Stanley (nyse: MS - news - people )
and Deutsche Bank (nyse: DB - news - people ) are among the
companies behind the products.
Anitia Raghaven, The Tax Dodge Derivative, Forbes, September
11, 2008 ---
Click Here
Meanwhile the IASB at the dawn of the 21st Century began to add meat to
its milk toast "politically correct" starter-set of international standards.
In many instances it copied FASB standards but left out many of the bright
line rules. Hence it generated a reputation for principles-based standards
instead of rules-based standards ---
http://faculty.trinity.edu/rjensen/theory01.htm#Principles-Based
Many of the nations, especially in Europe, that adopted IFRS do not have
strong equity capital markets given their historic traditions of raising
corporate capital via banks instead of individual investors buying and
selling shares of common stock. Protection of investors has not had the same
priorities for these nations as it has in the U.S. where faith in equity
capital market integrity is vital to our market-based capitalism ---
http://faculty.trinity.edu/rjensen/FraudRotten.htm
The IASB has a much smaller budget and research staff than the FASB. The
IASB relies on part-time board members and spends a huge amount on airline
and hotel bills for board members and staff of the IASB. Is it really
prepared to take on the creative accounting crooks of the world?
The bottom line is that IFRS is a weaker set of equity capital market
accounting standards than the present FASB standards in the United States.
And yet the large international auditing firms are pressuring the SEC and
especially Chairman Cox to force an IFRS replacement of FASB standards.
Chairman Cox is fervently trying to set the commitment for IFRS in stone
before President Bush leaves office --- perhaps in fear that a stronger
Democratic Party Executive Branch and Legislative Branch may not be so
inclined to drop the strong FASB standards.
This begs the question of why the large auditing
firms are lobbying so hard for IFRS standards to replace FASB standards?
There are legitimate reasons given the complexity of auditing international
firms having operations subject to varying domestic and international
accounting standards. And there may be less litigation risk when bright line
rules are replaced by principles-based standards that give auditors and
clients much more flexibility in accounting for transactions.
But for me there are also smell test concerns here. Auditing firms love
the soaring revenues from SOX, but they will love even more the soaring
revenues from clients having to transition from FASB standards to IFRS
international standards. Firstly, auditing firm clients will not understand
IFRS such that auditing firms will make fortunes educating and training each
of their clients about IFRS. Secondly, accounting systems, including
enormous databases and software systems, will have to be overhauled. For
example, all the firms in the U.S. who use LIFO inventory valuation will
have to be changed to something else since IFRS does not allow LIFO. Walla
--- the consulting service revenue surge becomes remindful of the Roaring
1990s.
The added auditing firm revenue from the IFRS transition may be as much
or more than the added revenue from SOX. Since there will be greatly
increased needs for accounting graduates and accounting professors, I
suppose I should be overjoyed by the transition of standard setting from the
FASB to the IASB. But to me this whole IFRS
transition in the U.S. and the race to lock it in place just does not pass
the smell test.
And lastly there is great concern in my mind that the IASB will in the
future be slower than the FASB in reacting to financial reporting issues
caused by uniquely creative accounting fraudsters in the United States. The
SEC held a gun to the IASB by saying that the SEC would never recognize
international standards until they developed a standard on accounting for
derivatives and hedging activities. Until then the IASB really dragged its
feet on this issue and waited until 2000 to issue a standard after FAS 119
and 133 pioneered the effort. The SEC also held a gun to the FASB’s head on
derivatives accounting, and the FASB issued FAS 119 in 1994 six years before
the IASB got its act together.
SUMMARY: Cisco Systems
Inc. finally heeded to years of investor clamoring and approved its
first-ever dividend, the latest technology giant to do so as its business
matures. The networking giant, like many of its technology peers, has long
built up a war chest of cash and investments. As of Jan. 29, the company had
$4.9 billion in cash and $35.3 billion in investments. The dividend would
cost the Cisco some $335 million a quarter.
CLASSROOM APPLICATION: This
article could serve as a basis for a discussion of how to account for
dividends, as well as the reasons for dividends and why a company would
declare them.
QUESTIONS:
1. (Introductory) What is a dividend? When can they be declared?
Who makes the decision to declare a dividend for a company?
2. (Introductory) How do you book a dividend and its payment into
the accounting records? What dates are significant? What accounts are
affected? How are balance sheet accounts impacted? How are income statement
accounts impacted?
3. (Advanced) Why do companies declare dividends? What factors
should management consider when declaring a dividend? What are other options
does management have for the use of cash?
4. (Advanced) What is the difference between an "income company"
and a "growth company"? What part do dividends play in these
classifications? Why do some companies choose one category or the other?
What are the different goals and priorities of management between these
classifications?
5. (Advanced) How has Cisco used its cash in the past? Why has it
made the decision to pay dividends at this point?
6. (Advanced) The article states "the dividend would cost Cisco
some $335 million a quarter." Is a dividend an expense? What does the
reporter mean by this statement?
Reviewed By: Linda Christiansen, Indiana University Southeast
Cisco Systems Inc. finally heeded to years of
investor clamoring and approved its first-ever dividend, the latest
technology giant to do so as its business matures.
Cisco will pay a quarterly dividend of six cents a
share. The company will make the payment on April 30 to shareholders of
record on March 31.
The networking giant, like many of its technology
peers, has long built up a war chest of cash and investments. As of Jan. 29,
the company had $4.9 billion in cash and $35.3 billion in investments. The
dividend would cost the Cisco some $335 million a quarter.
The dividend payout comes as Cisco faces questions
about the strength of its core networking business. Cisco has been combating
the notion that it is no longer a growth company, exacerbated by several
quarters of disappointing results. Cisco shares recently rose 1.9% to
$17.32. The stock has been down roughly 35% over the past year.
"Cisco's leadership position in the markets we
serve is strong, and the time is right for Cisco to pay our first-ever cash
dividend," Chief Financial Officer Frank Calderoni said.
Cisco first said in September that it would begin
paying a dividend, targeting a yield of 1% to 2%. At the time, Chief
Executive John Chambers said the dividend would be funded through cash
generated from its North American operations.
Standard & Poor's equity analyst Ari Bensinger said
the current amount would result in a 1.4% yield. "We like that Cisco is
increasing its commitment to enhancing shareholder value and putting some of
its large $40 billion cash stockpile and strong free cash flow generation to
better use," Mr. Bensinger said in a note.
Cisco previously used its cash stockpile to make
acquisitions, such as the $3.3 billion purchase of teleconferencing company
Tandberg. On Monday, it purchased digital media company Inlet Technologies
for $95 million in cash. It also preferred repurchasing stock over
dividends.
Jensen Comment
It is extremely important in elementary accounting to explain both why stock
dividends are fundamentally different from cash dividends and why the accounting
for both types of "dividends" is fundamentally different. Why is the term "stock
dividend" really an oxymoron? What is the difference between a stock dividend
and a stock split?
David Raggay has repeatedly argued that international standards are superior
to U.S GAAP, and that the U.S. investors will be better off when the Cox-Herz
IFRS Express Train reaches the station.
Although
international standards have come a long way, in my viewpoint they will be a
disaster at the present time for U.S. investors in U.S. companies. The current
partnership between the IASB and the FASB is vastly superior. The IASB keeps the
FASB focused on international issues, and the FASB can more effectively deal
with U.S. reporting issues, particularly when dealing with Taliban-like contract
writers on Wall Street.
People on the
Cox-Herz Express just do not realize how dependent the IASB has been on FASB
research, illustrations, and implementation guidelines of FASB rules. Without
the FASB, the IASB does not have the infrastructure and the money to deal with
the Taliban-like financial contract writers in the United States (where 80% if
the lawyers in the world reside).
At the risk of being mauled and run out of town,
where is the empirical evidence of the deficiencies in IFRS and their
inability to provide investors with cogent information suitable for use in
developed capital markets?
David Raggay
September 18, 2008 reply from Bob Jensen
OK David,
For
empirical evidence, look at all the IFRS-based reports referenced at the
following two sites:
http://faculty.trinity.edu/rjensen/Fraud001.htm
One example cited in the above link reads as follows: The biggest question for investors was
Parmalat's total debt level. Parmalat reported a "gross" debt figure
that of €6 billion as of Sept. 30, 2003 . But this "gross" figure
excluded bonds the company said it had bought back but hadn't retired.
Parmalat argued that the bonds no longer needed to be considered as part
of total debt because the company was effectively paying interest to
itself, and it no longer had an obligation to any outsiders as far as
that debt was concerned. At the time, accountants and S&P said that the
practice was strange, but that technically
there was nothing wrong with it.
Jensen Comment
Why was the above reporting "not technically wrong" under IFRS?
More to
the point are direct examples of deficiencies in IFRS
I cannot find a single instance in IFRS where the subject of a synthetic
lease is taken up. I don’t know how investors can know how companies are
accounting for their synthetic leases under IFRS ---
http://faculty.trinity.edu/rjensen//theory/00overview/speOverview.htm
This is just one of many instances where IFRS is lacking guidance on how to
deal with complicated contracts. The reason in this
case is that IFRS fails to specifically address some important financial
reporting issues interlocked with U.S. tax law, issues that are not
particularly important in the other jurisdictions of the IASB and,
therefore, less important to the IASB.
Here’s
another example --- a biggie!
The IASB does not have guidance for primary beneficiaries because it does
not have consolidation guidance equivalent to FASB Interpretation No. 46
(revised December 2003) Consolidation of Variable Interest Entities.
But mostly
you miss the point David. It’s possible to do all most anything as well or
better under IFRS because IFRS is like the Ten Commandments that, in
“principle,” cover everything in their vast breadth. The problem is that the
IASB lacks the research staff, funding, and intense full-time effort of
Board members to give us anywhere near the guidance of how to apply
principles in many complicated specific instances. IFRS may allow the best
accounting on the planet but there’s no roadmap (not even decent
illustrations) on how to deal with complex contracts. The IASB may get
better if it gets more money for research and hires specialists who really
understand derivatives, structured financings, valuation complexities of
interest rate swaps, deficiencies in regression testing of hedge
effectiveness (like how can regressions look so great when the changes in
value are so ineffective for hedging?), etc.
The FASB has
been the IASB’s crutch. For the last two decades the IASB has had the
pleasure to lean on the considerable research of the FASB and to lean the
illustrations and implementation guidance generated by the FASB. Where would
it have been today without the FASB’s research and guidance?
Exhibit A --- All the FASB’s DIGs --- http://www.fasb.org/derivatives/
Where’s the IASB equivalent guidance?
More
frightening is where IFRS be when the FASB is dead and gone. The IASB is
like a babe in the woods when it comes to the creative complexity U.S. firms
have in writing contracts to manage earnings and keep debt off the balance
sheet. These contract writers are like the Taliban and just keep coming back
from their caves (on Wall Street we call them cubicles) again and again and
again. They lose more than they win, but they never quit.
Unlike many other nations
that either did not have national accounting standards or had weak and
incomplete sets of standards, the FASB over the years produced the best
set of accounting standards in the world (although there is no such
thing a perfect set since companies are always writing contracts to
circumvent most any standard). The FASB standards were heavily
rule-based due to the continual battles fought by the FASB in the
trenches of U.S. firms seeking to manage earnings and keep debt of the
balance sheet with ever-increasing contract complexities such as
interest rate swaps invented in the 1980s, SPE ploys, securitization
"sales," synthetic leasing, etc.
Bob Jensen ---
http://faculty.trinity.edu/rjensen/FraudRotten.htm#DerivativesFrauds
The IASB is
used to supplying standards for nations who aren’t as concerned with equity
funding and protection of investing stockholders. Banking systems supply
more of the capital in those nations. In the U.S., the FASB has had to be
much more concerned about protecting investors from devious contract writers
who are artists when it comes to painting rosy pictures. Unlike the FASB,
the IASB does not have deep background in art history.
People on the
Cox-Herz Express just do not realize how dependent the IASB has been on FASB
research, illustrations, and implementation guidelines of FASB rules.
Without the FASB, the IASB does not have the infrastructure and the money to
deal with the Taliban-like financial contract writers in the United States
(where 80% if the lawyers in the world reside).
And that is
my quota on mixing metaphors for in one message day.
Bob Jensen
Sir
David Tweedie, Chairman of the IASB
From Double Entries on March 28, 2002
The
International Accounting Standards Board (IASB) appears concerned to
note that a number of press articles quote Sir David Tweedie, Chairman
of the IASB, as stating that Enron's collapse and other recent
accounting irregularities could not have occurred under international
accounting standards (IAS).
The IASB
subsequently issued a statement to make clear that these reports are not
correct.
Sir David stated his views on Enron's collapse when he testified before
the Committee on Banking, Housing and Urban Affairs of the United States
Senate on 14 February 2002. See our story at
http://accountingeducation.com/news/news2717.html for more details
Jensen Comment
You can read Tweedie's entire testimony at
http://banking.senate.gov/02_02hrg/021402/tweedie.htm
Rules,
with all their flaws, better constrain managers and compromised auditors.
The Sarbanes-Oxley Act and the Securities Exchange Commission move too
quickly when they prod the Financial Accounting Standards Board, the
standard setter for US GAAP, to move immediately to a principles-based
system. Priorities respecting reform of corporate reporting in the US need
to be ordered more carefully. Incentive problems impairing audit performance
should be solved first through institutional reform insulating the audit
from the negative impact of rent-seeking and solving adverse selection
problems otherwise affecting audit practice. So long as auditor independence
and management incentives respecting accounting treatments remain suspect,
the US reporting system holds out no actor plausibly positioned to take
responsibility for the delicate law-to-fact applications that are the
hallmarks of principles-based systems. Principles, taken alone, do little to
constrain rent-seeking behaviour. In a world of captured regulators, they
invite applications that suit the regulated actor's interests.
Rules, with all their flaws, better constrain managers and compromised
auditors. Broadbrush reformulations of
rules-based GAAP should follow only when institutional reforms have
succeeded. William W. Bratton (Professor of Law at
Georgetown University), "Rules, Principles, and the Accounting Crisis in the
United States," European Business Organization Law Review (EBOR)
(2004), 5 : 7-36 Cambridge University Press, May 4, 2004 ---
Click Here
Resistance is Futile
On this issue we are confronting the tightly-knit worldwide establishment
that closed ranks and shut off debate on this railroad. Maybe it's just sour
grapes, because our academy was completely left out when Cox-Herz caved in
to the wishes of the largest international auditing firms.
Don’t you smell just a bit of train smoke on this very
important watering down of U.S. GAAP?
Bob
Jensen, Tom Selling, David Albrecht, and Shyam Sunder are finding it a lonely place back at the
Debate Depot. Thus far I don’t think many of our friends in the academy are
resisting even though I think many don’t like the stench aboard this
speeding train --- at
http://faculty.trinity.edu/rjensen/theory01.htm#MethodsForSetting
I’m about to
give up on the FASB and the SEC. This is where you can find me, where the
air is clear and free of train smoke ---
http://hk.youtube.com/watch?v=C-F3vSrJIUQ
I have three
questions that I really want you to answer
(David Raggay)?
1. Why the rush to commit in 2008 (now)
the United States to IFRS on an express train schedule? From a strategy
standpoint here in the U.S. it would seem better to wait and hold a carrot
in front of the IASB so that the IASB gets its infrastructure and funding in
place to handle the job of setting standards for the U.S. and all the rest
of the planet.
2. Why should our local Presby Construction Company that has audits to
maintain a line of credit at a local bank have to rush to change over to
IFRS global standards on such an express schedule by 2011? There just does
not seem to be enough time for this company to change over all its
accounting software (e.g., eliminate the LIFO inventory system), rewrite
leasing contracts, train employees, etc.
3. Why should so many accounting educators in the U.S., who cannot possibly
be up to speed to teach IFRS and FASB standards jointly by 2011, be forced
to do so without more time to prepare for this complete overhaul of the
courses, the curriculum, and the CPA Examination. NASBA has not yet
committed itself to an all-IFRS exam by 2011. Our accounting educators will
have the burden of teaching both FASB and IASB standards simultaneously when
preparing students for the CPA examination. I’m glad I’ve retired from
teaching!
You admit that
IFRS is not necessarily superior to FASB standards for U.S. companies. Why
the rush to wipe out FASB standards so hurriedly?
It’s my opinion that, relative to the FASB, IFRS has poor funding, an
inadequate full-time research budget, an inadequate full-time research
staff, inadequate IFRS implementation guidelines for U.S. companies in the
transition, and not enough full-time IFRS Board members to so quickly take
over the setting of accounting standards for the United States, let alone
the entire planet.
So David, even
if it is inevitable that the IASB will eventually have a standard setting
monopoly, what’s the rush in 2008 to commit to this by 2011 when there’s not
even a business plan in place for the IASB to have the infrastructure,
funding, and “superior” standards to do the job?
I’m not asking
you to defend the ultimate takeover of the planet with one global set of
standards. My question is why we have to commit to this before the IASB is
ready to do the job?
I think
the reason is plain and simple. For a few more months at least we have a
Chair of the SEC who is willing to abuse his powers in favor of large
international accounting firms without giving other stakeholders a voice in
the debate!
Cox has to
force this thing through quickly before he’s ridden out of town after the
November 2008 election.
Addendum
The large international accounting firms, the AICPA officials, and the SEC
closed ranks in the U.S. and did not give all stakeholders (small CPA firms,
companies, educators, legislators, etc.) any voice in the decision to wipe
out U.S. GAAP in favor of IFRS by 2011.
This was railroaded in favor of the self-serving large international
accounting firms and Chris Cox abusing his power as head of the SEC. The
best use of this train would be to ride Chris Cox out of town. McCain
promises to rid us of Cox. I think Obama will do the same thing. But, but,
but, Democrats and Republicans missed all sorts of opportunities for
responsible government including attacking infectious greed from Main Street
to Wall Street. Instead we’ve had repeated scandals in part due to a biased
choice for Chair of the SEC with a hidden agenda bent on imposing
principles-based standards where auditors and clients will be given vast
flexibility to account for some transactions (like synthetic leases) any way
they so choose.
I weep at the failure of academics or Democrats or Republicans to
seriously address the largest accounting problem in the history of the world
--- accounting for unfathomable debt of the United States. I don’t have much
faith that either party in power will improve the accountability standards
of the United States. See Appendix A at
http://faculty.trinity.edu/rjensen/2008Bailout.htm
Nor will either party derail the Cox-Herz Express Train set in motion
before 2008.
As
indicated elsewhere, I deliberately chose to stay out of the discussion on
the timing of the adoption of IFRS by the US. There are arguments for and
against such a move, which I shall not enumerate since I intend to remain
neutral on this issue.
In my view, that is a
decision to be taken by the relevant stakeholders in each country. My
comments focused on the suitability of principles-based standards with
appropriate guidance, for use in global capital markets.
In your comments you also
allude to the impacts on what might be regarded by some as SMEs. I am sure
that you are aware that the IASB has issued in draft form, standards for use
by SMEs in the preparation of general-purpose financial statements. My
personal view, not those of the IASB or of other members of the committees
on which I sit, is that the draft standards do not go far enough in
providing relief for these entities. This, however, is another matter.
The IASB is a standard
setter. Regulation is currently and possibly shall continue to remain with
individual jurisdictions.
A quick
clarification –It is not my opinion that IFRS are currently superior to US
GAAP. I do, however, believe that a principles-based approach, along with
certain guidance, is a superior approach to one which is primarily
rules-based. As an example, and I plan to get back to Prof. Jensen on an
issue pertaining to synthetics as soon as I get the chance, I often refer to
the criteria for recognizing a finance (capital) lease under both sets of
standards.
Under FAS
13, a lease is a capital lease, if the PV of the MLP is >= 90% of the FV of
the asset. We are all aware of those bright accountants and financial
engineers who will structure leases such that the PV of the MLP is 89.23% of
the FV of the asset and we therefore have an operating lease under US GAAP.
Under IFRS, we can technically have a situation where the said ratio is 65%,
but if, in the opinion of the accounting professional, “substantially all of
the risks and rewards of ownership are transferred fro the lessor to the
lessee”, we have a finance lease. The standard is not perfect of course,
which is why it is carded for improvement.
I
believe that I have plainly stated that one of the areas where IFRS are
considered deficient (and where US GAAP is superior) is revenue recognition.
There are several other areas where improvements to IFRS are required and
many of these are the subject of joint efforts between IASB and FASB. The
updated MOU issued by FASB on September 11 highlights these areas:
http://www.fasb.org/intl/MOU_09-11-08.pdf
It
is my belief that international comparability of financial statements is a
precursor to the effectiveness of global capital markets and is inevitable
in a global economy. This is one of the lofty goals to which the IASC
aspired when it was formed back in the 70’s (with the US as one of its
founding members). As a student at that time, I did not think that such a
goal was even remotely possible. We now have the benefit of seeing it happen
before our eyes and the opportunity is there for the world to participate in
the process and ensure that the resulting standards are the best ones
possible.
David
September 19, 2008 reply from
Bob Jensen
September 19, 2008 reply from
Bob Jensen
Hi David,
Thanks for the clarification. Can I conclude from your
remarks that the Cox-Herz IFRS Express in the U.S. should be sidetracked
until the IASB corrects more of its glaring weaknesses in standards,
structure, research support, lack of illustrations, and implementation
guidelines? You seem to be saying that global standards are becoming more in
sight on the horizon, but that we aren’t there yet!
You asked for an example where FASB standards are
deficient relative to FASB standards. One of the examples I provided was
synthetic leasing. Synthetic leasing is ignored entirely in the
international standards.
You then took
us in the direction of leasing in general. I want to point out that
synthetic leasing is an issue totally apart from problems in FAS 13 and IAS
17/
Synthetic leasing is a FIN 46-R issue, and
the FASB is way behind the FASB in dealing with VIEs --- not that the FASB
is anywhere close having a good solution to VIEs even though it is a lot
further along on researching the issue and putting some fingers in the dikes
of corruption that burst forth with Andy Fastow's 3,000 plus SPEs ---
http://faculty.trinity.edu/rjensen//theory/00overview/speOverview.htm
Quote of the Day: Another example of why we should sidetrack the Cox-Herz
Express Train
"Contingent Liabilities: A Troubling Signpost on the Winding Road to a
Single Global Accounting Standard," by Tom Selling, The Accounting Onion,
May 26, 2008 ---
Click Here
The Global
Accounting Race to the Bottom
And so we have the
IASB’s ineffable ongoing six-year project to make a hairball out of IAS 37.
If these two standards, IAS 37 and FAS 5, are to be brought closer together
as the ballyhooed Memorandum of Understanding between IASB and FASB should
portend, it would make much more sense for the FASB to revise FAS 5 to make
it more like IAS 37. After all, convergence isn’t supposed to take forever;
even if you don’t think IAS 37 is perfect, there are a lot more serious
problems IASB could be working harder on: leases, pensions, revenue
recognition, securitizations, related party transactions, just to name a few
off the top of my head. But, the stakeholders in IFRS are evidently telling
the IASB that they get their jollies from tennis without lines. And, the
IASB, dependent on the big boys for funding, is listening real close.
Basically, the IASB
has concluded that all present obligations – not just those that are more
likely than not to result in an outflow of assets – should be recognized. It
sounds admirably principled and ambitious, but there’s a catch. In place of
the bright-line probability threshold in IAS 37, there would be the fuzziest
line criteria one could possibly devise: the liability must be capable of
“reliable” measurement. We know that "probable" without further guidance
must at least lie between 0 and 1, but what amount of measurement error is
within range of “reliable”? The answer, it seems, would be left to the whim
of the issuer followed by the inevitable wave-your-hands-in-the-air rubber
stamp of the auditor.
It’s not as if the
IASB doesn’t have history from which to learn. Where the IASB is trying to
go in revising IAS 37, we’ve already been in the U.S. The result was all too
often not a pretty sight as unrecognized liabilities suddenly slammed into
balance sheets like freight trains. As I discussed in an earlier post,
retiree health care liabilities were kept off balance sheets until they were
about to break unionized industrial companies. Post-retirement benefits were
doled out by earlier generations of management, long departed with their
generous termination benefits, in order to persuade obstreperous unions to
return to the assembly lines. GM and Ford are now on the verge of settling
faustian bargains of their forbearers with huge cash outlays: yet for
decades the amount recognized on the balance sheet was precisely nil. The
accounting for these liabilities had been conveniently ignored, with only
boilerplate disclosures in their stead, out of supposed concern for reliable
measurement. Yet, everyone knew that zero as the answer was as far from
correct as Detroit is from Tokyo – where, as in most developed countries,
health care costs of retirees are the responsibility of government.
Continued in article
It is my strong conviction that the IASB is nowhere
near being able to take on the financial reporting problems of the world. It
will be even less able to do so once its solid partner, the FASB, is killed
off by Cox, Herz, and the largest global accounting firms.
How do you propose that the IASB, after national
standard setters like the FASB have been eliminated, deal with any nation’s
financial reporting problems that are linked primarily to that nation for
some reason such as interlinking with that nation’s tax code?
My illustration of
synthetic leases in the U.S. may
not be the best illustration, but it does illustrate the problem of
nation-specific financial reporting issues that the IASB is not likely take
up with high priority.
How can the IASB deal with financial reporting
standards and implementation guidelines for financial reporting issues
unique to each nation in its constituency if the national standard setters
give monopoly power (Shyam Sunder’s term) to the IASB?
It is one thing to want global standards for all
financial reporting. It is quite another to deal with problems unique to
each country.
Another and probably better example is the issue of
global accounting standards in nations with deep religious customs and
beliefs. How will global accounting standards conflict with Sharia? ---
http://en.wikipedia.org/wiki/Sharia
My point is that global standards are a lofty dream
divorced from reality in spite of the music being played on the Cox-Herz
IFRS Express Train. In reality nations across the board have uniquely
national issues that the IASB presently is ill-equipped to tackle.
TO SEE Islamic
finance in action, visit the mutating coastline of the Gulf. Diggers claw
sand out of the sea off Manama, Bahrain’s capital, for a series of
waterfront developments that are part-funded by Islamic instruments. To the
east, Nakheel, a developer that issued the world’s largest Islamic bond (or
sukuk) in 2006, is using the money to reorganise the shoreline of
Dubai into a mosaic of man-made islands.
Finance is
undertaking some Islamic construction of its own. Islamic banks are opening
their doors across the Gulf and a new platform for sharia-compliant
hedge funds has attracted names such as BlackRock. Western law firms and
banks, always quick to sniff out new business, are beefing up their
Islamic-finance teams.
Governments are
taking notice too. In July Indonesia, the most populous Muslim country, said
it would issue the nation’s first sukuk. The British government,
which covets a position as the West’s leading centre for Islamic finance, is
also edging towards issuing a short-term sovereign sukuk. France
has begun its own charm offensive aimed at Islamic investors.
Set against ailing
Western markets such vigour looks impressive. The oil-fuelled liquidity that
has pumped up Middle Eastern sovereign-wealth funds is also buoying demand
for Islamic finance. Compared with the ethics of some American subprime
lending, Islamic finance seems virtuous as well as vigorous. It frowns on
speculation and applauds risk-sharing, even if some wonder whether the
industry is really doing anything more than mimicking conventional finance
and, more profoundly, if it is strictly necessary under Islam (see
article).
Sukuks in the souk
As the buzz around
the industry grows, so do expectations. The amount of Islamic assets under
management stands at around $700 billion, according to the Islamic Financial
Services Board, an industry body. Standard & Poor’s, a rating agency, thinks
that the industry could control $4 trillion of assets. Others go further,
pointing out that Muslims account for 20% of the world’s population, but
Islamic finance for less than 1% of its financial instruments—that gap, they
say, represents a big opportunity. With tongue partly in cheek, some say
that Islamic finance should by rights displace conventional finance
altogether. Western finance cannot service capital that wants to find a
sharia-compliant home; but Islamic finance can satisfy everyone.
Confidence is one
thing, hyperbole another. The industry remains minute on many measures: its
total assets roughly match those of Lloyds TSB, Britain’s fifth-largest bank
(though some firms that meet sharia-compliant criteria may attract
Islamic investors without realising it). The assets managed by Islamic rules
are growing at 10-15% annually—not to be sniffed at, but underwhelming for
an industry that attracts so much attention. Most of all, the industry’s
expansion is tempered by its need to address the tensions between its two
purposes: to serve God and to make as much money as it can.
That is a stiff
test. A few devout Muslims, many of them in Saudi Arabia, will pay what Paul
Homsy of Crescent Asset Management calls a “piety premium” to satisfy
sharia. But research into the investment preferences of Muslims shows
that most of them want products that benefit their savings, as well as their
souls—rather as ethical investors in the West want funds that do no harm,
but are also at least as profitable as other investments.
A combination of
ingenuity and persistence has enabled Islamic finance to conquer some of the
main obstacles. Take transaction costs which tend to be higher in complex
Islamic instruments than in more straightforward conventional ones.
Sharia-compliant mortgages are typically structured so that the lender
itself buys the property and then leases it out to the borrower at a price
that combines a rental charge and a capital payment. At the end of the
mortgage term, when the price of the property has been fully repaid, the
house is transferred to the borrower. That additional complexity does not
just add to the direct costs of the transaction, but can also fall foul of
legal hurdles. Since the property changes hands twice in the transaction, an
Islamic mortgage is theoretically liable to double stamp duty. Britain
ironed out this kink in 2003 but it remains one of the few countries to have
done so.
However, just as
in conventional finance, as more transactions take place the economies of
scale mean that the cost of each one rapidly falls. Financiers can recycle
documentation rather than drawing it up from scratch. The contracts they now
use for sharia-compliant mortgages in America draw on templates
originally drafted at great cost for aircraft leases.
Islamic financiers
can also streamline their processes. When Barclays Capital and Shariah
Capital, a consultancy, developed the new hedge-fund platform, they had to
screen the funds’ portfolios to make sure that the shares they pick are
sharia-compliant. That sounds as if it should be an additional cost,
but prime brokers already screen hedge funds to make sure that risk
concentrations do not build up. The checks they make for their Islamic hedge
funds can piggyback on the checks they make for their conventional hedge
funds.
Mohammed Amin of
PricewaterhouseCoopers, a consulting firm, says the extra transaction costs
for a commonly used Islamic financing instrument, called commodity
murabaha, total about $50 for every $1m of business. That is small
enough to be recouped through efficiencies in other areas, or to be absorbed
in lenders’ profit margins. In addition, bankers privately admit that less
competition helps keep margins higher than in conventional finance.
“Conceptually, Islamic finance should cost more, as it involves more
transactions,” says Mr Amin. “The actual cost is tiny and can be lost in the
wash.”
The other area of
substantive development has been in redefining sharia-compliance.
New products require scholars to cast sharia in fresh, and
occasionally uncomfortable, directions. Some investors express surprise at
the very idea of Islamic hedge funds, for example, because of prohibitions
in sharia on selling something that an investor does not actually
own.
“You encounter a
wall of scepticism whenever you do something new,” says Eric Meyer of
Shariah Capital. “It is no different in Islamic finance.” He says that it
took eight long years to bring his idea of an Islamic hedge-fund platform to
fruition, applying a technique called arboon to ensure that
investors, in effect, take an equity position in shares before they sell
them short. Industry insiders describe an iterative process, in which
scholars, lawyers and bankers work together to understand new instruments
and adapt them to the requirements of sharia.
Differences in interpretation of sharia between countries can
still hinder the economies of scale. Moreover, the scholars can sometimes
push back. Earlier this year, the chairman of the Accounting and Auditing
Organisation for Islamic Financial Institutions (AAOIFI), an industry body,
excited controversy by criticising a common form of sukuk issuance that
guarantees the price at which the issuer will buy back the asset
underpinning the transaction, thereby enabling investors’ capital to be
repaid. Such behaviour contravened an AAOIFI standard demanding that assets
be bought back at market prices, in line with the sharia principle of
risk-sharing. The sukuk market has enjoyed years of rapid growth (see
chart), but early signs are that the AAOIFI judgment has dented demand.
Although Islamic finance has done well to reduce its costs and
broaden its product range, it has yet to clear plenty of other hurdles.
Scholars are the industry’s central figures, but recognised ones are in
short supply. A small cadre of 15-20 scholars repeatedly crops up on the
boards of Islamic banks that do international business. That partly reflects
the role, which demands a knowledge of Islamic law and Western finance, as
well as fluency in Arabic and English. It also reflects the comfort that
this handful of recognised names brings to investors and customers.
There are plenty of initiatives to nurture more scholars but for
the moment, the stars are pressed for time. That can be a problem when banks
are chasing their verdict on bespoke transactions. It takes a scholar about
a day to wade through the documentation connected with a sukuk issue, for
example. But scholars are not always immediately available. “You’ve got to
have the scholar’s number programmed into your mobile phone and be able to
get hold of them,” says a banker in the Gulf. “That is real competitive
advantage.”
Assets are another bottleneck. The ban on speculation means that
Islamic transactions must be based on tangible assets, such as commodities,
buildings or land. Observers say that exotic derivatives in intangibles such
as weather or terrorism risk could not have an Islamic equivalent. But in
the Middle East, at least, the supply of assets is limited. “Lots of
companies in the Gulf are young and don’t have assets such as buildings to
use in transactions,” says Geert Bossuyt of Deutsche Bank. This limits the
scope for securitisation, a modern financing technique that is backed by
assets and is thus seen by sharia scholars as authentically Islamic. There
are not enough properties to bundle into securities.
Governments have more assets to play with. The Indonesians have
approved the use of up to $2 billion of property owned by the finance
ministry in their planned sukuk issuance later this year. But oil-rich
governments in the Gulf have little need to issue debt when they are flush
with cash. That is a problem. Sovereign debt would establish benchmarks off
which other issues can be priced. It would also add to the depth of the
market, which would help solve another difficulty: liquidity.
It may seem odd to worry about liquidity when lots of Muslim
countries are flush with cash, but many in Islamic finance put liquidity at
the top of their watchlist. The chief concern is the mismatch between the
duration of banks’ liabilities and their assets. The banks struggle to raise
long-term debt. In a youthful industry, their credit histories are often
limited; they also lack the sort of inventory of assets that corporate sukuk
issuers have.
Desert liquidity
As a result, Islamic banks depend on short-term deposit funding,
which, as Western banks know all too well, can disappear very rapidly. “Lots
of assets are generally of longer term than most deposits,” says Khairul
Nizam of AAOIFI. “Banks have to manage this funding gap carefully.” If there
were a liquidity freeze like the one that struck Western banks a year ago,
insiders say that the damage among Islamic banks would be greater.
There are initiatives to develop a sharia-compliant repo market
but for the time being the banks have only limited scope for getting hold of
money fast. Loans and investments roll over slowly. The lack of sharia-compliant
assets and a tendency for Islamic investors to buy and hold their
investments have stunted the secondary market. The shortest-term
money-management instruments available today are inflexible. Cash reserves
are high, but inefficient. Western banks with Islamic finance units, or
“windows”, are just as troubled by tight liquidity as purely Islamic
institutions are: their sharia-compliant status requires them to hold assets
and raise funds separately from their parent banks.
There are other sources of danger, too. Because Islamic banks
face constraints on the availability and type of instruments they can invest
in, their balance-sheets may concentrate risk more than those of
conventional banks do. The industry’s ability to steer its way through
stormy waters is largely untested, although Malaysian banks do have memories
of the Asian financial crisis in the 1990s to draw on.
None of these tensions need derail the growth of Islamic finance
just yet. There is plenty of demand, whether from oil-rich investors, the
faithful Muslim minorities in Western countries or the emerging middle
classes in Muslim ones. There is lots of supply, in the form of
infrastructure projects that need to be financed, Western borrowers looking
for capital and ambitious rulers eager to set up their own Islamic-finance
hubs. The industry is innovative; new products keep expanding the range of
sharia-compliant instruments. And as in conventional finance, the economics
of the Islamic kind improve as it gains scale.
But further growth itself contains a threat. The AAOIFI ruling on
sukuk earlier this year neatly captured the contradictory pressures on the
industry. On the one hand, bankers are worried that the narrow enforcement
of sharia standards is liable to stifle growth; on the other some observers
fear that Islamic finance is becoming so keen to drum up business that its
products, with all their ingenuity, are designed to evade strict sharia
standards. This presents a dilemma. If the industry introduces too many new
products, cynics will argue that sharia is being twisted for economic
ends—the scholars are being paid for their services, after all. But if it
fails to innovate, the industry may look too medieval to play a full part in
modern finance.
Balancing these imperatives will become even harder as
competition grows fiercer. Anouar Hassoune of Moody’s, a credit-rating
agency, believes that unscrupulous newcomers could harm the reputation of
the entire industry, “like the space shuttle undone by something the size of
a 50 cent coin”. Islamic finance serves two masters: faith and economics.
The success of the industry depends on satisfying both, even if the price of
that is a bit more inefficiency and a bit less growth.
I do not recall commenting on the issue of the
timing of the proposed adoption of IFRS by the US. This was deliberate.
My view is that it is a chicken and egg situation.
As we speak, I believe that there moves afoot to strengthen the governance
of the IASB. Governance, as well as issues related to the technical and
administrative capacities/capabilities of the IASB are issues which I
believe can be easily addressed in a couple of years once clear and
non-partisan thinking prevails.
With regard to the “elimination” of FASB, it is my
view that there will always be a need for national standard setters,
particularly in order to address country-specific issues emanating from the
legal frameworks and/or cultural issues. I am however of the view that
countries should not seek to hold on to national GAAP for purely
nationalistic reasons. It strikes me as counter-productive also to converge
with IFRS if full adoption is possible. One only has to look at the
Australian example to see the co-existence of a national standard-setter
with the IFRS. In the Australian situation, also, the negative effects of
having to look for guidance in the IFRS as well as to the local institute
have been recognized.
In my view, converging with IFRS while maintaining
unnecessary national differences still begs the question of global
comparability. As one author (it may have been Paul Pacter) put it, such an
approach results in all the pain with only some of the gain.
As we all know, IFRS are currently permitted or
required in over 100 countries worldwide. Given that they are also widely
recognized as “high quality” accounting standards, their widespread use is
strong reason to consider them as a possible basis for global standards.
David Raggay
September 19, 2008 reply from
Bob Jensen
I don’t think keeping the FASB is intended or at least not intended at
anywhere near the cost and extent of operations. The IASB will no longer
have the FASB as the crutch holding it up on complex issues.
Why the rush if the needed IASB global standards are not in place and the
IASB infrastructure and budget are not yet in place to become the monopoly
standard setter for the planet earth. Granted the IASB has made progress,
but it is nowhere near where it needs to be to dictate the financial
reporting of the planet. As far as the U.S. is concerned, Wall Street’s
contract writers will have a field day with international standards.
Without the FASB, the
IASB won't even know it's being had.
I have
found the AECM debate on IFRS fascinating. To get another view on IFRS, I
just read Ball’s IFRS paper, “ ‘IFRS: pros and cons for investors’,
International Accounting Policy Forum, special issue of Accounting and
Business Research, June 2006.
If I
understand correctly, the major benefit of all countries adopting IFRS is
the resulting comparability of financial reports and the improved quality of
these financial reports because the reporting is based on principles instead
of rules. My major takeaway from Ball’s paper is that imposing a set of
accounting standards (e.g., IFRS) does not mean that the standards will be
implemented uniformly. Thus even if the argument can be made that IFRS is a
better set of standards, the implementation of these standards will vary
across country. Actual financial reporting practice (quality) is affected by
local economic and political forces. Thus the goal of comparability across
countries probably will not be achieved. Furthermore, as this becomes
evident, the method used to signal quality reporting will be one of
enforcement standards rather than accounting standards.
Ball
states, “ Implementation is the Achilles heel of IFRS. There are
overwhelming political and economic reasons to expect IFRS enforcement to be
uneven around the world, including within Europe. Substantial international
differences in financial reporting quality are inevitable, and my major
concerns are that investors will be misled into believing that there is more
uniformity in practice than actually is the case and that, even to
sophisticated investors, international differences in reporting quality now
will be hidden under the rug of seemingly uniform standards.”
Ball
refers to an analogy between IFRS and the metric system of uniform weights
and measures: “The weight of the butcher’s thumb on the scale is heavier in
…[other country X].” He continues, “Despite uniform measurement rules, the
butcher’s discretion in implementing them is limited only by the practiced
eye of the customer, by concern for reputation, and by the monitoring of
state and private inspection systems. The lesson from this saying is that
monitoring mechanisms operate differently across nations.”
In
countries that adopted IFRS, did financial reporting change substantively?
Are reports more comparable across country? How do we determine if reports
are more comparable? I am sure there is research on these issues, but I am
not familiar with the research.
In the interest of fair play in the IFRS debate,
attached is an article from the FT with a different perspective on why to
keep US GAAP. I believe this particular argument has a lot of merit.
Regards,
Pat Walters
SEC's mandate will lead to a monopoly
By Shyam Sunder
Published: September 18 2008 03:00 | Last
updated: September 18 2008 03:00
If US companies are required to use
international accounting standards, it will effectively create a
single set of standards used around the world by taking away the one
system - US GAAP - with the influence and significance to challenge
the international rules.
According to the Securities and Exchange
Commission, which has proposed a roadmap for companies to transfer
to the new international financial reporting standards, the move
would integrate the world's capital markets by providing a common
high-quality accounting language, and increase confidence and
transparency in financial reporting.
These are lofty and desirable goals. But why
mandate a monopoly? The top-down imposition of a single set of
standards will move us away from, not closer to, the SEC's goals.
First, principles-based standards are less
enforceable. By allowing more room for judgment of managers and
auditors, they introduce greater diversity and result in fewer, not
more, comparable reports.
Second, the SEC does not explain what it means
by "high quality". Qualities such as decision usefulness,
reliability, timeliness, and verifiability often conflict: expensing
the value of employee stock options is a high-quality standard for
some and low for others.
Third, standard-setters try to devise new
rules to account for market innovations. Identifying which
accounting rule is better calls for experimentation. At the moment,
US standard-setters can look overseas; with the proposed worldwide
monopoly of IFRS, comparisons of alternative treatments will become
impossible.
Fourth, the economic substance of business
transactions depends on their legal, commercial, market, governance
and managerial environment. Even within the US, the same set of
accounting rules does not yield similar results across industries.
Greater comparability of financial reports of all public firms
across more than 100 countries is a pipedream. Within the European
Union, accountants find little comparability between the financial
reports of, say, Italian and Dutch firms - and both report under
IFRS. Many Asian countries embraced IFRS to attract foreign capital
but plan to use their own interpretations. So much for
comparability.
Fifth, unlike a uniform system of weights and
measures, the conduct of business changes in response to the
accounting rules applied.
The metaphor of natural languages is more
appropriate, where the meaning of words arises from their usage, and
ambiguity and multiplicity of meanings are norms, not exceptions.
Esperanto is an example of a failed effort to replace the world's
languages with a single language.
The SEC would better protect investors by
allowing two or more standard-setters to compete for royalty
revenues from companies that could choose one brand of standards to
prepare their reports. Standards competition produces efficient
results in fields such as appliances, bond ratings, higher education
and stock exchanges.
Investor or consumer self-interest, combined
with some regulatory oversight, keeps such competition from racing
to the bottom. It also keeps the door open for faster response to
financial engineering and limits the complexity of the standards.
Allowing a worldwide monopoly
to a single manufacturer serves neither the public nor the
manufacturer for long. Development of IFRS is good news; a
government mandate to grant it a monopoly is not.
Shyam Sunder is James L. Frank Professor of Accounting, Economics
and Finance at Yale School of Management.
www.ft.com/accountancy
From: Sunder,
Shyam [mailto:shyam.sunder@yale.edu] Sent: Friday, September 19, 2008 2:06 PM To: Jensen, Robert Subject: RE: Thanks Shyam
Dear
Bob: Far from it. I have always liked what you do, even criticism. Keep it
up. I have enclosed links to two related working papers (based on talked I
have given during the past year) that might be of interest:
"Top Ten Reasons Why U.S. Adoption of IFRS is a Terrible Idea," by Tom
Selling, The Accounting Onion, September 10, 2008 ---
http://accountingonion.typepad.com/
In a recent publication in TAR she said something that surprised me a bit. In
essence she proclaimed that if the abrupt transition of US GAAP with a big bang
(e,g, in 2011) does not transpire the FASB will transition US GAAP to be
equivalent to IFRS. This would be a much slower "evolutionary" process since
every FASB Standard, Interpretation, and Implementation Guideline would have to
be cherry picked to remove most of the bright line rules, many illustrations
would have to be revised or deleted, and a majority of FASB Board members would
have to vote on each amendment.
Actually some leading nations did not adopt IFRS with a "big bang." For
example, Canada and Australia are working toward converting domestic accounting
standards to be consistent with IFRS standards. This will eventually have the
same result as a big bang transition, but the process is more evolutionary and
leaves in place domestic standards where there are no IFRS standards covering
certain transactions because the IASB has either not taken up those issues or
cannot agree on a solution at the present time.
How could this be if the Matching Principle is dead?
September 1, 2012 message from Scott Bonacker
If you need an example for a class, here is
one about how third party developers and the way they offer products through
Intuit is being changed -
At a high level, the
current changes are the result of revenue recognition requirements as
determined by the Intuit auditors. The short story is that if Intuit
sells the QuickBooks desktop product, they are required to recognize the
revenue over the time period that the customer receives services related
to that product. For example, if a customer is using QuickBooks 2010,
and Intuit is providing support for the sync manage for that product,
then (in theory) the time period for the revenue recognition is not when
the software was sold. The revenue should be allocated over the time
period that Intuit is incurring costs for that product. In this case, if
they provide support for the Sync Manager until the product is sunsetted,
then the time period could be 3 plus years as compared to recognizing
the revenue in the year of purchase.
This paper identifies challenges and opportunities
created by global financial reporting for the education and research
activities of U.S. academics. Relating to education, after overviewing the
relation between global financial reporting and U.S. GAAP, it offers
suggestions for topics to be covered in global financial reporting curricula
and clarifies common misunderstandings about the concepts underlying
financial reporting. Relating to research, it explains how and why research
can provide meaningful input into standard-setting, and identifies questions
that can motivate research related Go topics on the International Accounting
Standards Board’s technical agenda and to the globalization of financial
reporting.
. . .
Globalization of financial reporting is becoming a
reality. However, many challenges remain. There are many around the world
unfamiliar with independent standard-setting and an investor focus for
financial reporting. They are struggling with the changes but are learning.
No change is universally popular, and revolutionary
“big bang” change is very
difficult. Evolutionary change is somewhat
easier to implement and absorb, although changing multiple times is costly.
We also have not yet fully resolved the issue of individual country
modifications to standards, which stand in the way of truly global financial
reporting. Outside of the U.S., there is a concern that the U.S. will
dominate. This concern relates not only to our thinking about issues, but
also to the way the standards are written. In particular, there is a concern
that the U.S. tendency to provide considerable detailed guidance will
manifest itself in global standards. Inside the U.S., there is a concern
that IFRS lack rigor and, thus, are not high quality. There also is a
concern that the standards are not specific enough and enforcement around
the world is not strict enough to ensure consistent application. Clearly,
there is a tension. However, progress in the last five years toward global
financial reporting has been breathtaking, and it continues apace. The SEC
permitting use of IFRS in the U.S. would be a major step forward.
The implications for U.S. academics are profound.
The U.S. is deeply involved in and will be affected by global financial
reporting. U.S. academics need to educate first themselves and then their
students to be able to participate in a global world. There also is a myriad
of open questions for research that U.S. academics can address. The capital
markets are demanding a single language of business. They are demanding that
the single language of business be developed internationally, not solely in
the U.S. This demand for a single global language of business will be met.
The market forces are too great to stop. The question is how, not whether,
it will happen, and how, not whether, U.S. academics will participate.
On Page 1166 she flatly asserts:
First, there is no “matching principle.” That is,
matching is not an end in itself and matching is not an acceptable
justification for asset or liability recognition or measurement. The
conceptual framework explains that matching involves the simultaneous or
combined recognition of revenues and expenses that result directly and
jointly from the same transactions or other events (FASB 1985, para. 146;
IASB 2001, para. 95). Matching will be an outcome of applying standards if
the standards require accounting information that meets the qualitative
characteristics and other criteria in the conceptual framework. Matched
economic positions will naturally result in matched accounting outcomes.
However, the application of a matching concept in the conceptual framework
does not allow the recognition of items in the statement of financial
position that do not meet the definition of assets or liabilities (IASB
2001, para. 95). Thus, there would be no justification for deferring expense
recognition for an expenditure that provides no future economic benefit or
for deferring income recognition for a cash inflow that will not result in a
future economic sacrifice.
But matching still seems to prevail even though there is no more "matching
principle according to the IASB and the FASB. The answer is that revenue can be
deferred when there will be "future economic sacrifice." Sounds like matching to
me. Neither domestic nor international standards allow early
realization of revenue before it is legally earned. The standards just do not
allow automobile inventories to be written up to expected sales prices until
those sales are finalized. Carrying the inventories at something other than
sales value is part and parcel to the "matching principle" eloquently laid out
years ago by Paton and Littleton. Both international and domestic standards
still require cost amortization, depreciation, and creation of warranty
reserves. These are all rooted in the "matching principle" which has not yet
died when defining assets and liabilities in the conceptual framework. In most
instances the historical cost is still being booked and spread over the expected
life of future economic benefits. Even if a company adopted a replacement cost
(current cost) adjustment of historical cost of a depreciable asset, those
replacement costs still have to be depreciated since old equipment cannot simply
be adjusted upward to new, un-depreciated replacement cost.
Paton and Littleton never argued that the "matching principle" for expense
deferral applies to assets that have "no future economic benefits." In that case
there would be no benefits against which to match the deferred expense.
Hence there's no deferral in such instances. I do not buy Barth's contention
that there is no longer any "matching principle." If there are potential future
benefits, the matching principle still is king except in certain instances where
assets are carried at exit values such is the case for precious metals actively
traded in commodity markets and financial assets not classified as
"held-to-maturity."
The Matching Principle lives on when there are expected "future economic
sacrifices."
September 1, 2012 message from Scott Bonacker
If you need an example for a class, here is
one about how third party developers and the way they offer products through
Intuit is being changed -
At a high level, the
current changes are the result of revenue recognition requirements as
determined by the Intuit auditors. The short story is that if Intuit
sells the QuickBooks desktop product, they are required to recognize the
revenue over the time period that the customer receives services related
to that product. For example, if a customer is using QuickBooks 2010,
and Intuit is providing support for the sync manage for that product,
then (in theory) the time period for the revenue recognition is not when
the software was sold. The revenue should be allocated over the time
period that Intuit is incurring costs for that product. In this case, if
they provide support for the Sync Manager until the product is sunsetted,
then the time period could be 3 plus years as compared to recognizing
the revenue in the year of purchase.
What you've stated is merely the cause-effect argument of the Matching
Principle.
Matching Principle
Accounting: A fundamental concept of accrual
basis accounting that offsets revenue against expenses on the basis of
their cause-and-effect relationship. It states that, in measuring net
income for an accounting period, the costs incurred in that period
should be matched against the revenue generated in the same period.
http://www.businessdictionary.com/definition/matching-principle.html
The principle that requires a company to match
expenses with related revenues in order to report a company's
profitability during a specified time interval. Ideally, the matching is
based on a cause and effect relationship: sales causes the cost of goods
sold expense and the sales commissions expense. If no cause and effect
relationship exists, accountants will show an expense in the accounting
period when a cost is used up or has expired. Lastly, if a cost cannot
be linked to revenues or to an accounting period, the expense will be
recorded immediately. An example of this is Advertising Expense and
Research and Development Expense.
http://www.accountingcoach.com/terms/M/matching-principle.html
I think the Matching Principle still dominates standards mostly because most
inventories are carried at cost (not spot prices) until revenues are
recognized from sales (with some LCM frictions that are due to obsolescence,
spoilage, etc.). To me that's the cause-effect Matching Principle ala Paton
and Littleton (1940).
For example, a speculating company that elects to carry harvested corn in
granary rather than deliver it to market in October carries the inventory at
cost rather than the current spot prices. If the corn was marked to spot
prices daily this would would be a violation of the Matching Principle. One
inconsistency in the accounting standards is that we do mark precious metals
to spot in violation of the Matching Principle. But we carry most
commodities at historical cost with supplemental disclosures of fair values.
This begs the question of why there's an accounting difference between corn
versus gold. One basis for this difference is that corn stored in a
company's granary is more likely to vary from the exacting standardized
standards of corn defining the spot prices on the CBOT, CME, CBOE, etc.
Significant error might arise, for example, by marking this granary corn to
CBOT spot prices for corn not exactly alike the corn traded on the CBOT.
Corn stored in a granary tends to lose moisture content, and not all
granaries are alike. Corn in a Minnesota granary in December has a different
moisture loss than corn stored in a Mississippi granary in December.
However, gold stored in a Minnesota vault stays the same as gold stored in a
Mississippi vault. Hence, there is some basis for marking gold inventories
to CBOT spot prices while not marking corn inventories to CBOT spot prices.
In the case of sales of goods under long-term warranties such as a five-year
warranty of the sale of a vehicle, we recognize the full revenue in
the year of the sale and then estimate the warranty costs to be deducted
from that full revenue.
In the case of Quickbooks we defer some of the revenue because of future
services paid in advance. Hence, full revenue is not recognized when
collected. We recognize the deferred revenue over time via the Matching
Principle.
This begs the question on why there's a difference between deferring a
portion of revenues for Quickbooks and not deferring revenues for long-term
warranties. I think the key difference is the proportion of customers who
will need future services.
In the case of Quickbooks, all customers receive future services with
a portion of "revenues" collected in advance. Hence some revenue collected
in advance is deferred, thereby deferring a high proportion of profit
recognition for all customers. This is the Matching Principle whether you
want to admit it or not.
In the case of warranties, only a small proportion proportion of the sales
revenue will be lost in future years to warranties since most customers will
not demand warranty services. Hence, no revenue is deferred, although
warranty costs are estimated for matching purposes. This is the Matching
Principle whether you want to admit it or not.
The Matching Principle lives on irrespective of whether a
portion of revenue is deferred or future estimated expenses are deducted
from realized revenues.
Respectfully,
Bob Jensen
If
General Electric buys a factory robot for $10 million and pays another $10
million for installation in a plant producing wind turbines, suppose the
following:
Historical Cost: $20 million
(early in 2008) with an estimated productive life of 15 years
Replacement Cost: $30 million (with the increase attributed in large measure to
increased robot demand due to environmental and energy legislation in 2009)
Exit Value: $0 with the loss caused mainly by immense transaction costs of
dismantling, transporting, and re-assembly that make buying a new robot cheaper
than moving a used robot.
Value in Use: Unknown because of unknown discount rates, covariances with other
tangible and intangible items, and inseparability of future cash flows
attributable to one robot in one factory. In terms of covariance, if wind
turbines have the GE boiler plate, the value in use of the robot is much higher
than if wind turbines have the Bernie Madoff boiler plate.
Exit value theorists
will place $0 exit value on the balance sheet for this robot. Unless this wind
turbine plant is deemed a non-going concern, the $0 exit value is the worst
possible valuation in terms of error in estimating value in use and earnings.
Under a double entry system, growth company earnings will nearly always get
clobbered by exit values relative to stagnant companies. In a sense Replacement
(Current) Cost companies also get clobbered for non-financial assets that can be
used effectively and efficiently for many years of production without
replacement. Of course Replacement Cost accounting conforms to Capital
Maintenance Theory ---
http://faculty.trinity.edu/rjensen/Theory01.htm#FairValue
I‘ve never agreed with these theorists on exit valuation except in the case of
financial instruments and derivative financial instruments and non-going
concerns.
Some might argue that all partionings of balance sheet item values into
components are arbitrary. We should only generate aggregated line items such as
Factory 1 value, Factory 2, value, etc. Or perhaps we cannot partition value any
further than one line item called Value of General Electric. Of course this
cannot be reliably measured from thin trades of a miniscule proportion of
marginal trades day-to-day on the stock market (called the blockage valuation
problem). Nor can it be reliably estimated via economic models due to unknown
future cash flows, unknown discount rates, unknown and unstable values of
intangibles, unknown environmental and labor legislation, and the thinnest
possible market for the purchase of the entire conglomerate of General Electric
as a whole.
For a time Baruch Lev strongly
advocated using market share prices for valuing intangibles, but his models
proved be particularly unstable and lacked robustness ---
http://faculty.trinity.edu/rjensen/Theory01.htm#TheoryDisputes
Furthermore they put the cart before the horse. Accounting reports are supposed
to help decision makers make market decisions. Lev’s approach works backwards by
using market values to make accounting decisions.
The FASB and IASB both
want financial reporting in terms of value in use. The trouble is that for most
non-financial balance sheet items the only person with a valuation estimate
worth considering is the Wizard of Oz. Witness how badly Bank America overvalued
Merrill Lynch when the toxic Merrill Lynch was purchased by B of A in 2008. CEO
Lewis should've consulted the Wizard of Oz before agreeing to an outrageous
purchase price. The point here is that experts in huge corporations make huge
mistakes when valuing companies to buy and sell. The markets are just too thin
at this level of aggregation.
On Page 1166, Mary Barth states:
Second, few financial statement amounts are stated
at historical cost. Assets and liabilities are typically initially measured
at the value established by an exchange, which is their cost. But, some type
of remeasurement is pervasive. The only amounts in financial statements
today that are always historical costs are those for cash and land in the
transaction currency. Essentially all other amounts reflect changes in time,
events, or circumstances since the transaction date. Amounts for short-term
assets and liabilities, e.g., inventory, receivables, and accounts payable,
are historical costs if they have not been impaired. However, once an entity
recognizes an impairment of inventory or an allowance for uncollectible
accounts receivable, the amounts are no longer historical costs. Also,
entities depreciate or amortize long-term assets and revalue them or write
them down when they are impaired, and amortize issue premium or discount on
long-term debt. They also remeasure many financial instruments at fair
value. Impaired, amortized, revalued, or otherwise remeasured amounts are
not historical costs. Thus, framing the measurement debate in financial
reporting as historical cost versus fair value misleads and obfuscates the
issues.
Both international and domestic standards call for historical-cost based
accounting of many assets that are not impaired and many financial assets and
liabilities intended to be held to maturity. Paton and Littleton recognized
historical cost write-downs under the "conservatism" principle for impairments.
That did not change their usage of the term "historical cost based" financial
statements or the basic underlying concept of matching. It simply recognized
that historical cost must be adjusted for impairments so as to not to mislead
financial statement users by reporting book values in excess of value in use.
Paton and Littleton did not argue for write downs to exit values if exit values
(in the case of a non-going concern) were the worst possible (liquidation) uses
not intended by a going concern.
Beginning on Page 1167, Mary Barth also states:
Fifth, the income statement has not become less
important than the statement of financial position. Some believe it has
because the conceptual framework definitions of financial statement elements
are anchored in the asset definition. Income and expenses are defined in
terms of changes in assets and liabilities. However, this focus on assets
and liabilities—the elements in the statement of financial position—is not
because they are more important than income and expenses. Rather, it is
because standard-setters have not been able to identify a conceptually
consistent and operational way of defining and measuring income and
expenses, and thus profit or loss, without reference to assets and
liabilities. This approach also is consistent with the concept of economic
income being the change in wealth during the period (Hicks 1946).
Standard setters may wish that the income statement was less important than
the balance sheet, but in reality trends in earnings and cash flows are the two
most watched patterns by analysts and investors who've by now come to realize
that the balance sheet is a mess comprised items measured under different
measuring sticks and a summation to net book value that is totally meaningless
to anybody. Earnings are residually impacted by asset valuations. However, many
exit value adjustments are relegated to AOCI rather than current earnings under
such standards as FAS 130 and FAS 133 in order to adjust asset and liability
values for transitional variation fair values that might never be realized due
to fair value adjustments and hedging.
In my viewpoint, exit or fair value accounting in many instances is
misleading when fair values are assumed to be exit values of non-financial
assets. Exit values assume the worst possible use of assets (i.e. liquidations)
when in fact what is or will be required in the standards is value in the best
possible use. But the best possible use includes higher order covariance
components that in nearly every instance are not practical to measure. I discuss
these covariance issues at
http://faculty.trinity.edu/rjensen/theory01.htm#FairValue
In summary, I agree with Mary Barth on the issue that a single set of
international accounting standards will one day be in place for virtually all
nations in the free world. I also think these should be evolutionary standards
where the FASB reworks domestic standards, interpretations, and implementation
guidelines to eliminate differences that exist between U.S. GAAP and
international GAAP.
I'm even willing to accept the elimination of many of the bright line rules
in U.S. GAAP. However, I worry that more principles-based standards will lead to
greater reporting inconsistencies of virtually identical transactions. One of
the problems is that principles-based standards and implementation rely
increasingly on imperfect conceptual frameworks. It is impossible to lay out
conceptual frameworks that are not vague.
There are strong
arguments for not converging domestic standards completely to international
standards, including the arguments of Yale’s Shyam Sunder and Chicago’s Ray Ball
and others such as Tom Selling, J. Edward Ketz, and David Albrecht.
Bob Jensen's threads on controversies of standard setting are at
http://faculty.trinity.edu/rjensen/theory01.htm#Principles-Based
Principles-Based
Accounting Relies More on Conceptual Frameworks, and Therein Lies the Problem
Mark Penno has written
a very academic paper on vagueness and logical fallacies in accounting standard
conceptual frameworks. This is a very important research study for all
accounting educators to read, especially educators who expound principles-based
standards. Many of the problems, however, also apply to rule-based standards.
I especially like the
"sorites paradox" illustrated with the heap
(soros) of sand illustration.
SYNOPSIS:
Rules are fundamental to financial reporting, tax regulation, and auditing
processes, and therefore the limitations of rule-based structures are of
primary interest to accountants. All rule systems are plagued by the problem
of vagueness, which implies that some very important decisions cannot be
objectively described as “right” or “wrong,” and must be based on an
authority’s judgment. This problem becomes most acute when accounting faces
rapid technological changes, financial engineering, creative tax planning,
or changes in the way that business is done. If the environment were static,
explicit rules could eventually be developed for each category and consulted
when making classifications. In contrast, dynamic environments present new
problems characterized by vagueness. In this paper, I will review several
definitions of vagueness, and show how they are tied to a conceptual
framework. In particular, I will discuss the potential roles of
verifiability, relevance, and consistency under any feasible vague
conceptual accounting framework.
. . .
TYPES OF VAGUENESS
Uni-Dimensional Vagueness
Most of the literature on vagueness studies the uni-dimensional or soritical
form of vagueness, with the latter label taken from the “sorites paradox.”
To illustrate the paradox, suppose that I assume: If a pile of n + 1 grains
of sand is a heap (soros); then a pile of n grains of sand is also a heap.
But then, by permitting n to become smaller, I am—by classical logic—led to
the inevitable conclusion that one grain of sand is also a heap—which is
false. Technically, unidimensional vagueness requires two instances, tT and
tF, where tT is definitely-a-member of Category C, and tF is
definitely-not-a-member of Category C. As we move along the dimension from
tT to tF, we reach an instance, say tj, which is neither definitely-a-member
of Category C, nor is it definitely-not-a-member of Category C. That is, its
status is indeterminate.. .
2
See, for example, Endicott (2000, 2001, 379) who argues “In fact, law is
necessarily very vague.” For a treatment of gray areas, see
Ullmann-Margalit (1990, 756), who refers to such gray areas in the
context of “the wide spectrum of social norms, stretching from the
diffuse, informal, non-institutional norms at one end to the
institutional and legal ones on the other.”
3
See Cuccia et al. (1995) for an introduction to the problem(s) of vague
standards in accounting.
4
See Dye (2002) for a somewhat different discussion of standards creep.
5
Contrast this to Lipman (2006) who asks “Why is language vague?”—to
which his abstract replies, “I don’t know."
The twentieth century
witnessed a variety of attempts to resolve this problem. (something like tj).
Thus, instead of being forced to decide whether an item is either in the
category or not in the category (law of excluded middle), an individual is
given a third choice: the status of the item is indeterminate. The flaw with
this approach, however, is that we now have to specify a new boundary
between true and indeterminate items, and a second new boundary between
indeterminate and false items. These boundaries again will not be sharp
(requiring us to again partition the interval even further). These
additional problems are collectively referred to as higher-order vagueness,
with the partitioning exercise reaching the final limit in fuzzy logic,
where each item is assigned a number, . . . representing the
membership-value (truth-value), or in our case, degree of membership in
Category C.
Other types of vagueness are discussed in the article
To conclude, I have
attempted to demonstrate that any conceptual framework in accounting must
acknowledge vagueness. In contrast to the popular notion of vagueness, the
roles of certain vagueness-induced criteria such as consistency and
relevance were made more precise, and the role of verifiability
reconsidered. On a parting note, Lipman (2006) writes: “In short, it is not
that people have a precise view of the world, but communicate it vaguely;
instead they have a vague view of the world. I know of no model which
formalizes this.” While a complete model of vague conceptual frameworks has
yet to be developed, it is my hope that this paper might be viewed as a
beginning.
I read Penno’s paper this morning. Fascinating
read! I found the following statement intriguing: “[A]n immediate
implication of vagueness is that accountants may reach a point where
gathering more evidence will not change their minds, yet the accounting
determinations remain controversial.” What I take from this is that no
matter how much effort is expended, the “answer” relies on judgment because
the data do not avail themselves to unique sets, e.g., “R&D” or “not R&D.”
As the “R&D” set expands to include data that do not have common
characteristics, regulators seek to improve transparency by either “lumping”
(defining a unique characteristic that must exist to be in the set) or
“splitting” (create subsets in which the data have unique characteristics).
When I try to make sense of papers like this, I
wish I had a stronger background in philosophy, so that I could more fully
appreciate the points he makes. I would love to hear what others take away
from this paper.
Amy Dunbar
UConn
There are strong
arguments for not converging domestic standards completely to international
standards, including the arguments of Yale’s Shyam Sunder and Chicago’s Ray Ball
and others such as Tom Selling, J. Edward Ketz, and David Albrecht.
Bob Jensen's threads on controversies of standard setting are at
http://faculty.trinity.edu/rjensen/theory01.htm#Principles-Based
Valuation Premises Fair value measurements
of assets must consider the highest and best use of the asset, which is
determined from the perspective of market participants rather than the reporting
entity’s intended use. Under current U.S. GAAP, the asset’s highest and best use
determines the valuation premise. The valuation premise determines the nature of
the fair value measurement; that is, whether the fair value of the asset will be
measured on a stand-alone basis ("in-exchange") or measured based on an
assumption that the asset will be used in combination with other assets
("in-use"). The proposed ASU would remove the terms in-use and in-exchange
because of constituents’ concerns that the terminology is confusing and does not
reflect the objective of a fair value measurement. The proposed ASU would also
prohibit financial assets from being measured as part of a group. The FASB
decided that the concept of highest and best use does not apply to financial
assets, and therefore their fair value should be measured on a stand-alone
basis. Entities would still have the ability to measure fair value for a
nonfinancial asset either on a stand-alone basis or as part of a group,
consistent with the nonfinancial asset’s highest and best use.
It must be kept in mind
that the statements certified are not ours but are our clients--and our clients
do not care to mix explanations of accounting theory with explanations of their
business nor can we pass onto our readers the responsibility for appraisal of
differences in accounting theory. Those fields are for you and me to grapple
with, not the public. In general, clients are not primarily interested in
arguments of accounting theory at the time of preparing their reports. The
companies whose accounts are certified are chiefly interested in what is said to
their shareholders, and in the hard practical facts of how accounting rules
affect them, their competitors and other companies. Usually they are very
critical of what we call accounting principles when these called principles are
unrealistic, inconsistent, or do not protect or distinguish scrupulous
management from the scrupulous.
"The Need for An Accounting Court," by Leonard Spacek, The Accounting
Review, 1958, Pages 368-379 ---
http://faculty.trinity.edu/rjensen/FraudSpacek01.htm
Jensen Comment
Fifty years later I'm a strong advocate of an accounting court, but I envision a
somewhat different court than than envisioned by the great Leonard Spacek in
1958. Since 1958, the failure of anti-trust enforcement has allowed business
firms to merge into enormous multi-billion or even trillion dollar clients
who've become powerful bullies that put extreme pressures on auditors to bend
accounting and auditing principles. For example see the way executives of Fannie
Mae pressured KPMG to bend the rules (an act that eventually got KPMG fired from
the audit).
In my opinion the time has come where auditors and
clients can take their major disputes to an Accounting Court that will use
expert independent judges to resolve these disputes much like the Derivatives
Implementation Group (DIG)
resolved technical issues for the implementation of FAS 133. The main
difference, however, is that an Accounting Court should hear and resolve
disputes in private confidence that allows auditors and clients to keep these
disputes away from the media. The main advantage of such an Accounting Court is
that it might restrain clients from bullying auditors such as became the case
when Fannie Mae bullied KPMG.
Who would sit on accounting courts is open to debate,
but the "judges" could be formed by the State Boards of Accountancy much like a
grand jury is formed by a court of law. Accounting court cases, however, should
be confidential since they deal with sensitive client information.
I really don't anticipate a flood o cases in an
accounting court. But I do view the threat of taking client-auditor disputes to
such courts (in confidence) as a means of curbing the bullying of auditors by
their enormous clients.
The problem is that poor anti-trust enforcement coupled
with mergers of huge companies have combined to create mega-clients that
auditing firms cannot afford to lose after gearing up to handle such large
clients. I think we saw this in the "clean opinions" given to all the enormous
failing banks (like WaMu) and enormous Wall Street investment banks (like
Lehman). The big auditing firms just could not afford to question bad debt
estimates, mortgage application lies, and CDO manipulations of such clients.
I find it hard to
believe that auditors failed to detect an undercurrent of massive subprime
"Sleaze, Bribery, and Lies" that transpired in the Main Street banks and
mortgage lending companies ---
http://faculty.trinity.edu/rjensen/2008Bailout.htm#Sleaze
The sleaze was so prevalent the auditors must've worn their chest-high waders on
these audits.
The Largest Earnings Management Fraud in
History and Congressional Efforts to Cover it Up
Without trying to place the blame on
Democrats or Republicans, here are some of the facts that led to the
eventual fining of Fannie Mae executives for accounting fraud and the
firing of KPMG as the auditor on one of the largest and most lucrative
audit clients in the history of KPMG. The restated earnings purportedly
took upwards of a million journal entries, many of which were
re-valuations of derivatives being manipulated by Fannie Mae accountants
and auditors (Deloitte was charged with overseeing the financial statement
revisions.
Fannie Mae may have conducted the largest
earnings management scheme in the history of accounting.
. . . flexibility
also gave Fannie the ability to manipulate earnings to hit -- within
pennies -- target numbers for executive bonuses. Ofheo details an
example from 1998, the year the Russian financial crisis sent
interest rates tumbling. Lower rates caused a lot of mortgage
holders to prepay their existing home mortgages. And Fannie was
suddenly facing an estimated expense of $400 million.
Well, in its
wisdom, Fannie decided to recognize only $200 million, deferring the
other half. That allowed Fannie's executives -- whose bonus plan is
linked to earnings-per-share -- to meet the target for maximum bonus
payouts. The target EPS for maximum payout was $3.23 and Fannie
reported exactly . . . $3.2309. This bull's-eye was worth $1.932
million to then-CEO James Johnson, $1.19 million to
then-CEO-designate Franklin Raines, and $779,625 to then-Vice
Chairman Jamie Gorelick.
That same year
Fannie installed software that allowed management to produce
multiple scenarios under different assumptions that, according to a
Fannie executive, "strengthens the earnings management that is
necessary when dealing with a volatile book of business." Over the
years, Fannie designed and added software that allowed it to assess
the impact of recognizing income or expense on securities and loans.
This practice fits with a Fannie corporate culture that the report
says considered volatility "artificial" and measures of precision
"spurious."
This
disturbing culture was apparent in Fannie's manipulation of its
derivative accounting. Fannie runs a giant derivative book in an
attempt to hedge its massive exposure to interest-rate risk.
Derivatives must be marked-to-market, carried on the balance sheet
at fair value. The problem is that changes in fair-value can cause
some nasty volatility in earnings.
So, Fannie
decided to classify a huge amount of its derivatives as hedging
transactions, thereby avoiding any impact on earnings. (And we mean
huge: In December 2003, Fan's derivatives had a notional value of
$1.04 trillion of which only a notional $43 million was not
classified in hedging relationships.) This misapplication continued
when Fannie closed out positions. The company did not record the
fair-value changes in earnings, but only in Accumulated Other
Comprehensive Income (AOCI) where losses can be amortized over a
long period.
Fannie had
some $12.2 billion in deferred losses in the AOCI balance at
year-end 2003. If this amount must be reclassified into retained
earnings, it might punish Fannie's earnings for various periods over
the past three years, leaving its capital well below what is
required by regulators.
In all, the
Ofheo report notes, "The misapplications of GAAP are not limited
occurrences, but appear to be pervasive . . . [and] raise serious
doubts as to the validity of previously reported financial results,
as well as adequacy of regulatory capital, management supervision
and overall safety and soundness. . . ." In an agreement reached
with Ofheo last week, Fannie promised to change the methods involved
in both the cookie-jar and derivative accounting and to change its
compensation "to avoid any inappropriate incentives."
But we don't
think this goes nearly far enough for a company whose executives
have for years derided anyone who raised a doubt about either its
accounting or its growing risk profile. At a minimum these
executives are not the sort anyone would want running the U.S.
Treasury under John Kerry. With the Justice Department already
starting a criminal probe, we find it hard to comprehend that the
Fannie board still believes that investors can trust its management
team.
Fannie Mae
isn't an ordinary company and this isn't a run-of-the-mill
accounting scandal. The U.S. government had no financial stake in
the failure of Enron or WorldCom. But because of Fannie's implicit
subsidy from the federal government, taxpayers are on the hook if
its capital cushion is insufficient to absorb big losses. Private
profit, public risk. That's quite a confidence game -- and it's time
to call it.
**********************************
:"Sometimes
the Wrong 'Notion': Lender Fannie Mae Used A Too-Simple Standard For
Its Complex Portfolio," by Michael MacKenzie, The Wall Street
Journal, October 5, 2004, Page C3
Lender Fannie
Mae Used A Too-Simple Standard For Its Complex Portfolio
Much has been
made of the accounting improprieties alleged by Fannie's regulator,
the Office of Federal Housing Enterprise Oversight.
Some investors
may even be aware the matter centers on the mortgage giant's $1
trillion "notional" portfolio of derivatives -- notional being the
Wall Street way of saying that that is how much those options and
other derivatives are worth on paper.
But
understanding exactly what is supposed to be wrong with Fannie's
handling of these instruments takes some doing. Herewith, an effort
Go touch on what's what -- a notion of the problems with that
notional amount, if you will.
Ofheo alleges
that, in order to keep its earnings steady, Fannie used the wrong
accounting standards for these derivatives, classifying them under
complex (to put it mildly) requirements laid out by the Financial
Accounting Standards Board's rule 133, or FAS 133.
For most
companies using derivatives, FAS 133 has clear advantages, helping
to smooth out reported income. However, accounting experts say FAS
133 works best for companies that follow relatively simple hedging
programs, whereas Fannie Mae's huge cash needs and giant portfolio
requires constant fine-tuning as market rates change.
A Fannie
spokesman last week declined to comment on the issue of hedge
accounting for derivatives, but Fannie Mae has maintained that it
uses derivatives to manage its balance sheet of debt and mortgage
assets and doesn't take outright speculative positions. It also uses
swaps -- derivatives that generally are agreements to exchange
fixed- and floating-rate payments -- to protect its mortgage assets
against large swings in rates.
Under FAS 133, if
a swap is being used to hedge risk against another item on the
balance sheet, special hedge accounting is applied to any gains and
losses that result from the use of the swap. Within the application
of this accounting there are two separate classifications:
fair-value hedges and cash-flow hedges.
Fannie's
fair-value hedges generally aim to get fixed-rate payments by
agreeing to pay a counterparty floating interest rates, the idea
being to offset the risk of homeowners refinancing their mortgages
for lower rates. Any gain or loss, along with that of the asset or
liability being hedged, is supposed to go straight into earnings as
income. In other words, if the swap loses money but is being applied
against a mortgage that has risen in value, the gain and loss cancel
each other out, which actually smoothes the company's income.
Cash-flow
hedges, on the other hand, generally involve Fannie entering an
agreement to pay fixed rates in order to get floating-rates. The
profit or loss on these hedges don't immediately flow to earnings.
Instead, they go into the balance sheet under a line called
accumulated other comprehensive income, or AOCI, and are allocated
into earnings over time, a process known as amortization.
Ofheo claims
that instead of terminating swaps and amortizing gains and losses
over the life of the original asset or liability that the swap was
used to hedge, Fannie Mae had been entering swap transactions that
offset each other and keeping both the swaps under the hedge
classifications. That was a no-go, the regulator says.
"The major
risk facing Fannie is that by tainting a certain portion of the
portfolio with redesignations and improper documentation, it may
well lose hedge accounting for the whole derivatives portfolio,"
said Gerald Lucas, a bond strategist at Banc of America Securities
in New York.
The bottom line is that both the FASB and the IASB must someday soon
take another look at how the real world hedges portfolios rather than
individual securities. The problem is complex, but the problem has come
to roost in Fannie Mae's $1 trillion in hedging contracts. How the SEC
acts may well override the FASB. How the SEC acts may be a vindication
or a damnation for Fannie Mae and Fannie's auditor KPMG who let Fannie
violate the rules of IAS 133.
I have some "top line" thoughts
on accounting & the credit crisis.
First, I don't believe
accounting "causes" crises. However, in my view, US GAAP accounting rules
contributed to the lack of transparency about the financial position &
performance of companies who engaged in securitizations involving sub-prime
mortgages.
So here are some tidbits for
thought re: the failure of financial reporting to provide relevant
information for economic decision-making:
(1) Securitization SPE/VIEs
could be moved off-balance sheet if they were "legally isolated" from the
company that created them. Legal isolation was based on opinions of
attorneys. These vehicles proved not to be legally isolated when "legal
isolation" was tested by the market place.
(2) Models measuring fair
values of financial instruments include assumptions about the
characteristics of the instruments. Rarely, if ever, do they include
assumptions about more fundamental economics, such as real estate prices or
general market collapse. Since the belief was that "real estate prices would
always rise", the possibility of a general collapse of real estate prices
would have received an extremely low weighting even if this variable was
included in a fair value model. There is nothing that accounting rules can
do (in my view) to create a comprehensive & complete list of variables to be
included in fair value models. All we can do is provide guidance on who to
estimate fair values.
(3) Only when defaults started
to occur did the information begin to creep in the financial statements
through
(a) more realistic estimates of
fair values of instruments on the books and
(b) through moving back onto
the books assets that had been moved off-balance sheet in SPEs.
On the IFRS front, I wrote a
monograph on this issue for the Institute of Chartered Accountants in
Australia. If anyone is interested in my emailing them a copy, email me
off-list.
Regards,
Pat Walters
Fordham University
September 16, 2008 reply from
Many made excellent points on this topic
You hear from these giant firms (e.g., AIG, GM,
Ford, etc.) telling the government “we are too big to fail” sounds like
blackmailing the government. Are they expecting us to consider the size of
the company as factor in the going concern determination? Also both
presidential campaigns call for “tougher” regulations on markets, are they
talking about us? Are they talking about regulators (government agencies)
who now will be operating major firms in Wall Street? BTW, should GASB rules
apply to these firms?
In my opinion, it is hard to believe gurus in
financial markets such as Bear Stern, Lehman Brothers, or Goldman Sachs with
top experts were unaware of risk of real estate loans, or could not manage
their greed as they did in the past. After all, they have gone through
several cycles of real estate ups and downs over last 100+ years.
I think this time accountants cannot be blamed, and
Bob did a good job explaining that mark-to-market is not the source of the
problem. I keep looking for more theories to help me understand what
happened so I can better manage my retirement funds in the future. To start,
I would like to research whether mixing trade and politics played a role in
this crisis (Zane commented on the intertwining nature of the problems), or
perhaps sudden devaluation of dollar caused massive sell off on mortgage
securities packages in foreign markets; and finally created the run on
financial institutions.
Saeed R.
September 17, reply from Bob Jensen
Hi Saeed,
You stated “.To start, I would like to research
whether mixing trade and politics played a role in this crisis . . . “
Hint:
They were, and still are, all in bed together.
In the mortgage
meltdown crisis, these are the feet of ignorant and all-powerful
representatives in Congress and the Senate (Chris
Dodd in particular), investment bankers, greedy local bankers, crooked
real estate appraisers, greedy credit insurance brokers, and yes the
international auditing firms that did not insist on proper bad debt
allowances because they feared losing their biggest clients. In fairness,
PwC did insist on providing details about how Fannie could get kicked in the
tail, but the seemingly endless footnotes overwhelmed even the most diligent
analysts. Most other sets of audited financial statements, in retrospect,
were more like the “feet together” picture.
In the IFRS
transition fiasco, these are the bedded-together feet of SEC Chairman Cox,
FASB Chairman Herz, the IASB members, and the CEOs of all the large
international auditing firms.
IFRS tends to be diverging from the quality of financial reporting
Related party disclosures are just one more example
of where IFRS tends to be diverging from the quality of financial reporting that
results in the relatively low cost of capital we currently enjoy in the United
States. China is a highly distinct economy and any attempt to craft disclosure
rules that respond to the peculiar needs of its economy and society are likely
to clash with what is best for U.S. investors. (So much for the idea that one
single set of accounting standards can work well the world over!) As the
second-largest economy in the world, China is already demonstrating its
willingness to use its economic clout to shape IFRS to his own needs, which as I
have stated, would not just deprive investors of relevant and reliable
information, but could further increase the risk of loss due to fraud.
"IAS 24: Related Party Disclosures Are Too Transparent to Suit China," by Tom
Selling, The Accounting Onion, September 10, 2008 ---
http://accountingonion.typepad.com/theaccountingonion/2008/09/ias-24-related.html
Forget IFRS for a moment if you will – let us
pretend that they don’t exist. Are you of the opinion that rules lead to
transactions and events being more faithfully represented than principles?
If no, would you support a gradual move from
current US GAAP to principles-based US GAAP in a manner that allows proper
acclimatization by all stakeholders?
David
November 27, 2008 reply from Bob Jensen
Hi David,
I have argued over and over that rules in many instances lead to greater
consistency, easier enforcement, and better safety. My classic examples are
traffic rules. The principle “reduce speed in a school zone” just does not
work well when some drivers think that reducing speed from 55 mph to 40 mph
meets the “principle.” Parents of school children are ever so grateful for
bright-line signs posted setting maximum speed to something like 20 mph in
school zones.
In the U.S. over the past four decades, we’ve seen where enormous clients
that auditing firms cannot afford to lose have been bullying auditors to
points where auditors exercised poor judgments about accounting
“principles.” My best example here is when CEO Frank Raines bullied KPMG to
violate FAS 133 rules about hedge accounting for heterogeneous macro hedges.
As a result of the rules, the government caught Fannie Mae and KPMG. KPMG
got fired from the audit and Frank Raines got fired from Fannie Mae and was
required to pay over a million dollars in fines.
Had there only been a “principle” about macro hedging without some bright
line rules, chances are that both Raines and KPMG would still be misleading
investors at Fannie Mae, because they could argue that they just applied
different “judgment” about accounting principles vis-à-vis what judgments
other firms and auditors might apply in the same circumstances. It was the
Three-Percent rule (now a 10 % Rule in FIN 46) that essentially brought down
both Enron and Andersen. Without such a bright line rule, Enron might still
be gouging electric power companies, Andersen might still be performing
terrible audits, and Andy Fastow might be the new Secretary of the U.S.
Treasury.
My point is that enormous clients are prone to bullying auditors in the
U.S. and, without some of the bright line rules in such areas as revenue
realization, hedge accounting, and SPE accounting (that 10% rule today), the
bad guys would still be cooking the books in the U.S. instead of having to
pay up in court ---
http://faculty.trinity.edu/rjensen/Fraud001.htm
Obviously, no accounting standards can be exclusively principles-based (IFRS
has some bright line rules) or rules-based (U.S. GAAP leaves a lot of leeway
for professional judgment in most standards). I think what you’ve
overlooking, David, is the history of bright line rules in U.S. GAAP.
Bright line rules typically were introduced when business firms were
abusing the privilege of judgment. These abuses led to many inconsistencies
such as when Boeing said it sold an airliner to Eastern Airlines, but
Eastern Airlines reported in was only renting the airliner from Boeing.
These abuses also misled investors and led to a lot of unearned bonuses
because principles-based standards led to greater ability to manage earnings
to the penny just to get a bonus (as in the case of Franklin Raines at
Fanney Mae).
Sure it’s easy to point to some bright line rules that have not worked
well such as the FAS 13 bright line rules separating operating leases from
capital leases. It’s easier to generate a “principle” that there can be no
operating leases and make every lease a capital lease. But this is more than
just a “principle.” This is a harsh bright line rule that simply sets the
bar for operating leases at zero.
Of course doing away with operating leases entirely is not necessarily a
good thing in theory. There is a difference when there’s zero chance of ever
being an owner after decades of paying rent under an operating lease such as
when a bookstore rents a 1,000 square-foot shop in the Galleria Shopping
Mall. The Galleria has no intention whatsoever of ever passing ownership
title to a mere 1,000 square feet in a million square-foot mall. The firm
that leases the entire million square feet mall itself, however, may well
become the owner of the Galleria Mall under a true capital lease after
making lease payments for 30 years and then paying an ending one dollar to
own the mall.
Hence there is a difference between the book store’s lease (never a
chance to own) and the mall lease allows the lessee to purchase the mall for
a dollar after 30 years of paying rent. Standards that consider the book
store lease and the mall’s lease as equivalents is not necessarily correct
in “principle.”
My threads on rules-based versus principles-based standards are at
http://faculty.trinity.edu/rjensen/theory01.htm#Principles-Based
Neither basis for accounting standards is perfect in every instance, but I
hate accounting standards that give greater flexibility to enormous clients
to bully auditors and manage earnings to maximize bonuses rather than
shareholder value.
What a more gradual convergence to test principles-based standards slower
in the U.S. business environment to see where they are allowing run-away
earnings management and financial reporting manipulation. This would allow
the U.S. to pressure the IASB to insert some bright line rules, before the
U.S. buys into IFRS entirely, where the most egregious earnings management
is being attempted under principles-based standards.
Bob Jensen
More IFRS Quotations: Those Principles Based Things Called (repeat
after me boys and girls) --- "Standards" In other words, an entity will evaluate each
contract whenever and however it wants. Do you need to smooth your earnings? If
yes, those new construction projects are going to be accounted for under IAS 11
(percentage of completion method). Or, are you going to need the earnings next
year to make your bonus target? If so, those new projects you just started are
going to be accounted for under IAS 18 (essentially, the completed contract
method). Even if they could, no auditor would dare to risk its fee by calling
your "judgment" into serious question.
Tom Selling, "IFRIC 18: Revenue Recognition Rules Hark Back to Not-So-Good Ole
Days of U.S. Accounting," The Accounting Onion, September 3, 2008 ---
http://accountingonion.typepad.com/theaccountingonion/2008/09/ifric-18-revenu.html
The American Way
U.S. GAAP takes a different approach, borne out of
lessons learned the hard way. Statement of Financial Accounting Standards (SFAS),
No. 66, Accounting for Sales of Real Estate, requires use of the percentage
of completion method for recognizing earnings from sales of units in
condominium projects or time-sharing interests (¶37), irrespective of a
buyer's ability to affect the construction. SFAS No. 66 was issued in 1982,
and its provisions were clearly motivated by a desire to put a halt to
premature and inappropriate revenue recognition practices taking place in
the real estate industry. Broad principles of revenue recognition have a
certain attraction, but managers quickly figured out how to comply with the
letter of an accounting principle (making the auditor happy), while at the
same time completely disregarding its spirit. All sorts of investors, be
they unsophisticated individuals hoping for a quick killing or ambitious
loan officers looking for a few extra basis points, were taken in by the
financial shenanigans of real estate companies that rode roughshod over the
principles-based accounting guidance that existed at the time.
If there is a principle in SFAS No. 66 it is that
you don't get to pick and choose under U.S. GAAP. I can't speak of financial
reporting elsewhere, but in the U.S. financial reporting environment, that's
a good thing. It bespeaks volumes about the current leadership of the SEC
that it thinks otherwise—as evidenced by its near monotonic support of an
IFRS that marches ever forth toward chicken salad for issuers.
September 4, 2008 reply from Bob Jensen
The problem with IFRS is the absolving of bright lines. It becomes
inevitable that a given transaction might be treated in three different ways
under international GAAP by three different companies, and the auditing
firms will have fewer bright lines to bring about consistent coverage of a
lot of things like the examples raised by Tom Selling on IFRS 3, IFRS 11 and
IFRS 18.
IAS 39 brightens the lives of firms trying to manage earnings with
complicated derivative financial instruments. Auditors will not be able to
achieve consistency on their own without some bright lines when accounting
for derivative financial instruments and hedging activities.
Standards are intended to bring about consistent accounting for a
virtually identical transactions and to reduce the likelihood of runaway
earnings management. I don’t think IFRS at the present time will do that in
numerous instances when the FASB bright lines are dimmed. There are,
gratefully, some counter examples but these are too few and far between.
What will also be bad is the difficulty of teaching
principles-based standards. Tom’s complaint about IFRS 11 versus IFRS 18 is
an excellent example. It was easy to teach the bright lines of FAS 66, but
what do you tell students about IFRS 11 and IFRS 18? Do we simply tell them
that earnings management via choice of alternative rules is acceptable?
Clearly this has been the case in some US GAAP instances, but the entire
history of the FASB has been to close the most egregious loopholes.
Another good example is oil and gas accounting. Purportedly anything
still goes in international GAAP, although I’m the first to admit that I
know very little about oil and gas accounting.
But the biggest problem of IFRS will be
correcting GAAP loopholes being used by U.S. companies. Back in 1993 when
the SEC Chairman said the three biggest problems in financial reporting were
“derivatives, derivatives, and derivatives,” he asked then FASB Chairman
Dennis Beresford to jump. Denny asked how high, and the result was actually
darned quick (FAS 119) and darned high with the FASB’s bright-lined FAS 133
and its ensuing amendments.
In the future, when an SEC Chairman asks the
Chair of the IASB to jump, the IASB Chair will have to get permission from
upwards of 100 nations before moving an inch. Correcting financial reporting
abuses will be like asking the U.N. to correct carbon emission abuses.
This does not mean FASB is better than the IASB. What
it means as FASB may be much quicker to make it harder for creative
accountants in the U.S.
Principle-based does not mean less responsibility
for proper reporting or being irresponsible. Similarly, more standards have
not prevented disasters, at least in the U.S.
Decision about selecting certain standard is a
joint decision among CFO, Board of Directors, Audit Committee (and may be
the auditor) where they collectively should be responsible - to some extent
this was attempted under SOX.
In arriving such decision they should consider
long-term reaction of the capital markets, if interested in going concern
and rewards for their stockholders.
I think the argument has already shifted about
standards, from being an accounting thing to being a corporate governance
matter.
Also, I think it’s time to have an honest
discussion of what should we realistically expect from any set of standards.
Saeed
September 4, 2008 reply from Bob Jensen
Let me address your excellent question about what we should expect from
any set of standards?
My $.02 on this is that first and foremost, under a set of accounting
standards, identical transactions should be accounted for consistently.
Standards should decrease rather than increase management’s discretion to
manage earnings via the ledger entries. Principles-based standards are not
inherently bad as long as management and auditors use consistent logic when
applying the same principle. In the “good ole days” this was not the case
when some companies booked leases that other companies did not book as debt,
some companies booked debt for health care expenses of retirees and other
companies didn’t have the slightest idea what they would be paying out for
retiree medical bills, etc. The “good ole days” is replete with
off-balance-sheet financing ---
http://faculty.trinity.edu/rjensen/theory01.htm#OBSF2
Some might argue that we should allow creative accounting to trump
consistency accounting, because then better ways of accounting for
transactions might evolve just as species adapted in theories of Darwin.
Put me down as being opposed to this evolution theory of accounting on the
grounds that too many investors and creditors will be harmed by creative
fraud. Humans are better able to reason solutions to accounting issues
rather than rely on evolution.
I always remember an example given years ago about Boeing versus Eastern
Airlines. Each new airliner acquired by Eastern Airlines from Boeing was
booked as a sale by Boeing and was not booked as a purchase by Eastern
Airlines when accounting for the transaction as an operating lease. When
some other airlines were booking the same acquisitions as purchases it
eventually dawned on the SEC that some sort of bright line was needed to
achieve consistency. The bright line that we got, however, was not bright
enough and companies commenced to abuse FAS 13 rules. The problem was that a
better bright line was needed relative to what the FASB gave us in FAS 13.
In other words, the problem was not the bright line concept. The problem was
the bright line itself. IAS 17 still does not solve the consistency problem
with a principles-based standard.
My oft-repeated illustration is the “principle” that drivers should not
speed when driving by a school. Without some bright line, how do you arrest
someone reducing speed from 55 mph to 40 mph in a school zone? For this
reason, we post a bright line saying that speeding is anything above 20 mph
in a school zone. Then most drivers consistently do not exceed 20 mph in a
school zone, and those that go 40 mph are subject to arrest.
The problem with IFRS is the absolving of bright lines. It becomes
inevitable that a given transaction might be treated in three different ways
under international GAAP by three different companies, and the auditing
firms will have fewer bright lines to bring about consistent coverage of a
lot of things like the examples raised by Tom Selling on IFRS 3, IFRS 11 and
IFRS 18.
IAS 39 brightens the lives of firms trying to manage earnings with
complicated derivative financial instruments. Auditors will not be able to
achieve consistency on their own without some bright lines when accounting
for derivative financial instruments and hedging activities.
Standards are intended to bring about consistent accounting for a
virtually identical transactions and to reduce the likelihood of runaway
earnings management. I don’t think IFRS at the present time will do that in
numerous instances when the FASB bright lines are dimmed. There are,
gratefully, some counter examples but these are too few and far between.
What will also be bad is the difficulty of teaching principles-based
standards. Tom’s complaint about IFRS 11 versus IFRS 18 is an excellent
example. It was easy to teach the bright lines of FAS 66, but what do you
tell students about IFRS 11 and IFRS 18? Do we simply tell them that
earnings management via choice of alternative rules is acceptable? Clearly
this has been the case in some US GAAP instances, but the entire history of
the FASB has been to close the most egregious loopholes.
Another good example is oil and gas accounting. Purportedly anything
still goes in international GAAP, although I’m the first to admit that I
know very little about oil and gas accounting.
But the biggest problem of IFRS will be correcting GAAP loopholes being
used by U.S. companies. Back in 1993 when SEC Chairman said the three
biggest problems in financial reporting were “derivatives, derivatives, and
derivatives,” he asked then FASB Chairman Dennis Beresford to jump. Denny
asked how high, and the result was actually pretty high with the FASB’s
bright-lined FAS 133 and its ensuing amendments.
In the future, when an SEC Chairman asks the Chair of the IASB to jump,
the IASB Chair will have to get permission from upwards of 100 nations
before moving an inch. Correcting financial reporting abuses will be like
asking the U.N. to correct carbon emission abuses.
Principle-based does not mean less
responsibility for proper reporting or being irresponsible. Similarly,
more standards have not prevented disasters, at least in the U.S.
Saeed, undoubtedly you have an international
perspective that I simply don't have. Born and raised in the US, I once
crossed into Canada to view the non-US side of Niagara Falls. Otherwise, I
guess I'm US centric. I focus on US issues.
The US has a long history that has led me to the
following conclusions: (1) Many US corporations are led by management teams
that are ethically challenged. When considering actions, they ascertain the
cost of disobeying rules. If the benefits from disobeying rules exceed the
costs, then so frequently a decision is made to disobey rules. Frequently,
this leads to disregard for numbers reported in financial reports. (2)
Having bright lines in rules has resulted in better financial reporting in
the US. The US long has had an accounting rule which requires Lessees to
report leases as capital leases under certain circumstances. The rule was
long ignored, until a couple of years ago when the SEC announced it would
start enforcing the rule. Suddenly, there were announcements by several
hundred companies in which they said they would restate prior financial
statements so they would be in compliance. If having Lessees reporting
capital leases under certain circumstances is a good thing (and I don't
think the current rules are way too lenient) then US rules contributed to
better financial reporting. IFRS would never have been a factor, as the
principles permit Lessees to avoid capital lease reporting about 100% of the
time. (3).US auditing firms have a historical record of being wimps. Rarely,
if ever, capable of influencing companies Go toe the line until the arrival
of SOX, US corps have a track record of firing auditing firms and hiring a
less courageous firm willing to provide a more favorable audit opinion.
Against this context, expecting US auditing firms to enforce good intentions
of Principles without allowing legally accepted bright lines is simply pie
in the sky thinking. Moreover, US auditing firms had a long chapter in their
history when they included weighing the financial benefits of relaxed
oversight against the cost of adverse legal judgments from dissatisfied
investors. (4) US corporations expect very explicit rules that set the
bounds for proper behavior. We have a very litigious society here, with more
lawyers per capital than any other country. We have evolved to where the
only way to get certain behavior is to have very explicit rules. Otherwise,
lawyers can get anybody off.
In the US, having rules instead of principles
results in (1) widespread breaking of rules and (2) better overall behavior.
How can this be? We have laws setting speed limits on highways and streets.
Most citizens routinely choose to break the rules. If I'm driving on an
Interstate Highway and the speed limit is posted at 65, then I frequently
choose to drive at 68. I reason that the benefits exceed the costs. More
people choose to drive faster than me than choose to drive slower than me.
The average speed may very well be 73. Never-the-less, if we just had a
principle that people should drive at a safe rate of speed, then I'm pretty
sure that average speed would be very much higher and as a result there
would be many more disastrous highway crashes. If everybody would follow the
rules as written, then we could have higher speed limits.
Decision about selecting certain standard is a
joint decision among CFO, Board of Directors, Audit Committee (and may be
the auditor) where they collectively should be responsible - to some extent
this was attempted under SOX.
I don't think this is the case in the US. The
numbers that are reported in financial statements result from the decision
of the CEO. CFO's don't have all that much influence. In the US, CFO's don't
always have as much influence as they should have in terms of reporting
proper numbers. For example, the average tenure for CFOs is very short,
frequently measured in months instead of years. Second, CFOs can get fired
for many reasons. In the same way that US corporations have a history of
opinion shopping when they hire auditors, CEOs have a long history of
numbershopping when they hire CFOs.
Likewise, directors are nominated by the CEO
Effectively, in the US choice of accounting standards and the numbers
reported is really the responsibility of the CEO.
In arriving such decision they should consider
long-term reaction of the capital markets, if interested in going concern
and rewards for their stockholders.
Yes, the CEO is almost always driven by the stock
market reaction when choosing which numbers to report in the financials.
Missing the projected EPS always results in a stock price drop, so there is
intense pressure to report numbers that match the projections. Switching to
IFRS will not change this.
I think the argument has already shifted about
standards, from being an accounting thing to being a corporate governance
matter.
Perhaps in Europe, but not in the US.
In the US, the real issue is about getting
companies to follow the rules we have. Changing standards only means that
more time is to be wasted as companies and enforcers work toward a new
equilibrium of what is accepted. Ed Ketz has a really good commentary this
month about this.
Like Tom Selling, I believe that the information
desires of investors should be pre-eminent in terms of guiding the numbers
reported. Moving to IFRS is a disaster for them.
You begin by stating what “principles-based does
not mean,” but perhaps you could tell us what you think principles-based is
supposed to mean? I doubt if any two of us on this listserv could come to
precise agreement on that crucial point.
The point of my post was to predict that IFRIC 15
will be severely and systematically abused; and moreover, cynical me
suspects that is what the IFRIC intends. Time will tell which one of us
turns out to be right, but if IFRIC 15 were applied in the U.S., history
would be on my side.
As to what management – who accepts responsibility
for the financial statements -- “should” do, we know that especially with
the way that corporate governance works in the U.S., what they “should” do
according to your analysis is rarely what they actually do. In my
experience, managers – even the good ones – don’t care about accounting
principles. To be as kind as possible, they care about reporting the
earnings number that they think should be reported. Your statement that
“decision about selecting certain standard is a joint decision…” is merely
wishful thinking. Also, recall that IFRIC 15 states that the judgment
required is not a choice of accounting policy.
Finally, if by “honest” discussion you mean that my
contribution is anything less than that, then I most kindly suggest you
consider your words more carefully.
As someone who takes the AECM "digest" rather than
individual emails, I often feel I'm a bit behind the times in my response to
issues presented.
Bob Jensen copied from Tom Selling's Accounting
Onion regarding IFRS accounting for construction contracts. Given the
forthcoming SEC proposal to permit (require) US companies to adopt IFRS (for
some potentially as early as 2009), I suspect we will be debating IFRS
issues quite a bit.
Some full disclosure to put my comments in context:
I have been actively involved with the IASB and its predecessor since 1995.
I teach IFRS workshops for the Canadian Institute of Chartered Accountants
to help Canadians prepare for their conversion in 2011.
Next: I believe we need to separate the accounting
principles themselves from companies compliance. My comments are on the
standards, not on whether a particular company complies. Certainly, US
companies do not always compy with US GAAP...that's why there are securities
regulators.
Now for my comment on Tom's comment: I do not
believe that IFRS permits companies the latitute that Tom implies.
Construction contracts are within the scope of IAS 11, not IAS 18. This is
not a free choice. IAS 11 requires the use of the percentage of completion
method and prohibits the use of the completed contract method, regardless of
time period for construction. If a company cannot determine the percentage
of completion, the default is to the cost recovery method.
IFRS is not simply the "ten commandments" of
financial reporting. There is guidance and there are prohibitions and
requirements. There are excellent disclosures, not required by US GAAP.
That said, don't take my or anyone's word for IFRS
requirements. Academics can get on-line access to Standards,
Interpretations, Newsletters, etc. for 110 pounds. If you are a member of
the IAAER (www.iaaer.org), I believe you can get an even better deal. If the
US is really going to converge with IFRS by 2014, it's not too early to
learn the rules (oops, principles).
And, I haven't yet decided whether this is good
news or bad news for the US. There are lots of pros and lots of cons. We
don't need to search for cons that don't exist.
So much for my mini "rant".
I love this list.
Regards, Pat Walters
Fordham University
September 4, 2008 reply from Bob Jensen
Hi Pat,
Thanks for your
comments. I’ll let Tom make the first rebuttal on the construction contract
accounting. I might note that percentage-of-completion for services is
scoped into IAS 18 paragraphs 20-28 such that I think Tom still has a point.
However, I defer to his next reply.
The
more I get into IAS 39 I’m finding that, vis-à-vis FAS 133, IAS 39 just does
not provide the degree of guidance for helping preparers account for the
complex derivatives instruments contracts and hedging activities and
securitizations. IAS 39 along with IAS 32 are really going to be difficult
to integrate into new intermediate accounting textbooks for instructors in
the U.S. who’ve become accustomed to specificity and bright lines.
What I really do
not like about IASB standards in general is that they really lack extensive
illustrations provided by the FASB. I generally learn the most from
illustrations! Financial accounting textbook authors are going to have to
dream up a lot more illustrations for international standards. FAS 133 and
its ensuing amendments are replete with great starting illustrations. What I
really like to do is embellish these illustrations such as in the
(133ex01a.xls … 133ex10a.xls) Excel workbooks listed at
http://www.cs.trinity.edu/~rjensen/
IAS 39 just does not have the illustrations for me to build upon like I
utilized from FAS 133 and the DIG pronouncements.
I would like to
mention that the large accounting firms have supplied quite a lot of IFRS
helpers (including some illustrations) for AAA members in the Commons --- http://commons.aaahq.org/
Financial accounting faculty should perhaps begin to integrate some IFRS
material into courses.
The way members
can access these materials is to click on the menu choice Emerging Topics
and the IFRS.
I’ve been trying
to get the Commons to add new emerging topics, especially XBRL. Hopefully,
there will be other emerging topics as well.
I want to
encourage AECMers to make a visit to the commons daily or at least weekly.
The Commons is a bold and somewhat expensive service that is free to all
members. To make it worthwhile, we all need to pitch in to support our
Commons. At the moment it will house working papers and serve up short
videos among other things. It also a great free service for collaborative
papers, projects, and even alumni clubs for faculty who graduated from the
same doctoral programs.
I also might
mention that I really like the way IASB standards downloaded (for a fee)
into my computer and created a little button that’s always visible and
allows me into the IFRS and IAS database with one click of the button.
Searching the IASB standards is much, much easier than searching FASB
standards even when taking into account the FASB’s new Codification database
(free online but not downloadable in the same sense as the IASB database).
For example, it took me less than 30 seconds just now to get into the
percentage-of-completion content of IAS 18. Alas, there are not many
illustrations here for dummies like me. There are a lot of fuzzy words like
in Paragraphs 21 and 22:
21. The recognition of revenue by
reference to the stage of completion of a transaction is often referred to
as the percentage of completion method. Under this method, revenue is
recognised in the accounting periods in which the services are rendered. The
recognition of revenue on this basis provides useful information on the
extent of service activity and performance during a period. IAS 11 also
requires the recognition of revenue on this basis. The requirements of that
Standard are generally applicable to the recognition of revenue and the
associated expenses for a transaction involving the rendering of services.
What’s
“probable?”
When does “uncertainty arise?”
Doesn't this leave a lot of wiggle room for earnings management?
How about some illustrations and guidelines!
And I close with
my real worry about replacing the FASB with the IASB.
But the biggest problem of IFRS will be
correcting GAAP loopholes being used by U.S. companies. Back in 1993 when
the SEC Chairman said the three biggest problems in financial reporting were
“derivatives, derivatives, and derivatives,” he asked then FASB Chairman
Dennis Beresford to jump. Denny asked how high, and the result was actually
darned quick (FAS 119) and darned high with the FASB’s bright-lined FAS 133
and its ensuing amendments.
In the future, when an SEC Chairman asks the
Chair of the IASB to jump, the IASB Chair will have to get permission from
upwards of 100 nations before moving an inch. Correcting financial reporting
abuses will be like asking the U.N. to correct carbon emission abuses.
This does not mean FASB is better than the IASB. What
it means as FASB may be much quicker to make it harder for creative
accountants in the U.S.
Bob Jensen
Those of you who
would like to listen to Denny talk about the early history of FAS
133 while he was Chairman of the FASB may click on the following
links (turn your speakers on):
Audio 1 --- Dennis Beresford in
1994 in New York City
BERES01.mp3
Audio 2 --- Dennis Beresford in
1995 in Orlando
BERES02.mp3
These were recorded
by me at the annual American Accounting Association meetings when
Denny was presenting FASB updates at the time. The
“derivatives, derivatives, derivatives” remark can be found
in the Audio 1 tape.
If you are
interested in a lot of other audio (and some video) history of FAS
133 may want to listen to excerpts from speakers in some of my early
FAS 133 training workshops for accounting firms ---
http://www.cs.trinity.edu/~rjensen/000overview/mp3/133summ.htm
The are older media files captured before some FAS 133 amendments
such as the cross-currency amendments that came later in FAS 138.
Allow me to briefly describe to you my IFRS chops,
which I would like to quickly point out are probably less extensive than
yours. I started teaching IFRS about 10 years ago as a follow-on to work I
was doing in Europe on US GAAP and SEC reporting by Foreign Private Issuers.
My activities as a consultant on IFRS reporting have been somewhat limited,
but I estimate that I have taught one- and two-day IFRS courses (including
comparisons with US GAAP) about 30 times.
I would like to respond to two points that you made
in your e-mail. First, you stated:
“I believe we need to separate the accounting
principles themselves from companies compliance. My comments are on the
standards, not on whether a particular company complies. Certainly, US
companies do not always compy [sic] with US GAAP...that's why there are
securities regulators.”
Even if it were possible to separate accounting
standards from enforcement, I don't believe it would be in the public
interest in the US, as accounting standard setting has been inextricably
tied to enforcement. Nor, when you look at the securities laws, do I think
it ever was the intention to separate the two. The simplest example I can
think of is FAS 2 (R&D). It requires that all research and development be
expensed, because it was too costly, if not impossible, to enforce a
principled determination of which R&D expenditures should be capitalized,
and which should be expensed. That was 35 years ago, and little has changed;
if anything, the need for clear rules has become greater. (Of course, some
clear rules are manifestly silly, and were crafted to invite abuse; but
that's not what I'm talking about here. See for example the rules allowing
for deferral and amortization of actuarial gains and losses on pension
plans. As you know, IFRS also has this silly provision, albeit in a slightly
different form.)
Second, you stated:
“I do not believe that IFRS permits companies
the latitute [sic] that Tom implies. Construction contracts are within
the scope of IAS 11, not IAS 18. This is not a free choice. IAS 11
requires the use of the percentage of completion method and prohibits
the use of the completed contract method, regardless of time period for
construction. If a company cannot determine the percentage of
completion, the default is to the cost recovery method.
Perhaps I was not as clear as I could have been in
making my intended point, which is that the new IFRIC 15 allows, by virtue
of its fuzzy criteria, a somewhat free choice between IAS 11 and IAS 18 for
arrangements within the scope of IFRIC 15. If one chooses IAS 18 for such an
arrangement would, then the result obtained is similar, if not identical, to
the completed contract method. (Admittedly, I am throwing out this last
sentence without spending the time to take in in-depth look at IAS 18 today,
so I am making this statement based solely on my recollection. But, the main
point is that having a free choice between applying IAS 11 and IAS 18
provides issuer with a new opportunity to manipulate the timing of earnings
recognition that does not exist in US GAAP.)
Here is my 2 cents. I believe SEC is rushing to the
adoption of IFRS. I also believe that USA is different from all other
countries. USA is considered the only true capitalist country in the world
as fas as I know. The other countries are either social capitalist or
communists, or something in between. What may works for these other
countries may not necessarily work for USA. In a capitalistic country such
as USA, there are much more incentives to manipulate financial reporting
than in non-capitalistic countries. One of such incentives is the
compensation packages of the company's officers, which, in most cases, is
related to the bottom line of the income statements. I do not think anywhere
in the world the compensation packages of the officers for a public company
come close to those of USA.
Although corruption and fraud are universal, the
problem in USA is that many of the ordinary shareholders will be hurt by
manipulation of financial reporting. While I do not have data to support the
following proposition and someone from the list may provide such a data and
correct me on this, I do not thing any country in the world has as many
investors as USA in the stock market. That is, the amount of investments
made by the public in USA companies is much higher than investments made by
the public in each of the other countries (e.g., UK or Germany or France).
Therefore, to protect the public and reduce manipulation of financial
reporting, rule-bases principles seems to be a better choice for the USA.
Let me add an optimistic microview of accounting
standards and how they are a part of transparent financial reporting. I have
no confidence that I can influence the macroworld of accounting standards
(SEC / IFRS), but I have had evidence this week again of the influence of
accounting professors on improving financial reporting one company at a time
through our students.
In the graduate Accounting Research Methods class
students must complete an individual project on a research topic of their
choice, and I encourage students to select a topic that is an issue in their
own company. A student came up to me this week and told me that her company
is implementing her accounting research methods project on cooperative
marketing. The company was using inconsistent and inaccurate methods and
estimates, and she made a case based on accounting standards for
improvements including implementation procedures specific to her company. It
is not surprising to me that doing the financial reporting in line with GAAP
will also help them get accurate information to help them manage the
cooperative marketing.
I do not believe that most on-the-ground managers
are dishonest and want to take advantage of opportunities for self-dealing
via bad accounting. (And bad accounting usually just shuffles numbers
between periods "improving" numbers in one period at the expense of some
other period. The costs of bad accounting in decreased efficiency or
transaction costs to manipulate financial statements are usually real cash
outflows that can be demonstrated as well.) Her managers were persuaded.
There is a case for principled acccounting if someone makes the case for it,
and it is our students who are in the position to do so. My student isn't in
a position to be paid based on company stock or bonus tied to accounting
numbers, but she is getting a bonus and raise for the outcome of her
accounting research methods project.
I want to influence the accounting line workers who
are the ones who make the most difference in most companies by the
accounting work they produce. There are way more management accountants in
the world doing the accounting than there are auditors and executives
overseeing the accounting.
Barbara W. Scofield, PhD, CPA
Associate Professor of Accounting
University of Dallas scofield@gsm.udallas.edu
Preface: I think if I'm going to be able to
participate in the debate effectively, I'm going to need to move off the
"digest" version and into "real time" mode. I love this list!
Bob wrote:
Be
that as it may, the SEC held a gun to the IASB by saying that the SEC
would never recognize international standards until they developed a
standard on accounting for derivatives and hedging activities. Until
then the IASB really dragged its feet on this issue and waited until
2000 to issue a standard after FAS 119 and 133 pioneered the effort. The
SEC also held a gun to the FASB’s head on derivatives accounting, and
the FASB issued FAS 119 in 1994 six years before the IASB got its act
together.
The IASB's primary standard on derivative
accounting, IAS 39, Financial Instruments: Recognition & Measurement, is
fundamentally the work of the IASC (the predecessor body to the IASB). The
IASC consisted of approx 14 delegations representing the main constituencies
(auditors, preparers, analysts) with regulators thrown into the mix as
observers. There were approximately 90 people sitting around this table and
votes were by delegation. I had the privilege to be the technical advisor
to the anayst/investment association delegation from 1995 until the IASB
took over from the IASC in 2000. Therefore, the dynamics and politics of
this board were very different from that of the IASB today. In addition,
the IASC had other standards to finalize to meet the IOSCO agreement and it
only met 4 times per year. It's not surprising to me that it took the
longest to finalize financial instruments. Also, staff support at the IASC
could be counted on two hands during this time!
A standard on financial instruments was part of the IOSCO agreement with the
IASC. If the IASC created a "comprehensive body of high quality accounting
standards", IOSCO (not just the SEC) would consider recommending and its
member bodies permitting use of IAS/IFRS in cross-border listings. IOSCO
decisions must be unanimous.
Accounting for financial instruments was (in my view) the most difficult
standard for the IASC to finalize. It had at the time a project to require
full fair value accounting for all financial instruments (which would have
negated the need for most hedge accounting), but it became obvious that they
would not have the necessary votes for such a model so IAS 39 was designed
to take US GAAP and create a "principle-based" version in order to meet the
requirements of the IOSCO agreement . (I will be the first to admit this was
unsuccessful.)
In addition, the view expressed was that "no one would ever have to apply
IAS 39 because we would have completed the Fail Value project and have moved
on to a better standard." I also didn't believe that was going to happen.
Sometimes, I hate to be right.
I think it is important to distinguish between those standards issued by the
IASC (IAS) and those issued (or fundamentally changed) by the IASB (IFRS).
Yes, they are both
authoritative.
In my view, the IASB (together with the FASB) in their convergence projects
are working to improve both sets of standards. Neither is 100% successful
at this. Sometimes I believe the IASB gets it (more) right and sometimes
the FASB. Both are trying.
Regards,
Pat Walters
Fordham University
September 15, 2008 reply from Bob Jensen
Hi Pat,
Actually the
initial plan of the IASB was to pretty much adopt FAS 133 “word for word” as
IAS 39. My former doctoral student (I did not supervise his dissertation),
Paul Pacter, who had worked some on FAS 133 for the IASB was hired away by
the IASC to work on the new IAS 39. It soon became evident that, although
the SEC and IOSCO wanted a rigorous IAS 39. But it was soon discovered that
copying the rigorous FAS 133 as IAS 39 was not going to be viewed as
‘politically correct’ by other nations having a voice in the IASB. It would
look like the IASC was being too influenced by the United States.
Then Paul and
others commenced to write a new IAS 39, but they admittedly referred to the
new FAS 133 all the time while doing so. The IASC/IASB just didn’t and still
does not, have a sufficient research budget for such an extensive and
technical standard as IAS 39. The FASB has considerably more resources to
hire finance experts and to outsource many tough problems on derivatives to
investment bankers.
You can read
more about the history of IAS 39 (and the IOSCO Agreement) from Paul
Pacter’s presentation transcript in one of my 1998 FAS 133 workshops. At the
time of Paul’s 1998 presentation, IAS 39 was in the exposure draft stage as
the IASC’s ED 62 ---
http://faculty.trinity.edu/rjensen/acct5341/speakers/pacter.htm#003.03
The following
statement by Paul in that 1998 presentation is very revealing about the
development of IAS 39 and some other international standards:
Begin Quote
I became the project manager of that (IAS 39) project and tried to adopt the
FASB's various standards, before the new SFAS 133 standard, essentially word
for word.
I literally took the CD-ROM of all the FASB standards, EITF interpretations,
AICPA, SOP, blah, blah, blah. I lifted out all the standards, I put it in a
logical sequence, there are about seven or eight major American standards,
let alone all these others, there's a total of 180 pronouncements but we
only lifted out the major ones. And I presented to our Board in November a
three-hundred page document including the FASB's 162-B Exposure Draft that
became SFAS 133 in revised form. I included all that stuff on the
derivatives in hedging. And we gave the IASC Board this wheelbarrow full of
paper. And it to did not fly. Number one, The Board did not think it was
appropriate to adopt one nation's standard without more study..
Number two, there's some stuff in SFAS 133 and the other standards that we
just don't agree with. Number three, the IASC standards normally deal with
matters of principle. We don't offer 50 pages containing 25 examples of
embedded derivatives --- maybe we should because we're going to leave some
of our constituents a in the dark about this stuff.
The bottom line is that we're going to have our
principles, and we won't offer 50 pages of examples on hedge effectiveness.
We will, however, discuss what we mean by hedge effectiveness. So the Board
said for the reasons we want our own standards. And so we began working on a
separate standard and that led up to our Exposure Draft 62.
Paul Pacter
End Quote
http://faculty.trinity.edu/rjensen/acct5341/speakers/pacter.htm#003.03
Also because
many naïve accounting professors expound that it is not necessary to learn
FAS 133 or IAS 39 if fair value standards are adopted, I would like to focus
on the following quotation in your message Pat:
Begin Quote
In addition, the view expressed was that "no one would ever have to apply
IAS 39 because we would have completed the Fail Value project and have moved
on to a better standard." I also didn't believe that was going to happen.
Sometimes, I hate to be right.
Patricia Walters
End Quote
It’s true that
fair value accounting in some instances will by-pass FAS 133 and IAS 39, but
a huge proportion (actually I think over half) of the hedging activities in
practice entail using a derivative financial instrument to hedge an
unbooked hedged item
such as a forecasted purchase/sale hedged item, a forecasted
borrowing/loaning transaction, and a foreign currency risk at a forward
point in time. In these instances where the hedged item is not even booked
as an asset or liability, it is impossible to offset changes in booked
hedging values with changes in value of unbooked hedged items.
It is
inconceivable that forecasted transactions will ever be booked as assets or
liabilities even though they can be hedged for cash flow (or fair value if
the underlying is contracted). This would propel financial reporting
completely out of orbit into the galaxy of hypothetical transactions.
Furthermore the
most arcane parts of IAS 39 and FAS 133 are hedges of unbooked hedged items.
For example, when a company hedges an unbooked firm commitment to purchase a
million gallons of jet fuel at $4.48 per gallon a year from now, the firm
commitment hedged item, like other purchase contracts, cannot be booked.
It’s changes in fair value must, however, be factored into hedge
effectiveness testing and the booking of a really strange account called
“Firm Commitment” that has nothing to do with the booking of the hedged item
itself, Illustrations are provided at
http://faculty.trinity.edu/rjensen/CaseAmendment.htm
Hence it is very
misleading to imply to students that if fair value accounting is adopted for
financial and/or financial items that it is not necessary to learn the
technicalities of IAS 39 or FAS 133. This just isn’t the case even when fair
value accounting is applied to every financial and non-financial item. And I
most certainly hope and pray that fair value accounting will never be
adopted to that extent ---
http://faculty.trinity.edu/rjensen/theory01.htm#FairValue
There were and
still are differences between FAS 133 and IAS 39, although the differences
are rather minor in terms of “principles-based” standards. There are, of
course, many more bright lines, illustrations, and guidelines in FAS 133,
but most of those components fit into IAS 39 principles. Below is a short
module from a book that I am writing:
Definitions
of derivatives
IAS 39: Does
not define “net settlement” as being required to be scoped into IAS 39
as a derivative such as when interest rate swap payments and receipts
are not net settled into a single payment.
FAS 133: Net
settlement is an explicit requirement to be scoped into FAS 133 as a
derivative financial instrument.
Implications:
This is not a major difference since IAS 39 scoped out most of what is
not net settled such as Normal Purchases and Normal Sales (NPNS) and
other instances where physical delivery transpires in commodities rather
than cash settlements. Also IAS 39 applies net settlement as a criterion
in scoping a loan commitment into IAS 39. IAS 39 makes other concessions
to net settlement such as in deciding whether a "loan obligation" is a
derivative.[1]
Offsetting
amounts due from and owed to two different parties
IAS 39: Required if legal right of
set-off and intent to settle net.
FAS 133:
Prohibited.
Multiple
embedded derivatives in a single hybrid instrument
IAS 39: Sometimes accounted for as
separate derivative contracts.
FAS 133: Always combined into a
single hybrid instrument.
Implications:
FAS 133 does not allow hybrid instruments to be hedged items. This
restriction can be overcome in some instances by disaggregating for
implementation of IAS 39.
Subsequent
reversal of an impairment loss
IAS 39: Previous impairment losses
may be reversed under some circumstances.
FAS 133: Reversal is not allowed for
HTM and AFS securities.
Implications:
The is a less serious difference since Fair Value Options (FVOs) were
adopted by both the IASB and FASB. Companies can now avoid HTM and AFS
implications by adopting fair values under the FVO hedged instrument.
Derecognition of financial assets
IAS 39: It is possible, under
restrictive guidelines, to derecognise part of an a financial instrument
and no "isolation in bankruptcy" test is required.
FAS 133: Derecognise financial
instruments when transferor has surrendered control in part or in whole.
An isolation bankruptcy test is required.
Status: This
inconsistency in the two standards will probably be resolved in future
amendments.
Hedging
foreign currency risk in a held-to-maturity investment
IAS 39: Can qualify for hedge accounting for
FX risk but not cash flow or fair value risk.
FAS 133: Cannot
qualify for hedge accounting.
IAS 39
Hedging foreign currency risk in a firm commitment to acquire a business in
a business combination
IAS 39: Can qualify for hedge accounting.
FAS 133: Cannot
qualify for hedge accounting.
Assuming
perfect effectiveness of a hedge if critical terms match
IAS 39: Hedge effectiveness must
always be tested in order to qualify for hedge accounting.
FAS 133: The “Shortcut Method” is
allowed for interest rate swaps.
Implications:
This is an important difference that will probably become more political
due to pressures from international bankers.
Use of
"basis adjustment"
IAS 39: Fair value hedge: Basis is adjusted when the hedge expires or is
dedesignated. Cash flow hedge: Basis is adjusted when the hedge expires or is
dedesignated.
FAS 133: Fair value hedge: Basis is adjusted when the hedged item is sold
or otherwise utilized in operations such as using raw material in
production.[2] Cash flow hedge of a transaction resulting in an asset or liability:
OCI or other hedge accounting equity amount remains in equity and is
reclassified into earnings when the earnings cycle is completed such as
when inventory is sold rather than purchased or when inventory is used
in the production process.[3]
Implication:
This is am important difference that needs to be resolved. The FAS 133
approach, in our viewpoint, is unnecessarily complicated.
IAS 39
Macro hedging
IAS 39: Allows hedge accounting for
portfolios having assets and/or liabilities with different maturity
dates.
FAS 133: Hedge accounting treatment
is prohibited for portfolios that are not homogeneous in virtually all
major respects.
Implications:
This is pure theory pitched against practicality, politics, and how
industry hedges portfolios. It is a very sore point for companies having
lots and lots of items in portfolios that make it impractical to hedge
each item separately.
The most important differences may arise simply
because both IAS 39 and FAS 133 do not provide bright lines on how to
account for a particular financial contract or hedging contract. Financial
statements may then differ under the two standards because one company
reasoned one way under IAS 39, whereas a similar contract is accounted for
differently by a company that reasoned another way under FAS 133.
Similarly FAS 133 has many more bright lines and
other implementation guidance for many more types of derivative instruments
than does IAS 39. When faced with such circumstances, many companies under
IAS 39 will turn to FAS 133 for guidance. This lends some consistency when
for some contracts not mentioned in IAS 39 that are illustrated in IAS 39.
IAS 39 is a clear-cut example of where IFRS
standards tend to be “principles-based” whereas U.S. GAAP tends to be
“rules-based” with many more bright lines that reduce subjective judgment on
how to account for contracts. It’s outside the scope of this portfolio to
discuss the merits and drawbacks of each foundation upon which sets of
standards rest.[4]
Principles-based standards are a bit like common law where the courts make
laws more rules based as cases are decided over time. Similarly, standards
like IAS 39 become more like “rules-based” standards as accounting practice
becomes filled with illustrations of how thousands of types of derivatives
contracts are accounted for “by tradition” when bright lines are not spelled
out in the standards themselves. Already practice guidance databases such as
Comperio[5]
from PricewaterhouseCoopers are filling up with illustrations of how some
types of contracts have been accounted for that are not mentioned in IAS 39.
Of course in some instances FAS 133 is cited for further guidance.
Since IAS 39 is so much
less detailed than FAS 133, its implementation may vary widely in some
nations due to tradition and national laws that vary between nations. The
most obvious instance is where national laws carve out certain parts.
I do know Paul Pacter (although I did not know he
was one of your doctoral students) and that he was the staff person
responsible for drafting IAS 39. I was a member of the Financial Analyst
delegation on the IASC at the time IAS 39 was being developed. I agree that
the IASC wanted IAS 39 to be comparable to FAS 133. I also agree that that
would not have been approved by the members of the IASC board as it was
constituted at the time. In that respect, one could think of IAS 39 as the
first unsuccessful convergence project.
At the same time, Alex Millburn of the CICA staff,
was the chair of a task force (called the Joint Working Group) of
essentially the Anglo Saxon countries' standard setting bodies plus the IASC
whose task was to develop a full-fair value model for financial instruments.
In the background of the development of IAS 39, it was understood that a
full-fair value model was a non-starter at that time but those who favored a
fair value model believed that the JWG could accomplish its goal and a new
standard be passed by the IASB before the implementation date of IAS 39
arrived (which of course did not happen). The EU IAS-39 carve-out is
testament to difficulties the IASC (and subsequently the IASB) had in
gaining approvabl of IAS 39.
You are absolutely correct in that staff support at
the IASC was woefully inadequate. Paul would have been one of the few senior
accountants and, perhaps the only one with US GAAP experience. Each project
essentially had one person "supported" by a advisory committee of volunteers
from consituent delegations. It still is inadequate. Shifting the funding by
the PCAOB from the FASB to the IASB is an essential element of adoption of
IFRS by the US. The IASB has the same problems with funding as the FASB used
to have before SOX.
The principal goal of the IASC at the point that
IAS 39 was on its agenda was to meet its commitment under the IOSCO
agreement by the deadline. There was a great deal of political pressure to
get a standard on financial instruments in place. Hence, there were
unquestionably many compromises to get the necessary votes to accomplish
that.
Jensen Comment
I think Glen already mentioned the KPMG survey of professors. The SmartPros
article has a nice summary of outcomes. The bottom line is that accounting
instructors are pretty much going to avoid teaching IFRS until they can teach it
directly from textbooks and cases that others have written.
Why don't I find that surprising?
There's already a boatful of free IFRS material for intermediate accounting
lectures, test banks, etc. at the AAA Commons. Click on the menu choice Emerging
Topics and then IFRS ---
http://commons.aaahq.org
Here's the deal.
FASB Board member Tom Linsmeier predicts that IFRS will not take over
until his ten-year FASB term expires.
The average retirement age of accounting instructors is 63.6 years.
Jim Hasselback explains that well over half of accounting instructors at
all ranks are within ten years of the average age of retirement ---
http://www.jrhasselback.com/AtgDoctInfo.html
Conclusion: More than half of all U.S. accounting instructors
won't have to care didley about IFRS.
Don't you pity the young faculty in transition who learned the FASB rules and
are too young to make it to the finish line (meaning being eligible for Medicare
at Age 62) before IFRS rises up like the Great Wall? That's a bad analogy.
Actually the Great Wall is built out of hard rock. IFRS is principles-based. No
rocks in the IFRS wall. It's more of a wall of politically correct fog.
TOPICS: Accounting,
Financial Accounting, Financial Accounting Standards Board, GAAP,
Generally accepted accounting principles, International
Accounting Standards Board, SEC, Securities and Exchange
Commission
SUMMARY: This
opinion page piece begins with three jokes about accountants
that may be offensive to students, then commences the narrative
with the assertion that accountants may now "...deserve some
respect after all [because] accountants in the U.S. are signing
up for a fundamental rethinking of how they do their jobs
[and]...as a result, it should finally be possible for global
investing and trade to operate on a common understanding, or
accounting, of businesses." The piece goes on to emphasize that
IFRS are principles-based whereas U.S. GAAP is based on rules,
to argue that U.S. GAAP complexity often masks economic reality,
and that the relative size of the published volume of U.S. GAAP
rules is a "nine-inch, three volume set of pronouncements,
whereas IFRS is a slim two-inch book." Related articles from a
Lehigh faculty member, Jim Largay, and a member of the FASB's
Small Business Advisory Council broaden the perspective somewhat
and highlight the tax implication of IFRS precluding the use of
LIFO.
CLASSROOM
APPLICATION: Discussing the current state of transition to
IFRS, the notions of principles-based versus rules-based
standard setting, and the practical implications of this
significant change in U.S. reporting can be done in any
financial, international, or MBA accounting class.
QUESTIONS:
1. (Introductory) What was the recent SEC announcement
on change in accounting for U.S. publicly traded companies? Did
the SEC actually announce "...that the U.S. will abandon
Generally Accepted Accounting Principles" (GAAP) as promulgated
by the Financial Accounting Standards Board (FASB)?
2. (Introductory) Throughout this opinion page piece,
the author refers to U.S.-based accounting pronouncements as
GAAP and international standards as IFRS. Define the terms
generally accepted accounting principles (GAAP) and
international financial reporting standards (IFRS). Identify a
more appropriate term to describe U.S. promulgated financial
reporting standards to parallel the term IFRS.
3. (Advanced) Define the terms "principles-based" and
"rules-based" financial reporting standards. What is the
argument by Professor James Largay in the related article, about
the likely progress of IFRS in this fashion?
4. (Introductory) One related article is written by a
member of the FASB's Small Business Advisory Committee. Does the
SEC's planned acceptance of IFRS impact reporting by non-public
U.S. businesses? Support and explain your answer.
5. (Advanced) What is the problem with tax reporting,
as U.S. companies switch to IFRS? In the U.S. in general, must
tax accounting and financial statement reporting be done
similarly? Support and explain your answer.
6. (Advanced) Mr. Crovitz argues that the complexity of
U.S. GAAP reporting standards at times result in masking
economic reality. What are the objectives and qualitative
characteristics of financial reporting in relation to this
issue? How is it that U.S. financial reporting may stray from
these goals?
Reviewed By: Judy Beckman, University of Rhode Island
What's the definition of an accountant? Someone who
solves a problem you didn't know you had in a way you don't understand.
What's an auditor? Someone who arrives after the
battle and bayonets the wounded.
And drum roll, please: What are Generally Accepted
Accounting Principles? The difference between accounting theory and
practice.
No joke, accountants are the Rodney Dangerfields of
business. But perhaps they deserve some respect after all. Accountants in
the U.S. are signing up for a fundamental rethinking of how they do their
jobs. As a result, it should finally be possible for global investing and
trade to operate on a common understanding, or accounting, of businesses.
The Securities and Exchange Commission recently
announced that the U.S. will abandon Generally Accepted Accounting
Principles -- for almost 75 years, the bible for U.S. accountants -- joining
more than 100 countries around the world instead in using the London-based
International Financial Reporting Standards. Pointing to the "remarkably
quickening pace of acceptance of a true lingua franca for accounting," SEC
Chairman Chris Cox set out a timetable for all U.S. companies to drop GAAP
by 2016, with the largest companies switching as early as next year.
There are specific differences between the two
systems; for example, the international system only allows the first-in,
first-out inventory accounting system. The most important difference is that
the international standard is based on principles, whereas GAAP is based on
rules. GAAP suffers from the complexity of trying to set rules for all
situations, a complexity that often masks economic reality.
GAAP rules fill a nine-inch, three-volume set of
pronouncements plus interpretive information. In contrast, IFRS is a slim
two-inch book. GAAP was crafted in part by the pressures of the U.S. legal
system. Companies have been glad for GAAP rules as defenses for claims of
accounting irregularities. But these rules often only pretend to provide
clarity. There are hundreds of pages of GAAP covering how to account for
derivatives, but this didn't stop opaque pricing mismatches, which helped
create the credit crunch. GAAP rules allowed trillions of dollars in
securitized financial assets and liabilities to stay off the books of U.S.
financial firms, while the international standard, by focusing on the true
underlying economics, kept these on the books for firms based elsewhere.
It's surprising that there is no common language
for measuring the performance of companies. Until recently, all major
countries had their own accounting rules, but IFRS has become the approach
of choice. Inconsistent approaches to accounting make it hard to compare an
energy company based in Texas with one based in Amsterdam, a bank in New
York with one in London, or a biotech firm in Boston with one in Singapore.
A single set of accounting rules would mean more effective global disclosure
and transparency. It would reduce costs for multinationals that must now
prepare multiple books. It would also make U.S. exchanges more competitive
for listings by eliminating accounting differences.
A measure of the importance of a single standard is
the dislocation that getting there will cause. It will mean rewriting
business school texts and retraining of corporate finance departments. The
forensic accountants who sniff out problems will have to develop instincts
using a new set of measures. The transition will also be tough on investors.
Under the SEC proposal, larger companies in the same industry would switch
to the international standard before smaller companies do. Investors for the
transition period would have to compare similar companies using different
accounting.
The big U.S.-based accounting firms generally
support the abandonment of GAAP. Skeptics could call this switch in systems
the equivalent of the accountant full-employment act for many years, but the
profession itself also recognizes that GAAP often fails to reflect
underlying economics.
A PriceWaterhouseCoopers briefing document for
executives on the accounting change notes that changes will also be
necessary in the law. "If an accounting and reporting framework that relies
on professional judgment rather than detailed rules is to flourish in the
U.S., the legal and regulatory environment will need to evolve in ways that
remain to be seen." These include that "regulators will need to respect
well-reasoned professional judgments."
A system based on principles could create new
defenses for company boards and accountants who try to do the right thing,
if they fully disclose why they thought that a particular accounting
treatment made sense. The law will have to adjust to accept more ambiguity
in accounting, as a necessary condition for reporting with maximum accuracy.
As technology has shown in other areas of life,
agreed-upon standards and accepted operating systems drive usage and
efficiency. Common measures add value to information. If even the
belt-and-suspenders accounting profession is willing to take on the risks of
switching its basic system for assessing businesses, we're truly in an era
when anything that adds to understanding belongs in the asset column, while
anything that undermines transparency is a liability.
"Currency Translation Adjustments: Use Excel to understand how
multinational companies manage currency translation risks,"
by Susan M. Sorensen and Donald L. Kyle,
EXECUTIVE
SUMMARY
Accounting for
currency translation risks can be very
complex. This article addresses
only the basics and provides some tools to
help the reader understand the issues and
find resources.
Globalization
has changed the old accounting rule that
debits equal credits. Net income
became just one part of comprehensive
income, and the equity part of the
accounting equation became: Equity = Stock +
Other Comprehensive Income + Retained
Earnings. Other comprehensive income
contains items that do not flow through the
income statement. The currency translation
adjustment in other comprehensive income is
taken into income when a disposition occurs.
Accounting
risk may be hedged. One way that
companies may hedge their net investment in
a subsidiary is to take out a loan
denominated in the foreign currency. Some
firms experience natural hedging because of
the distribution of their foreign currency
denominated assets and liabilities. It is
possible for parent companies to hedge with
intercompany debt as long as the debt
qualifies under the hedging rules. Others
choose to enter into instruments such as
foreign exchange forward contracts, foreign
exchange option contracts and foreign
exchange swaps. Unfortunately, FX rate
changes cannot always be anticipated and
hedging has risks and costs.
Susan
M. Sorensen, CPA, Ph.D., has 30
years of public accounting experience and is
an assistant professor of accounting, and
Donald L. Kyle, CPA, Ph.D.,
is a professor of accounting, both at the
University of Houston–Clear Lake. Their
e-mail addresses are
sorensen@uhcl.edu
and
kyle@uhcl.edu,
respectively.
TOPICS: Accounting,
FASB, Financial Accounting, Financial Accounting Standards
Board, GAAP, Generally accepted accounting principles, SEC,
Securities and Exchange Commission
SUMMARY: On
Wednesday, the Securities and Exchange Commission (SEC) held a
roundtable, which began a process that could ultimately lead all
publicly listed American companies to follow IFRS instead of
U.S. GAAP as promulgated by the Financial Accounting Standards
Board (FASB). The process is planned in two steps: "The SEC's
proposal would allow some large multinational companies to
report earnings according to international accounting beginning
in 2010. The agency also laid out a road map by which all U.S.
companies would switch to IFRS beginning in 2014."
CLASSROOM
APPLICATION: Any financial reporting class in undergraduate
or graduate accounting or general business administration
programs may use this article to discuss globalize financial
reporting and investment market trends.
QUESTIONS:
1. (Introductory) Summarize the proposed change in
financial reporting standards discussed in an SEC roundtable on
Wednesday, August 27.
2. (Introductory) Who is criticizing the proposed
process for change to IFRS by U.S. companies? What are the
concerns?
3. (Advanced) "The U.S. accounting system is based on
detailed rules, while the international system expects companies
to follow broad principles." Give one example of a bright-line
rule in U.S. accounting standards that is set out in terms of
broad principles under IFRS.
4. (Advanced) Refer to your answer to question 3 above.
As a professional accountant, do you think that you would tend
to provide more flexibility under the U.S. or international
accounting standards to clients wanting to consider alternative
treatments in their financial statements? Support your answer.
5. (Advanced) The SEC is considering the funding source
for standards setter IASB, as part of its requirements for
moving to IFRS as the basis of accounting for U.S. companies.
What was the recent change in the source of funding for U.S.
standards setter FASB? Why does this issue impact acceptability
of the accounting standards themselves?
Reviewed By: Judy Beckman, University of Rhode Island
The Securities and Exchange Commission signaled the
demise of U.S. accounting standards, kicking off a process Wednesday that
could ultimately require all publicly listed American companies to follow an
international model instead.
Introduced in two steps, the shift could eventually
cut costs for companies and smooth cross-border investing. At the same time,
investors worry it will create confusion, especially during the transition.
Other critics worry that the international system offers too much wiggle
room for companies, compared with the more precise rules enshrined in U.S.
standards.
The SEC's proposal would allow some large
multinational companies to report earnings according to international
accounting beginning in 2010. The SEC estimates at least 110 U.S. companies
would qualify based on their market capitalization, among other factors. The
agency also laid out a road map by which all U.S. companies would switch to
International Financial Reporting Standards, or IFRS, beginning in 2014, at
the expense of U.S. Generally Accepted Accounting Principles, the guiding
light of accountants for decades.
The proposals will be open for public comment for
60 days and could be finalized later this year.
U.S. corporations gave the news a qualified
welcome. Margaret Smyth, controller at aerospace and building-services
conglomerate United Technologies Corp., said the possibility of having one
set of books around the world, though still years away, would result in
"tremendous savings." In the short term, Ms. Smyth said the shift would be
expensive and added that "there are some issues that still need to be worked
out," particularly in the realm of tax accounting.
The SEC says the change will help the U.S. to
compete globally because many other nations use the international standards
or plan to do so. Larger companies, especially those with overseas
subsidiaries, have urged the SEC to move in this direction. They hope a
single accounting standard will enable U.S. investors to more easily compare
a retailer in the U.S. with one in France, for example.
SEC Chairman Christopher Cox noted that 100
countries around the globe use IFRS and two-thirds of U.S. investors
currently own securities of foreign companies.
"The increasing world-wide acceptance and U.S.
investors' increasing ownership of foreign companies make it plain that if
we do nothing and simply let these trends develop, comparability and
transparency will decrease for U.S. investors and issuers," he said.
The proposal marks the capstone of Mr. Cox's push
as chairman to lower global barriers for U.S. investors. It also stems from
a concern, voiced more loudly before the credit crunch took hold, that Wall
Street was losing business to overseas competitors. In particular, some say
the New York Stock Exchange and other U.S. exchanges have been a less
attractive place for global companies to list their shares because of the
distinct U.S. accounting standards.
Mr. Cox will likely step down following the
November presidential election and the next administration could have
different priorities. But several observers say it's likely the shift to
IFRS will still occur.
Skeptics, even those who agree with the concept of
a common accounting language, called the SEC's approach wrongheaded. Barbara
Roper, director of investor protection at the Consumer Federation of
America, said allowing certain U.S. companies to switch ahead of others
would "shift the burden of the translation between the two accounting
languages onto investors."
When companies can choose which standard to use,
"there's every reason to believe...they'll choose the language that paints
their financials in the rosiest light," she added.
The U.S. accounting system, which is ingrained in
textbooks, business schools and company treasuries, is based on detailed
rules, while the international system expects companies to follow broad
principles. In practice, the systems differ on smaller matters, such as the
timing of when a company should note any change in the value of an
investment.
Under U.S. GAAP, for example, research and
development costs are generally treated as expenses when they occur. Under
the international standards, once a project gets to the development stage
the costs are spread out over time. GAAP also provides specific instructions
for industries such as oil and insurance. IFRS doesn't.
Higher Earnings
Jack Ciesielski, an accountant and publisher of the
Analyst's Accounting Observer, says accounting under IFRS tends to lead to
higher earnings. He examined filings from 137 foreign companies whose shares
traded in the U.S. in 2006. That was the final year that U.S. regulators
required these companies to translate their books into GAAP from IFRS. Mr.
Ciesielski says 63% of the companies reported higher earnings under the
international standard, and the median increase was 11.1%.
A move to international standards "will likely
inflate the earnings of U.S. companies and mislead investors," said Gregory
Pai of Paradigm Asset Management in White Plains, N.Y. On the plus side, he
noted, the convergence should eventually allow multinationals to save on
their accounting bills.
The SEC's road map requires the two bodies that
oversee U.S. and international accounting rules to narrow the differences.
Arnold Hanish, chief accounting officer of Eli
Lilly & Co., said he wouldn't recommend that the drug maker adopt the
international standards earlier, assuming it was eligible to do so.
"We wouldn't be ready," he said, since the company
estimates it will take two and a half years to make the shift, which he
called "a massive effort." A major issue that remains to be resolved, he
said, relates to how inventories will be treated for tax purposes.
Big U.S. accounting firms support the push to a
single world-wide rule book, and say the transition will take years. D.J.
Gannon, a partner with Deloitte & Touche LLP in Washington, figures most
U.S. companies aren't ready yet to switch to international accounting, and
probably need five to seven years to prepare. "Education and training is a
big issue," Mr. Gannon said.
Independent Source
The International Accounting Standards Board, the
London-based body that sets the international standards, is currently funded
by companies and auditing firms, while its U.S. counterpart, the Financial
Accounting Standards Board, is essentially funded with a tax on companies.
The SEC says finding a stable and independent source of funding for the IASB,
founded in 2001, is one of the conditions it has set for going ahead with
the switch. The SEC and other regulators have agreed to create a monitoring
body to fund and oversee IASB.
Under that structure, the SEC, which has sole
oversight over the U.S. board, would be one of seven regulators overseeing
the international board. Some companies, such as Microsoft Corp., say the
SEC should recognize that its role would be "different and less direct" as a
result. These companies urge the SEC to be cautious in writing its own
guidance and interpretations of international rules. Otherwise, they say,
several national interpretations of the same global rules may develop,
defeating the purpose of a single standard.
The SEC has been discussing a shift to a single
accounting standard for years. While some in the U.S. resisted eliminating
GAAP quickly, believing the divergence with the international standard was
too great, efforts accelerated as markets became more global and Europe
unified around IFRS. Last year, the SEC permitted foreign companies to file
U.S. financial statements using the international rules.
The SEC intends in 2011 to check progress on its
conditions, such as independent funding for the international standards
board. If it is satisfied, it would recommend starting the shift to the
international standards for all U.S.-listed companies in 2014. SEC
Commissioner Elisse Walter, a Democrat, called the plan momentous, but said
the U.S. should vote for the switch in 2011 "if and only if" the conditions
are met.
Notable Quotations About the SEC's New Proposals for Oil & Gas Accounting
I think I can always tell when the fix is in. First,
big lies are woven into a large dose of truth, so they won't look to be as big
as they are. There are certainly many things in the SEC's proposal to recommend
it, especially along the lines of expanding the types of reserves that would be
disclosed, and updating important definitions. Second, when the justification
for a proposal makes no sense, there can be no debate; you can't tell the
emperor he's naked. The lesson of the Cox's SEC is to never forget about the big
special interests that write big checks to the big politicians that made him
emperor for a day. Tom Selling, "SEC on Oil and Gas Disclosures: Current Prices Aren't
'Meaningful'?" The Accounting Onion, July 25, 2008 ---
http://accountingonion.typepad.com/theaccountingonion/2008/07/oil-and-gas-dis.html
"Last Ditch" Effort (before Bush leaves office) by SEC Chairman to
Force IFRS on the US as a Concession to Industry and Large Accounting Firms The sad think is that the FASB (under Bob Herz) and the SEC (under
Christopher Cox) applaud the move to UN-style accounting rule making
James D. Cox, a securities law expert at Duke Law
School who returned this week from teaching corporate law in Europe, said the
shift to international rules amounted to “outsourcing safety standards.” “We
would not for a moment tolerate having American auto safety standards set by
China or India,” he said. “Why should we do it for financial safety standards?
There has to be some accountability.”
See below
Charles Wankel (St Johns University) called my attention to this important
article
Federal officials say they are
preparing to propose a series of regulatory changes to enhance American
competitiveness overseas, attract foreign investment and give American
investors a broader selection of foreign stocks.
But critics say the changes appear to be a
last-ditch push by appointees of President Bush to dilute securities rules
passed after the collapse of Enron and other large companies — measures that
were meant to forestall accounting gimmicks and corrupt practices that led
to those corporate failures.
Legal experts, some regulators and Democratic
lawmakers are concerned that the changes would put American investors at the
mercy of overseas regulators who enforce weaker rules and may treat
investment losses as a low priority.
Foreign regulators are beyond the reach of
Congress, which oversees American securities regulation through confirmation
proceedings, enforcement hearings and approval of the Securities and
Exchange Commission’s budget.
The commission is preparing a timetable that will
permit American companies to shift to the international rules, which are set
by a foreign organization and give companies greater latitude in reporting
earnings. Companies that have used both domestic and overseas rules have, on
average, been able to report revenues and earnings that were 6 percent to 8
percent higher under the international standards, according to accounting
experts.
Though foreign accounting standards are stronger in
some ways than American accounting principles, they are weaker in some
important areas. They enable companies, for example, to provide fewer
details about mortgage-backed securities, derivatives and other financial
instruments at the center of today’s housing crisis and that have troubled
many Wall Street firms, including Bear Stearns.
The shift to international standards could also
wind up eliminating the conflict-of-interest rules, adopted after the
collapse of Arthur Andersen and Enron, that have limited auditors from
performing both accounting work and consulting for the same client.
James D. Cox, a securities law expert at Duke Law
School who returned this week from teaching corporate law in Europe, said
the shift to international rules amounted to “outsourcing safety standards.”
“We would not for a moment tolerate having American
auto safety standards set by China or India,” he said. “Why should we do it
for financial safety standards? There has to be some accountability.”
The S.E.C. also plans to announce details of a
pilot program that would enable foreign brokers to deal directly with
American investors, while continuing to be largely regulated by the foreign
country. The first country in the program will be Australia, although
officials hope to eventually include other countries. In a third move, the
Public Company Accounting Oversight Board, which works under the supervision
of the S.E.C., is preparing a rule that would allow it to defer to foreign
regulators for inspections of some of the 800 foreign auditors of overseas
companies that sell stock in the United States.
The oversight board was created by the
Sarbanes-Oxley law of 2002 in response to the accounting scandals at Enron
and other large companies. The law requires the board to inspect regularly
all accounting firms that certify the financial results of companies whose
shares are sold in the United States.
Officials say the proposed changes reflect the
decades-long push toward global markets. They say the changes are necessary
to attract capital from abroad and will protect Americans as they
increasingly look to invest overseas. In the decade ending last November,
American holdings of foreign stock increased to $4.3 trillion from $1.2
trillion.
“You are seeing a world now where everything is
mobile,” Ethiopis Tafara, director of international affairs at the S.E.C.,
said in an interview. “You have securities issuers that are mobile. Broker
dealers can provide services from anywhere. Exchanges are mobile, and
electronic trading platforms don’t need a physical location. You have
capital that is mobile, it travels almost anywhere around the world.”
“When you have everything that is mobile, the way
we think about our mandate — investor protection and enforcement — has to
take this into account,” Mr. Tafara said.
Mr. Tafara said that the mutual recognition
agreement with Australia would continue to protect American investors
because the S.E.C. would continue to have the authority to prosecute foreign
companies under antifraud provisions of the law for what he called “lying,
stealing and cheating.” The S.E.C. would continue to investigate accusations
of illegal insider trading, for example, an area where the commission has
been more vigorous than many foreign jurisdictions.
But the S.E.C. would not enforce many
investor-protection laws involving issues ranging from the quiet period
before a stock offering to market manipulation, financial disclosures and
abusive trading tactics. Nor would foreign officials apply a panoply of
American securities rules that are unique in that they are intended to
protect minority shareholders. Instead, the commission would rely on its
Australian counterpart to enforce its securities regulations, which often
involve different standards.
In a speech earlier this year,
Christopher Cox, the agency’s chairman, said that working on the transition
to international accounting standards and reaching enforcement agreements
with foreign countries like the Australians were two of the most important
items on his agenda as his term comes to a close.
Continued in article
Dimming of the Bright Lines: FAS 133 Déjà Vu
FAS 133 on accounting for derivative financial instruments and hedging
activities is unarguably the most complicated accounting standard ever produced
on the face of the earth. It is the only standard that required a long-term
implementation group to help companies and auditors implement the standard. But,
in fairness, it is complicated mostly because of the variety of complex
derivatives contracts invented in practice, including new contracts being
invented every day. FAS 133 was produced due to the immense derivatives
derivatives scandals that commenced in the 1980s ---
http://faculty.trinity.edu/rjensen/FraudRotten.htm#DerivativesFrauds
The FASB is considering amending FAS 133 after a string of such amendments as
FAS 137, 138, 140, 149, 155, and countless Derivative Implementation Group (DIG)
pronouncements ---
http://www.fasb.org/derivatives/
Exposure Draft No. 1590-100 is at
http://www.fasb.org/draft/ed_hedging_amendment_st133.pdf
The bottom line is that the proposed amendments simplify implementation of such
things as hedging ineffectiveness tests and benchmark hedging of interest rate
risk.
Simply preserving the capacity to
hedge benchmark interest rate changes, however, is not sufficient – at least
for fair value hedges. The elimination of the shortcut treatment is also
troublesome. The shortcut treatment obviates any concern having to do with
effectiveness and simply adjusts the carrying value of the hedged item in
such a way as to foster the all-in interest expenses or revenues to conform
to the economic objectives of the hedge – i.e., a result that is entirely
consistent with the goal of swapping from fixed to floating interest rates.
Without shortcut, firms have tied themselves in knots trying to demonstrate
something to be true that isn’t – that the swap’s result could be expected
to offset the fair value change of the debt do to the risk being hedged.
Never have; never will. By eliminating the shortcut option, the proposed
amendment really exacerbates an unworkable situation.
There really is an easy fix for this
problem. In the classical application of interest rate swaps, when entities
use swaps to convert fixed rate debt to floating, their objective relates to
prospective cash flows. They care nothing about offsetting fair values. As a
consequence, the problem would be solved if the FASB permitted
all
interest rate hedges that relate to future
cash flows – whether fixed or floating -- to be accounted for as cash flow
hedges, with (effective) gains or losses being recognized in OCI and later
reclassified to earnings.
At present,
this course of action is not allowed because a prerequisite for cash flow
hedging is that the forecasted cash flow designated as the hedged item must
be uncertain. That requirement, however, could be (and should be)
eliminated. If the economic objective of the hedge is to alter future cash
flows, entities should be able to say so and apply an accounting treatment
consistent with this view. That would be cash flow hedging. Fair value
hedging should be limited to those applications when the economic objective
is to compensate for changes in fair value of the hedged item -- for real!
With the requirement to apply fair value hedges to
all
circumstances when fixed
rate instruments serve as the hedge item, FAS 133 has taken the round peg
and crammed it into a square hole.
Impacts on Risk Management Practice
The seeming allowance to designate
benchmark interest rate changes as the risk being hedged for a company’s own
debt when hedged from inception is not nearly as generous as it might seem.
Obviously, if nothing changes, the companies that rely on thisallowance will
largely feel like the amendment didn’t change anything. But stuff happens.
For instance, the company might find it advantageous to restructure its
debt. Doing so, however, would likely force the company to forego
designating the benchmark rate as the risk being hedged.
4
I believe this
restriction will likely cause managers to ignore available market
efficiencies in order to preserve their original accounting treatment. In
the aggregate, this effect could be quite costly.
The need for flexibility is equally
relevant in connection with the consideration of terminating hedges. The
proposed amendment allows firms either to exit from a derivative or to
de-designate the hedge relationship leaving the derivative in place provided
an offsetting derivative is initiated coincidently with the de-designation.
(Does this second derivative have to be a perfect mirror image of the first?
The proposal doesn’t specify.) However, if the second approach is taken
(which would likely be an attractive course of action if the original
contract were a large liability, thereby requiring a large cash payment to
exit), the new rules would preclude using the original derivative in any
subsequent hedging relationship if hedging were again deemed to be
desirable. It’s the same economics to terminate a derivative or to cover it.
I believe the accounting should respect this equivalence. Again, these new
rules would likely bias economic decisions to the detriment of market
efficiency.
Software / Programming Implications
One other significant change under the
amendment has to do with the process of determining the split between other
comprehensive income (OCI) and earnings for hedge results that have some
aren’t perfect. It’s convenient to address this issue with reference to a
hypothetical derivative – i.e., a derivative that delivers exactly the gain
or loss required to offset the risk being hedged. Currently, the process is
asymmetric. That is, ineffective results impact earnings only if the actual
derivative’s gain or loss is larger that the hypothetical derivative’s gain
or loss. Under the new approach, ineffectiveness will impact earnings in
both directions. Put another way, the OCI allocation will be
determined solely on the basis of the
hypothetical’s result, and the earnings impact will
reflect any difference between actual
results and hypothetical results, regardless of which is the larger.
Whether this adjustment is an
improvement or not is subject to debate. Arguments can be made for both
approaches. In any case, a change will necessitate reprogramming spread
sheets and/or FAS 133 accounting software, across the board. Significant
costs; questionable benefits.
"Reasonably Effective"
Threshold Although we agree with the Board that the establishment of a
quantitative threshold or bright-line is inappropriate for determining hedge
effectiveness, we are concerned with the introduction of the "reasonably
effective" threshold. The Exposure Draft does not define this term, nor
provide much guidance on how it should be applied. In addition, paragraph A9
of the Exposure Draft notes that the determination of "reasonably effective"
would depend on facts and circumstances and may be different depending on
the objective, such as whether the fair value option is available for the
hedged item. However, it is unclear why the effectiveness of a hedging
relationship should be higher or lower depending on the availability of the
fair value option. We are also concerned that in the absence of a better
understanding of the Board's intent, practice will inevitably try to
establish a bright line for assessing hedge effectiveness. As an alternative
to establishing a threshold that might be misinterpreted as a new bright
line, we believe the Board should provide a discussion of the factors to be
considered in determining whether there is an adequate economic relationship
between the hedged item and the hedging instrument that achieves the risk
management strategy.
Jensen Comments
I tend to be a bright line proponent. Doing away with bright lines in FAS 133
may create more problems than its worth, especially with respect to comparing
how any two companies treat identical transactions and events.
The Fairy Tale of 'True and Fair View' and a Modest Proposal for Real
'Core Principles',
The elusiveness of a meaning for 'true and fair' in
an accounting context stems from a lack of meaning for that quintessentially
British phrase in a capital markets context. Financial reporting is about
producing information: is it possible that truth telling could not result in
fair reporting? Answer: no way. Therefore, 'and fair' adds nothing whatsoever;
and besides, everyone learns in Accounting 101 that accrual accounting and
'truth' don't mix anyway. The point is that cunning Tweedie, like Soc Gen and
its auditors, can construe 'true and fair' to mean anything and at any time.
Just like the emperor in the cautionary fairy tale, IFRS wears no clothes; his
royal highness and subjects are deceived by the Tweedie tailor (pun intended) to
disbelieve their eyes, and to behave as if IFRS is adorned with some noble
British bromide.
Tom Selling, "The Fairy Tale of 'True and Fair View' and a Modest Proposal for
Real 'Core Principles'," The Accounting Onion, July 10, 2008 ---
http://accountingonion.typepad.com/theaccountingonion/2008/07/the-core-prin-1.html
More on how to lie with statistics
It brings to mind the joke about Bill Gates walking
into a bar and suddenly everyone in the room becomes a millionaire.
Statistically, by averaging the incomes in the room, the statement is true.
Zachary Karabell (see below)
Once upon a time, and for most of the 20th century,
there was. The data that we use today is a product of the nation-state, and
was created in order to give government the tools to gauge the health of the
nation. The Bureau of Labor Statistics, which measures the unemployment rate
and inflation, was created around the turn of the 20th century, and for much
of that century the U.S. was a cohesive unit. It was its own most important
market, its own source of consumption, and its own source of credit.
Big-picture statistics form the basis of almost
every discussion about "the economy." But these statistics are averages
reporting one blended number that is treated as if it applies to all 300
million Americans. It brings to mind the joke about Bill Gates walking into
a bar and suddenly everyone in the room becomes a millionaire.
Statistically, by averaging the incomes in the room, the statement is true.
Macro data and big-picture statistics like GDP
growth, the unemployment rate and consumer spending are all large averages.
The fact that the economy is growing or contracting by 1% or 2% is taken as
a proxy not just for the economic health of the nation, but for the economic
health of the bulk of its citizens. The same goes for consumer spending. If
it goes up or down 2%, that is taken as representative not just of the
statistical fiction called "the American consumer" but as indicative of the
behavior and attitudes of U.S. consumers writ large.
To begin with, someone in the upper-income brackets
is living a different life than those in the lower-income brackets. The top
20% of income earners spend more than the lower 60% combined. The wealthiest
400 people have more than $1 trillion in net worth, which exceeds the
discretionary spending of the entire federal government. These groups are
all American, yet it would be stretching the facts to the breaking point to
assert that they share an economic reality. On the upper end, the soaring
price of food and fuel hardly matter; on the other end, they matter above
all else. The upper end does matter quantitatively, but the group of people
on the lower end is vastly larger and therefore has more resonance in our
public and electoral debate.
Look at housing, widely regarded as a national
calamity. The regional variations depict something different. In Stockton,
Calif., one in 75 households are in foreclosure; in Nebraska, the figure is
one in every 1,459; and the greater Omaha area is thriving. Similar
contrasts could be made between Houston and Tampa, or between Las Vegas and
Manhattan. Home prices have plunged in certain regions such as Miami-Dade,
and stayed stable in others such as San Francisco and Silicon Valley.
Houston, bolstered by soaring oil prices, has a 3.9% unemployment rate; the
rate in Detroit, depressed by a collapsing U.S. auto industry, is 6.9%. The
notion that these disparate areas share a common housing malaise or similar
employment challenges is a fiction.
We hear continual stories of the subprime economy
and its fallout on Main Street and Wall Street. All true. Yet there is also
an iPhone economy and a Blackberry economy. Ten million iPhones were sold
last year at up to $499 a pop, and estimates are for 20 million iPhones sold
this year, many at $199 each. That's billions of dollars worth of iPhones.
Add in the sales of millions of Blackberrys, GPS devices, game consoles and
so on, and you get tens of billions more.
The economy that supports the purchases of these
electronic devices is by and large not the same economy that is seeing
rampant foreclosures. The economy of the central valley of California is not
the same economy of Silicon Valley, any more than the economy of Buffalo is
the same as the economy of greater New York City. Yet in our national
discussion, it is as if those utterly crucial distinctions simply don't
exist. Corn-producing states are doing just fine; car-producing states
aren't.
The notion that the U.S. can be viewed as one
national economy makes increasingly less sense. More than half the profits
of the S&P 500 companies last year came from outside the country, yet in
indirect ways those profits did add to the economic growth in the U.S. None
of that was captured in our economic statistics, because the way we collect
data – sophisticated as it is – has not caught up to the complicated web of
capital flows and reimportation of goods by U.S.-listed entities for sale
here.
These issues are not confined to the U.S. Every
country is responsible for its own national data, and every country is
falling victim to a similar fallacy that its national data represent
something meaningful called "the economy."
In truth, what used to be "the economy" is just one
part of a global chess board, and the data we have is incomplete,
misleading, and simultaneously right and wrong. It is right given what it
measures, and wrong given what most people conclude on the basis of it.
The world is composed of hundreds of economies that
interact with one another in unpredictable and unexpected ways. We cling to
the notion of one economy because it creates an illusion of shared
experiences. As comforting as that illusion is, it will not restore a
simplicity that no longer exists, and clinging to it will not lead to viable
solutions for pressing problems.
So let's welcome this new world and discard
familiar guideposts, inadequate data and outmoded frameworks. That may be
unsettling, but it is a better foundation for wise analysis and sound
solutions than clinging to a myth.
The nation’s jobless rate has declined to its
lowest level in three years, a fact that has left Jamie Bean, an unemployed
air-conditioner repairman, feeling more left out than ever.
Bean, 36, lost his job in December. Now he is
scrambling to keep up with child-support payments to his wife, who is also
unemployed. “As it stands now, I can’t afford to get divorced,” he said,
managing a wry smile.
Bean’s
predicament is not unlike that of many people who have a high school
education or less. Not only were they hit especially hard by the
recession but they have continued losing ground in the recovery that has
followed.
By
disproportionate numbers, these Americans have given up looking for
work, making the nation’s recovery appear better than it is. If the
unemployment rate counted the 2.8 million people who want jobs but have
stopped looking, it would sit at 9.9 percent rather than its current
8.3 percent.
These would-be workers
are falling behind as other people are gaining momentum, economists say.
Employment prospects are modestly improving for college graduates, for
instance, but dimming for those who have a high school diploma or less.
The number of
Americans facing this predicament isn’t small. Nearly a third of the
nation’s labor market has only a high school diploma. And more than one
in 10 of these workers lost their jobs between late 2007 and early 2011,
according to the
Urban Institute, a nonpartisan think tank.
About a third of those job losses occurred since the recovery began in
mid-2009.
The news is worse for
high school dropouts. One in five of them have lost their jobs since
2007, with about half of those losses occurring after the recession
ended, the Urban Institute said. Overall, the unemployment rate for high
school dropouts was 13.1 percent last month.
The recovery, economists
say, has highlighted the consequences of not earning a college degree.
“There has been a
considerable difference in who is getting those jobs,” said Pamela J.
Loprest, director of the Urban Institute’s Income and Benefits Policy
Center. She added that recent improvements in the jobless rate have not
significantly lifted the burden on less-educated workers.
“Lower-educated workers got hit harder. And the recovery has been uneven
in that it has most benefited those with more skills.”
President Obama hailed
the Labor Department’s most recent report that the nation’s unemployment
rate had ticked down for the fifth consecutive month as evidence of an
accelerating recovery.
Although the latest jobs
report showed broad-based gains, the nation has a long way to go to make
up for the positions lost during the recession — especially in some
traditionally blue-collar occupations that were decimated by the
recession.
Manufacturers, led
by the auto industry, created 50,000 jobs in January and have added more
than 300,000 positions in the past two years. But those gains pale in
comparison with the
2 million manufacturing jobs that were lost
during the recession. Similarly, construction jobs have grown in recent
months, but not nearly enough to offset the
1.5 million that were lost
in the recession.
Jensen Comment
Sadly, the same thing is happening with the state of financial reporting of
global companies. The once tough minded FASB (leases, pensions, pooling,
post-retirement benefits, stock options, derivatives, etc.) is caving in to
globalization of accounting standards that is analogous to turning over law
making to the United Nations. The goal is to "welcome this new world and discard
familiar guideposts (read that bright lines in accounting standards), inadequate
data and outmoded frameworks."
Perhaps I'm a luddite, but I do not think IASB's so-called principles-based
standards provide "a better foundation for wise analysis and sound solutions
than clinging to myth." All these principle-based standards are going to do is
make it harder to pin down CEO crooks and incompetent auditors in court.
"Accounting rule-makers putting markets at risk," by Michael Starkie,
Financial Times,.June 12 2008 ---
Click Here
Sir, Whither accounting?
I write this letter in a personal capacity. My
qualifications for expressing these opinions are that I have been chief
accountant at BP for the past 14 years and have been for some years chairman
of the UK's CBI Financial Reporting Panel and a member of the European
Financial Reporting Advisory Group Technical Expert Group.
Recent years have seen major changes in the
topography of accounting standards; acceptance by the European Union
(subject to endorsement) of International Financial Reporting Standards and
by other countries also, and the decline in the influence of US generally
accepted accounting principles as the US capital markets have become
relatively less attractive.
What a wasted opportunity, then, that the current
body of IFRS is so unhelpful for the markets when the accounting world was
given this historic opportunity to create something that should have been
both useful for markets and with the potential to be welcomed globally. I
recall a year or two ago that the heads of leading accounting firms said
that current international financial reporting was broken. But nothing has
been done about this.
And the future looks even bleaker. The
International Accounting Standards Board continues to develop an accounting
model about which users of financial information have grave misgivings.
Probably the most disturbing example is the use of predominantly
mark-to-model exit values in the balance sheet, which cannot be relevant for
a market trying to assess the economic performance and position of companies
that have the intention of continuing to operate as going concerns. In the
interests of brevity I will not list other examples though there are enough
voices of protest being raised by those in the financial world to make it
apparent that all is far from well.
How have things come to this pass? I have
concluded, albeit with regret, that the fundamental problem is the members
of the IASB. Collectively as board members they do not have the experience
and wisdom to produce and maintain accounting standards that are useful for
the capital markets and the wider economy. And some of the board members are
clearly committed to an extreme view of recognition and measurement which
will severely damage the operation of markets and ultimately economies.
Recent appointments to the board are too little and too late to change the
overall thrust.
Continued in article
Andersen's demise didn't solve the broader problem of the cozy collaboration
between auditors and their corporate clients. "This is day-to-day business in
accounting firms and on Wall Street," says former SEC Chief Accountant Lynn
Turner. "There is nothing extraordinary, nothing unusual, with respect to
Enron." Will Congress and the SEC do what's needed to restore trust in the
system?
See "More Enrons Ahead" video in the list of Frontline (from PBS) videos on
accounting and finance regulation and scandals ---
http://www.pbs.org/wgbh/pages/frontline/shows/regulation/view/
Accounting Educators should pay more attention to the following blog that
seeks out weaknesses in company filings of 10Q (and other reports) with the SEC
Investors often overlook SEC filings, and it is the
job of the 10Q Detective to dig through businesses’ 8-K and 10-Q SEC
filings, looking for financial statement ‘soft spots,' (depreciation
policies, warranty reserves, and restructuring charges, etc.) that may
materially impact Quality of Earnings
Accounting
Golden Fleece Quotations (read that bull crap)
I want to conclude by explaining what I mean by
"truly believe." I'm just a politician ... whoops, I mean lawyer ... who really
doesn't know much about what all you CFOs have to go through to make your
numbers. Frankly, the details of the differences between IFRS and U.S. GAAP
don't concern me much. I just threw in "truly" to impress upon you that I am on
your side -- kind of like "no kidding," or "I swear." In other words, even
though I don’t have a single good answer to any of the questions I have raised
today, don’t worry, because we're going through with this anyway. I truly
believe that If IFRS is good for you, it's good for the SEC; and it must be good
for everyone. John White, Director of the SEC’s Division of Corporation Finance, as
quoted by Tom Selling in The Accounting Onion, June 9, 2008 ---
http://accountingonion.typepad.com/theaccountingonion/2008/06/accounting-convergence-decoding-john-whites-speech.html
Big Four accounting firm Deloitte & Touche has formed a consortium to
accelerate integration of International Financial Reporting Standards (IFRS)
into college curricula.
Through the
IFRS University Consortium, Deloitte is
contributing resources to Ohio State and Virginia Tech universities
to assist the schools in developing IFRS curricula. The
contributions to Ohio State and Virginia Tech include drafting
course materials such as classroom guides and case studies and
providing Deloitte professionals as lecturers. The classroom guides
and course materials will be made available to other interested
universities.
The
announcement was made at the Deloitte/Federation of Schools of
Accountancy (FSA) Faculty Consortium meeting in Chicago, a
curriculum development program for accounting educators that is
sponsored annually by the Deloitte Foundation, the not-for-profit
arm of Deloitte LLP.
Participating schools can benefit by having input in the direction,
goals and resources available from the consortium; participation in
periodic webcasts; sharing of best practices used in the classroom;
involvement in the development of materials; and access to the
support and guidance from Deloitte professionals, as well as to
Deloitte IFRS information resources, publications and training
sessions.
There
is no cost for institutions to join the Deloitte IFRS University
Consortium.
FINANCIAL REPORTING PORTAL
www.financialexecutives.org/blog
Find news highlights from the SEC, FASB and the
International Accounting Standards Board on this
financial reporting blog from Financial Executives
International. The site, updated daily, compiles
regulatory news, rulings and statements, comment letters
on standards, and hot topics from the Web’s largest
business and accounting publications and organizations.
Look for continuing coverage of SOX requirements, fair
value reporting and the Alternative Minimum Tax, plus
emerging issues such as the subprime mortgage crisis,
international convergence, and rules for tax return
preparers.
Alternative (conventional accounting) rules may, for
the individual citizen, mean the difference between employment and unemployment,
reliable products and dangerous ones, enriching experiences and oppressive ones,
stimulating work environments and dehumanising ones, care and compassion for the
old and sick versus intolerance and resentment.
Tony Tinker, 1985
Financial Reporting should provide information that
is useful to present and potential investors and creditors and other users in
making rational investment, credit and similar decisions ...(through the
provision of information that will help them to assess)..... the amount, timing
and uncertainty of net cash inflows to the related enterprise
FASB Concept Number 1 of the Conceptual Framework, 1978
The
SEC has been one of the most prominent
and well-respected of federal agencies
during most of its history. Strict
adherence to a focused mission on
disclosure in regards to the regulation
of financial reporting by public
companies has been its trademark.
Having said that, however, the SEC has
been far from pristine in implementing a
disclosure-only policy. Certain actions
could be characterized by some as a form
of “merit regulation”—some companies may
have been unfairly subject to undue
scrutiny, and others may have received
an undeserved pass. The SEC has also
used its broad powers to make rules
requiring added disclosures in some
circumstances, and allowing abbreviated
disclosures in others. For example, the
SEC has added disclosure requirements to
the offering documents of “blank check”
companies, and also provided disclosure
accommodations to smaller and foreign
companies.
But, if some were to criticize the SEC
for merit regulation, cavils of this
sort are on the fringes of SEC
activity. And, most important to the
criticisms I'm fixin' to deliver, they
all relate to the regulatory activities
concerning disclosures by
companies to the SEC. But now, an SEC
official -- the chair, no less -- has
seen fit to make gratuitous disclosures
for certain
public companies.
Here's the situation. Last Tuesday
(March 11, 2008), SEC Chair Christopher
Cox made the following statement to
reporters: "We have a good deal of
comfort about the capital cushions that
these firms [the five largest investment
banks, which included Bear Stearns] have
been on." (http://www.cnbc.com/id/23576630)
At the time,
Bear's stock was at $60, a five-year
low, and just the day before, Bear
issued a press release denying rumors of
liquidity problems. The stock tumbled
to $30 early Friday, and over the
weekend, JP Morgan struck a deal to buy
Bear Stearns for a paltry $2 per share.
(For reasons I don't want to cover here,
the current market price as I write this
is around $5 per share.)
It's a serious thing that investors may
have relied on false and misleading
information issued by
Bear Stearns, but it is quite another
for the SEC to have issued information
for Bear
Stearns. (I am trying to making a
principled statement here, so that fact
that investors who relied on that
information got taken to the cleaners is
notable, though not the sole basis of my
critique.) Heretofore, a company either
complies with the disclosure rules, or
it doesn’t; the SEC doesn’t make
congratulatory announcements for
companies it finds to have been
exemplary compliers, disclosers, or what
have you. But if you fail to comply,
then that’s when the SEC will tell the
world about you; there are thousands of
examples of the consistent
implementation of this policy.
I imagine that Cox would defend himself
on the basis that the SEC is in a
curious position with respect to
companies like Bear Stearns. One of the
many jobs given to the SEC by Congress
is to monitor the “capital adequacy” of
broker-dealers. The objective is to
provide a form of protection for the
assets of clients who have deposited
cash and securities with
broker-dealers. Thus, the SEC is
serving two masters, having very
different interests in Bear Stearns:
clients and shareholders.
When Cox chose to speak about Bear
Stearns last Tuesday, both groups of
Bear Stearns stakeholders were
listening, and at least some in each
group responded with diametrically
opposite courses of action:
• Some clients of Bear may have
been calmed, but too many disregarded
Cox’s assurances, took their money and
ran;
•
Some investors on the verge of selling
their shares had a change of mind -- and
some may have even bought stock based on
his assurances.
Cox should have known that he was
unavoidably sending a signal of
encouragement to jittery investors who
were trying to decide whether or not to
buy, hold, or sell shares of Bear
Stearns. If SEC history is any guide,
it was simply not appropriate for him to
have done so. Just as a real estate
agent cannot claim to represent parties
on both sides of a transaction, the SEC
cannot claim to be "the investor's
advocate" at the same moment they are
functioning as the public relations
spokesperson for the investee. It would
have been far better to have left the
public relations role to other
government officials.
The question of how much SEC credibility
has been lost is difficult for me to
judge. Assuming this were an isolated
instance, it would be significant. But
seen as the latest in a series of
questionable actions reflecting the
SEC's stance on investor protection, the
Bear Stearns case is just more
confirming evidence of an altered SEC
culture. I am sad to say that the
process of restoring credibility to a
once peerless agency cannot begin until
there is a new chair.
The Financial Accounting Standards Board on
Friday issued FASB Statement No. 162, The Hierarchy of Generally Accepted
Accounting Principles.
The new standard is intended to improve financial
reporting by identifying a consistent framework, or hierarchy, for selecting
accounting principles to be used in preparing financial statements that are
presented in conformity with U.S. generally accepted accounting principles
for nongovernmental entities.
Prior to the issuance of Statement 162, GAAP
hierarchy was defined in the American Institute of Certified Public
Accountants Statement on Auditing Standards (SAS) No. 69, The Meaning of
Present Fairly in Conformity With Generally Accepted Accounting Principles.
SAS 69 has been criticized because it is directed
to the auditor rather than the entity. Statement 162 addresses these issues
by establishing that the GAAP hierarchy should be directed to entities
because it is the entity (not its auditor) that is responsible for selecting
accounting principles for financial statements that are presented in
conformity with GAAP.
Statement 162 is effective 60 days following the
SEC's approval of the Public Company Accounting Oversight Board Auditing
amendments to AU Section 411, The Meaning of Present Fairly in Conformity
with Generally Accepted Accounting Principles. It is only effective for
nongovernmental entities; therefore, the GAAP hierarchy will remain in SAS
69 for state and local governmental entities and federal governmental
entities.
For those of you who are interested in such things,
there has been a significant change in the wording of IAS32 (para 18b).
Previously, the standard was interpreted to require all managed or mutual
funds to display sums due to unitholders as liabilities. The standard was
not as rigid as was supposed as it used the expression ‘may’ not ‘must’ (see
below). Nonetheless most of the managed funds in my part of the world
(Australia & NZ) rushed, lemming like, headlong into creating that
accounting anomaly, the ’equityless’ entity.
It didn’t seem to matter to them that an entity
without equity is utterly inconsistent with the concepts set out in the
Framework (the IASB version of the conceptual framework) in that the notions
of revenue, expense and income pivot on the existence of equity. Without
equity there can be no income. Without income there can be no complete set
of financial statements as required by IAS1. Notwithstanding this
irregularity, the IASB saw fit to include an example in the Appendices to
IAS32 which specifically provided an example of an ‘equityless’ entity.
Now there is a elaborate variation in the
definitions in IAS32 which carefully carves out entities such as managed
funds and co-operative companies so that a residual, subordinate interest
assumes its rightful place as equity.
But it was never necessary. Consider this little
example. If the reader were to follow this link http://www.mfsgroup.com.au/managed-funds/premium-income-fund/
he or she would see that an announcement had been made, the effect of which
is to suspend redemptions from a fund that has been adversely affected by
the ‘credit crunch’ emanating from America. This fund is named, ironically,
the MFS Premium Income Fund. Perhaps it might be renamed the ‘not quite so
premium repayment of capital invested fund’, but I digress.
If the reader was to follow the links still further
to the financial statements (Annual Report on the right) they would discover
a set of financials drawn up in accordance with IFRS, or at least the
Australian version thereof. The reader would then find that the $880 million
of unitholders’ funds was a liability (see balance sheet page 29). The
reader will also note that it isn’t really classified as such as the
remainder of the requirements in respect to liabilities aren’t met. But
anyway the presentation holds itself out as a liability.
And what was that classification based on? It was
based on this:
‘For example, open-ended mutual funds … may provide
their unitholders … with a right to redeem their interests in the issuer at
any time for cash’ ( emphasis added).
Funny that … what it doesn’t say is ‘at any time
for cash unless the manager doesn’t want to give it to them’.
The truth of the matter is that the unitholders’
funds were never liabilities because the trust deed or some other founding
document or agreement always gave the manager the right to suspend. Yet the
preparers ignored this provision. When I say the preparers I really the mean
the auditors, because, if my experience is anything to go by, the auditors
are leading the charge on this matter and they will not listen to cogent
argument to the contrary. I turned out to be right and they were wrong.
What are the lessons from this?
First, the auditors do not have a monopoly on
wisdom. They need to be challenged when they assert primacy, a primacy which
I understand is asserted initially in London and disseminated across the
rest of the world.
Second, IFRS are very poorly drafted and can clash
with the concepts that purportedly underlie them. Whilst we cannot escape
the depredations anytime soon, Americans should be very concerned. The
Europeans, in a triumphalist tone, now openly say that IFRS will replace the
existing US GAAP (FAS etc.) (see Accountancy Jan 2008 page 114)*. This would
be a travesty. For whilst FAS have their problems they are at least drafted
by people who have a vague idea about accounting.
For those of you in the USA, you should be very
afraid. Maybe not, the byzantine IFRS, in my view, sound the death knell of
standard setting as we know it.
RBW
*PS: the same Accountancy magazine has the
following fascinating little exchange in regard to Northern Rock (or Wreck
as it is sometimes called between the head of assurance at PWC and an
investigating Member of Parliament (a Mr Fallon). This fiasco has cost the
UK Government about $US100 to $US150 billion so far.
‘[Head of Assurance] said that PWC did not advise
on the securitizations [of loans], but was responsible for writing ‘comfort
letters’ that were used in prospectuses aimed at potential investors.
This riled Fallon, who retorted: ‘You have audited
and provided comfort to the biggest banking disaster for 150 years.’
"FASB Governance: Damn the Feedback, Full Speed Ahead to IFRS!," by
Tom Selling, The Accounting Onion, February 26, 2008 ---
http://accountingonion.typepad.com/
The Financial Accounting Foundation (FAF), the body
that governs the FASB, has issued a
press release announcing the results of their one
meeting to consider the feedback on their proposals to change the way the
FASB operates. To reiterate from a prior
post (though somewhat less gentle this time!) the
proposing document was a model of obfuscation. It was clear from the outset
that FAF wasn't at all interested in knowing what anyone else had to say
about reducing the size of the FASB, voting rules, or how the FASB would set
its agenda. Any discussion of past problems, current needs, etc. were vague
(more accurately, not mentioned) in a thinly veiled attempt to frustrate and
limit comments. It certainly frustrated me; I abandoned the effort as soon
as I realized that anything I wrote could, by design, amount to no more than
the equivalent of shooting at a flea with an elephant gun while
blindfolded.
So, predictably -- and despite the clear protests
of Financial Executives International, the CFA Institute and numerous former
board members -- all the proposals passed muster with flying colors. One of
my readers, who shall remain anonymous, wrote to me soon after he heard the
FAF news to tell me that he had spoken to a former FASB project manager
about it, and the only comment he had was "unbelievable."
Would You Trust the Future of U.S. GAAP to
These Guys?
The rat I had been smelling for weeks walked right
into the middle of the room during the
FAF press conference in which its members
rationalized their actions with comments to the effect that requiring new
board members to all have knowledge of "investing" (whatever that means)
will assure that the entire board will give adequate consideration to
investor needs. Right. Guess who will be excluded: someone to replace
Donald Young, the current investor representative, whose term expires this
year; and you can forget about any more academics, lest some pesky dissenter
asks too many uncomfortable questions that could slow down the IFRS
convergence train.
And, what kind of convergence are we going to get
under the new FASB? If facilitating a constructive and stable convergence
with IFRS is the real goal, why is it appropriate for the IASB to have
fourteen members, and now the FASB only five? No good answer.
Why is it appropriate for the IASB to require a super-majority vote of nine
members to adopt a new rule, and the FASB only a simple majority of three --
the FASB chair, who now sets the agenda, plus two handpicked shills? No
good answer. What evidence is there that it will be difficult to find
new board members who are sufficiently knowledgeable of IFRS to hit the
ground running when they are appointed? LOL.
It's obvious to me that the real goal
is not a convergence to benefit U.S. investors; for that would
require careful study, thinking and time. The real goal is
quick-and-dirty convergence -- so that the big audit firms can get on with
the business of charging large fees for the accounting changeovers while at
the same time lowering their long-term audit risk -- and so that their
clients can manage earnings with less fear of interference by the SEC (see
my earlier posts
here and
here for the reasons why this is so, and why it is
harmful to investors).
Speaking of the SEC, What's Their Take?
By the way, FASB's pronouncements are rules for
public companies to follow whilst the SEC so deigns. One would think,
therefore, that the SEC would have taken more than a passing interest in
changes to how the FASB is organized and governed. Yet, I haven't noticed a
peep out of Conrad Hewitt, the SEC's chief accountant. Given his recent
track record, I can't say I'm surprised. All I can say is that I'm glad
that I served in the Office of the Chief Accountant in a different era.
Under the current administration the SEC has become more the captain of the
public company cheerleaders and less the watchdog of investors.
Question
Are our U.S. standard setters bent transitioning to IFRS (and its loopholes) in
the U.S. like fools rushing in where angels fear to tread?
"IFRS Chaos in France: The Incredible Case of Société Générale," by Tom
Selling, The Accounting Onion, March 7, 2008 ---
http://accountingonion.typepad.com/
IFRS Chaos in France: The Incredible Case of
Société Générale "Breaking
the Rules and Admitting It" is the title of Floyd
Norris's column describing the accounting by Société Générale for the losses
incurred by their rogue trader Jérôme Kerviel; the title is provocative
enough, but it's still not adequate to describe this amazing story. Although
I am reluctant to come off as a prudish American unfairly criticizing suave
and sophisticated French norms, what Société and its auditors have
perpetrated would be regarded here as the accounting equivalent of
pornography.
I don't aim to re-write Norris's excellent column,
who rightly asks what a case like this says about the prospects for IFRS
adoption in the U.S. But, I want to make two additional points. To tee them
up, here's an encapsulation of the sordid tale:
Société Générale chose to lump Kerviel's 2008
trading losses in 2007's income statement, thus netting the losses of the
later year with his gains of the previous year. There is no disputing that
the losses occurred in 2008, yet the company's position is that application
of specific IFRS rules (very simply, marking derivatives to market) would,
for reasons unstated, result in a failure of the financial statements to
present a "true and fair view." You might also be interested to know that
the financial statements of French companies are opined on by not just one
-- but two -- yes, two -- auditors. Even by invoking the "true and fair"
exception, Société Générale must still be in compliance with IFRS as both
E&Y and D&T have concurred. How could both auditors be wrong? C'est
imposible. The first point I want to make is that Société's motives to
commit such transparent and ridiculous shenanigans are not clearly apparent
from publicly available information. My unsubstantiated hunch is that it has
to do with executive compensation. For example, could it be that 2007
bonuses have already been determined on same basis that did not have to
include the trading losses (maybe based on stock price appreciation)?
Moreover, pushing the losses back to 2007 could have bee the best way to
clear the decks for 2008 bonuses, which could be based on reported earnings
-- since the stock price has already tanked.
The second point was made by Lynn Turner, former
SEC Chief Accountant in a recent email. The PCAOB and SEC are considering a
policy of mutual recognition of audit firms whereby the PCAOB would promise
not to inspect foreign auditors opining on financial statements filed with
the SEC. Instead, the U.S. investors would have to settle for the
determination of foreign authorities. Thus, if the French regulators saw
nothing wrong with the actions of local auditors -- even operating under the
imprimaturs of EY or D&T -- then the PCAOB could not say otherwise.
Never mind the black eye the Société debacle gives
IFRS, this sordid case must surely signal the SEC that mutual recognition
would be a step too far; however, I'm not counting on the current SEC
leadership to get the message.
It is not often that a major international bank
admits it is violating well-established accounting rules, but that is what
Société Générale has done in accounting for the fraud that caused the bank
to lose 6.4 billion euros — now worth about $9.7 billion — in January.
In its financial statements for 2007, the French
bank takes the loss in that year, offsetting it against 1.5 billion euros in
profit that it says was earned by a trader, Jérôme Kerviel, who concealed
from management the fact he was making huge bets in financial futures
markets.
In moving the loss from 2008 — when it actually
occurred — to 2007, Société Générale has created a furor in accounting
circles and raised questions about whether international accounting
standards can be consistently applied in the many countries around the world
that are converting to the standards.
While the London-based International Accounting
Standards Board writes the rules, there is no international organization
with the power to enforce them and assure that companies are in compliance.
In its annual report released this week, Société
Générale invoked what is known as the “true and fair” provision of
international accounting standards, which provides that “in the extremely
rare circumstances in which management concludes that compliance” with the
rules “would be so misleading that it would conflict with the objective of
financial statements,” a company can depart from the rules.
In the past, that provision has been rarely used in
Europe, and a similar provision in the United States is almost never
invoked. One European auditor said he had never seen the exemption used in
four decades, and another said the only use he could recall dealt with an
extremely complicated pension arrangement that had not been contemplated
when the rules were written.
Some of the people who wrote the rule took
exception to its use by Société Générale.
“It is inappropriate,” said Anthony T. Cope, a
retired member of both the I.A.S.B. and its American counterpart, the
Financial Accounting Standards Board. “They are manipulating earnings.”
John Smith, a member of the I.A.S.B., said: “There
is nothing true about reporting a loss in 2007 when it clearly occurred in
2008. This raises a question as to just how creative they are in
interpreting accounting rules in other areas.” He said the board should
consider repealing the “true and fair” exemption “if it can be interpreted
in the way they have interpreted it.”
Société Générale said that its two audit firms,
Ernst & Young and Deloitte & Touche, approved of the accounting, as did
French regulators. Calls to the international headquarters of both firms
were not returned, and Société Générale said no financial executives were
available to be interviewed.
In the United States, the Securities and Exchange
Commission has the final say on whether companies are following the nation’s
accounting rules. But there is no similar body for the international rules,
although there are consultative groups organized by a group of European
regulators and by the International Organization of Securities Commissions.
It seems likely that both groups will discuss the Société Générale case, but
they will not be able to act unless French regulators change their minds.
“Investors should be troubled by this in an I.A.S.B.
world,” said Jack Ciesielski, the editor of The Analyst’s Accounting
Observer, an American publication. “While it makes sense to have a ‘fair and
true override’ to allow for the fact that broad principles might not always
make for the best reporting, you need to have good judgment exercised to
make it fair for investors. SocGen and its auditors look like they were
trying more to appease the class of investors or regulators who want to
believe it’s all over when they say it’s over, whether it is or not.”
Not only had the losses not occurred at the end of
2007, they would never have occurred had the activities of Mr. Kerviel been
discovered then. According to a report by a special committee of Société
Générale’s board, Mr. Kerviel had earned profits through the end of 2007,
and entered 2008 with few if any outstanding positions.
But early in January he bet heavily that both the
DAX index of German stocks and the Dow Jones Euro Stoxx index would go up.
Instead they fell sharply. After the bank learned of the positions in
mid-January, it sold them quickly on the days when the stock market was
hitting its lowest levels so far this year.
In its annual report, Société Générale says that
applying two accounting rules — IAS 10, “Events After the Balance Sheet
Date,” and IAS 39, “Financial Instruments: Recognition and Measurement” —
would have been inconsistent with a fair presentation of its results. But it
does not go into detail as to why it believes that to be the case.
One rule mentioned, IAS 39, has been highly
controversial in France because banks feel it unreasonably restricts their
accounting. The European Commission adopted a “carve out” that allows
European companies to ignore part of the rule, and Société Générale uses
that carve out. The commission ordered the accounting standards board to
meet with banks to find a rule they could accept, but numerous meetings over
the past several years have not produced an agreement.
Investors who read the 2007 annual report can learn
the impact of the decision to invoke the “true and fair” exemption, but
cannot determine how the bank’s profits would have been affected if it had
applied the full IAS 39.
It appears that by pushing the entire affair into
2007, Société Générale hoped both to put the incident behind it and to
perhaps de-emphasize how much was lost in 2008. The net loss of 4.9 billion
euros it has emphasized was computed by offsetting the 2007 profit against
the 2008 loss.
It may have accomplished those objectives, at the
cost of igniting a debate over how well international accounting standards
can be policed in a world with no international regulatory body.
"In being identified as the lone wolf
behind French investment bank Société
Générale's staggering $7.1-billion loss
Thursday, Jérôme Kerviel joined the
ranks of a rare and elite handful of
rogue traders whose audacious
transactions have single-handedly
brought some of the world's financial
powerhouses to their knees.
This notorious company includes Nick
Leeson, who brought down Britain's
Barings Bank in 1995 by blowing
$1.4-billion, Yasuo Hamanaka, who
squandered $2.6-billion on fraudulent
copper deals for Sumitomo Corp. of Japan
in 1998, John Rusnak, who frittered away
$750-million through unauthorized
currency trading for Allied Irish Bank
in 2002 and Brian Hunter of Calgary, who
oversaw the loss of $6-billion on hedge
fund bets at Amaranth Advisors in 2006.
On January 30, 2008 Dr. Andrew D. Bailey, Jr. (former AAA president, SEC
Deputy Chief Accountant, and faculty member at several universities) wrote a
long letter to the U.S. Department of Treasury's Advisory Committee on the
Accounting Profession.
January 30, 2008
Mr. Arthur Levitt, Jr.
Mr. Don Nicolaisen
Advisory Committee on the Accounting Profession
Office of Financial Institutions Policy, Room 1418
Department of the Treasury
1500 Pennsylvania Avenue, NW
Washington, DC 20220
Dear Mr. Levitt and Mr. Nicolaisen:
I am pleased to submit comments about a number of the
issues under consideration by the Treasury Department’s Advisory Committee
on the Auditing Profession. I would be pleased to discuss my views with the
Committee or the Staff.
From the Publisher of the
AccountingWeb on June 19, 2008
Some friends of ours are
currently on vacation in Russia, which got me to thinking, "I wonder what
it's like to be an accountant in Russia?" I have no idea. It wasn't all that
long ago that International Financial Reporting Standards were adopted by
the Russian Finance Ministry, so it's probably been a rather challenging
profession as of late! If you have any first-hand knowledge of accounting in
the Russian Federation, please
e-mail me so we can
share it with AccountingWEB readers.
In the meantime, here are some key Russian facts:
Population: 142 million
Largest city (and
capital): Moscow
Second largest city:
St. Petersburg
Size: the largest
country in the world by more than 2.5 million square miles
Ethnic groups:
Russian 79.8%,
Tatar 3.8%,
Ukrainian 2%,
other 14.4%
Russia now has offices of the Big 4 accounting
firms and maybe other Western CPA firms as well. One of my former students
accepted a transfer to the PwC office in Moscow. It proved to be a
fast-track to becoming a partner in PwC. Russian companies are seeking
equity investors throughout the world, and to do so they have to add
accounting assurances much like the other companies in the global economy
seek assurances.
More Reasons Why Tom and I Hate Principles-Based Accounting Standards
"Contingent Liabilities: A Troubling Signpost on the Winding Road to a Single
Global Accounting Standard," by Tom Selling, The Accounting Onion, May 26, 2008
---
Click Here
By the logic of others, which I can’t explain,
fuzzy lines in accounting standards have come to be exalted as
“principles-based” and bright lines are disparaged as “rules-based.” One of
my favorite examples (actually a pet peeve) of this phenomenon is the
difference in the accounting for leases between IFRS and U.S. GAAP. The
objective of the financial reporting game is to capture as much of the
economic benefits of an asset as possible, while keeping the contractual
liability for future lease payments off the balance sheet; a win is scored
an “operating lease,” and a loss is scored a “capital lease.” As in tennis,
If the present value of the minimum lease payments turns out to be even a
hair over the 90% line of the leased asset’s fair value, your shot is out
and you lose the point.
The counterpart to FAS 13 in IFRS is IAS 17, a
putative principles-based standard. It’s more a less a carbon copy of FAS 13
in its major provisions, except that bright lines are replaced with fuzzy
lines: if the present value of the minimum lease payments is a “substantial
portion” (whatever that means) of the leased asset’s fair value, you lose
operating lease accounting. If FAS 13 is tennis, then IAS 17 is
tennis-without-lines. Either way, the accounting game has another twist: the
players call the balls landing on their side of the net; and the only job of
the umpire—chosen and compensated by each player—is to opine on the
reasonableness of their player's call. So, one would confidently expect that
the players of tennis-without- lines have a much lower risk of being
overruled by their auditors… whoops, I meant umpires.
Although lease accounting is one example for which
GAAP is bright-lined and IFRS is the fuzzy one, the opposite is sometimes
the case, with accounting for contingencies under FAS 5 or IAS 37 being a
prime exaple. FAS 5 requires recognition of a contingent liability when it
is “probable” that a future event will result in the occurrence of a
liability. What does “probable” mean? According to FAS 5, it means “likely
to occur.” Wow, that sure clears things up. With a recognition threshold as
solid as Jell-o nailed to a tree and boilerplate footnote disclosures to
keep up appearances, there should be little problem persuading one’s
handpicked independent auditor of the “reasonableness” of any in or out
call.
IAS 37 has a similar recognition threshold for a
contingent liability (Note: I am adopting U.S. terminology throughout, even
though "contingent liabilities" are referred to as "provisions" in IAS 37).
But in refreshing contrast to FAS 5, IAS 37 unambiguously nails down the
definition of “probable” to be “more likely than not” —i.e., just a hair
north of 50%. Naively assuming that companies actually comply with the
letter and spirit of IAS 37, then more liabilities should find their way
onto the balance sheet under IFRS than GAAP. And, IAS 37 also has more
principled rules for measuring a liability, once recognized. But, I won’t
get into that here. Just please take my word for it that IAS 37 is to FAS 5
as steak is to chopped liver.
The Global Accounting Race to the Bottom
And so we have the IASB’s ineffable ongoing
six-year project to make a hairball out of IAS 37. If these two standards,
IAS 37 and FAS 5, are to be brought closer together as the ballyhooed
Memorandum of Understanding between IASB and FASB should portend, it would
make much more sense for the FASB to revise FAS 5 to make it more like IAS
37. After all, convergence isn’t supposed to take forever; even if you don’t
think IAS 37 is perfect, there are a lot more serious problems IASB could be
working harder on: leases, pensions, revenue recognition, securitizations,
related party transactions, just to name a few off the top of my head. But,
the stakeholders in IFRS are evidently telling the IASB that they get their
jollies from tennis without lines. And, the IASB, dependent on the big boys
for funding, is listening real close.
Basically, the IASB has concluded that all present
obligations – not just those that are more likely than not to result in an
outflow of assets – should be recognized. It sounds admirably principled and
ambitious, but there’s a catch. In place of the bright-line probability
threshold in IAS 37, there would be the fuzziest line criteria one could
possibly devise: the liability must be capable of “reliable” measurement. We
know that "probable" without further guidance must at least lie between 0
and 1, but what amount of measurement error is within range of “reliable”?
The answer, it seems, would be left to the whim of the issuer followed by
the inevitable wave-your-hands-in-the-air rubber stamp of the auditor.
It’s not as if the IASB doesn’t have history from
which to learn. Where the IASB is trying to go in revising IAS 37, we’ve
already been in the U.S. The result was all too often not a pretty sight as
unrecognized liabilities suddenly slammed into balance sheets like freight
trains. As I discussed in an earlier post, retiree health care liabilities
were kept off balance sheets until they were about to break unionized
industrial companies. Post-retirement benefits were doled out by earlier
generations of management, long departed with their generous termination
benefits, in order to persuade obstreperous unions to return to the assembly
lines. GM and Ford are now on the verge of settling faustian bargains of
their forbearers with huge cash outlays: yet for decades the amount
recognized on the balance sheet was precisely nil. The accounting for these
liabilities had been conveniently ignored, with only boilerplate disclosures
in their stead, out of supposed concern for reliable measurement. Yet,
everyone knew that zero as the answer was as far from correct as Detroit is
from Tokyo – where, as in most developed countries, health care costs of
retirees are the responsibility of government.
Holding the recognition of a liability hostage to
“reliable” measurement is bad accounting. There is just no other way I can
put it. If this is the way the IASB is going to spend its time as we are
supposed to be moving to a single global standard, then let the race to the
bottom begin.
Here’s an interesting development of how auditor
independence issues can impact firm-client relationships.
FTI Consulting (NYSE: FCN), a premier provider of
problem-solving consulting and technology services to major corporations,
financial institutions and law firms, recently announced that it had
switched from Ernst and Young to KPMG as its public auditor for 2006.
The reason: Ernst wants to hire FTI as a consulting
vendor, and believes that its independence could be impaired if E&Y
continues to be the auditor for FTI. So both firms reach an agreement that
FTI should no longer have E&Y as an auditor after Q1-2006. According to FTI,
there have been no disagreements with or adverse opinions expressed by E&Y
for 2004 and 2005. FTI then switches to KPMG as an independent auditor.
If we read this correctly, E&Y loses FTI’s audit
fees and has to pay FTI’s consulting fees, so it is getting impacted
financially on two fronts. We take it that they must have really wanted
FTI’s services to go these lengths.
In terms of background…..FTI Consulting was founded
by Daniel W. Luczak and Joseph R. Reynolds in 1982. It was formerly known as
Forensic Technologies International Corporation and subsequently changed its
name to FTI Consulting, Inc. The company is based in Baltimore, Maryland.
From The Wall Street Journal Weekly Accounting Review on May 2, 2008
SUMMARY: FTI
Consulting looks like a great place to make money, judging by
its financials. But for investors, looks can be deceiving. The
company is structuring some transactions in creative ways that
result in a favorable appearance on the financial statements.
CLASSROOM
APPLICATION: This article shows students how transactions
that are presented on the financial statements in a way that is
not technically wrong can still misrepresent the condition of
the company to the users of the financial statements.
QUESTIONS:
1. (Advanced) What are "earn-outs?" How does FTI
utilize earn-outs? Why does the firm choose to use earn-outs?
2. (Advanced) How does FTI represent the earn-outs on
its financial statements? Is FTI's accounting treatment
considered proper under GAAP? How could the users of the
financial statements misunderstand this transaction as it is
presented on the financial statements?
3. (Advanced) What does one financial manager suggest
must be done to the FTI financial statements to get a true
picture of the earn-out transactions? Do you agree with his
assessment? Why or why not?
4. (Introductory) Do you think that FTI is structuring
the earn-outs to make its financial statements look favorable?
Why or why not? What are the long-term consequences of
presenting the earn-outs in this manner?
5. (Introductory) Could FTI present the earn-outs as
compensation expense? Would that be a violation of GAAP?
6. (Advanced) Why does FTI give forgivable loans? Who
is benefited? How are forgivable loans presented on FTI
financial statements? What are the effects of forgivable loans
on the financial statements?
7. (Advanced) What are the ethical implications of FTI
using these presentations of earn-outs and forgivable loans to
compensate its employees?
SMALL GROUP
ASSIGNMENT:
Search online sources for FTI Consulting financial statements
and other financial information. Can you find information on the
earn-outs? How are the forgivable loans expressed in the
financial statements? Are either of these transactions presented
in the notes to the financial statements? How could investors
discover the facts of these transactions if they had not read
the Wall Street Journal article?
Reviewed By: Linda Christiansen, Indiana University Southeast
Judging by its financials, FTI Consulting Inc.
looks like a great place to make money. For investors, looks can be
deceiving.
FTI, which provides legal, financial and
public-relations services, handsomely pays the hundreds of professionals it
has been adding to its ranks through a series of acquisitions. In the first
quarter, FTI bought eight companies and added 445 employees in 49 days.
But FTI's method of paying for its new companies
and rewarding its new executives largely avoids any negative effect on
earnings. As a result, its operating income looks bigger, fueling its
share-price rise and winning praise from analysts and investors. Meanwhile,
its sizable and growing compensation-type payouts and loans go largely
unnoticed by investors.
FTI's shares rose 11 cents to $67.69 in trading
Friday on the New York Stock Exchange. That put them up 9.8% for the year
and more than double where they were at the start of 2007.
FTI, which has a market value of $3.3 billion, is
trading at 27 times estimated 2008 earnings, or a 50% premium on average to
its peers, such as the smaller Huron Consulting Group Inc., according to
Thomson Reuters. Only one analyst rates it a "sell." Others rave about
earnings growth and how the sagging economy will benefit FTI's restructuring
practice, which made up 26% of the company's revenue of $1 billion last
year.
FTI, which will report its first-quarter earnings
next month, declined to comment.
Like other companies that count people as their
main asset, FTI uses "earn-outs" to pay many executives who come with its
acquisitions. Under this model, an acquirer gives its new company an upfront
payment and then gives the company's owners or executives additional
payments over the next few years based on performance targets.
While there isn't anything technically wrong with
these additional payments, they make expenses look smaller and earnings
appear larger than they otherwise would because the earn-outs aren't treated
as compensation expense, which is subtracted from earnings.
Instead, they appear as contingent payments on the
cash-flow statement and intangible assets on the balance sheet, neither of
which drive investor sentiment as much as the earnings numbers on the income
statement.
"I think of earn-outs as a mechanism for inflating
operating income," says Michael Winter, a portfolio manager at hedge-fund
Otter Creek Management, which manages about $160 million in assets and
doesn't own FTI shares. "For a true quality-of-earnings figure, an investor
needs to add those amounts back to earnings as compensation expense."
Earn-outs aren't small change for a company that
has made so many acquisitions and that reported pretax income last year of
$150 million. In the first quarter, FTI paid nearly $43 million in earn-outs
for earlier acquisitions, and it has said it expects to pay $49 million in
earn-outs over the next few years for its latest deals.
Some analysts regard earn-outs as a necessary evil.
"It is important to be cognizant of the financial and accounting
ramifications of earn-outs, but they're an important way for
professionals-based companies to make sure interests are aligned," says
Timothy McHugh, an analyst for William Blair & Co. who has a "buy" rating on
FTI stock.
Another practice employed by FTI, doling out
"forgivable" loans, is far less common in corporate America. In 2006, it
launched an incentive compensation program that involved granting $30
million in cash payments "in the form of unsecured general recourse
forgivable" loans, to senior managing directors and other employees. Last
year FTI paid out $35 million in forgivable loans to about 57 senior
managing directors and others. "The amount of forgivable loans we make could
be significant," FTI said in a recent Securities and Exchange Commission
filing.
FTI typically amortizes the cost of these loans
over five years, meaning a fraction of them have an impact on income in the
current periods. The total costs aren't reflected until FTI fully forgives
the loans. While they are a great incentive to employees, their effect on
earnings is delayed.
"It seems that they really go out of their way to
compensate people very well and avoid affecting the income statement," says
Donn Vickrey, head of research firm Gradient Analytics.
Mr. Vickrey is an earnings-quality analyst who doesn't
formally cover FTI. "It gives them a whole lot of room to make their
earnings number every quarter."
Jensen Comment
Yet another example of why I'm in favor of bright lines.
"Mr. Vickrey is an earnings-quality analyst who doesn't
formally cover FTI. "It gives them a whole lot of room to make their earnings
number every quarter."
Hi David,
You said: "Intelligently applying principles makes
rules unnecessary."
Then why do we have traffic police?
Why do we have internal and external auditors?
How can we make all drivers "intelligent" with always
high levels of ethics? How can we make all intelligent drivers immune from peer
pressure to break the rules?
Principle 1: Don't drive above any speed that is unsafe
in any zone.
Principle 2: Don't drink too much and drive.
Rule 1: 20 mph (non-metric) maximum speed in a school
zone where many students are walking to and from school.
Rule 2: An alcohol blood level in excess of .10 is a punishable offense for
vehicle drivers on any road or street.
The principles are perfect in theory, and the rules are
disputable because a teen driver going 40 mph with a blood alcohol level of .20
may actually be less dangerous than the old lady who can't see well driving 10
mph on her way to a MADD anti-drinking meeting.
But now tell me David:
Does each five-year old child's mother feel safer and
every traffic cop feel more effective with the principles or the rules in school
zones?
You said that GAAP "bright lines" mean that "bright
people" will figure out new ways to cross the bright lines.
In reality I'm sure you, as my good friend, agree that
there are no optimal solutions on either end of the Principles versus Rules
spectrum. We only differ sometimes as to where to stop making rules in
particular circumstances. What I fear more than you is that all clients of
auditors are not perfectly ethical --- otherwise why require auditors in the
first place?
Perhaps principles will suffice for auditors to
determine whether a lease is an operating lease or how much should be placed in
an allowance for doubtful accounts. But bright lines are needed when clients are
successfully changing auditors to get more friendly applications of
"principles."
I honestly think that what led to Andersen's implosion
is that some of the partners in charge of huge audits like WorldCom and Enron
were caving in to client pressures to cross the lines. It's the violation of
bright lines that eventually brought down Andersen and its sneaky clients. Enron
knowingly lept over the SEC's 3% bright line for SPEs. And FASB set a
fiber-optic line expensing bright line rule that WorldCom knowingly crossed.
Most interesting in all of this is that many accounting
theorists would've supported WorldCom's CFO (Scott) argument that fiber-optic
line lines should've been capitalized and depreciated. But there was a
bright-line rule in place to the contrary, and WorldCom executives were
secretive and sneakily crossed that bright line, out of the sight of their own
internal auditors, for over $1 billion in higher earnings and stock prices.
Breaking the rule in secret benefitted WorldCom executives because the market
thought WorldCom playing by the conservative rules in place.
Often the worst crooks get caught up by bright lines
much like Al Capone (who rarely did his own dirty work) finally got sent to
prison because of bright lines in the tax code. Without the tax code bright
lines. The lofty Big Al might've continued on for more years of organized crime.
I'm thankful we have bright lines in our traffic laws,
accounting rules, and tax codes. You, David, and I just have to argue about
where to paint the lines. I've got a bigger paint bucket and more paint brushes
Question Were accountants responsible for the dotcom bubble and burst at the turn of
the Century?
Jensen Answer
The article below fails to directly mention where auditors contributed the most
to the 1990's bubble. The auditors were allowing clients to get away with murder
in terms of recognizing revenue that should never have
been recognized. The dotcom companies were not yet making profits but
were full of promise as the bubble filled with hot air. In financial reporting
(especially in
pro forma reporting) dotcom companies shifted the attention from profit
growth to revenue growth. But much of the revenue growth they got away with
reporting was due to bad judgment on the part of their auditors. Corrections
finally began to appear after the EITF belatedly made some bright line decisions
---
http://faculty.trinity.edu/rjensen/ecommerce/eitf01.htm
I give auditors F grades when auditing the hot
air balloons of dotcom companies. This shows what can happen when we let
judgment overtake some of the bright line rules in accounting standards.
Auditors were supposed to have "principles" when they had no bright lines to
follow. The auditing firms demonstrated their lack of professional principles in
the 1990s.
"Were accountants responsible for the dotcom bubble
and burst?" This worrying allegation emerged from a question two weeks ago
at the ICAEW IT Faculty annual lecture.
During a thought-provoking talk on Second Life and
related issues, Clive Holtham mentioned the dotcom bubble, which prompted
the pointed follow-up question from one audience member.
The answer was that they weren't - which accorded
with the general audience reaction. The reason? Accountants, Holtham argued,
had not made the investment and business decisions that fuelled the boom and
led to the bust.
Some would argue that this is exactly why
accountancy, perhaps more than accountants, was responsible. Why weren't
accountants more involved in these decisions? We would surely expect
accountants to have been stressing the need to temper the wild enthusiasm
with a bit of solid business analysis. It's hard to escape the conclusion
that accountants either didn't put forward the right arguments, or were not
sufficiently influential. Accountants either lacked the confidence to
participate forcefully enough in the debate, or were viewed as not knowing
enough about IT.
Either way, it suggests that the main accountancy
bodies had allowed a major change in business to occur without preparing
their members to deal competently and confidently with it. If technology had
been seen as a natural competency of an accountant, accountants might have
been more able to fight their corner over the excesses of the dotcom era.
Anyway, that was years ago. Surely things have
changed. The recent AccountingWEB/National B2B Centre survey on accountants'
involvement in ebusiness was introduced in the following terms: "In spirit
accountants would like to get involved with ebusiness, but the reality of
their current knowledge and workload means that only a small minority are
able to help clients take advantage of new technology opportunities."
It's unfair to blame the accountants themselves.
Their workload is a significant factor. Government has been piling
regulation after regulation upon them and it must be a struggle to keep up
with just what they consider their core skills and knowledge. Ethically, you
would not expect accountants to offer advice in areas in which they do not
consider themselves adequately qualified. Technology is such a vast and
rapidly moving area that it's pretty hard for most full time IT
professionals to keep up, let alone accountants with their myriad other
responsibilities. Yet the need, and opportunity, certainly seems to be
there. Various government initiatives in the past have sought to identify
sources of competent advice to help companies succeed in ebusiness.
Usually, articles about accountants doing more in
the field of IT elicit comments about "leaving it to the IT professionals".
The worry is that accountants may not know enough to be able to do so
confidently and therefore they withdraw from any involvement - this is what
the AccountingWeb/NB2BC survey seems to suggest is happening. This is in
nobody's interest. Businesses may fail to exploit key opportunities,
accountants will lose out on income and probably credibility, and IT
specialists will have fewer clients. A more ebusiness-confident accountancy
profession should be able not only to offer advice itself, but also to
recommend, trust and work with specialists where required.
To achieve this it's vital that the professional
bodies help their members more than they are doing currently. What seems to
be missing is a set of boundaries. What exactly do accountants need to know
about IT and ebusiness in order to be able to confidently and competently
advise their clients? How can you, as an accountant, assess your competence
in this vital area?
It's not as if this is anything new, The
International Federation of Accountants (IFAC) has been working on a revised
Education Practice Statement regarding 'Information Technology for
Professional Accountants' for years and in October 2007 released
International Education Practice Statement 2 (IEPS 2) after consultation
with accountancy bodies worldwide. This sets out "IT knowledge and
competency requirements" for the qualification process, but also for
continuing professional development.
So should accountants be more active in advising
on ebusiness? Should they do it themselves or work with specialists? And are
the professional bodies doing enough to help their members in this, and
other IT related, areas? We look forward to hearing the views of
AccountingWEB members so that we can carry this debate forward.
Interestingly, most of the criticism of accountants
during the dotcom bubble was not for allowing premature revenue recognition
but, to the contrary, for failure to allow recording of internally developed
goodwill. Dotcoms were reporting losses that critics at the time said should
have been profits because of the purported existence of unrecognized
intangible future benefit. (BTW, I always remember Denny’s term for pro
forma reporting—EBS (everything but bad stuff).)
Let me play the devil's advocate (and here I really
AM the devil). I look forward to your witty repartee.
I think the root cause of the dot-com (and much
else that has happened) is the tax law provision that limited the tax
deductibility of executive compensation to $1 million.
This led to perverse incentives on the part of the
managers to fiddle with the financial statements to maximize the price at
which IPOs could be floated.
As John Coffee has stated in his book Gatekeepers,
"when one pays the CEOs with stock options, one is using a high octane fuel
that creates incentives for short-term financial manipulation and accounting
gamesmanship".
The dot-com bust is an expemplar for the worst in
the American and European corporate governance.
On the one hand, it is an example of American
system of perverse incentives for financial statement manipulation (which is
addressed by SOx and the corporation codes only peripherally) fueled by
non-cash executive compensation. On the other hand, it is an example of a
typical European fraud in the sense of the "insiders'" (primarily the
venture capitalists, greed (which European laws have addressed in the past).
The consequences of non-cash executive
compensation, in my opinion, is the scourge of the American corporate scene,
that is destroying the employee morale, perceived equity of the "system",
the good old-fashioned idea that each pay one's dues to the society, and
ultimately our way of life in the United States. To give just one example,
the following is the data on the CEO compensation as a multiple of average
employee compensation in various countries:
531:1 USA
25:1 UK
21:1 Canada
16:1 France
11.1 Germany
10:1 Japan __________________
Source: Gatekeepers, by John Coffee.
Shouldn't we be surprised that social unrest and
crime in the US is so low? Shouldn't we auditors be paranoid (and not just
sceptical) of the machinations of management?
And one would have to a fool to think that this is
the "equilibrium" market situation, decided by millions of the 'homo
economicus' persuasion in the "market"..
Goodwill is almost a red herring in this equation.
Its recognition would only fuel the perverse incentives of managers.
Financial statements for most firms of the dot-com variety are already a
fiction; goodwill accounting is just one more dose of fictionitis.
Respectfully submitted,
Jagdish S. Gangolly,
Associate Professor (
j.gangolly@albany.edu
)
Chairperson, Department of Accounting & Law, School of
Business
Director, PhD Program in Information Science, College of Computing &
Information
State University of New York at Albany, Albany, NY 12222.
Phone: (518) 442-4949 URL:
http://www.albany.edu/acc/gangolly
March 12, 2008 reply from Bob Jensen
With all due respects to Ed and Jagdish, I
still think that inflated revenue reporting and other creative accounting
ploys led to a bubble of artificially inflated stock prices of dotcom
companies. It was more than the "premature revenue recognition" that Ed
mentions. It was reporting of questionable revenues that would never be
realized in cash. For example dotcomA contracts with dotcomB, dotcomC, ...,
dotcomZ to trade advertising space on Websites and vice versa for all
combinations of contracting dotcom companies. Each company counts the trade
at estimated value as revenue and expense even though there will never be
any cash flows for these advertising trades.
The dotcom companies did not inflate profits
with this move but they dramatically inflated revenues which was all they
cared about since the investing public never expected them to show a profit
early on. You can read about how bad this bartering scam became ---
http://faculty.trinity.edu/rjensen/ecommerce/eitf01.htm#Issue02
And auditors let the dotcom companies get away with this scam until EITF
99-17 made auditors finally recognize the errors of their ways.
Issue 01: Should a company that acts as a distributor or reseller of
products or services record revenues as gross or net?
Examples of Creatively Reporting at Gross:
Priceline.com brokered airline tickets
online and included the full price of the ticket as Priceline.com
revenues. This greatly inflated revenues relative to traditional
ticket brokers and travel agents who only included commissions as
revenue.
eBay.com included the entire price of
auctioned items into its revenue even though it had no ownership or
credit risk for items auctioned online.
Land's End issued discount coupons (e.g.,
20% off the price), recorded sales at the full price, and then
charged the price discount to marketing expense.
Issue 02: Should a company that swaps website advertising with
another company record advertising revenue and expense?
Issue 03: Should discounts or rebates offered to purchasers of
personal computers in combination with Internet service contracts be
treated as a reduction of revenues or as a marketing expense?
Issue 04: Should shipping and handling fees collected from customers
be included in revenues or netted against shipping expense?
Discounts and rebates are traditionally
deducted from gross revenues to arrive at a net revenue figure that
is the basis of revenue reporting. Internet companies, however, did
not always follow this treatment. Discounts and rebates have been
reflected as operating expenses rather than as reductions of
revenue.
Handling fees and pricing rebates
throughout accounting history could not be included in revenues
since the writing of the first accounting textbook. Auditors knew
this very well from the history of accounting, but it took EITF
00-14 in Year 2000 to remind auditors that this bit of history
applied to dotcom companies as well as mainstream clients.
Definition of Software
Issue 07: Should the accounting for products distributed via the
Internet, such as music, follow pronouncements regarding software
development or those of the music industry?
Issue 08: Should the costs of website development be expensed similar
to software developed for internal use in accordance with SOP 98-1?
Revenue Recognition
Issue 9: How should an Internet auction site account for up-front and
back-end fees?
Issue 10: How should arrangements that include the right to use
software stored on another company’s hardware be accounted for?
Issue 11: How should revenues associated with providing access to, or
maintenance of, a website, or publishing information on a website, be
accounted for?
Issue 12: How should advertising revenue contingent upon “hits,”
“viewings,” or “click-throughs” be accounted for?
Issue 13: How should “point” and other loyalty programs be accounted
for?
Prepaid/Intangible Assets vs. Period Costs
Issue 14: How should a company assess the impairment of capitalized
Internet distribution costs?
Issue 15: How should up-front payments made in exchange for certain
advertising services provided over a period of time be accounted for?
Issue 16: How should investments in building up a customer or
membership base be accounted for?
Miscellaneous Issues
Issue 17: Does the accounting by holders for financial instruments
with exercisability terms that are variable-based future events, such an
IPO, fall under the provisions of SFAS 133?
Issue 18: Should Internet operations be treated as a separate
operating segment in accordance with SFAS 131?
Issue 19: Should there be more comparability between Internet
companies in the classification of expenses by category?
Issue 20: How should companies account for on-line coupons?
In nearly every instance dotcom companies
were inflating the promise of their new companies with creative accounting
blessed by their auditors until the EITF and other FASB pronouncements set
some bright lines that auditors had to stand behind. The investing public
was nearly always misled by both the audited financial statements and the
pro forma statements of dotcom companies in the 1990s. Then the bubble
burst, in part, by bright line setting by the EITF and the FASB.
Here’s another example of why I’m dubious of principles-based standards in
accounting and auditing. Nothing should've prevented KPMG from being more
professional on this huge audit. KPMG still amazes me on how it wins awards for
everything from employee relations to minority student support but falls down on
the services for which it gets paid by selling illegal tax shelters
(over a half billion in
fines and legal fees ), performing sloppy audits (e.g., being fired from
the enormous Fannie Mae audit), and now this. There’s a whole lot of good stuff
and bad stuff referenced at
http://faculty.trinity.edu/rjensen/Fraud001.htm
In an interview Wednesday, Mr. Missal said KPMG
"didn't have the healthy skepticism that you would expect from your outside
independent auditors." One of the accounting errors Mr. Missal identified
involved a decision not to account for a
"growing backlog" of troubled loans New
Century was obligated to repurchase. Senior New
Century executives knew as far back as 2004 that the subprime-mortgage boom was
doomed to go bust, Mr. Missal said. But he said its accounting practices allowed
those dangers to be disguised. See below
A court-appointed investigator looking into the
collapse of New Century Financial Corp. said in a report that its auditor,
KPMG LLP, devised some of the improper accounting strategies that allowed
the company to hide its financial problems for years.
The investigator, Michael J. Missal, said the
company might be able to recover money for its creditors by suing KPMG for
professional negligence and negligent misrepresentation. He also recommended
the company sue several of its former top executives to recover millions of
dollars in bonuses and other compensation paid to them.
KPMG "contributed to certain of these accounting
and financial reporting deficiencies by enabling them to persist and, in
some instances, precipitating the company's departure from applicable
accounting standards," Mr. Missal said in a 550-page report filed with the
U.S. Bankruptcy Court in Wilmington, Del., and released Wednesday.
Dan Ginsburg, a spokesman for KPMG, said, "We
strongly disagree with the report's conclusion concerning KPMG. We believe
that an objective review of the facts and circumstances will affirm our
position."
The Justice Department, as part of its
investigation into New Century's collapse, is looking at individuals at KPMG
who audited the company, according to people familiar with the case. But
these individuals are not currently a target of the investigation, according
to a person familiar with the matter. The Justice Department inquiry is
being handled out of the Santa Ana office of the U.S. attorney for
California's central district, based in Los Angeles. A spokesman for KPMG
declined to comment.
A spokesperson for New Century said in a statement:
"The Company is pleased that the Examiner's report is finally completed and
that we can take the next steps of confirming the plan of liquidation,
therefore substantially concluding the bankruptcy process."
In his report, Mr. Missal said that in one
instance, a KPMG partner who led the New Century audit team castigated a
subordinate who had questioned one of the company's accounting practices as
it prepared to file its 2005 annual report with the Securities and Exchange
Commission.
According to Mr. Missal, the KPMG partner told the
subordinate in an email: "I am very disappointed we are still discussing
this. As far as I am concerned, we are done. The client thinks we are done.
All we are going to do is p- everybody off."
New Century, based in Irvine, Calif., was once one
of the country's biggest providers of mortgages to people with poor credit
histories. In 2006, it originated nearly $60 billion in subprime mortgages.
It collapsed in April 2007 after its accounting problems came to light,
accelerating the meltdown in the subprime-mortgage market. That meltdown
precipitated the biggest credit crunch in at least a decade.
In his report, Mr. Missal said New Century had "a
brazen obsession with increasing loan originations, without due regard to
the risks associated with that business strategy." Its loan-production
department, he said, was "the dominant force in the company," which trained
mortgage brokers in sessions it referred to as "CloseMore University."
The company had low standards for originating
loans, Mr. Missal said. "The predominant standard for loan quality was
whether the loans New Century originated could be initially sold or
securitized in the secondary market," he said. "The increasingly risky
nature of New Century's loan originations created a ticking time bomb that
detonated in 2007."
New Century owes its creditors more than $1
billion, but it has said in court papers that they are likely to recover no
more than 17 cents of every dollar they are owed. Because the company has
few assets left, much of that funding is likely to come from lawsuits
against parties responsible for the company's collapse.
In an interview Wednesday, Mr. Missal said KPMG
"didn't have the healthy skepticism that you would expect from your outside
independent auditors." One of the accounting errors Mr. Missal identified
involved a decision not to account for a "growing backlog" of troubled loans
New Century was obligated to repurchase.
Senior New Century executives knew as far back as
2004 that the subprime-mortgage boom was doomed to go bust, Mr. Missal said.
But he said its accounting practices allowed those dangers to be disguised.
An independent report commissioned by the Justice
Department concluded that the "improper and imprudent practices" of now-bankrupt
subprime lender New Century Financial were condoned and enabled by the company's
independent auditor, KPMG.
Zac Bissonnette, "KPMG engulfed in subprime accounting scandal," Blogging
Stocks, March 27, 2008
http://bstocksdev.weblogsinc.com/2008/03/27/kpmg-engulfed-in-subprime-accounting-scandal/
A sweeping five-month investigation into the
collapse of one of the nation’s largest subprime lenders points a finger at
a possible new culprit in the mortgage mess: the accountants.
New Century Financial, whose failure just a year
ago came at the start of the credit crisis, engaged in “significant improper
and imprudent practices” that were condoned and enabled by auditors at the
accounting firm KPMG, according to an independent report commissioned by the
Justice Department.
In its scope and detail, the 580-page report is the
most comprehensive document yet made public about the failings of a mortgage
business. Some of its accusations echo charges that surfaced about the
accounting firm Arthur Andersen after the collapse of Enron in 2001.
E-mail messages uncovered in the investigation
showed that some KPMG auditors raised red flags about the accounting
practices at New Century, but that the KPMG partners overseeing the audits
rejected those concerns because they feared losing a client.
From its headquarters in Irvine, Calif., New
Century ruled as one of the nation’s leading subprime lenders. But its
dominance ended when it was forced into bankruptcy last April because of a
surge in defaults and a loss of confidence among its lenders.
The report lays bare the aggressive business
practices at the heart of the mortgage crisis.
“I would call it incredibly thorough analysis,”
said Zach Gast, an analyst at RiskMetrics who raised concerns about
accounting practices at New Century and other lenders in December 2006.
“This is certainly the most in-depth review we have seen of one of the
mortgage lenders that we have seen go bust.”
A spokeswoman for KPMG, Kathleen Fitzgerald, took
strong exception to the report’s allegations. “We strongly disagree with the
report’s conclusions concerning KPMG,” she said. “We believe an objective
review of the facts and circumstances will affirm our position.”
The report zeros in on how New Century accounted
for losses on troubled loans that it was forced to buy back from investors
like Wall Street banks and hedge funds. Had it not changed its accounting,
the company would have reported a loss rather than a profit in the second
half of 2006.
The report said that investigators “did not find
sufficient evidence to conclude that New Century engaged in earnings
management or manipulation, although its accounting irregularities almost
always resulted in increased earnings.”
Even so, the profits were the basis for significant
executive bonuses and helped persuade Wall Street that the company was in
fine health when in fact its business was coming apart, the report contends.
In bankruptcy court, creditors of New Century say
they are owed $35 billion. The company’s stock peaked at nearly $65.95 in
late 2004; it was trading at a penny on Wednesday.
A spokesman for New Century, which is being managed
by a restructuring firm under the supervision of the bankruptcy court, said
the company was pleased that the report had been published.
The investigation was led by Michael J. Missal, a
lawyer and former investigator in the enforcement division of the Securities
and Exchange Commission who was hired by the United States trustee
overseeing the case in United States Bankruptcy Court in Delaware.
Mr. Missal, who also worked on an investigation of
WorldCom’s accounting misstatements, concluded that KPMG and some former New
Century executives could be legally liable for millions of dollars in
damages because of their conduct.
In the aftermath of the collapse of Enron, Arthur
Andersen was indicted and convicted on obstruction of justices charges. The
conviction was overturned by the Supreme Court in 2005, long after the
company had ceased doing business.
Mr. Missal drew an analogy to Enron and said there
was evidence that KPMG auditors had deferred excessively to New Century.
“I saw e-mails from the engaged partner saying we
are at the risk of being replaced,” Mr. Missal said in a telephone interview
about a KPMG partner working on the audit of New Century. “They acquiesced
overly to the client, which in the post-Enron era seems mind-boggling.”
Ms. Fitzgerald of KPMG countered, “There is
absolutely no evidence to support that contention.”
In one exchange in the report, a KPMG partner who
was leading the New Century audit responded testily to John Klinge, a
specialist at the accounting firm who was pressing him on a contentious
accounting practice used by the company.
“I am very disappointed we are still discussing
this,” the partner, John Donovan, wrote in the spring of 2006. “And as far
as I am concerned we are done. The client thinks we are done.”
KPMG said Wednesday that a national standards
committee had approved the practice in question.
The accounting irregularities became apparent when
a new chief financial officer, Taj S. Bindra, started asking New Century’s
accounting department and KPMG to justify their approach, beginning in
November 2006.
I have been reading Missal's tome. It will be quite
some time before I am done with it. However, I have three comments.
1. Missal's tome is a treasure trove for financial
accounting instructors. It explains most relevant financial accounting much
better than any intermediate accounting text I have seen. In fact I am using
parts of it it in my 'Financial Statement Fraud & Corporate Governance'
class this semester.
2. Bob, I will refrain from ascribing motives or
assigning blame to any one. However, in my humble opinion, the problem may
be systemic and not just limited to one client or one CPA firm. Perhaps we
as academic could help the profession.
I am convinced that we accountants on our own may
not have the competence to do full audits of the financial sector without
the help of actuaries. The actuarial implications of just computing residual
interests by itself is mind-boggling, and that is only one miniscule item.
I have always felt that the intermediate accounting
sequence needs an extreme makeover, and now I am absolutely convinced. We
could cut down on most of the C***p that we fling at our unsuspecting
students (especially in our intermediate accounting classes) and listen to
our profession as to what could really help them.
Perhaps we could do with just one intermediate
class (I am sure my financial accounting colleagues will kill me if they get
to know this; they usually do not like to anything besides regurgitating the
Kieso "tome") and require students to do one finance oriented actuarial
class followed by specialized financial accounting classes? (I am just
floating my trial balloon here).
Our failure as academics in accounting has been
devastating to the auditing/accounting profession.
3. I share your scepticism regarding the so-called
principles-based standards. Accounting principles are of necessity
conflicting, and we totally lack the intellectual capacity, with the kind of
navel-gazing "research" we have been doing for the past thirty years, to
deal with conflicts among principles. We desperately neecd to look at the
way lawyers and judges/justices REASON in order to develop our own faculties
in coping with conflicting principles in arriving at "standards".
Jagdish, I read your comments with interest. I
think one problem we have in accounting academe (and by the way, I don't
teach Intermediate - I am a Managerial person, quite happily) is that we
are, like many professors in business schools especially, running a trade
school. In our case, we are teaching the students what they "need" to know
to pass the CPA exam. We have had this discussion on this site before - the
exam is well behind current needs and practice, and isn't likely to change
soon. This is what the students want: what do I need to take to pass the
exam. They ask this specific question. Not "what do I need to be a good
accountant" but "what do I need to take to sit for the exam." We research
state-by-state requirements, and make sure they take the right courses.
Courses change in response to the requirements (so that now some Internet
research capability is needed, for example), but it is all geared to the
same end.
And I am not sure that businesses/industry have a
great deal of motivation to see accounting make progress in the direction
you are indicating, because they too are acting out of self interest. The
excitement over "principles based" accounting rules really in many cases
I've read amounts to their thinking that it will back off the auditors, give
the companies more of what they like to call "flexibility" - some of us may
have other words for that.
No?
p
Mann macht und Gott lacht. old Yiddish expression
I do not forward advertising requests form commercial
vendors unless I feel that my "audience" would appreciate hearing about
particular new products and services. This one is very important to some
accounting researchers.
I am writing to let you know about two new research
modules available with the AuditAnalytics.com SEC research database.
Specifically, our Litigation Module now tracks all material federal
litigation involving Russell 3000 companies and all federal litigation
involving the top 100 audit firms. This module contains over 12,500 cases in
the database. It includes all securities class actions and SEC litigation
filed since the year 2000.
In the next few months we also will be making
available as an add-on our Advanced Restatement Data to include:
Net Income Effect*
Net Effect on Stockholders Equity*
First Announcement Date*
First Magnitude Announcement Date* All related
filings to each restatement*
*Data analysis for these fields restricted to
NYSE, Nasdaq and AMEX public companies and is currently populated from
2003 to present.
FIN 48 Revisions (All SEC registrants for
fiscal years beginning after Dec 15th, 2006) SAB 108 Revisions (All SEC
registrants for fiscal year ends after Nov 15th, 2006)
As the leader in Audit Industry Research,
AuditAnalytics.com provides detailed information on over 20,000 publicly
registered companies and over 1,500 accounting firms. Our database enables
you, your students and faculty to quickly search and analyze reported:
- SOX 404 Internal Controls and SOX 302
Disclosure Controls
- Restatements
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- Late filers (Form NT)
- Auditor fees, changes, and opinions
- Governance information (Non-historical)
I sincerely believe that you would find our online
service to be a valuable resource for your academic research. We are
currently offering special academic and educational subscription pricing for
the service and I would be happy to discuss this further at your
convenience. Please let me know if there is a good time for us to speak and
if you would like any additional information or an online demonstration of
the AuditAnalytics.com service.
Tom Hardy
IVES Group, Inc.
9 Main Street, Suite 2F
Sutton, MA 01590
Phone: (508) 476-7007 ext. 228
e-mail: thardy@ivesinc.com www.auditanalytics.com - Independent
Research Provider to the Accounting, Insurance, Research and Investment
Communities
A new Web site, TryXBRL.com, allows free
access to view and analyze complete XBRL-tagged financial statements for
over 12,000 publicly traded corporations.
After registering on the portal,TryXBRL.org,
corporate finance professionals can educate
themselves about the XBRL tagging process and view their own historical
financial information in XBRL format. Investors and analysts can
experience how XBRL reduces the complexity and costs associated with
analyzing performance data.
The site is a collaboration of EDGAR Online
Inc., a business and financial information provider, and R.R. Donnelley
& Sons Company, a print services company.
"Our goal has been to deliver solutions that
do not require technical expertise or excessive time commitments by
corporations wishing to take part in the SEC Voluntary Program or to
familiarize themselves with XBRL," said Philip Moyer, President and CEO
of EDGAR Online, Inc. "We are providing open access to our vast XBRL
database through a solution that enables corporations to begin filing
XBRL content with the SEC in as little as a few hours."
RR Donnelley and EDGAR Online have
collaborated to deliver XBRL filing solutions to corporations since
2005.
I just tried the site. Wow. Very powerful. I
confirmed the numbers for one company to make sure I knew what I was
seeing. It pulled the 2007 four quarter numbers for my selected company
and then the 4th qtr numbers for the three peer companies and my
selected company. I'm not sure where that 12,000 publicly traded
corporations is coming from. They must mean filings, not corporations. I
found the following table for March/June 2005 in Appendix F.
http://www.sec.gov/info/smallbus/acspc/acspc-finalreport.pdfIf you include pink sheet companies, the
data for which are not publicly available (at least to my knowledge),
the total climbs to 13,094. Does anyone have a source for more recent
numbers of publicly traded corporations?
Listing Venue Number of Companies Listed
NYSE 2,553 AMEX 747 NASDAQ National Market 2,580 NASDAQ Capital Market1
593 OTC Bulletin Board 2,955 Total 9,428
The table (I only show part of it) has the
following footnote explanation: Source: Public data includes 13,094
companies from the Center for Research in Securities Prices at the
University of Chicago for NYSE and AMEX companies as of March 31, 2005
and from NASDAQ for NASDAQ and OTC Bulletin Board companies and from
Datastream Advance for Pink Sheets companies as of June 10, 2005. This
table was compiled by members of the staff of the SEC's Office of
Economic Analysis and does not necessarily reflect the views of the
Commission, the Commissioners, or other members of the Commission staff.
Securities and Exchange Commission Chairman
Christopher Cox has announced the launch of the "Financial Explorer" on
the SEC Web site to help investors quickly and easily analyze the
financial results of public companies. Financial Explorer paints the
picture of corporate financial performance with diagrams and charts,
using financial information provided to the SEC as "interactive data" in
eXtensible Business Reporting Language (XBRL).
At the click of a mouse, Financial Explorer
lets investors automatically generate financial ratios,
graphs, and charts depicting important
information from financial statements. Information including earnings,
expenses, cash flows, assets, and liabilities can be analyzed and
compared across competing public companies. The software takes the work
out of manipulating the data by entirely eliminating tasks such as
copying and pasting rows of revenues and expenses into a spreadsheet.
That frees investors to focus on their investments' financial results
through visual representations that make the numbers easier to
understand. Investors can use Financial Explorer by visiting
www.sec.gov/xbrl .
"XBRL is fast becoming the universal
language for the exchange of business information and it is the future
of financial reporting," said Cox. "With Financial Explorer or another
XBRL viewer, investors will be able to quickly make sense of financial
statements. In the near future, potentially millions of people will be
able to analyze and compare financial statements and make
better-informed investment decisions. That's a big benefit to ordinary
investors."
David Blaszkowsky, Director of the SEC's
Office of Interactive Disclosure, encouraged investors to try out the
new software. "Financial Explorer will help investors analyze investment
choices much quicker. I encourage both companies and investors to visit
the SEC Web site, try the software, and get a first-hand glimpse of the
future of financial analysis, especially for the retail investor."
Financial Explorer is open source, meaning
that its source code is free to the public, and technology and financial
experts can update and enhance the software. As interactive data becomes
more commonplace, investors, analysts, and others working in the
financial industry may develop hundreds of Web-based applications that
help investors garner insights about financial results through creative
ways of analyzing and presenting the information.
Bob Jensen's videos (created before the
SEC created the Financial Explorer) are at
http://www.cs.trinity.edu/~rjensen/video/Tutorials/
When I can find some time, I'll create a Financial Explorer update
video.
More on the Debate Between Rules-Based Versus Principles-Based Standards
"The Accounting Cycle Arbitrary and Capricious Rules: Lease Accounting --
FAS 13 v. IAS 17," by: J. Edward Ketz, SmartPros, March 2008 ---
http://accounting.smartpros.com/x61146.xml
One of the main arguments against a rules-based
accounting standards-setting system is that resulting rules are sometimes
arbitrary; correspondingly, proponents of principles-based accounting claim
that resulting standards will not be arbitrary, but rather logical,
consistent, transparent, and informative to financial statement users. Lease
accounting is often presented as an exemplar of this point. Since the IASB
standards are purportedly principles-based, let's compare the FASB rule
against the international accounting rule -- er, principle -- and look at
the differences. FAS 13 versus IAS 17.
IAS 17 classifies leases as finance leases or
operating leases, but this is mere words. Finance leases correspond to the
Financial Accounting Standards Board's capital leases. There are five
criteria for determining whether a lease is a finance lease; they are:
The lease transfers ownership to the lessee; The
lease contains a bargain purchase option to purchase that is expected to be
exercised; The lease is for the major part of the economic life of the
asset; The present value of the minimum lease payments amounts to
substantially all of the fair value of the leased asset; Only the lessee can
use the leased asset. The first four criteria correspond strongly with those
of FASB; the last one is also contained in FAS 13 even though it is not
specifically included as one of the criterion to determine whether a lease
is a capital lease.
Critics are correct inasmuch as FASB included
bright lines in criteria 3 and 4 (the 75 percent and the 90 percent
thresholds), whereas IASB did not. One wonders, however, whether that change
eliminates or enhances arbitrariness in financial reporting. True, FASB
chose thresholds that cannot be defended while IASB does not contain them.
The upshot might be to move the threshold from the standard-setter to the
preparer and the auditor, without the investor's being privy to the debate.
For example, the preparer might have a lease in which the present value of
the minimum lease payments amounts to (say) 95 percent of the fair value of
the asset and argues for operating lease treatment. What power and authority
does an auditor have to challenge that assertion?
Yes, FAS 13 contains bright lines that are
inherently arbitrary, as no economic theory supports the 75 percent or the
90 percent thresholds. But, the lack of bright lines does not solve the
issue at all -- it merely shifts the decision about the threshold from the
standard-setter to the preparer and to the auditor. This adds subjectivity
to the determination of an appropriate cutoff point between what is a
capital or an operating lease. Unfortunately, this reality places the
decision in the hands of the one being evaluated by the investment
community, and the last decade has shown us what happens when we entrust
accounting policy making to managers.
To my way of thinking, the arbitrariness in FAS 13
is significantly less than the arbitrariness inherent in IAS 17. To say it
another way, the transparency of FASB's arbitrariness to the investment
community trumps the opaqueness of IASB's rule.
The present value of the lease is calculated with
the interest rate implicit in the lease, if practicable; otherwise, the
present value is determined with the business enterprise's incremental
borrowing rate. Notice that IASB thereby allows financial engineering by the
managers of the entity. Managers can argue that they do not know and cannot
find out the implicit rate, obtain a lower present value of the leased item,
and then be in a better position to argue that the lease is an operating
lease. IASB's position conceptually is no better than FASB's on this point.
IASB defines assets and liabilities as follow:
An asset is a resource controlled by the entity as
a result of past events and from which future economic benefits are expected
to flow to the entity.
A liability is a present obligation of the entity
arising from past events, the settlement of which is expected to result in
an outflow from the entity of resources embodying economic benefits.
These definitions are not substantially different
from FASB's definitions. Most importantly, notice that if one is truly
principled, he or she must conclude that leased items are assets and lease
obligations are liabilities. There is no room for operating leases if
managers or auditors are adhering to the principles imbedded in the
definitions that IASB gives assets and liabilities.
Both FASB and IASB have ignored their own
conceptual frameworks in FAS 13 and IAS 17. Under both sets of definitions,
leased items are assets and lease obligations are liabilities. The only
logical conclusion for FASB and IASB is to require capitalization of all
leases.
. . .
FAS 13 is one of the most deficient standards ever
issued by FASB. Yet, IAS 17 contains most of the same errors and
shortcomings. Its only improvement -- removal of the bright lines -- is
actually a detriment because it assists managers in their efforts to
obfuscate meaningful communications with investors and creditors. If that's
the best example of principles-based accounting, give me rules any day.
"Will the Alphabet Soup of GAAP Soon Become Consomme?" by Tom Selling,
The Accounting Onion, February 4, 2008 ---
http://accountingonion.typepad.com/
ARB, APB, SFAS,
SOP, EITF, FSP, AIN, FIN, CON, SAB, AAER,
FRP, ASR, S-X. These are all
authoritative sources of GAAP, and I
probably left some out. So, four years
ago, the FASB began work on its project
to simplify the process of finding
answers to accounting questions by
creating a single, authoritative on-line
Codification—with the significant
exception of SEC literature. On January
15th, the FASB launched a one-year
“verification” period, during which the
Codification Research System will be
available online free of charge. To
access the Codification, a user must
first register at
http://asc.fasb.org.
I have by no means done a thorough
review of the Codification software, but
I decided to replicate a research
project I recently performed for a
client as a test of its usability. My
client had a series of questions about
an anticipated sale of part of their
operations, and in particular whether
presentation as discontinued operations
was specified for the current and future
periods. My resulting first impressions
of the Codification as a research tool
are these:
Response time is slow. I'm
concerned that as more users access
the codification, performance will
degrade even further.
The organization of topics could be
more logical. For example, the FASB
is working toward an asset/liability
approach to recognition and
measurement; so, why are revenues
and expenses discussed separately
from their balance sheet
counterparts? However, I was able
to the place where discontinued
operation guidance resides very
quickly.
The ability to place the cursor over
a defined term and read its
definition without clicking is very
convenient. The organization of
each topic in a systematic series of
sections and subsections appears
logical, consistent and potentially
helpful. However, reading off the
computer screen gets old very
quickly, in no small part because
the subsections are too granular to
be reader-friendly. For my task, I
chose to simplify things by using
the command to join all subsections
together -- and then dump everything
to paper along with citations to the
source documents. I suppose that if
you are looking for a particular
sentence or two in answer to a very
narrow question, reading off the
screen and jumping around using
hyperlinks could work fine; but I
wonder if that's more the exception
than the rule. Usually, I need to
be able to scan the entire content
with my eyes before I can hone in on
the words I need.
Overall, the codification project
continues to hold high promise and is
proceeding apace. A logical next step
for the SEC would be to determine how
they can reasonably make accounting
researcher more efficient and definitive
by incorporating their own literature
into the FASB's codification. At
present, the Codification does include
"authoritative" content issued by the
SEC (though not all), as well as
selected SEC staff interpretations.
Under the current regime, GAAP can be
created in an instant practically every
time an enforcement action takes place;
or a commissioner or high ranking staff
member opes their ruby lips to offer
their two cents worth about accounting.
The Financial Accounting
Standards Board on Tuesday launched the one-year verification phase of its
Accounting Standards Codification, a system that reorganizes the thousands
of U.S. GAAP pronouncements into accounting topics using a consistent
structure.
he
Codification organizes U.S. GAAP by 90 topics or issues on a new Web site,
http://asc.fasb.org. FASB expects the new
structure and system will reduce the amount of time and effort required to
solve an accounting research issue, improve usability of the literature
thereby mitigating the risk of noncompliance with standards, and provide
real-time updates as new standards are released. In addition, the system
should become the authoritative source of literature for the completed
XBRL taxonomy.
The structure includes all accounting standards issued by a standard-setter
within levels A through D of the current U.S. GAAP hierarchy, including
FASB, American Institute of Certified Public Accountants (AICPA), Emerging
Issues Task Force (EITF), and related literature. It excludes governmental
accounting standards.
"For a long time,
many users have said that GAAP is confusing," said Barry Melancon, AICPA
president and CEO. "The Codification represents a simplification of the
enormous body of accounting standards. It renders GAAP more understandable
and accessible for research."
During the
one-year verification period,
FASB will make the Codification available through
a new Web-based research system to solicit feedback from constituents to
confirm that the Codification accurately reflects existing GAAP for
nongovernmental entities.
After
receiving feedback, FASB is expected to formally approve the Codification as
the single source of authoritative U.S. GAAP, other than guidance issued by
the
Securities and Exchange Commission. The
Codification will include authoritative content issued by the SEC, as well
as selected SEC staff interpretations.
Upon approval by
FASB, all accounting standards (other than the SEC guidance) used to
populate the Codification will be superseded. At that time, with the
exception of any SEC or grandfathered guidance, all other accounting
literature not included in the Codification will become nonauthoritative.
Users who
register at
http://asc.fasb.org are able to review the
Codification free of charge and provide specific content-related feedback at
the individual paragraph level as well as general system-related feedback.
During the verification period, Codification content will be updated for
changes resulting from constituent feedback and new standards.
On cost (replacement)
versus (fair) value, Walter Teets and I have written a paper that we
recently submitted to FAJ. The basic thrust is that cost can be
associated with principles-based accounting, and value cannot. That’s
why FAS 157 is rules based and filled with anomalies. You can read the
working paper
here,
or read my blog post that it
was based on
here. Comments,
especially on the working paper, would be much appreciated.
"...as strange as this may sound, Bristol-Myers Squibb
was the latest company to do the equivalent of taking a
charge against cash when it announced a $275 million
impairment of debt investments that held such things as
surprise! subprime and home-equity loans.
Companies don't really take charges against cash, of
course, but investments that double as cash might as
well be cash. Auction-rate securities, as these arcane
investments are called, were deemed so safe that they
sat on the balance sheet not far from Treasurys in a
near-cash category called 'marketable securities.'
Until a few years ago, before a change in accounting
rules, Bristol-Myers accounted for auction-rate
securities as actual cash. They are so much like cash
that they yield just a fraction of a percent above cash
and, as Bristol-Myers regulatory filings say, can 'be
liquidated for cash at a short notice.'"
Question
Should "principles-based" standards replace more detailed requirements for
complex financial contracts such as structured financing contracts and financial
instruments derivatives contracts?
'Big-6' joint paper on principles-based accounting standards
The six largest global accounting
networks, including Deloitte Touche Tohmatsu, have jointly
published a paper on Principles-Based
Accounting Standards. The paper was launched to coincide
with a global public policy symposium in New York, hosted by
the firms. The paper, which sets out six key criteria for
principles based standards, was debated in a panel that
included IASB Chairman Sir David Tweedie and FASB Chairman
Robert Herz at the symposium. The six attributes proposed
for principles based standards are:
Faithful presentation of
economic reality
Responsive to users' needs for
clarity and transparency
Consistency with a clear
Conceptual Framework
Based on an appropriately
defined scope that addresses a broad area of accounting
Written in clear, concise, and
plain language
Allows for the use of
reasonable judgment
Click to
Download the Paper (PDF 607k). In releasing the paper, the
CEOs of the six global accounting networks said:
Over the past
several years, a growing dialogue has developed
about the future of financial reporting and the
public company audit profession. In order to advance
that dialogue, during the past year, we have engaged
in discussions with stakeholders around the world on
a number of issues critical to the longterm strength
and stability of global capital markets.
In these talks,
we have been struck by the breadth of support for
International Financial Reporting Standards (IFRSs)
as a single set of high-quality, accounting
standards that ultimately can be used around the
world. Stakeholders indicated their support for IFRS
in part because it is more principles-based than US
GAAP. There was, however, a lack of consensus on the
key characteristics of principles-based standards.
Preliminary decisions by SEC's financial reporting review panel
In June 2007, the US Securities and
Exchange Commission formed the SEC Advisory Committee on
Improvements to Financial Reporting to study the causes of
complexity in the US financial reporting system and to
recommend ways to make financial reports clearer and more
beneficial to investors, reduce costs and unnecessary
burdens for preparers, and better utilize advances in
technology to enhance all aspects of financial reporting.
See our
News Story of 28 June 2007. Last
week, the Advisory Committee held its third meeting and
reached some tentative decisions on changes that it might
propose. The Committee's deliberations were based on a
Draft Decision Memo (PDF 878k)
that sets out the definition and causes of compelxity and
proposals for reducing complexity. The Committee tentatively
agreed to support the following proposals, among others:
GAAP should be based
on transactions and activities, rather than
industries, and most existing industry-specific
guidance should be eliminated.
GAAP should provide
for a single method of accounting for a given
transaction or event and should not normally
include accounting policy choices.
The FASB should be the
source of interpretations of US GAAP, not other
parties.
The SEC and others
should acknowledge that principles-based
standards may result in a reasonable amount of
diversity in practice, and the SEC's compliance
and enforcement activities should not require
restatements that may not be material to
users/investors, so long as the basic principles
in US GAAP are followed. The SEC should
promulgate guidance on materiality in this
context.
Prior period financial
statements should only be restated for errors
that are material to those prior periods.
The SEC and PCAOB
should provide more protections from lawsuits or
SEC enforcement actions for companies and
auditors exercising reasonable professional
judgment.
The SEC should require
XBRL filings by the 500 largest domestic listed
companies, followed by evaluation and a decision
whether to extend this to all listed companies.
The SEC should provide
guidance on corporate websites that provide
financial information to investors.
The Advisory Committee will meet again in March and plans to
publish its final recommendations in third quarter 2008.
Click to Go to the
Advisory Committee's Web Page on the SEC website.
Jensen Comment
Because of the inconsistencies that will arise with "principles-based"
standards, I'm agin em! But that's like spitting into the wind!
Principles-Based Versus Rules-Based Accounting Standards
As Groucho Marx once said, "Those are my
principles, and if you don't like them...well, I have others."
Groucho would enjoy the heated stalemate over
principles-based accounting. Four years after the Sarbanes-Oxley Act
required the Securities and Exchange Commission to explore the feasibility
of developing principles-based accounting standards in lieu of detailed
rules, the move to such standards has gone exactly nowhere. ad
Broadly speaking, principles-based standards would
be consistent, concise, and general, requiring CFOs to apply common sense
rather than bright-lines. Instead of having, say, numerical thresholds to
define when leases must be capitalized, a CFO could use his or her own
judgment as to whether a company's interest was substantial enough to put a
lease on the balance sheet. If anything, though, accounting and auditing
standards have reached new levels of nitpickiness. "In the current
environment, CFOs are second-guessed by auditors, who are then third-guessed
by the Public Company Accounting Oversight Board [PCAOB], and then fourth-
and fifth-guessed by the SEC and the plaintiffs' bar," says Colleen
Cunningham, president and CEO of Financial Executives International (FEI).
Indeed, the Financial Accounting Standards Board
seems to have taken a principled stand in favor of rule-creation. The Board
continues to issue detailed rules and staff positions. Auditors have amped
up their level of scrutiny, in many cases leading to a tripling of audit
fees since 2002. And there is still scant mercy for anyone who breaks the
rules: the annual number of restatements doubled to more than 1,000 between
2003 and 2005, thanks to pressure from auditors and the SEC. The agency
pursued a record number of enforcement actions in the past three years,
while shareholder lawsuits, many involving accounting practices, continued
apace, claiming a record $7.6 billion in settlements last year and probably
more in 2006.
Yet the dream won't die. On the contrary,
principles are at the heart of FASB's latest thinking about changes to its
basic accounting framework, as reflected in the "preliminary views" the
board issued in July with the International Accounting Standards Board (IASB)
as part of its plan to converge U.S. and international standards.
Principles-based accounting has been championed by FASB chairman Robert Herz,
SEC commissioner Paul Atkins, SEC deputy chief accountant Scott Taub, and
PCAOB member Charlie Niemeier in various speeches over the past six months.
And they're not just talking about editing a few lines in the rulebook.
"We need FASB, the SEC, the PCAOB, preparers,
users, auditors, and the legal profession to get together and check their
respective agendas at the door in order to collectively think through the
obstacles," says Herz. "And if it turns out some of the obstacles are
hardwired into our structure, then maybe we need some legal changes as
well," such as safe harbors that would protect executives and auditors from
having their judgments continually challenged. Even the SEC is talking about
loosening up. Most at the agency favor the idea of principles instead of
rules, says Taub, even knowing that "people will interpret them in different
ways and we'll have to deal with it."
Standards Deviation Why lawmakers are so set on
principles and what exactly those principles would look like is all a bit
hazy right now. "Post-Enron, the perception was that people were engineering
around the accounting rules. We looked around the world and saw that England
had principles-based accounting and they didn't have scandals there, so we
decided this was the way to go," recounts CVS Corp. CFO David Rickard, a
Financial Accounting Standards Advisory Committee (FASAC) member.
But Rickard considers the approach "naive." His
firsthand experience with principles-based accounting, as a group controller
for London-based Grand Metropolitan from 1991 to 1997, left him unimpressed.
"We had accounting rules we could drive trucks through," he says.
Would such a change be worth the trouble? A recent
study that compared the accrual quality of Canadian companies reporting
under a relatively principles-based GAAP to that of U.S. companies reporting
by the rules suggests that there may be no effective difference between the
two systems. The authors, Queen's University (Ontario) professors Daniel B.
Thornton and Erin Webster, found some evidence that the Canadian approach
yields better results, but conclude that "stronger U.S. oversight and
greater litigation risk" compensate for any differences.
U.S. GAAP is built on principles; they just happen
to be buried under hundreds of rules. The SEC, in its 2003 report on
principles-based accounting, labeled some standards as being either "rules"
or "principles." (No surprise to CFOs, FAS 133, stock-option accounting, and
lease accounting fall in the former category, while FAS 141 and 142 were
illustrative of the latter.) The difference: principles offer only "a
modicum" of implementation guidance and few scope exceptions or
bright-lines. ad
For FASB, the move to principles-based accounting
is part of a larger effort to organize the existing body of accounting
literature, and to eliminate internal inconsistencies. "Right now, we have a
pretty good conceptual framework, but the standards have often deviated from
the concepts," says Herz. He envisions "a common framework" with the IASB,
where "you take the concepts," such as how assets and liabilities should be
measured, and "from those you draw key principles" for specific areas of
accounting, like pensions and business combinations. In fact, that framework
as it now stands would change corporate accounting's most elemental
principle, that income essentially reflects the difference between revenues
and expenses. Instead, income would depend more on changes in the value of
assets and liabilities (see "Will Fair Value Fly?").
For its part, the SEC has also made clear that it
does not envisage an entirely free-form world. "Clearly, the standard
setters should provide some implementation guidance as a part of a newly
issued standard," its 2003 report states.
The catch is that drawing a line between rules and
principles is easier said than done. Principles need to be coupled with
implementation guidance, which is more of an art than a science, says Ben
Neuhausen, national director of accounting for BDO Seidman. That ambiguity
may explain why finance executives are so divided on support for this
concept. Forty-seven percent of the executives surveyed by CFO say they are
in favor of a shift to principles, another 25 percent are unsure of its
merits, and 17 percent are unfamiliar with the whole idea. Only 10 percent
oppose it outright, largely out of concern that it would be too difficult to
determine which judgments would pass muster.
A Road to Hell? As it stands now, many CFOs fear
that principles-based accounting would quickly lead to court. "The big
concern is that we make a legitimate judgment based on the facts as we
understand them, in the spirit of trying to comply, and that plaintiffs'
attorneys come along later with an expert accountant who says, 'I wouldn't
have done it that way,' and aha! — lawsuit! — several billion dollars,
please," says Rickard.
Massive shareholder lawsuits were a concern for 36
percent of CFOs who oppose ditching rules, according to CFO's survey, and
regulators are sympathetic. "There are institutional and behavioral issues,
and they're much broader than FASB or even the SEC," says Herz, citing "the
focus on short-term earnings, and the whole kabuki dance around quarterly
guidance."
Continued in article
SEC Seeks Stronger GASB Securities and Exchange Commission Chairman Christopher
Cox wants the Governmental Accounting Standards Board to have more clout, he
said Wednesday in a speech at a community town hall meeting in Los Angeles.
SmartPros, July 19, 2007 ---
http://accounting.smartpros.com/x58440.xml
"SEC Advisory Panel Recommends Wholesale Changes in U.S. Accounting,"
by Judith Burns (Dow Jones Newswires), SmartPros, January 14, 2008 ---
http://accounting.smartpros.com/x60389.xml
A Securities and Exchange Commission advisory group
voted Friday to approve recommendations for wholesale changes in U.S.
accounting and financial reporting.
Among the changes unanimously backed by the panel:
base U.S. accounting rules on transactions and activities to avoid special
treatment for various industries, limit corporate financial restatements to
meaningful mistakes, and provide more protections from lawsuits or SEC
enforcement actions for companies and auditors exercising "reasonable"
professional judgment.
Any move away from industry-specific accounting
would be a big change likely Go touch off controversy, according to MFS
Investment Management Co. Chairman Robert Pozen, who heads the SEC advisory
panel on improvements to financial reporting. Pozen predicted "all hell's
going to break loose" once the group issues the recommendation, intended to
reduce complexity and make corporate results more comparable from industry
to industry.
Shielding companies and auditors from
second-guessing or lawsuits when they exercise professional judgment is sure
to be controversial as well. The advisory group urged the SEC to issue a
policy statement or a legal "safe harbor" protecting firms and auditors from
enforcement action or legal challenge provided they acted in good faith and
made a "reasoned" evaluation based on relevant information available to them
at the time.
On restatements, the advisory group called for
companies to correct errors when they are discovered and issue restatements
only for material items, an approach that would reduce the number of
restatements.
The group also wants to shed more light during the
so-called "dark period" after a company announces that it has found a
material error but before it issues a restatement of prior financial
results. The advisory panel called for companies to describe the error, the
periods that might be affected and that are under review, and give an
estimated range of the error's size, any impact it might have and what
management plans to do to prevent such errors in the future.
Deloitte Touche Chief Executive James Quigley, who
serves on the panel, called the recommended approach "a giant step forward"
and panel member Scott Evans, a senior vice president for asset management
at TIAA-Cref, a pension fund for teachers, said expanded disclosure "will
definitely help investors."
The group also endorsed a compromise proposal on
data-tagging technology by calling for the 500 largest U.S. public companies
to furnish reports to the SEC using data tags for part of the financial
statements. The tags, akin to bar codes for individual items in a financial
report, make it easy to find and compare corporate results. That, advocates
say, will benefit investors, analysts and regulators.
The SEC advisory panel is slated to meet again in
March and issue a final recommendation this summer.
Neutrality
In
Concepts Statement No. 2, the FASB asserts it should not issue a standard
for the purpose of achieving some particular economic behavior. Among other
things, this statement implies that the board should not set accounting
standards in an attempt to bolster the economy or some industry sector. Ideally,
scorekeeping should not affect how the game is played. But this is an impossible
ideal since changes in rules for keeping score almost always change player
behavior. Hence, accounting standards cannot be ideally neutral. The FASB,
however, actively attempts not to not take political sides on changing behavior
that favors certain political segments of society. In other words, the FASB
still operates on the basis that fairness and transparency in the spirit of
neutrality override politics. However, there is a huge gray zone that, in large
measure, involves how companies, analysts, investors, creditors, and even the
media react to new accounting rules. Sometimes they react in ways that are not
anticipated by the FASB.
It is said frequently by politicians, SEC and other
regulators, journalists and special interests that the accounting standard
setting process should and must be insulated from politics. As I explain in
this essay, this runs counter to everything we understand about accounting
theory. For decades it has been taught in every graduate accounting program
in the country that accounting standards have economic consequences. As a
result, I contend it is natural and predictable that competing economic
interest attempt a political solution to proposed accounting standards.
This is an important issue at this time, because
they are proposing major changes in the accounting regulatory landscape that
run counter to this conventional wisdom of the financial reporting and
capital market world.
Recently, current (Mary L. Schapiro) and past
(Roderick M. Hills, Harvey L. Pitt, and David S. Ruder) chairmen of the
Securities and Exchange Commission (SEC) and the current Chairmen of the
FASB (Robert Herz) and the IASB (Sir David Tweedie) have been publicly
remarking that the accounting standard setting process should and must be
insulated from the lobbying of special interest groups and the meddling of
government institutions.
Their concern is understandable, because it has
become known that various accounting enacted standards (i.e., fair value
rules, changing lease rules) have economic consequences that produce adverse
effects for certain identifiable corporate interests, and these parties
don’t like it. These affected parties only have three opportunities to lobby
their positions. They can lobby the FASB (or IASB) during the due process
stage before accounting standards are adopted, hoping to get the rule they
want. After implementation of a new rule, they can lobby their auditors for
favorable treatment when they consider how to account for transactions. If
these two fail to produce favorable results, the affected corporations have
one final alternative. They can continue to complain and seek the assistance
of politicians to get the accounting rule changed. Of course, the FASB and
the IASB wish to maintain their rule making franchise, and so they try to
protect their rules and their responsibilities.
The defense of the SEC/FASB/IASB position (insulate
accounting standard setting from politics) is based on a number of premises,
such as, (1) accounting standards are designed to benefit all users and
interests, (2) there is a best accounting rule for every occasion, (3)
accounting standards are economically neutral, and (4) selecting accounting
standards because of their economic impact is the devil’s work.
A famous Journal of Accountancy article, “The
Politicization of Accounting,” by the late University of Pennsylvania
professor David Solomons (1978) is sometimes cited in defense. As reported
by FASB Chairman Robert Herz, Professor Solomons argued for the information
neutrality of accounting standards. Herz quotes Solomons as saying,
“If it ever became accepted that accounting might
be used to achieve other than purely measurement ends, faith in it would be
destroyed just as faith in speedometers would be destroyed once it were
realized that they were subject to falsification for the purpose of
influencing driving habits.”
I also posted a comment (twice) at your blog, but
for some reason your blog won’t post my messages. Most likely there is just
not enough capacity for the likes of me.
My main contribution is to link to an outstanding
1989 article by Denny Beresford on economic consequences. I think this was
written while he was still Chairman of the FASB.
Neutrality is the quality
that distinguishes technical decision-making from political decision-making.
Neutrality is defined in FASB Concepts Statement 2 as the absence of bias that
is intended to attain a predetermined result. Professor Paul B. W. Miller, who
has held fellowships at both the FASB and the SEC, has written a paper titled:
"Neutrality--The Forgotten Concept in Accounting Standards Setting." It is an
excellent paper, but I take exception to his title. The FASB has not forgotten
neutrality, even though some of its constituents may appear to have. Neutrality
is written into our mission statement as a primary consideration. And the
neutrality concept dominates every Board meeting discussion, every informal
conversation, and every memorandum that is written at the FASB. As I have
indicated, not even those who have a mandate to consider public policy matters
have a firm grasp on the macroeconomic or the social consequences of their
actions. The FASB has no mandate to consider public policy matters. It has said
repeatedly that it is not qualified to adjudicate such matters and therefore
does not seek such a mandate. Decisions on such matters properly reside in the
United States Congress and with public agencies.
The only mandate the FASB
has, or wants, is to formulate unbiased standards that advance the art of
financial reporting for the benefit of investors, creditors, and all other users
of financial information. This means standards that result in information on
which economic decisions can be based with a reasonable degree of confidence.
A fear of information
Unfortunately, there is
sometimes a fear that reliable, relevant financial information may bring about
damaging consequences. But damaging to
whom? Our democracy is based on free dissemination of reliable information. Yes,
at times that kind of information has had temporarily damaging consequences for
certain parties. But on balance, considering all interests, and the future as
well as the present, society has concluded in favor of freedom of information.
Why should we fear it in financial reporting?
Continued in article
Questions
Is there a problem with how GAAP covers one's Fannie?
Would fair value accounting help in this situation?
Fannie Mae executives on
Friday defended a change in the way the mortgage lender discloses losses on
home loans amid concern from analysts that it could mask the true impact of
the credit crisis on its bottom line.
The chief financial officer and other executives of
the government-sponsored company, which reported a $1.4 billion
third-quarter loss last week, held a conference call with Wall Street
analysts to explain the recent change.
Analysts peppered the executives with questions in
a skeptical tone. The way Fannie discloses its mortgage losses, addressed in
an article published online by Fortune, raises extra concern among analysts
given that Fannie Mae was racked by a $6.3 billion accounting scandal in
2004 that tarnished its reputation and brought government sanctions against
it.
Moreover, the skepticism from Wall Street comes as
Fannie seeks approval from the government to raise the cap of its investment
portfolio.
The chief financial officer, Stephen Swad, said in
the call that some of the $670 million in provisions for credit losses on
soured home loans that Fannie Mae wrote off in the third quarter likely
would be recovered.
"We book what we book under (generally accepted
accounting principles) and we provide this disclosure to help you understand
it," Swad said.
Shares of Fannie Mae fell $4.30, or 10 percent, to
$38.74 on Friday, following a 10 percent drop the day before.
Shares of Fannie Mae skidded further Friday, after
falling 10% Thursday amid worries over the way the mortgage giant reports
credit losses and a gloomy outlook for the housing market.
The latest decline in the company's share price
came as Chief Financial Officer Stephen Swad on Friday attempted to
alleviate investor concerns about the company's credit losses.
In morning trading, Fannie shares were at $41.30,
down $1.75, or 4%. The shares had fallen as much as 14% early in the day
before recovering somewhat. Shares of Fannie's counterpart, Freddie Mac,
also fell, down $1.98, or 4.8%, to $39.91.
Thursday's drop came after Fortune magazine's Web
site reported a change in the method Fannie uses to report credit losses.
Last week, the nation's biggest investor in
home-mortgage loans reported that its credit losses in the year's first nine
months equaled 0.04% of the company's $2.8 trillion of mortgages and related
securities owned or guaranteed, up from 0.018% a year earlier. That was in
line with the company's forecast.
But the company changed its method of presenting
the figure, excluding unrealized losses on
certain loans that were marked down to reflect current market conditions.
Including those unrealized losses, the rate for this year's first nine
months was 0.075%, up from 0.023% a year before.
Fannie officials said the change was made to
separate realized losses from ones that haven't been realized and depend on
fluctuating market values for loans. A report from J.P. Morgan Chase & Co.
analyst George Sacco said the new method is similar to that used by Freddie
Mac. Fannie officials noted that both the realized and unrealized losses
were reflected in the earnings reported last week.
Fannie's stock had already been falling for a few
weeks amid worries about how hard Fannie would be hurt by rising mortgage
defaults. At an investment conference Thursday in New York, Wells Fargo &
Co.'s chief executive, John Stumpf, predicted more pain for mortgage lenders
in the year ahead as falling home prices cut the value of collateral, saying
the nationwide decline in housing is the worst since the Great Depression.
Thursday, Fannie shares dropped $4.78, or 10%, to
$43.04.
On Friday, Mr. Swad tried to explain further how
the company was accounting for potential losses.
Last week, Fannie Mae reported roughly $670 million
in credit losses in the third quarter related to certain charge-offs
recorded when delinquent loans were purchased from mortgage-backed
securities trusts. Mr. Swad explained Friday that portions of the credit
losses would likely be recovered.
Though these third quarter losses were charged off,
they are not considered realized losses, Mr. Swad said, because the loans
backing these securities could still be "cured." Mr. Swad said the company
was "required to take a charge when the market estimate is below our
purchase price." The company's experience, he added, "has shown that the
majority of these loans don't result in any realized losses." But he
declined to be more specific about what percentage of the loans would
eventually "cure."
Fannie last week released earnings for the first
three quarters of the year. It reported an additional unrealized loss of
$955 million in the value of private-label securities backed by subprime and
Alt-A mortgages through the end of the third quarter. This was in addition
to $376 million the company had previously accounted as a loss for these
securities this year.
For the record, there was no "accounting change" as
per this headline. A headline of "Fannie Mae follows GAAP" probably wouldn't
be quite as sexy but it would be 100% accurate. The company's clear
explanation of what it is required to do under GAAP is covered in the
conference call that is available on Fannie Mae's web site for those
accounting aficionados who want to learn more about AICPA Statement of
Position 03-03 that requires companies repurchasing loans to record them at
fair value. So the answer to your question is that fair value accounting
apparently only complicated analysts' understanding in this case.
Denny Beresford
November 17, 2007 reply from Bob Jensen
Hi Denny,
Your comment sheds a lot of light on this apparent gap between analyst
expectations and GAAP rules in this case. The SEC, FASB, and the IASB are
pushing hard and steady toward fair value accounting with FAS 155, 157, and
159 just being intermediary steps along the way. At least in this case,
however, required fair value accounting is allegedly contributing to the
plunge in Fannie Mae’s share values.
This is another example of the unpredictability of the Neutrality Concept
in standard setting. You point out (see below) that FASB seriously considers
neutrality for every new standard and interpretation with the goal of having
scorekeeping not affect how the game is played, but in athletics and
business it is virtually impossible to change how something is scored
without affecting policies and strategies. For example, when long shots in
basketball commenced to earn three points rather than two points it
fundamentally changed the game of basketball.
Perhaps this is all an example of what you, in 1989,
termed "relevant financial information may bring about damaging
consequences." (see a quote from your article below). It would have been
interesting if the media reporters in 2007 had cited your 1989 article in
this beating Fannie Mae is now taking by adhering to GAAP.
Neutrality is the quality that distinguishes
technical decision-making from political decision-making. Neutrality is
defined in FASB Concepts Statement 2 as the absence of bias that is intended
to attain a predetermined result. Professor Paul B. W. Miller, who has held
fellowships at both the FASB and the SEC, has written a paper titled:
"Neutrality--The Forgotten Concept in Accounting Standards Setting." It is
an excellent paper, but I take exception to his title. The FASB has not
forgotten neutrality, even though some of its constituents may appear to
have. Neutrality is written into our mission statement as a primary
consideration. And the neutrality concept dominates every Board meeting
discussion, every informal conversation, and every memorandum that is
written at the FASB. As I have indicated, not even those who have a mandate
to consider public policy matters have a firm grasp on the macroeconomic or
the social consequences of their actions. The FASB has no mandate to
consider public policy matters. It has said repeatedly that it is not
qualified to adjudicate such matters and therefore does not seek such a
mandate. Decisions on such matters properly reside in the United States
Congress and with public agencies.
The only mandate the FASB has, or wants, is to
formulate unbiased standards that advance the art of financial reporting for
the benefit of investors, creditors, and all other users of financial
information. This means standards that result in information on which
economic decisions can be based with a reasonable degree of confidence.
A fear of information
Unfortunately, there is sometimes a fear that
reliable, relevant financial information may bring about damaging
consequences. But damaging to whom? Our
democracy is based on free dissemination of reliable information. Yes, at
times that kind of information has had temporarily damaging consequences for
certain parties. But on balance, considering all interests, and the future
as well as the present, society has concluded in favor of freedom of
information. Why should we fear it in financial reporting?
Your post on 'neutrality' is very thought provoking and I am
especially appreciative of the link to Denny Beresford's article published
in 1989 in Financial Executive Magazine, which I had not recalled reading
for some time if ever; it is a great article.
I was fortunate to have Dr. David Solomons as my accounting theory professor
at Penn in 1982, and I have always been fascinated by the accounting
standard-setting process and Con. 2's qualitative characteristics of
financial reporting, in particular neutrality and representational
faithfulness, as well as the subject of accounting standard-setting vis-a-vis
public policy.
One of my favorite quotes from the term paper I wrote in Dr. Solomons' class
on the subject of 'Standard-Setting and Social Choice" was by Dale Gerboth,
in which Gerboth said:
“The public
accounting profession has acquired a unique quasi-legislative power
that, in important respects, is self-conferred. Furthermore, its
accounting ‘legislation’ affects the economic well-being of thousands of
business enterprises and millions of individuals, few of whom had
anything to do with giving the profession its power or have a
significant say in its use. By any standard, that is a remarkable
accomplishment.”
[Gerboth, Dale L., "Research, Intuition, and Politics in Accounting
Inquiry" The Accounting Review, Vol. 48, No. 3 (July 1973), pp. 475-482,
published by the American Accounting Association (cite is on pg 481).]
Returning to
Denny's 1989 article, I find it significant that he wrote:
"The
only mandate the FASB has, or wants, is to formulate unbiased standards
that advance the art of financial reporting for the benefit of
investors, creditors, and all other users of financial information. This
means standards that result in information on which economic
decisions can be based with a reasonable degree of confidence. ... Unfortunately,
there is sometimes a fear that reliable, relevant
financial information may bring about damaging consequences."
I believe the
above statement makes sense, and extending it further, the point I'd make
(let me note now these are my personal views) is that: it's one thing if
people want to 'throw caution to the wind' so to speak by saying 'ignore
public policy (or economic) consequences' - but it's another thing to say
that when the proposed accounting treatment would not necessarily 'result in
information on which economic decisions can be based with a reasonable
degree of confidence" or when 'reliability' has been overly sacrificed for
perceived 'relevance.'
Another
consideration should be - 'relevance' for whom and by whom, e.g. relevance
for some who base their own business or consulting service on, e.g.
fire-sale or liquidation prices, vs. e.g. going concern models of
valuation?
Said another
way, I think it's one thing to risk economic upheaval for high quality
standards, vs. risk economic upheaval for accounting standards of
questionable relevance, reliability or representational faithfulness.
Maybe the
concept of 'first, do no harm' is another way of saying this, i.e., do not
inflict unnecessary harm, particularly without exploring the reasonableness
of alternatives, and exploring motivations of all parties involved, and the
ability for investors to truly 'understand' what's behind numbers reported
in accordance with the accounting standards, and the reliability of those
numbers.
Rebecca McEnally & I wrote an article on Neutrality
in Financial Statements for the FASB Report in 2003 from the perspective of
the investor/creditor in which we support the concept of attempting to
achieve neutrality rather than conservatism (or prudence) in financial
reporting and why. (Available from me if anyone wants.)
One of the issues I've encountered over the years
is an elevation of "reliability" in financial reporting to a stature I don't
believe is warranted.
What do we really mean by reliable information?
Someone can demonstrate how it is calculated? Most would get the same answer
if asked to measure? Is something reliable when it's easy to audit?
Every balance sheet item including cash & cash
equivalent has an element of estimation in the measurement, especially in
mult-national companies that have selected functional currencies and
translated them into the presentation currency of the group.
Even with a goal of "neutrality" as one of its
qualitative characteristic, financial reporting will always be subjective.
Lack of "reliable measurement" can be used to do that. Measurements even at
cost require decisions about what's "directly attributable" and what isn't.
Neutrality may not be achievable but let's at least
try.
Regards
Pat Walters
Even though the neutrality-believing FASB is in a state
of denial about the impact of FSB 115-4 on decision making in the real world,
financial analysts and the Director of Corporate Governance at the Harvard Law
School are in no such state of denial,
"The Fall of the Toxic-Assets Plan," The Wall Street Journal, July 9, 2009 ---
http://blogs.wsj.com/economics/2009/07/09/guest-contribution-the-fall-of-the-toxic-assets-plan/
The government
announced plans to move forward with its
Public-Private Investment Program yesterday. Lucian Bebchuk,
professor of law, economics, and finance and director of the corporate
governance program at Harvard Law School, says that the
program, which has been curtailed significantly, hasn’t made the problem go
away.
The plan for buying troubled assets — which was
earlier announced as the central element of the administration’s financial
stability plan — has been recently curtailed drastically. The Treasury and
the FDIC have attributed this development to banks’ new ability to raise
capital through stock sales without having to sell toxic assets.
But the program’s inability to take off is in large
part due to decisions by banking regulators and accounting officials to
allow banks to pretend that toxic assets haven’t declined in value as long
as they avoid selling them.
The toxic assets clogging banks’ balance sheets
have long been viewed — by both the Bush and the Obama administrations — as
being at the heart of the financial crisis. Secretary Geithner put forward
in March a “public-private investment program” (PPIP) to provide up to $1
trillion to investment funds run by private managers and dedicated to
purchasing troubled assets. The plan aimed at “cleansing” banks’ books of
toxic assets and producing prices that would enable valuing toxic assets
still remaining on these books.
The program naturally attracted much attention, and
the Treasury and the FDIC have begun implementing it. Recently, however, one
half of the program, focused on buying toxic loans from banks, was shelved.
The other half, focused on buying toxic securities from both banks and other
financial institutions, is expected to begin operating shortly but on a much
more modest scale than initially planned.
What happened? Banks’ balance sheets do remain
clogged with toxic assets, which are still difficult to value. But the
willingness of banks to sell toxic assets to investment funds has been
killed by decisions of accounting authorities and banking regulators.
Earlier in the crisis, banks’ reluctance to sell
toxic assets could have been attributed to inability to get prices
reflecting fair value due to the drying up of liquidity. If the PIPP program
began operating on a large scale, however, that would no longer been the
case.
Armed with ample government funding, the private
managers running funds set under the program would be expected to offer fair
value for banks’ assets. Indeed, because the government’s funding would come
in the form of non-recourse financing, many have expressed worries that such
fund managers would have incentives to pay even more than fair value for
banks’ assets. The problem, however, is that banks now have strong
incentives to avoid selling toxic assets at any price below face value even
when the price fully reflects fair value.
A month after the PPIP program was announced, under
pressure from banks and Congress, the U.S. Financial Accounting Standards
Board watered down accounting rules and made it easier for banks not to mark
down the value of toxic assets. For many toxic assets whose fundamental
value fell below face value, banks may avoid recognizing the loss as long as
they don’t sell the assets.
Even if banks can avoid recognizing economic losses
on many toxic assets, it remained possible that bank regulators will take
such losses into account (as they should) in assessing whether banks are
adequately capitalized. In another blow to banks’ potential willingness to
sell toxic assets, however, bank supervisors conducting stress tests decided
to avoid assessing banks’ economic losses on toxic assets that mature after
2010.
The stress tests focused on whether, by the end of
2010, the accounting losses that a bank will have to recognize will leave it
with sufficient capital on its financial statements. The bank supervisors
explicitly didn’t take into account the decline in the economic value of
toxic loans and securities that mature after 2010 and that the banks won’t
have to recognize in financial statements until then.
Together, the policies adopted by accounting and
banking authorities strongly discourage banks from selling any toxic assets
maturing after 2010 at prices that fairly reflect their lowered value. As
long as banks don’t sell, the policies enable them to pretend, and operate
as if, their toxic assets maturing after 2010 haven’t fallen in value at
all.
By contrast, selling would require recognizing
losses and might result in the regulators’ requiring the bank to raise
additional capital; such raising of additional capital would provide
depositors (and the government as their guarantor) with an extra cushion but
would dilute the value of shareholders’ and executives’ equity. Thus, as
long as the above policies are in place, we can expect banks having any
choice in the matter to hold on Go toxic assets that mature after 2010 and
avoid selling them at any price, however fair, that falls below face value.
While the market for banks’ toxic assets will
remain largely shut down, we are going to get a sense of their value when
the FDIC auctions off later this summer the toxic assets held by failed
banks taken over by the FDIC. If these auctions produce substantial
discounts to face value, they should ring the alarm bells. In such a case,
authorities should reconsider the policies that allow banks to pretend that
toxic assets haven’t fallen in value. In the meantime, it must be recognized
that the curtailing of the PIPP program doesn’t imply that the toxic assets
problem has largely gone away; it has been merely swept under the carpet.
Bob Jensen's threads on Fannie Mae's enormous problem
(the largest in history that led to the firing of KPMG from the audit and a
multiple-year effort to restate financial statemetns) with applying FAS 133 ---
http://faculty.trinity.edu/rjensen/caseans/000index.htm#FannieMae
"Will Whopping Goodwill Hits Hurt Deals? The big question for many
investors is whether the backlash from past mergers will cool deal valuations
going forward," by Alix Stewart, CFO.com, July 1, 2009 ---
http://www.cfo.com/article.cfm/13940669/c_2984368/?f=archives
The hits just kept coming last winter, as company
after company reported huge goodwill impairment charges along with their
2008 earnings. Among the biggies: Conoco Phillips's $25 billion writedown
and CBS Corp's $14 billion one, plus multi-billion impairment charges from
Citigroup, Regions Financial, and AIG.
A billion here and a billion there, and it starts
to look like real money. A new report by KPMG, in fact, tallies by just how
much: a grand total of $340 billion for over 1600 large companies, or about
one-third of all the goodwill recorded on their books, according to Seth
Palatnik, partner in KPMG's Valuation Services practice. "This was a big
deal for many public companies," he says. Nearly 300 companies in the study
took such charges in reporting 2008 earnings, up from less than 100 the year
before. All told, over 400 public companies recorded goodwill impairment
charges in the past 12 months, according to data retrieved from Capital IQ
for CFO.com.
The big question for many investors is whether this
backlash from past mergers will affect deal valuations going forward. Not
likely, say some executives. Audiovox , which owns RCA and Energizer brands,
among others, recorded a $39 million charge related to goodwill last year.
But those charges are unlikely to affect the company's appetite for
acquisitions going forward, CEO Patrick Lavelle said in a May earnings call.
Decisions about making a deal rely on "the sales that we're picking up and
the gross profit and the income that's generated from that gross profit,
along with our ability to leverage our existing overhead so that we can
reduce the overhead of the acquired company," he said. "The goodwill doesn't
really, in my estimation, enter into that decision."
Goodwill, or the value of an acquisition's
intangible assets over and above its purchase price, must be tested at least
yearly, according to FAS 142, and more often when a "triggering event"
occurs. For the most part, it was the "triggering event" of dragging stock
prices that made book values look too high, forcing the goodwill testing and
subsequent write-downs, says Palatnik. While the charges don't affect cash
flow, they take a slice out of shareholders' equity and earnings-per-share
estimates, and imply that a company overpaid for the acquisitions it's now
writing down. Depending on how a company's loans are structured, the sudden
asset shrinkage could also trigger covenant violations.
Goodwill-related charges more than doubled from
2007, when $143 billion of goodwill was written down, and more than tripled
from the $87 billion of charges taken in 2006, according to the KPMG report.
It's no surprise that banks were the hardest-hit sector, accounting for
almost a quarter of the $340 billion. But many companies in the
semiconductor, technology hardware, media, and consumer goods industries
were sorely affected, too. Fourteen companies, including Symantec, Sirius XM,
and Cadence Design Systems, saw impairment charges swamp annual revenue,
according to data retrieved from Capital IQ for CFO.com.
Continued in article
Standard Setting and Securities Markets: U.S. Versus Europe
Some similarities to Chair of SEC, but some
important differences. SEC has direct regulatory powers over securities
markets, entities that offer securities in those markets, broker/dealers in
securities, auditors, and others. SEC can impose penalties on those it
regulates.
In Europe there is no pan-European securities
regulator equivalent to the SEC with direct regulatory powers similar to the
SEC's. Rather, there are 27 securities regulators (one from each member
state) who have that power. Here's a link to the list:
There is a coordinating body of European securities
regulators called CESR (the Committee of European Securities Regulators
(http://www.cesr-eu.org/)
but CESR's role is advisory, not regulatory.
When the European Parliament adopts legislation
(such as securitieslegislation) the legislation first has to be transposed
(legally adopted) into the national laws of the Member States. Commissioner
McCreevy's role is to propose policies and propose legislation to adopt
those policies in Europe, oversee implementation of the legislation in the
27 Member States (plus 3 EEA countries), and (through both persuasion and
some legal authority) try to ensure consistent and coordinated
implementation. The Commissioner also has outreach and liaison
responsibilities outside the European Union. Because there is no
pan-European counterpart to the SEC Chairman, Commissioner McCreevy
generally handles top level policy liaison between the SEC and Europe.
Like the Chair of the SEC, EU Commissioners are
political appointees.
Question
Is a major overhaul of accounting standards on the way?
Hint
There may no longer be the tried and untrusted earnings per share number to
report! Comment
It would be interesting to see a documentation of the academic research, if any,
that the FASB relied upon to commence this blockbuster initiative. I recommend
that some astute researcher commence to probe into the thinking behind this
proposal.
Pretty soon the bottom line may not be, well, the
bottom line.
In coming months, accounting-rule makers are
planning to unveil a draft plan to rework financial statements, the bedrock
data that millions of investors use every day when deciding whether to buy
or sell stocks, bonds and other financial instruments. One possible result:
the elimination of what today is known as net income or net profit, the
bottom-line figure showing what is left after expenses have been met and
taxes paid.
It is the item many investors look to as a key
gauge of corporate performance and one measure used to determine executive
compensation. In its place, investors might find a number of profit figures
that correspond to different corporate activities such as business
operations, financing and investing.
Another possible radical change in the works:
assets and liabilities may no longer be separate categories on the balance
sheet, or fall to the left and right side in the classic format taught in
introductory accounting classes.
ACCOUNTING OVERHAUL
Get a glimpse of what new financial statements
could look like, according to an early draft recently provided by the
Financial Accounting Standards Board to one of its advisory groups.The
overhaul could mark one of the most drastic changes to accounting and
financial reporting since the start of the Industrial Revolution in the 19th
century, when companies began publishing financial information as they
sought outside capital. The move is being undertaken by accounting-rule
makers in the U.S. and internationally, and ultimately could affect
companies and investors around the world.
The project is aimed at providing investors with
more telling information and has come about as rule makers work to one day
come up with a common, global set of accounting standards. If adopted, the
changes will likely force every accounting textbook to be rewritten and
anyone who uses accounting -- from clerks to chief executives -- to relearn
how to compile and analyze information that shows what is happening in a
business.
This is likely to come as a shock, even if many
investors and executives acknowledge that net income has flaws. "If there
was no bottom line, I'd want to have a sense of what other indicators I
ought to be looking at to get a sense of the comprehensive health of the
company," says Katrina Presti, a part-time independent health-care
contractor and stay-at-home mom who is part of a 12-woman investment club in
Pueblo, Colo. "Net income might be a false indicator, but what would I look
at if it goes away?"
The effort to redo financial statements reflects
changes in who uses them and for what purposes. Financial statements were
originally crafted with bankers and lenders in mind. Their biggest question:
Is the business solvent and what's left if it fails? Stock investors care
more about a business's current and future profits, so the net-income line
takes on added significance for them.
Indeed, that single profit number, particularly
when it is divided by the number of shares outstanding, provides the most
popular measure of a company's valuation: the price-to-earnings ratio. A
company that trades at $10 a share, and which has net profit of $1 a share,
has a P/E of 10.
But giving that much power to one number has long
been a recipe for fraud and stock-market excesses. Many major accounting
scandals earlier this decade centered on manipulation of net income. The
stock-market bubble of the 1990s was largely based on investors' assumption
that net profit for stocks would grow rapidly for years to come. And the
game of beating a quarterly earnings number became a distraction or worse
for companies' managers and investors. Obviously it isn't known whether the
new format would cut down on attempts to game the numbers, but companies
would have to give a more detailed breakdown of what is going on.
The goal of the accounting-rule makers is to better
reflect how businesses are actually run and divert attention from the one
number. "I know the world likes single bottom-line numbers and all of that,
but complicated businesses are hard to translate into just one number," says
Robert Herz, chairman of the Financial Accounting Standards Board, the U.S.
rule-making body that is one of several groups working on the changes.
At the same time, public companies today are more
global than local, and as likely to be involved in services or lines of
business that involve intellectual property such as software rather than the
plants and equipment that defined the manufacturing age. "The income
statement today looks a lot like it did when I started out in this
profession," says William Parrett, the retiring CEO of accounting firm
Deloitte Touche Tohmatsu, who started as a junior accountant in 1967. "But
the kind of information that goes into it is completely different."
Along the way, figures such as net income have
become muddied. That is in part because more and more of the items used to
calculate net profit are based on management estimates, such as the value of
items that don't trade in active markets and the direction of interest
rates. Also, over the years rule makers agreed to corporate demands to
account for some things, such as day-to-day changes in the value of pension
plans or financial instruments used to protect against changes in interest
rates, in ways that keep them from causing swings in net income.
Rule makers hope reformatting financial statements
will address some of these issues, while giving investors more information
about what is happening in different parts of a business to better assess
its value. The project is being managed jointly by the FASB in the U.S. and
the London-based International Accounting Standards Board, and involves
accounting bodies in Japan, other parts of Asia and individual European
nations.
The entire process of adopting the revised approach
could take a few years to play out, so much could yet change. Plus, once
rule makers adopt the changes, they would have to be ratified by regulatory
authorities, such as the Securities and Exchange Commission in the U.S. and
the European Commission in Europe, before public companies would be required
to follow them.
As a first step, rule makers expect later this year
to publish a document outlining their preliminary views on what new form
financial statements might take. But already they have given hints of what's
in store. In March, the FASB provided draft, new financial statements at the
end of a 32-page handout for members of an advisory group. (See an example.)
Although likely to change, this preview showed an
income statement that has separate segments for the company's operating
business, its financing activities, investing activities and tax payments.
Each area has an income subtotal for that particular segment.
There is also a "total comprehensive income"
category that is wider ranging than net profit as it is known today, and so
wouldn't be directly comparable. That is because this total would likely
include gains and losses now kept in other parts of the financial
statements. These include some currency fluctuations and changes in the
value of financial instruments used to hedge against other items.
Comprehensive income could also eventually include
short-term changes in the value of corporate pension plans, which currently
are smoothed out over a number of years. As a result, comprehensive income
could be a lot more difficult to predict and could be volatile from quarter
to quarter or year to year.
As for the balance sheet, the new version would
group assets and liabilities together according to similar categories of
operating, investing and financing activities, although it does provide a
section for shareholders equity. Currently, a balance sheet is broken down
between assets and liabilities, rather than by operating categories.
Such drastic change isn't likely to happen without
a fight. Efforts to bring now-excluded figures into the income statement
could prompt battles with companies that fear their profit will be subject
to big swings. Companies may also balk at the expense involved.
"The cost of this change could be monumental," says
Gary John Previts, an accounting professor at Case Western Reserve
University in Cleveland. "All the textbooks are going to have to change,
every contract and every bank arrangement will have to change." Investors in
Europe and Asia, meanwhile, have opposed the idea of dropping net profit as
it appears today, David Tweedie, the IASB's chairman, said in an interview
earlier this year.
Analysts in the London office of UBS AG recently
published a report arguing this very point -- that even if net income is a
"simplistic measure," that doesn't mean it isn't a valid "starting point in
valuation" and that "its widespread use is justification enough for its
retention."
Such opposition doesn't surprise many accounting
experts. Net income is "the basis for bonuses and judgments about what a
company's stock is worth," says Stephen A. Zeff, an accounting professor at
Rice University. "I just don't know what the markets would do if companies
stopped reporting a bottom line somewhere." In the U.S., professional
investors and analysts have taken a more nuanced view, perhaps because the
manipulation of numbers was more pronounced in U.S. markets.
That said, net profit has been around for some
time. The income statement in use today, along with the balance sheet,
generally dates to the 1940s when the SEC laid out regulations on financial
disclosure. But many companies have included net profit in one form or
another since the 1800s.
In its fourth annual report, General Electric Co.
provided investors with a consolidated balance sheet and consolidated
profit-and-loss account for the year ended Jan. 31, 1896. The company, whose
board at the time included Thomas Edison, generated "profit of the year" --
what today would be called net income or net profit -- of $1,388,967.46.
For the moment, net profit will probably exist in
some form, although its days are likely numbered. "We've decided in the
interim to keep a net-income subtotal, but that's all up for discussion,"
the FASB's Mr. Herz says.
Accounting Rule Is Eased for Foreign Companies Federal regulators tentatively agreed Wednesday to ease
an accounting requirement for foreign companies that trade on United States
exchanges. The action by the Securities and Exchange Commission paves the way
for a related change that would allow public companies to choose between
international and United States accounting standards when reporting financial
results. The step taken by the S.E.C. on Wednesday would eliminate a requirement
for foreign companies to reconcile their financial results with United States
standards called generally accepted accounting principles, or GAAP. Foreign
companies, which already adhere to what are called international financial
reporting standards, say the S.E.C. mandate is burdensome and costly. The
change, which awaits formal adoption after a 75-day public comment
period, would apply to 2008 annual reports, which are submitted in early 2009.
Associated Press, "Accounting Rule Is Eased for Foreign Companies," The New
York Times, June 21, 2007 ---
http://www.nytimes.com/2007/06/21/business/worldbusiness/21sec.html
From The Wall Street Journal Accounting Weekly Review on
March 30, 2007
SUMMARY: Robert E. Denham is Chairman
of the Financial Accounting Foundation (FAF), the oversight
organization of trustees for the Financial Accounting Standards
Board (FASB) and the Governmental Accounting Standards Board (GASB).
In this editorial page discussion, he responds to concerns
expressed in a March 9, 2007, editorial by former SEC Chairman
Arthur Levitt, Jr. Mr. Denham discusses the benefits of stable
funding that has been achieved for the FASB through
Sarbanes-Oxley requirements and wishes for such a resource for
the GASB. He comments on the fact that the FASB and the GASB
recently have taken "concrete steps to improve user input to the
standard-setting process." He also describes how the Boards have
faced enormous opposition at times from corporations and
Congressional leaders to do things that have in hindsight turned
out to be "the right thing to do. "As they demonstrated in
standing up to corporate and governmental pressure on options
expensing, the trustees act to protect the independence of the
standards setters when they are attacked by special interest
groups seeking to block or reverse the decisions of the boards.
Students may answer questions by referring to the organizations'
web sites at http://www.fasb.org/faf/
QUESTIONS:
1.) What is the Financial Accounting Foundation? What is its
role in relation to the Financial Accounting Standards Board (FASB)
and the Governmental Accounting Standards Board (GASB)?
2.) Why is it important that the FASB and GASB operate on an
independent basis? How did implementation of the Sarbanes-Oxley
law improve that ability for the FASB?
3.) What challenges do the FASB and GASB face in setting
standards that are controversial? How does independence help in
facing those challenges? Glean all you can from the articles or
from your own knowledge.
Reviewed By: Judy Beckman, University of Rhode
Island
The six biggest international audit firms have
called for a complete overhaul of corporate financial reporting as
the U.S. and Europe move toward convergence of international audit
standards.
In a Nov. 8 report, the accounting firms
propose to replace static quarterly financial statements with
real-time, Internet-based reporting that encompasses a wider range
of performance measures, including non-financial ones. The report
was signed by the chiefs of PricewaterhouseCoopers International,
Grant Thornton International, Deloitte, KPMG International, BDO
International, and Ernst & Young. The report can be downloaded
here.
"We all believe the current model is
broken," Mike D. Rake, KPMG's chairman, told the Financial Times.
"There are significant shortcomings to U.S. GAAP [Generally Accepted
Accounting Principles] and issues of concern with International
Financial Reporting Standards. We're not in a very happy situation."
Rake noted that quarterly reporting and the
short-term focus on companies' ability to meet Wall Street earnings
expectations helped foster accounting scandals. The firms have been
working on their proposals for more than a year.
The large discrepancy between the "book"
and "market" values of many listed companies is clear evidence that
the content of traditional financial statements is of limited use,
the report said. The audit firms recommend using non-financial
measures that would provide more valuable indications of a company's
future prospects, such as customer satisfaction, product or service
defects, employee turnover, and patent awards.
The report said the following developments
need to occur to ensure capital market stability, efficiency, and
growth:
--Investor needs for information are well
defined and met;
--The roles of the various stakeholders in these markets--financial
statement preparers, regulators, investors, standards setters, and
auditors--are aligned and supported by effective forums for
continuous dialogue;
--The auditing profession is vibrant, sustainable, and provides
sufficient choice for all stakeholders in these markets;
--A new business-reporting model is developed to deliver relevant
and reliable information in a timely way;
--Large, collusive frauds are more and more rare; and
--Information is reported and audited pursuant to globally
consistent standards.
ICGN Expresses Concerns Over
Convergence
Meanwhile, the
International Corporate Governance Network (ICGN) has expressed
concerns about a draft proposal on harmonizing international and
U.S. accounting standards. The ICGN argues that the draft doesn't
pay sufficient attention to shareholder rights and the stewardship
role of boards and investors.
"Convergence must be there to raise
standards," ICGN Executive Director Anne Simpson told the Financial
Times. "Convergence for its own sake is not of value."
The ICGN letter was in response to a
request for comment by the International Accounting Standards Board
(IASB) and its U.S. counterpart, the Financial Accounting Standards
Board (FASB) on a discussion paper on harmonization objectives. The
IASB and the FASB have been working on harmonizing the two
accounting systems since October 2002 and have set 2008 as the goal
for finalizing the process.
Unlike the current IASB auditing framework,
the discussion paper endorses a model more similar to U.S.
standards, dropping a key shareowner safeguard embedded in
U.K.-style standards, the ICGN noted. Rather than focusing audits on
past transactions, the discussion paper calls for audits to focus on
"decision-usefulness" that can affect company cash flows, the letter
said.
"We are concerned that this emphasis on the
ability to forecast the future does not fully capture the
requirements of stewardship, which is concerned with monitoring past
transactions and events," Mark Anson, the CEO of Hermes Pensions
Management who chairs the ICGN, wrote in the Nov. 2 letter. (A
Hermes affiliate is a part owner of ISS.)
"In many jurisdictions, financial
statements provide significant input into the decisions we make as
shareholders, by providing an account of past transactions and
events and the current financial position of the business," the ICGN
letter noted. "In de-emphasizing things that are particularly
[relevant to shareholders' risks and rights], the standards setters
could achieve the perverse effect of actually increasing the cost of
capital."
The ICGN includes more than 400
institutional and private investors, corporations, and advisers from
38 countries with capital under management in excess of $10
trillion, according to its Web site. The ICGN letter also was signed
by Claude Lamoureux, CEO of the Ontario Teachers' Pension Plan.
A copy of the IASB discussion paper, which
was published in July, can be downloaded
here.
Question
Will the U.S. adopt all IFRS international standards while the European Union
cherry picks which standards it will adopt?
From The Wall Street Journal Accounting Weekly Review on
April 27, 2007
"SEC to Mull Letting U.S. Companies Use International Accounting Rules,"
by David Reilly, The Wall Street Journal, Page: C3 ---
http://snipurl.com/WSJ0425
SUMMARY: The article describes the SEC's willingness to consider allowing
U.S. companies to use USGAAP or International Financial Reporting Standards (IFRS)
in their filings. This development stems from the initiative to allow
international firms traded on U.S. exchanges to file using IFRS without
reconciling to USGAAP-based net income and stockholders' equity as is now
required on Form 20F. "SEC Chairman Christopher Cox said the agency remains
committed to removing the reconciliation requirement by 2009. Such a move was
the subject of an SEC roundtable and is being closely watched by European Union
officials." The SEC will accept comments this summer on its proposal to
eliminate the reconciliation requirements. If the agency does implement this
change, then it will consider allowing U.S. companies the same alternative.
QUESTIONS:
1.) What is a "foreign private issuer" (FPI)? Summarize the SEC's current filing
requirements for these entities.
2.) Why is the SEC considering allowing U.S. companies to submit filings
under IFRS rather than U.S. GAAP?
3.) Why might the SEC's decision in this matter "spell the demise of USGAAP"?
4.) Define "principles-based standards" and contrast with "rules-based
standards." Give an example in either USGAAP or IFRS requirements for each of
these items.
5.) "Some experts don't think a move away from U.S. GAAP would necessarily be
bad." Who do you think would hold this opinion? Who would disagree? Explain.
6.) Define the term convergence in relation to global standards. Who is
working towards this goal?
Reviewed By: Judy Beckman, University of Rhode Island
Jensen Comment
Canada has already decided to adopt the IFRS in place of domestic Canadian
standards.
Also don't assume that the European Union automatically adopts
each IASB international standard. For example, the EU may not adopt IFRS 8 ---
http://www.iasplus.com/standard/ifrs08.htm
I am teaching a class, Research for Accounting
Professionals, and I have been thinking about how to prepare my students for
the "real world." I am looking for some insight re: the apparent increased
pressure on accountants. For example, some say that the financial reporting
environment is rivaling the tax world for the number of new rules that come
out every year. I counted the number of statements issued since per year and
found that the 1980s was the busiest period, with 1982 being the highest
year with 18 statements. Does anyone know why that was? If the number of
statements isn't increasing, is it the guidance from SEC that has increased,
or is the pressure coming from the SOX environment with its emphasis on
internal controls? Has the internal control guidance stepped up? Or is the
pressure simply the same pressure that all business people are facing from
increased global competition?
Amy Dunbar
University of Connecticut
School of Business
Department of Accounting
2100 Hillside Road, Unit 1041 Storrs, CT 06269
November 8, 2006 reply from Bob Jensen
Hi Amy,
I don’t think you can
compare numbers of FASB/SEC statements with any sort of confidence. How
do you compare FAS 133 (incredibly complex) with FAS 157 (relatively
simple)? The problem is not the number of new standards but the way new
standards merely add to a growing mountain of previous standards that
does not go away --- the mountain just grows higher and higher.
Our students must face
an exceedingly complex world of technology. They must have skills in
pivot tables, client databases, knowledge databases, ERP, and things
that were just not crashing down on our graduates in the 1980s.
I personally think
that a negative externality of technology has been increased risk of
fraud that increases pressures on auditors. For example, technology has
made it lucrative to steal IDs. Now we have huge conspiracies to steal
those IDs, as witnessed by the recent reporting of a gang, including
hotel owners, managers, and employees, that were stealing IDs at
multiple hotels. Internal controls have just not kept pace with the
level of theft risks and temptations, and our graduates are under
pressures to invent newer internal controls in complicated IT systems.
Hacker/Cracker criminals themselves are extremely sophisticated and
skilled. Our networked enemies can be anywhere on the globe.
Pressures are coming
from a wide variety of interacting causes, not the least of which is SOX
which is basically aimed at improving audit quality. What you had back
in the 1980s was auditing sham! Firms like Andersen were removing much
of the detail testing and trench work out of the audits, thereby taking
much of the pressure off of auditors in the field ---
http://faculty.trinity.edu/rjensen/fraud001.htm#RiskBasedAuditing
The world’s worst audit in history, WorldCom, brought this sham into the
light.
The audit scandals
(spread rather evenly among firms), litigation losses, the nose dive of
reputation of the CPA profession, and SOX turned much of this around and
now the audit firms are trying to restore the professionalism of their
work with a dramatic increase in funding to do the job. But the
pressures are bound to increase as well if auditors really try to do
professional work.
You have audit firms
being fired (the way KPMG was fired from Fannie Mae and E&Y was fired
from TIAA/CREF). You have clients paying millions upon millions to
restate financial statements because of bad auditing (e.g., Fannie is
spending over $100 million to produce restatements). This is bound to
pressure auditors assigned to do the job right. One of my former
students brought in by PwC to help generate Fannie’s restatements said
that he had to become an expert on valuing derivatives using a Bloomberg
terminal (as part of the restatement effort). How many of our accounting
education programs teach students how to value interest rate swaps on a
Bloomberg terminal?
But mostly I think the
pressure is on our graduates to deal with incredibly tough contracts
that their professors and their supervisors themselves do not
understand. Pressure is put on our green-as-grass new graduates to
understand and explain contract complexity all the way up the food chain
in their firms.
Below is a message
that I received yesterday from a recent graduate who went to work
immediately for AT&T rather than one of the big auditing firms. It helps
explain how our young graduates encounter contracts that do not appear
in our textbooks and how they must have skills and knowledge well beyond
what we taught in the past Century.
Hey again Dr. Jensen,
I have another derivatives
situation! Do you know anything about zero coupon bonds that are
puttable? I guess they are a relatively new transaction type
that banks are trying to push. I guess theory is that you
sacrifice some additional risk (by allowing the bondholder to
put to you) in return for a lower interest rate than a typical
zero coupon bond. It is my interpretation that written options
don't count for hedge accounting status unless they offset
another derivative instrument (FAS 133, P 396-401). It is also
my interpretation that this is a situation which would create a
difference in the bond value which would be reflected as an
income statement (other income/expense) effect.
However, I think the financial
components of the situation are over my head, and my boss is
trying to tell me that he thinks that all of this transaction
would either run through interest expense or there would be a
huge increase in income in the first period represented (with no
MTM throughout). I don't understand these arguments. Do you have
any idea what he is getting at?
I am really grateful for any help
you can provide, but I am starting to feel bad about emailing
you. I have always assumed that you enjoyed these kind of
discussions, but if you don't please don't feel obligated to
answer. Just let me know - I don't want to disturb your
retirement!
Each new message from a frustrated former student makes me happier that
I’m retired in the high hills. I would not want to be one of these
young men and women today.
Years ago, I suggested one of my doctoral students
(now a colleague) to prepare a graph that shows how the various standards
are related. The result was the graph attached.
Here, we represent each standard as a point,
equidistant from each other, on the circumference of a circle. Then we draw
an arrow from standard A to standard B if standard A amended Standard B. The
result is the attached graph. It looks more like an oval because I had to
compress the image to fit powerpoint slide.
The graph helps us understand the dynamics of
standards, forces us to ask questions as to why standards may be frequently
revised, why interpretation of "the GAAP" as opposed to standards becomes
difficult, and behooves us to ask what needs to be done.
This sort of a graph is used in information
retrieval as well as exploratory data analysis. I teach using this figure in
my statistics course for accountants (and not Accounting "Theory" course).
Those interested in my first class of the semester,
please Go to the following link:
I believe that SOX and the PCOAB shocked the FASB
for a while and I am not sure that the shock has worn off. I remember
reading in several journals that, with the advent of the PCOAB, the FASB
became tentative. Then I believe you have to consider the FASB process which
requires drafting and approvals with the constant threat of legislative
interference at the federal level. Many have questioned the long-term
efficacy of the FASB process itself. I believe in full disclosure and
feedback in the rule making process but it should not take years - expensing
options as only one of several examples.
I have also read that many believe the FASB is fast
becoming a dinosaur that has outlived its usefulness- it will certainly be
interesting.
Jim Formosa, M.S., CPA
Certified Senior WebCT Trainer
Associate Professor of Accounting
Nashville Community College 615-353-3420 FAX 615-356-1213
1. Codification is a neanderthal concept and a
vestige of the disastrous Napoleonic rule in Europe. It is expensive, does
nothing to resolve whatever ambiguities that might be present (in fact it
might exacerbate them), has high maintenance, and totally ignores all the
developments in information technologies over the past century. In fact, in
my humble opinion, codification is the accounting equivalent of Iraq (I am,
of course, exaggerating here). What is needed is NOT radical reconstitutive
surgery of the body of accounting standards (as in Iraq) by first
disemboweling them, but a philosophical reflection of the way we draft
standards (and how we use them) that is informed by the developments in
information technology.
In my humble opinion, the emerging technologies
surrounding the semantic web initiative of W3C is the way to go, but that
involves considerable research investments.
Years ago I tried a dialogue with some firms (and
also with FASB through some friends) about supporting research in the area,
but my plea fell on deaf ears (except for Arthur Andersen - their Litigation
Support people, who showed considerable interest before they tragically
disbanded).
2. Your second question as to why people still
refer to SASes rather than their codification, I think I can safely rest my
case in 1. above. Codification adds little value at great cost. Codification
is for the lazy people who want their thinking done for them.
If the standards are drafted well, codification is
a trivial task. One can have an algorithm for codification in less than a
semester of a competent doctoral student's time. Drafting the standards well
is another matter, and is a profoundly intellectual activity. We can not do
that without adequate theories of language competence, language use,
reasoning, and theories of textual interpretation (similar to legal
hermeneutics). And having examined the standards as well as EDGAR filings
over the past few years, I can safely say that we in accounting are quite
lacking in each of these.
1. That accounting standards standards have become
complex over the years is true. It is also perhaps true that they are
nowadays better drafted compared with the philosophical ramblings in very
early "standards". However, I personally don't think they are anywhere close
to the tax code in complexity (and of course length. For example, section 10
of SFAS 133, a relatively long paragraph for SFASes, is dwarfed by, for
example section 351 of the Tax code, a relatively average paragraph).
I will not resort to midieval torture of the reader
by reproducing the two sections side-by-side. But the elegance of the tax
code and the lack thereof is there plainly to be seen.
One of the problems with drafting in accounting
standards is in the way definitions are stated. In accounting, the
definitions are often given by examples rather than definitions with
exceptions to the definitions. That is not the only problem. There are a
slew of problems that I wrote about in an article titled "Some thoughts on
the Engineering of Financial Accounting Standards" that I wrote a long time
ago (in the second volume on AI in Accounting edited by Miklos Vasarhelyi.
It would be an interesting exercise comparing the
complexities between the two texts after developing appropriate metrics. I
am not sure accounting standards would measure up to the tax code, but I am
no expert in either field. Perhaps some one like Amy who is one in both can
enlighten us.
Jagdish
November 9, 2006 reply from Bob Jensen
Jagdish,
Codification with enforcement suppresses some types of atrocious
behavior. For example, thousands of CEOs commenced to steal from investors
by backdating stock options until disclosure rules were put in place.
Without codification and enforcement there's anarchy. With excess
codification freedom and creativity is suppressed. It's just very, very
difficult to set the bar optimally because Arrow's Impossibility Theorem
proved it to be impossible ---
http://en.wikipedia.org/wiki/Impossibility_theorem
We are thus doomed to forever debate codes of behavior ad infinitum.
As usual you make good points. However, financial contracting is so
complex that I'm like Amy is with tax accounting. I cannot imagine trying to
account on a subjective judgment basis without codification. Without
codification comparability is virtually impossible with exotic financial
structurings.
It's possible to reduce the problem with simplified rules/laws such as
eliminating 90% of the personal tax code with a new flat tax, eliminating
accrual accounting in favor of cash flow financial reporting, or reporting
on a "fair value" basis for all assets and liabilities. But the social
impacts of a flat tax are contentious. Cash flow reporting is a license for
CEOs to mislead and manipulate investors with cash flow timing
manipulations. Fair value reporting creates more fiction than fact (such as
wild earnings fluctuations of perfect hedges that eliminate cash flow or FX
risk).
Codification sets parameters on major types of behavior. What is "right"
versus "wrong" becomes anarchy if those parameters become subjective
variables. The never-ending debate becomes one of deciding what are the
"major types of behavior" to be codified since it is impractical and
undesirable to set a parameter for every element of behavior. In the case of
financial structuring we keep inventing new "major types." For example, the
interest rate swap was invented in 1984 and quickly became a major way to
raise capital before it even had to be disclosed (FAS 119) and eventually
booked (FAS 133) in Year 2000.
We are thus doomed to forever debate codes of behavior and accounting
standards ad infinitum.
My threads containing earlier arguments on this issue (e.g., Beresford
versus Ketz) are shown below.
A House of Representatives subcommittee is going to
have a public hearing on Wednesday that has the objective of discussing
"ways to promote more transparent financial reporting, including current
initiatives by regulators and industry."
Baker Subcommittee to Advocate Transparency in
Financial Reporting
The Financial Services Subcommittee on Capital
Markets, Insurance and Government Sponsored Enterprises, chaired by Rep.
Richard H. Baker (LA), will convene for a hearing entitled Fostering
Accuracy and Transparency in Financial Reporting. The hearing will take
place on Wednesday, March 29 at 10 a.m. in room 2128 of the Rayburn
building.
Members of the Subcommittee are expected to discuss
ways to promote more transparent financial reporting, including current
initiatives by regulators and industry.
For the capital markets to operate most
efficiently, information about public companies must be understandable,
accessible, and accurate. Corporate statements are mathematical summaries
meant to convey a company’s condition. The four basic documents which must
be filed with the U.S. Securities and Exchange Commission (SEC) are at the
heart of investor disclosure: the income statement, the cash flow statement,
the balance sheet, and the statement of changes in equity.
Among the current initiatives to improve the
clarity and usefulness of public company information is a trend away from
quarterly earnings forecasting, the use of technology to decrease
complexity, and a review of the various accounting standards and how they
interact.
Subcommittee Chairman Baker said, "If U.S. markets
are to remain on top in an increasingly competitive global marketplace, we
need to move away from the complex and cumbersome and explore technological
and other methods of enhancing the clarity, accuracy, and efficiency of our
accounting system. At the same time, we need to look at whether earnings
forecasting and the beat-the-street mentality, which appears to have
contributed to some of the executive malfeasance of the past several years,
truly serves the best interest of investors or the goal of long-term
economic growth."
The corporate scandals several years ago revealed
weaknesses in the financial reporting system. While many companies were
violating financial reporting requirements, regulatory complexity also may
have contributed to some lapses in compliance.
Fraud, general manipulation of statements, and
regulatory complexity all contribute to a reduction in the usefulness of
financial statements and all may obfuscate the picture of companies’
financial health. A number of recent studies have argued against the
practice of predicting future quarterly earnings, concluding that the drive
to “make the numbers” can lead to poor business decisions and the
manipulation of earnings.
Congress, regulators, and the industry subsequently
have assessed financial reporting failures and have reacted with efforts
aimed at strengthening the system, including many provisions of The
Sarbanes-Oxley Act of 2002.
More recent initiatives by regulators to streamline
financial reporting standards and accounting include:
A Financial Accounting Standards Board (FASB)
review of complex and outdated accounting standards;
The use of principles-based, rather than
rules-based, accounting;
FASB’s continued cooperation with the
International Accounting Standards Board on the convergence of
accounting standards; and
The use of eXtensible Business Reporting
Language, or XBRL, a computer code which tags data in financial
statements. The use of XBRL allows investors to quickly download
financial data onto spreadsheets for analysis.
Public Companies have been filing financial
statements with the SEC since the passage of the Securities Exchange Act of
1934.
March 28, 2006 reply from Bob Jensen
Hi Denny,
I know that we disagree on the principles based
standards initiative. My negative position on this is outlined somewhat at
http://snipurl.com/JensenPBS
I just don't think the principles based Ten
Commandments are sufficient to discard all statutes on felony law. I don't
think we can discard all FDA rules on drug testing and replace them with
principles based guidelines for pharmaceutical companies to follow. The same
can be said for environmental protection regulations, child protective
services, and whatever. Sometimes we need detailed rules so we have better
guidance as to what is right and what is wrong in specific and complex
circumstances.
You and I go back to the old days (and we passed the
CPA exam). GAAP was much less complex and could virtually be memorized. We
go back to the days when much was left to "auditor judgment."
But we also go back to the days when CEOs were not
fanatics about hitting analyst forecasts. We go back to days when top-tier
management compensation did not swing heavily an eps number. We go back to
the days when debt was debt and equity was equity. More importantly we go
back to the days when an auditor could actually understand contracts being
written.
In the past CEOs respected auditor decisions and did
not threaten auditors like in so many companies are doing today. Too many
times in recent years we've seen where virtually all big auditing firms have
caved in to pressures from large clients such as the way KPMG caved in on
Fannie Mae and Andersen caved in on various big clients ---
http://faculty.trinity.edu/rjensen/fraud001.htm#others
I think that less complex principles based
standards will only increase conflicts between clients and auditors. Neither
will know that rules (albeit complex rules as in the case of derivatives,
leases, VIEs, and pensions) are being broken if there are no detailed rules
to be broken.
I think the absence of detailed rules greatly
increase inconsistencies in "auditor judgment." I think absence of detailed
rules takes away auditor bargaining chips when dealing with clients.
I guess my bottom line conclusion is that the global
world of contracting, risk management, and mezzanine debt is totally unlike
the simpler world back in the old days when we were auditor whippersnappers.
Bob Jensen
Principles-Based Versus Rules-Based Accounting Standards
As Groucho Marx once said, "Those are my
principles, and if you don't like them...well, I have others."
Groucho would enjoy the heated stalemate over
principles-based accounting. Four years after the Sarbanes-Oxley Act
required the Securities and Exchange Commission to explore the feasibility
of developing principles-based accounting standards in lieu of detailed
rules, the move to such standards has gone exactly nowhere. ad
Broadly speaking, principles-based standards would
be consistent, concise, and general, requiring CFOs to apply common sense
rather than bright-lines. Instead of having, say, numerical thresholds to
define when leases must be capitalized, a CFO could use his or her own
judgment as to whether a company's interest was substantial enough to put a
lease on the balance sheet. If anything, though, accounting and auditing
standards have reached new levels of nitpickiness. "In the current
environment, CFOs are second-guessed by auditors, who are then third-guessed
by the Public Company Accounting Oversight Board [PCAOB], and then fourth-
and fifth-guessed by the SEC and the plaintiffs' bar," says Colleen
Cunningham, president and CEO of Financial Executives International (FEI).
Indeed, the Financial Accounting Standards Board
seems to have taken a principled stand in favor of rule-creation. The Board
continues to issue detailed rules and staff positions. Auditors have amped
up their level of scrutiny, in many cases leading to a tripling of audit
fees since 2002. And there is still scant mercy for anyone who breaks the
rules: the annual number of restatements doubled to more than 1,000 between
2003 and 2005, thanks to pressure from auditors and the SEC. The agency
pursued a record number of enforcement actions in the past three years,
while shareholder lawsuits, many involving accounting practices, continued
apace, claiming a record $7.6 billion in settlements last year and probably
more in 2006.
Yet the dream won't die. On the contrary,
principles are at the heart of FASB's latest thinking about changes to its
basic accounting framework, as reflected in the "preliminary views" the
board issued in July with the International Accounting Standards Board (IASB)
as part of its plan to converge U.S. and international standards.
Principles-based accounting has been championed by FASB chairman Robert Herz,
SEC commissioner Paul Atkins, SEC deputy chief accountant Scott Taub, and
PCAOB member Charlie Niemeier in various speeches over the past six months.
And they're not just talking about editing a few lines in the rulebook.
"We need FASB, the SEC, the PCAOB, preparers,
users, auditors, and the legal profession to get together and check their
respective agendas at the door in order to collectively think through the
obstacles," says Herz. "And if it turns out some of the obstacles are
hardwired into our structure, then maybe we need some legal changes as
well," such as safe harbors that would protect executives and auditors from
having their judgments continually challenged. Even the SEC is talking about
loosening up. Most at the agency favor the idea of principles instead of
rules, says Taub, even knowing that "people will interpret them in different
ways and we'll have to deal with it."
Standards Deviation Why lawmakers are so set on
principles and what exactly those principles would look like is all a bit
hazy right now. "Post-Enron, the perception was that people were engineering
around the accounting rules. We looked around the world and saw that England
had principles-based accounting and they didn't have scandals there, so we
decided this was the way to go," recounts CVS Corp. CFO David Rickard, a
Financial Accounting Standards Advisory Committee (FASAC) member.
But Rickard considers the approach "naive." His
firsthand experience with principles-based accounting, as a group controller
for London-based Grand Metropolitan from 1991 to 1997, left him unimpressed.
"We had accounting rules we could drive trucks through," he says.
Would such a change be worth the trouble? A recent
study that compared the accrual quality of Canadian companies reporting
under a relatively principles-based GAAP to that of U.S. companies reporting
by the rules suggests that there may be no effective difference between the
two systems. The authors, Queen's University (Ontario) professors Daniel B.
Thornton and Erin Webster, found some evidence that the Canadian approach
yields better results, but conclude that "stronger U.S. oversight and
greater litigation risk" compensate for any differences.
U.S. GAAP is built on principles; they just happen
to be buried under hundreds of rules. The SEC, in its 2003 report on
principles-based accounting, labeled some standards as being either "rules"
or "principles." (No surprise to CFOs, FAS 133, stock-option accounting, and
lease accounting fall in the former category, while FAS 141 and 142 were
illustrative of the latter.) The difference: principles offer only "a
modicum" of implementation guidance and few scope exceptions or
bright-lines. ad
For FASB, the move to principles-based accounting
is part of a larger effort to organize the existing body of accounting
literature, and to eliminate internal inconsistencies. "Right now, we have a
pretty good conceptual framework, but the standards have often deviated from
the concepts," says Herz. He envisions "a common framework" with the IASB,
where "you take the concepts," such as how assets and liabilities should be
measured, and "from those you draw key principles" for specific areas of
accounting, like pensions and business combinations. In fact, that framework
as it now stands would change corporate accounting's most elemental
principle, that income essentially reflects the difference between revenues
and expenses. Instead, income would depend more on changes in the value of
assets and liabilities (see "Will Fair Value Fly?").
For its part, the SEC has also made clear that it
does not envisage an entirely free-form world. "Clearly, the standard
setters should provide some implementation guidance as a part of a newly
issued standard," its 2003 report states.
The catch is that drawing a line between rules and
principles is easier said than done. Principles need to be coupled with
implementation guidance, which is more of an art than a science, says Ben
Neuhausen, national director of accounting for BDO Seidman. That ambiguity
may explain why finance executives are so divided on support for this
concept. Forty-seven percent of the executives surveyed by CFO say they are
in favor of a shift to principles, another 25 percent are unsure of its
merits, and 17 percent are unfamiliar with the whole idea. Only 10 percent
oppose it outright, largely out of concern that it would be too difficult to
determine which judgments would pass muster.
A Road to Hell? As it stands now, many CFOs fear
that principles-based accounting would quickly lead to court. "The big
concern is that we make a legitimate judgment based on the facts as we
understand them, in the spirit of trying to comply, and that plaintiffs'
attorneys come along later with an expert accountant who says, 'I wouldn't
have done it that way,' and aha! — lawsuit! — several billion dollars,
please," says Rickard.
Massive shareholder lawsuits were a concern for 36
percent of CFOs who oppose ditching rules, according to CFO's survey, and
regulators are sympathetic. "There are institutional and behavioral issues,
and they're much broader than FASB or even the SEC," says Herz, citing "the
focus on short-term earnings, and the whole kabuki dance around quarterly
guidance."
Robert Herz, chairman of the Financial Accounting
Standards Board, spoke at the AICPA National Conference on Current SEC and
PCAOB Developments* on December 6. Similar to the speech by SEC Chairman
Christopher Cox on the previous day, Mr. Herz directed his comments to the
proposition "that we need to reduce the complexity of our reporting system."
The proposition may be true, but Herz did little to advance the cause in his
speech.
In
particular, Robert Herz merely asserted his beliefs without adding
any logic or any evidence that the reporting system is too complex.
Worse, he touts principles-based accounting as the savior for the
world of financial reporting, but again provides no argumentation to
support his hypothesis. Maybe it’s because there is none. (Read
the full speech.)
Given that we have two chairmen making some brash
comments about the complexity of accounting, let’s investigate this further.
Is complexity really bad? Is complexity really the major problem with
financial reporting?
Is complexity bad?
Suppose a patient visits his or her general
practitioner about some medical problem. After some initial testing, the
general practitioner refers the patient to a specialist. The patient obtains
a copy of the referral letter, but has difficulty reading it. Should a
government agency intervene, complaining that the letter is "too complex"
and require medical doctors to apply plain English?
I think the answer is obvious -- of course not.
When one doctor writes to another physician, he or she may employ scientific
jargon. They are both trained in biology, chemistry, and medicine. The
complex vocabulary and the complex theories that they utilize actually
improve the communication process. The additional complexity allows a doctor
to make more precise statements about the patient's condition and about
possible solutions to the medical problem. Requiring plain English
statements would create greater ambiguity and distort the communication
process.
Of course, when the doctor talks with the patient,
he or she must use plain English. Because the patient does not have medical
training, the patient will not understand the more precise language and
therefore the communication process will suffer if the physician employs
medical language. As the physician employs the less precise language of
everyday English, the patient will learn more about the medical problem and
possible future tests. Some communication with a less precise language is
better than virtually no communication with a more powerful language
designed for experts.
While the analogy isn't perfect, it fits the
accounting scenario. When business enterprises report on their financial
condition and on their results during the past year (or quarter), they can
more precisely convey their message by applying a more precise accounting
language. This text, however, is meant for those trained in finance and in
accounting. Complexity can actually improve the communication process when
the recipient is a sophisticated user.
Naïve financial statement readers may not
understand the language of accounting, but they are not necessarily hurt by
that situation. Just as general practitioners can revert from a medical
language to everyday language when they speak with patients, financial
analysts and brokers can employ plain English when they speak with clients.
In this manner, the messages contained in an annual (or quarterly) report
become disseminated to a wide audience.
More precise language and better economic theories
will improve the communication between business enterprises and
sophisticated users, even if the reports are complex. Sophisticated users
can then translate the messages into plain English and convey these stories
to naïve users.
Is complexity really the major problem?
When remonstrating the overly complex accounting
rules and when touting principles-based accounting, Chairman Herz points to
"bright lines" as an example of what's wrong with current-day standards. I
agree with him that such bright lines constitute a problem, but the problem
isn’t the complexity introduced by these bright lines. The problem is that
these bright lines are arbitrary and capricious. Instead of relying upon
economic theory, the FASB (and the SEC whenever it enters the skirmish) has
invented these bright lines that have no meaning and no empirical referent.
Consider leases: the FASB created the 90 percent
cutoff point for deciding whether a lessee had to capitalize a lease, but it
never informed us why. If the present value of the future cash commitments
equals 89.9 percent of the property's fair value, then the lease is an
operating lease; but if it equals 90 percent, then the lease is a capital
lease. What economic theory does the FASB rest its decision on? No theory at
all. The board randomly and recklessly introduced this bright line into the
literature.
If the board really wanted to improve financial
reporting, then it would require lessees to capitalize all leases that had
duration greater than one year. You introduce no fictitious bright lines and
ironically, you simplify the accounting! More importantly, the rule would
require corporations to tell it as it is rather than distort the economic
reality of the lease.
Continued in article
Jensen Comment
Although there is a ground swell of support for both principles-based accounting
standards and greatly simplified standards, I'm inclined to be against both
movements. Business contracting, especially risk diffusion and management
contracting, is becoming so complex that I think principles-based
standards and greatly simplified standards are moves in the wrong direction.
Powerful new financial analysis tools in networked communications, meta-tagging
(e.g., XBRL), and database sharing (eventually object-oriented database
elements) will be greatly harmed if complex standards do not accompany complex
contracting. I think Professor Ketz has taken a bold stand in the above
article, and I personally take the same stance. This, of course, puts me
at odds with the current and many former directors of standard setting bodies
(e.g., the FASB and the IASB), including my very good friend Dennis Beresford
who sides with Bob Herz and probably influenced Bob Herz. See
http://faculty.trinity.edu/rjensen//theory/00overview/theory01.htm
I'm not necessarily arguing in favor of more bright lines. We can
perhaps avoid these bright lines with more details, albeit complex details,
about contracts, hedging strategies, hedging effectiveness, mezzanine debt
contracts, VIEs, etc. Years ago Bill Beaver (in an innovative unpublished
working paper) argued in favor of database reporting to get around some of the
bright lines problems. This is more complex reporting, but we can have
develop the technologies needed to analyze database reporting. What we
cannot do is do away with complex standards to deal with how complex contracts
are reported in the databases. The standards are what makes comparisons
between databases possible.
The analogy relating accounting to medicine is on target. In this era of DNA
advances in medicine, we do not want medical standards to become less complex in
a more complex world of knowledge. We hope the standards become more complex to
match the increased complexity of our understanding. Similarly, we hope the
standards of accounting become more complex to match the increased complexity of
contracts around the world.
Robert Herz, chairman of the Financial Accounting
Standards Board, spoke at the AICPA National Conference on Current SEC and
PCAOB Developments* on December 6. Similar to the speech by SEC Chairman
Christopher Cox on the previous day, Mr. Herz directed his comments to the
proposition "that we need to reduce the complexity of our reporting system."
The proposition may be true, but Herz did little to advance the cause in his
speech.
In
particular, Robert Herz merely asserted his beliefs without adding
any logic or any evidence that the reporting system is too complex.
Worse, he touts principles-based accounting as the savior for the
world of financial reporting, but again provides no argumentation to
support his hypothesis. Maybe it’s because there is none. (Read
the full speech.)
Given that we have two chairmen making some brash
comments about the complexity of accounting, let’s investigate this further.
Is complexity really bad? Is complexity really the major problem with
financial reporting?
Is complexity bad?
Suppose a patient visits his or her general
practitioner about some medical problem. After some initial testing, the
general practitioner refers the patient to a specialist. The patient obtains
a copy of the referral letter, but has difficulty reading it. Should a
government agency intervene, complaining that the letter is "too complex"
and require medical doctors to apply plain English?
I think the answer is obvious -- of course not.
When one doctor writes to another physician, he or she may employ scientific
jargon. They are both trained in biology, chemistry, and medicine. The
complex vocabulary and the complex theories that they utilize actually
improve the communication process. The additional complexity allows a doctor
to make more precise statements about the patient's condition and about
possible solutions to the medical problem. Requiring plain English
statements would create greater ambiguity and distort the communication
process.
Of course, when the doctor talks with the patient,
he or she must use plain English. Because the patient does not have medical
training, the patient will not understand the more precise language and
therefore the communication process will suffer if the physician employs
medical language. As the physician employs the less precise language of
everyday English, the patient will learn more about the medical problem and
possible future tests. Some communication with a less precise language is
better than virtually no communication with a more powerful language
designed for experts.
While the analogy isn't perfect, it fits the
accounting scenario. When business enterprises report on their financial
condition and on their results during the past year (or quarter), they can
more precisely convey their message by applying a more precise accounting
language. This text, however, is meant for those trained in finance and in
accounting. Complexity can actually improve the communication process when
the recipient is a sophisticated user.
Naïve financial statement readers may not
understand the language of accounting, but they are not necessarily hurt by
that situation. Just as general practitioners can revert from a medical
language to everyday language when they speak with patients, financial
analysts and brokers can employ plain English when they speak with clients.
In this manner, the messages contained in an annual (or quarterly) report
become disseminated to a wide audience.
More precise language and better economic theories
will improve the communication between business enterprises and
sophisticated users, even if the reports are complex. Sophisticated users
can then translate the messages into plain English and convey these stories
to naïve users.
Is complexity really the major problem?
When remonstrating the overly complex accounting
rules and when touting principles-based accounting, Chairman Herz points to
"bright lines" as an example of what's wrong with current-day standards. I
agree with him that such bright lines constitute a problem, but the problem
isn’t the complexity introduced by these bright lines. The problem is that
these bright lines are arbitrary and capricious. Instead of relying upon
economic theory, the FASB (and the SEC whenever it enters the skirmish) has
invented these bright lines that have no meaning and no empirical referent.
Consider leases: the FASB created the 90 percent
cutoff point for deciding whether a lessee had to capitalize a lease, but it
never informed us why. If the present value of the future cash commitments
equals 89.9 percent of the property's fair value, then the lease is an
operating lease; but if it equals 90 percent, then the lease is a capital
lease. What economic theory does the FASB rest its decision on? No theory at
all. The board randomly and recklessly introduced this bright line into the
literature.
If the board really wanted to improve financial
reporting, then it would require lessees to capitalize all leases that had
duration greater than one year. You introduce no fictitious bright lines and
ironically, you simplify the accounting! More importantly, the rule would
require corporations to tell it as it is rather than distort the economic
reality of the lease.
Continued in article
Jensen Comment
Although there is a ground swell of support for both principles-based accounting
standards and greatly simplified standards, I'm inclined to be against both
movements. Business contracting, especially risk diffusion and management
contracting, is becoming so complex that I think principles-based
standards and greatly simplified standards are moves in the wrong direction.
Powerful new financial analysis tools in networked communications, meta-tagging
(e.g., XBRL), and database sharing (eventually object-oriented database
elements) will be greatly harmed if complex standards do not accompany complex
contracting. I think Professor Ketz has taken a bold stand in the above
article, and I personally take the same stance. This, of course, puts me
at odds with the current and many former directors of standard setting bodies
(e.g., the FASB and the IASB), including my very good friend Dennis Beresford
who sides with Bob Herz and probably influenced Bob Herz. See
http://faculty.trinity.edu/rjensen//theory/00overview/theory01.htm
I'm not necessarily arguing in favor of more bright lines. We can
perhaps avoid these bright lines with more details, albeit complex details,
about contracts, hedging strategies, hedging effectiveness, mezzanine debt
contracts, VIEs, etc. Years ago Bill Beaver (in an innovative unpublished
working paper) argued in favor of database reporting to get around some of the
bright lines problems. This is more complex reporting, but we can have
develop the technologies needed to analyze database reporting. What we
cannot do is do away with complex standards to deal with how complex contracts
are reported in the databases. The standards are what makes comparisons
between databases possible.
The analogy relating accounting to medicine is on target. In this era of DNA
advances in medicine, we do not want medical standards to become less complex in
a more complex world of knowledge. We hope the standards become more complex to
match the increased complexity of our understanding. Similarly, we hope the
standards of accounting become more complex to match the increased complexity of
contracts around the world.
The Financial Accounting Standards Board and the
International Accounting Standards Board have joined forces to flesh out a
common conceptual framework. Recently they issued some preliminary views on
the "objectives of financial reporting" and the "qualitative characteristics
of decision-useful financial reporting information" and have asked for
comment.
To obtain "coherent financial reporting," the
boards feel that they need "a framework that is sound, comprehensive, and
internally consistent" (paragraph P3). In P5, they also state their hope for
convergence between U.S. and international accounting standards.
P6 indicates a need to fill in certain gaps, such
as a "robust concept of a reporting entity." I presume that they will
accomplish this task later, as the current document does not develop such a
"robust concept."
Chapter 1 presents the objective for financial
reporting, and the description differs little from what is in Concepts
Statement No. 1. This objective is "to provide information that is useful to
present and potential investors and creditors and others in making
investment, credit, and similar resource allocation decisions." The emphasis
lay with capital providers, as it should. If anything, I would place greater
accent on this aspect, because in the last 10 years, so many managers have
defined the "business world" as including managers and excluding investors
and creditors. To our chagrin, we learned that managers actually believed
this lie, as they pretended that the resources supplied by the investment
community belonged to the management team.
FASB and IASB further explain that these users are
interested in the cash flows of the entity so they can assess the potential
returns and the potential variability of those returns (e.g., in paragraph
OB.23). I wish they had drawn the logical conclusion that financial
reporting ought to exclude income smoothing. Income smoothing leads the user
to assess a smaller variance of earnings than warranted by the underlying
economics; income smoothing biases downward the actual variability of the
earnings and thus the returns.
Later, in the basis of conclusions, the document
addresses the reporting of comprehensive income and its components (see
BC1.28-31). Currently, FASB has four items that enter other comprehensive
income: gains and losses on available-for-sale investments, losses when
incurring additional amounts to recognize a minimum pension liability,
exchange gains and losses from a foreign subsidiary under the all-current
method, and gains and losses from derivatives that hedge cash flows.
The purported reason for this demarcation between
earnings and other comprehensive income rests with the purported low
reliability of measurements of these four items; however, the real reason
for these other comprehensive items seems to be political. For example, FASB
capitulated in Statement No. 115 when a number of managers objected to
reporting gains and losses on available-for-sale securities because that
would create volatility in earnings. (I find it curious how FASB caters to
the whims of managers but claims that the primary rationale for financial
reporting is to serve the investment community.) Because one has a hard time
reconciling other comprehensive income with the needs of investors and
creditors, it would serve the investment community better if the boards
eliminate this notion of comprehensive income.
Two IASB members think that an objective for
financial reporting should encompass the stewardship function (see AV1.1-7).
Stewardship seems to be a subset of economic usefulness, so this objection
is pointless. It behooves these two IASB members to explain the consequences
of adopting a stewardship objective and how these consequences differ from
the usefulness objective before we can entertain their protestation
seriously.
Sections BC1.42 and 43 ask whether management
intent should be a part of the financial reporting process. Given management
intent during the last decade, I think decidedly not. Management intent is
merely a license to massage accounting numbers as managers please.
Fortunately, the Justice Department calls such tactics fraud.
Chapter 2 of this document concerns qualitative
characteristics. For the most part, this presentation is similar to that in
Concepts Statement No. 2, though arranged somewhat differently. Concepts 2
had as its overarching qualitative characteristics relevance and
reliability. This Preliminary Views expounds relevance, faithful
representation, comparability, and understandability as the qualitative
characteristics.
The discussion on faithful representation is
interesting (QC.16-19) inasmuch as they distinguish between accounts that
depict real world phenomena and accounts that are constructs with no real
world referents. They explain that deferred debits and credits do not
possess faithful representation because they are merely the creation of
accountants. I hope that analysis applies to deferred income tax debits and
credits.
Verifiability implies similar measures by different
measurers (QC.23-26). I wish FASB and IASB to include auditability as an
aspect of verifiability; after all, if you cannot audit something, it is
hardly verifiable. Yet, the soon to be released standard on fair value
measurements includes a variety of items that will prove difficult if not
impossible to audit.
Understandability is obvious, though the two boards
feel that users with a "reasonable knowledge of business and economic
activities" can understand financial statements. I no longer agree. Such a
person might employ a profit analysis model or ratio analysis on a set of
financial statements and mis-analyze a firm's condition because he or she
did not make analytical adjustments for off-balance sheet items and other
fanciful tricks by managers. This includes so many of Enron's investors and
creditors. No, to understand financial reporting today, you must be an
expert in accounting and finance.
Benefits-that-justify-costs acts as a constraint on
financial reporting. While this criterion is acceptable, too often the
boards view costs only from the perspective of the preparers. I wish the
boards explicitly acknowledged the fact that not reporting on some things
adds costs to users. When a business enterprise engages in aggressive
accounting, the expert user needs to employ analytical adjustments to
correct this overzealousness. These adjustments consume the investor's
economic resources and thus involve costs to the investment community.
In the basis-for-conclusions section, FASB and IASB
explain that the concept of substance over form is included in the concept
of faithful representation (see paragraphs BC2.17 and 18). While I don't
have a problem with that, I think they should at least emphasize this point
in Chapter 2 rather than bury it in this section. Substance over form is a
critically important doctrine, especially as it relates to business
combinations and leases, so it deserves greater stress.
On balance, the document is well written and
contains a good clarification of the objective of financial reporting and
the qualitative characteristics of decision-useful financial reporting
information. I offer the criticisms above as a hope to strengthen and
improve the Preliminary Views.
My most important comment, however, does not
address any particular aspects within the document itself. Instead, I worry
about the usefulness of this objective and these qualitative characteristics
to FASB and IASB. To enjoy coherent financial reporting, there not only is
need for a sound, comprehensive, and internally consistent framework, we
also must have a board with the political will to utilize the conceptual
framework. FASB ignored its own conceptual framework in its issuance of
standards on:
* Leases (Aren't the financial commitments of the
lessee a liability?) * Pensions (How can the pension intangible asset really
be an asset as it has no real world referent?) * Stock options (Why did the
board not require the expensing of stock options in the 1990s when stock
options clearly involve real costs to the firm?), and * Special purpose
entities (Why did the board wait for the collapse of Enron before dealing
with this issue?).
Clearly, the low power of FASB -- IASB likewise
possesses little power -- explains some of these decisions, but it is
frustrating nonetheless to see the board ignore its own conceptual
framework. Why engage in this deliberation unless FASB is prepared to follow
through?
J. EDWARD KETZ is accounting professor at The Pennsylvania
State University. Dr. Ketz's teaching and research interests focus on
financial accounting, accounting information systems, and accounting ethics.
He is the author of
Hidden Financial Risk, which explores the causes of recent
accounting scandals. He also has edited
Accounting Ethics, a four-volume set that explores ethical
thought in accounting since the Great Depression and across several
countries.
Suggestions for accountancy from the Directors of the SEC and the FASB
From The Wall Street Journal Accounting Weekly Review on December
9, 2005
TITLE: SEC's Cox Wants Simpler Rules, More Competition for Accounting
REPORTER: Judith Burns
DATE: Dec 06, 2005
PAGE: C3
LINK:
http://online.wsj.com/article/SB113381176660114298.html
TOPICS: Accounting, Auditing, Auditing Services, Public Accounting,
Sarbanes-Oxley Act, Securities and Exchange Commission
SUMMARY: Questions relate to helping students understand the status various
influences on the accounting profession from the AICPA, the SEC, the FASB, and
the legislature via the Sarbanes-Oxley Act.
QUESTIONS:
1.) Where did SEC Chairman Christopher Cox describe the ways in which he wants
to see change in the accounting and auditing professions? What is the purpose of
that organization? (Hint: you may find out about the organization's mission via
its web site at www.aicpa.org
2.) In accordance with law, how is the Securities and Exchange Commission
(SEC) responsible for accounting and reporting requirements in the United
States? Hint: you may investigate the SEC's mission via its web site at
www.sec.gov
3.) What are the issues associated with complex accounting rules? Who
establishes those rules? In what way are those rules influenced by the SEC?
4.) The SEC has named an interim chairman of the Public Company Accounting
Oversight Board (PCAOB). How is this speech's topic related to the process of
change in leadership at the PCAOB?
5.) Commissioner Cox indicated his concern over the fact that only 4 public
accounting firms perform audit and accounting work for most of the publicly
traded companies in the U.S. and that regulators may have contributed to that
concentration. How is that the case? What might regulators do to change that
situation?
U.S. securities regulators hope to make accounting
rules less complicated while increasing competition in a field now dominated
by just four firms, Securities and Exchange Commission Chairman Christopher
Cox said.
Addressing a meeting of the American Institute of
Certified Public Accountants, Mr. Cox called for clearer, more
straightforward accounting rules, saying that would benefit investors,
public companies and accountants.
"Plain English is just as important in
accountancy," he said.
Mr. Cox also raised concern about concentration in
the U.S. accounting profession, with the Big Four firms -- Deloitte & Touche
LLP, Ernst & Young LLP, KPMG and PricewaterhouseCoopers -- handling the vast
majority of public-company audits. He said this "intense concentration"
isn't desirable, adding that regulators need to consider whether their rules
are inhibiting competition in the field.
SEC Commissioner Paul Atkins, who also addressed
the meeting, acknowledged that regulators were surprised by the cost of
internal-control rules that took effect for the largest U.S. companies last
year, and he said he hopes such costs will be lower this year.
The rules stem from the Sarbanes-Oxley Act, passed
by Congress in 2002. They mandate that public companies make an annual
examination of their internal controls related to financial reporting,
subject to review by these companies' outside auditors.
The SEC is "at an early stage" in considering who
should head the Public Company Accounting Oversight Board now that William
McDonough, its former chairman, has stepped down, Mr. Atkins said.
Last week the SEC named oversight board member Bill
Gradison, a member of Congress, as interim oversight board chairman. Mr.
Atkins said Mr. Gradison, an Ohio Republican, could be in the running as a
permanent chair "if he wants to be."
In repeated speeches, Dennis Beresford, former Chairman of the FASB, has
called for simplification of accounting standards and guidelines. For
example see the following reference:
"Can We Go Back to the Good Old Days?" by Dennis R. Beresford, The CPA
Journal ---
http://www.nysscpa.org/cpajournal/2004/1204/perspectives/p6.htm
December 6, 2005 message from Dennis Beresford [dberesfo@terry.uga.edu]
1. Accounting rules need to be simplified. "The
accounting scandals that our nation and the world have now mostly weathered
were made possible in part by the sheer complexity of the rules." "The sheer
accretion of detail has, in time, led to one of the system's weaknesses -
its extreme complexity. Convolution is now reducing its usefulness."
2. The concentration of auditing services in the
Big 4 "quadropoly" is bad for the securities markets. The SEC will try to do
more to encourage the use of medium size and smaller firms that receive good
inspection reports from the PCAOB.
3. The SEC will continue to push XBRL. "The
interactive data that this initiative will create will lead to vast
improvements in the quality, timeliness, and usefulness of information that
investors get about the companies they're investing in."
A very interesting talk - one that seems to promise
a high level of cooperation with the accounting profession.
Convergence of foreign and domestic accounting rules could catch some U.S.
companies by surprise Although many differences remain between U.S. generally
accepted accounting principles (GAAP) and international financial reporting
standards (IFRS), they are being eliminated faster than anyone, even Herz or
Tweedie, could have imagined. In April, FASB and the IASB agreed that all major
projects going forward would be conducted jointly. That same month, the
Securities and Exchange Commission said that, as soon as 2007, it might allow
foreign companies to use IFRS to raise capital in the United States, eliminating
the current requirement that they reconcile their statements to U.S. GAAP. The
change is all the more remarkable given that the IASB was formed only four years
ago, and has rushed to complete 25 new or revamped standards in time for all 25
countries in the European Union to adopt IFRS by this year. By next year, some
100 countries will be using IFRS. "We reckon it will be 150 in five years,"
marvels Tweedie. "That leaves only 50 out."
Tim Reason, "The Narrowing GAAP: The convergence of foreign and domestic
accounting rules could catch some U.S. companies by surprise," CFO Magazine
December 01, 2005 ---
http://www.cfo.com/article.cfm/5193385/c_5243641?f=magazine_coverstory
David Fordham wrote the following after a very long and very interesting
illustration of corporate accounting:
*****************
Seeing businesses in Europe, I'm learning that the European laws are to
accountants what weight lifting is to the Mr. Atlas competition. The really
good European accountants are without peer when it comes to working within
the system to turn a profit under the rules. So this begs the question:
should we more agressively teach accountants how to help their managers?
Would we be more valuable as "trusted partners" to management if we could be
more helpful in this way?
******************
Jensen Comment:
First I would note that in Europe most financing was and still is raised
from banks who work in close partnership with companies. As in Japan, these
banks are almost insiders that can get most any kind of information they want
irrespective of accounting rules.
Until the IASB wanted to crack into the U.S. Stock exchanges, the IAS
standards were pretty much milk toast. If the former IASC (it was IASC in those
days) standards had replaced the FASB standards, U.S. Corporations would have
been ecstatic with IASC off-balance sheet financing opportunities and
opportunities to create hidden reserves and manage earnings. European companies
are notorious for managing earnings with hidden reserves.
Whether the two Davids (Albrecht and Fordham) like it or not, the FASB has
struggled to make management of earnings and the hiding of debt more difficult
in the U.S. The standards are now almost incomprehensible (especially for
derivatives, SPEs, mezzanine financing, re-insurance, etc.) because U.S.
companies countered the FASB standards with ever-increasing exotic financial
contracts.
Before complaining about the complexity of FASB standards, first take a
serious look at the absolute nightmare of complexity of the financial and
insurance contracting. Especially look at the absolutely ridiculous derivative
financial instrument contracts that are intentionally designed to be too complex
for accountants or trust investors to understand ---
http://faculty.trinity.edu/rjensen/FraudRotten.htm#DerivativesFrauds
Many exotic contracts are relatively new. We now have over $100 trillion in
interest rate swaps that were not even invented until 1984.
One of my favorite quotations is a 1994 quotation from Denny Beresford while,
as Chairman of the FASB, he was making a presentation in NYC at the annual AAA
meetings. He was at the time being extremely pressured by the SEC to issue what
became FAS 133 in 1998.
The quotation went something like this:
*******************
"The Director of the SEC, Arthur Levitt, tells me the three main problems
for the SEC and FASB are derivatives, derivatives, and derivatives. I had to
ask some experts to tell me what a derivative is, because until now I
thought a derivative was something a person my age takes when prunes don't
quite do the job. Jon Stewart of Arthur Andersen tells me that there are
over 1,000 kinds of complex derivative contracts . . . "
********************
Once again, David, my main point to you is that accounting standards outside
the U.S., Canada, Australia, and New Zealand, did not have to be too complex
since most financing was raised from insiders (mostly banks) who had inside
information sources. The countries with the complex standards rely more on
equity investors who only get the information provided to the public by
companies. The FASB has declared that protection of the public investors is its
number one priority (as is also the case with the SEC).
The real problem we are now facing is that corporations no longer take
accounting seriously other than as something to get around. This has led to an
ever-increasing game where the FASB discovers misleading accounting, writes a
new standard or interpretation, and subsequently discovers how corporations are
re-writing contracts to get around the new standard.
Will this vicious cycle ever cease? Not as long as corporate managers
continue to view accounting as an opportunity to creatively paint rosy
portraits.
David Albrecht asked:
"Has anyone a good definition of financial statement transparency?"
I just want to point out that the UK, which is in
Europe, doesn't meet Bob's description of mostly bank finance. Our financing
is much like that of the US - mostly equity, and our lenders are kept at
arm's length from the board.
And a lot of our accountants are howling at the way
IFRS change the accounts. It's not that people are trying to hide things by
using lax standards (although, from my experience as an auditor, I know that
this does of course happen). It's the fact that we and others don't
understand accounts any more! I'm doing some research at the moment that
involves interviewing experienced CFOs of large listed companies. Almost all
of them are complaining that the IFRS, being 'market' facing, are making a
nonsense of the numbers, because in most cases there isn't a market, and so
they are having to use poor proxies. It's taking us away from factually
based accounts and into a world of estimates - which in some ways makes
earnings management easier, not harder! That was the gist of the FT article
that David cited.
Incidentally, there is a really interesting paper
about the fundamental differences between US and UK approaches to financial
regulation and standards, that sets out why convergence is going to be a
problem - if it ever happens. The title is "Where economics meets the law:
US reporting systems compared to other markets" and you can download it from
the ICAEW's website at
http://www.icaew.co.uk/members/index.cfm?AUB=TB2I_79757|MNXI_79757
Outline is:
"In particular the paper examines: * the evolution
of the US financial reporting model; * contrasting approaches to accounting
and auditing: 'principles' versus 'prescription'; * shareholder rights and
the governance function of annual financial statements; * investor behaviour
and corporate governance; * accounting convergence with the US or
recognition of the differences.
Divided by common language is the first in the
Beyond the myth of Anglo-American corporate governance series which aims to:
Challenge commonly held assumptions regarding the
perceived similarity of US and UK corporate governance systems; Identify
possible areas for convergence and, where not practical, clarify why
elements of one system may not be appropriate for incorporation into
another; Anticipate developments and set out challenges for future thinking
about the US and UK models and encourage transatlantic dialogue."
Regards
Dr Ruth Bender
Cranfield School of Management UK
Dr. Ijiri was one of my major professors in the doctoral program at
Stanford. I'm naturally drawn to things he writes. He is one of the
long-time advocates of historical cost based accounting. He is in fact
much more dedicated to it than
Bill Paton (but not
Ananias Littleton) where Paton and Littleton are best known advocates of
historical cost accounting. The following is the lead article in the
Journal of Accounting and Public Policy, July/August 2005, pp. 255-279.
US accounting standards and their
environment:
A dualistic study of their 75-years of transition
Yuji Ijiri Tepper School of Business, Carnegie Mellon University
Abstract This article examines the 75-year transition of the US accounting
standards and their environment. It consists of three parts, each having
two themes: Part (1) Past changes: 1. The first market crash and the
second market crash; 2. Facts-based accounting and forecasts-based
accounting, Part (II) Present issues: 3. The reform legislation
(Sarbanes-Oxley Act) and the reform administration; 4. Procedural fairness
and pure fairness, and Part (III) Future trends: 5. Forecast
protection and forecast separation; 6. Principles-based systems and
rules-based systems. These themes are each examined from dualistic
perspectives by contrasting two fundamental concepts or principles. The
article concludes with the strong need to focus on "procedural fairness" in
establishing accounting standards as well as in implementing the reform
legislation and administration, in contrast to "pure fairness" that is
almost impossible to achieve by anyone.
Accounting Rules So Plentiful "It's Nuts" There are perhaps 2,000 accounting rules and standards
that, when written out, possibly exceed the U.S. tax code in length. Yet, there
are only the Ten Commandments. So Bob Herz, chairman of the rule-setting
Financial Accounting Standards Board, is asked this: How come there are 2,000
rules to prepare a financial statement but only 10 for eternal salvation? "It is
nuts," Herz allows. "But you're not going to get it down to ten commandments
because the transactions are so complicated. . . . And the people on the front
lines, the companies and their auditors, are saying: 'Give me principles, but
tell me exactly what to do; I don't want to be second-guessed.' " Nonetheless,
the FASB (pronounced, by accounting insiders, as "FAZ-bee") is embarking on
efforts to simplify and codify accounting rules while improving them and
integrating them with international standards.
"Accounting Rules So Plentiful 'It's Nuts' ; Standards Board Takes on Tough Job
to Simplify, Codify," SmartPros, June 8, 2005 ---
http://accounting.smartpros.com/x48525.xml
"Historically, norms of accounting played
an important role in corporate financial reporting. Starting with
the federal regulation of securities, accounting norms have been
progressively replaced by written standards....[and]enforcement
mechanisms, often supported by implicit or explicit power of the
state to impose punishment. The spate of accounting and auditing
failures of the recent years raise questions about the wisdom of
this transition from norms to standards....It is possible that the
pendulum of standardization in accounting may have swung too far,
and it may be time to allow for a greater role for social norms in
the practice of corporate financial reporting."
"The monopoly rights given to the FASB in
the U.S. (and the International Accounting Standards Board or IASB
in the EU) deprived the economies, and their rule makers, from the
benefits of experimentation with alternative rules and structures so
their consequences could be observed in the field before deciding on
which rules, if any, might be more efficient. Rule makers have
little idea, ex ante, of the important consequences (e.g., the
corporate cost of capital) of the alternatives they consider."
"Given the deliberate and premeditated
nature of financial fraud and misrepresentation (and other white
color crimes), "clarifications of the rules invite and facilitate
evasion"
And my favorite!
"Indeed the U.S. constitution, a document
that covers the entire governance system for the republic, has less
than 5,000 words. The United Kingdom has no written constitution. A
great part of the governance of both countries depends on norms. Do
accountants deal with greater stakes?"
BTW: I like the prescriptions called for as
well, but will allow you to read those (pages 20 to 22 of paper)
Cite: Sunder, Shyam, "Social Norms versus
Standards of Accounting" (May 2005). Yale ICF Working Paper No. 05-14.
http://ssrn.com/abstract=725821
Let me close by citing Harry
S. Truman who said, "I never give them hell; I just tell them the truth and they
think its hell!"
Great Speeches About the State of Accountancy
"20th Century Myths," by Lynn Turner when he was still Chief Accountant at the
SEC in 1999 ---
http://www.sec.gov/news/speech/speecharchive/1999/spch323.htm
It is
interesting to listen to people ask for simple, less complex
standards like in "the good old days." But I never hear them ask for
business to be like "the good old days," with smokestacks rather
than high technology, Glass-Steagall rather than Gramm-Leach, and
plain vanilla interest rate deals rather than swaps, collars, and
Tigers!! The bottom line is—things have changed. And so have people.
Today, we have enormous pressure on CEO’s and
CFO’s. It used to be that CEO’s would be in their positions for an
average of more than ten years. Today, the average is 3 to 4 years.
And Financial Executive Institute surveys show that the CEO and CFO
changes are often linked.
In such an environment, we in the auditing
and preparer community have created what I consider to be a
two-headed monster. The first head of this monster is what I call
the "show me" face. First, it is not uncommon to hear one say, "show
me where it says in an accounting book that I can’t do this?" This
approach to financial reporting unfortunately necessitates the level
of detail currently being developed by the Financial Accounting
Standards Board ("FASB"), the Emerging Issues Task Force, and the
AICPA’s Accounting Standards Executive Committee. Maybe this isn’t a
recent phenomenon. In 1961, Leonard Spacek, then managing partner at
Arthur Andersen, explained the motivation for less specificity in
accounting standards when he stated that "most industry
representatives and public accountants want what they call
‘flexibility’ in accounting principles. That term is never clearly
defined; but what is wanted is ‘flexibility’ that permits greater
latitude to both industry and accountants to do as they please." But
Mr. Spacek was not a defender of those who wanted to "do as they
please." He went on to say, "Public accountants are constantly
required to make a choice between obtaining or retaining a client
and standing firm for accounting principles. Where the choice
requires accepting a practice which will produce results that are
erroneous by a relatively material amount, we must decline the
engagement even though there is precedent for the practice desired
by the client."
We create the second head of our monster
when we ask for standards that absolutely do not reflect the
underlying economics of transactions. I offer two prime examples.
Leasing is first. We have accounting literature put out by the FASB
with follow-on interpretative guidance by the accounting
firms—hundreds of pages of lease accounting guidance that, I will be
the first to admit, is complex and difficult to decipher. But it is
due principally to people not being willing to call a horse a horse,
and a lease what it really is—a financing. The second example is
Statement 133 on derivatives. Some people absolutely howl about its
complexity. And yet we know that: (1) people were not complying with
the intent of the simpler Statements 52 and 80, and (2) despite the
fact that we manage risk in business by managing values rather than
notional amounts, people want to account only for notional amounts.
As a result, we ended up with a compromise position in Statement
133. To its credit, Statement 133 does advance the quality of
financial reporting. For that, I commend the FASB. But I believe
that we could have possibly achieved more, in a less complex
fashion, if people would have agreed to a standard that truly
reflects the underlying economics of the transactions in an unbiased
and representationally faithful fashion.
I certainly hope that we can find a way to
do just that with standards we develop in the future, both in the
U.S. and internationally. It will require a change in how we
approach standard setting and in how we apply those standards. It
will require a mantra based on the fact that transparent, high
quality financial reporting is what makes our capital markets the
most efficient, liquid, and deep in the world.
Landmark Exposure Draft containing joint proposals to improve and align
accounting for business combinations
The International Accounting Standards Board (IASB),
based in London, and the US Financial Accounting Standards Board (FASB) have
announced publication of an Exposure Draft containing joint proposals to
improve and align accounting for business combinations. The proposed
standard would replace IASB’s International Financial Reporting Standard (IFRS)
3, Business Combinations and the FASB’s Statement 141, Business
Combinations.
Sir David Tweedie, IASB Chairman and Bob Herz, FASB
Chairman, emphasized the value of a single standard to users and preparers
of financial statements of companies around the world as it improves
comparability of financial information. "Development of a single standard
demonstrates the ability of the IASB and the FASB to work together,” Tweedie
continued.
Recently I visited my pharmacy to pick up eyedrops
for my two golden retrievers. Before he would give me the prescription, the
pharmacist insisted I sign a form on behalf of Murphy and Millie, representing
that they had been apprised of their rights under the new medical privacy
rules. This ludicrous situation is a good illustration of how complicated life
has gotten.
I was still shaking my head later that same day when
I was clicking mindlessly through the 150 or so channels that my local cable
TV service makes available to me. I happened to land on The Andy Griffith
Show, and the few minutes I spent with Andy, Barney, Opie, and Aunt Bea got me
thinking about the Good Old Days. Wouldn’t it be nice, I thought, to go back
to the Good Old Days of the profession in the early 1960s when I graduated
from college?
Back then, accounting was really simple. The
Accounting Principles Board hadn’t issued any standards yet, and FASB didn’t
exist. So we didn’t have 880 pages listing all of the current rules and
guidance on derivative financial instruments, for example. The totality of
authoritative GAAP at that time fit in one softbound booklet about one-third
the size of the new derivatives guidance.
In those Good Old Days, the SEC had been around for
quite a while but it rarely got excited about accounting matters. Neither
mandatory quarterly reporting nor management’s discussion and analysis
(MD&A) had yet come into being, for example. And annual report footnotes
could actually be read in an hour or so.
The country had eight major accounting firms, and
becoming a partner in one was a truly big deal. Lawsuits against accounting
firms were rare, and almost none of them resulted in substantial damages
against the accountants.
In short, accounting seemed more like a true
profession, with good judgment and experience key requirements for success.
Of course, however much we might like to return to
simpler times, it’s easier said than done. And most of us would never give
up the many benefits of progress, such as photocopiers, personal computers,
e-mail, the Internet, and cellphones. But I think that accounting rules may
have become more complicated than necessary.
Let me start with a mea culpa. You may remember the
famous line from the comic strip Pogo: “We have met the enemy, and he is us!”
Well, you may be tempted to rephrase that quote to “We have met the enemy,
and he is … Beresford!”
I plead guilty to having led the development of 40 or
so new accounting standards over my time at FASB. A number of them had
pervasive effects on financial statements, and some have been costly to apply.
I always tried to be as practical as possible, however, although probably few
would say that I was 100% successful in meeting that objective.
In any event, more-recent accounting standards and
proposals seem to be getting increasingly complicated and harder to apply.
Even the best-intentioned accountants have difficulty keeping up with all of
the changes from FASB, the AICPA, the SEC, the EITF, and the IASB. And some
individual standards, such as those on derivatives and variable-interest
entities, are almost impossible for professionals, let alone laypeople, to
decipher.
Furthermore, these days, companies are subject to
what I’ll call quadruple jeopardy. They have to apply GAAP as best they can,
but they are then subject to as many as four levels of possible
second-guessing of their judgments.
First, the external auditors must weigh in. Second,
the SEC will now be reviewing all public companies’ reports at least once
every three years. Third, the PCAOB will be looking at a sample of accounting
firms’ audits, and that could include any given company’s reports.
Finally, the plaintiff’s bar is always looking for opportunities to
challenge accounting judgments and extort settlements. Broad Principles Versus
Detailed Rules
I suspect that all this second-guessing is what leads
many companies and auditors to ask for more-detailed accounting rules. But we
may have reached the point of diminishing returns. In response to the
complexity and sheer volume of many current standards, some have suggested
that accounting standards should be broad principles rather than detailed
rules. FASB and the SEC have expressed support for the general notion of a
principles-based approach to accounting standards. (It’s kind of like apple
pie and motherhood: Who can object to broad principles?) Of course,
implementing such an approach is problematic.
In 2002, FASB issued a proposal on this matter. And
last year the SEC reported to Congress on the same topic. Specific things that
FASB suggested could happen include the following:
Standards should always state very clear objectives.
Standards should have a clearly defined scope and there should be few, if any,
exceptions (e.g., for certain industries). Standards should contain fewer
alternative accounting treatments (e.g., unrealized gains and losses on
marketable securities could all be run through income rather than the various
approaches used at present). FASB also said that a principles-based approach
probably would include less in the way of detailed interpretive and
implementation guidance. Thus, companies and auditors would be expected to
rely more on professional judgment in applying the standards.
The SEC prefers to call this approach “objectives-based”
rather than “principles-based.” SEC Chief Accountant Donald Nicolaisen
recently repeated the SEC’s support for such an approach, agreeing with the
notion of clearly identifying and articulating the objective for each
standard. Although he also suggested that objectives-based standards should
avoid bright-line tests such as lease capitalization rules, he called for “sufficiently
detailed” implementation guidance, including real-world examples.
Although FASB and the SEC may have reached a meeting
of the minds on the overall notion of more general principles, they may
disagree on the key point of how much implementation guidance to provide. FASB
thinks that a principles-based approach should include less implementation
guidance and rely more on judgment, while the SEC thinks that “sufficiently
detailed” guidance is needed, and I suspect that would make it difficult to
significantly reduce complexity in some cases.
In any event, FASB recently said that it may take “several
years or more” for preparers and auditors to adjust to a change to less
detail. Meantime, little has changed with respect to individual standards,
which if anything are becoming even harder to understand and apply.
I’ve heard FASB board members say that FASB
Interpretation (FIN) 46, on variable-interest entities (VIE), is an example of
a principles-based standard. I assume they say this because FIN 46 states an
objective of requiring consolidation when control over a VIE exists. But the
definition of a VIE and the rules for determining when control exists are
extremely difficult to understand.
FASB recently described what it meant by the
operationality of an accounting standard. The first condition was that
standards have to be comprehensible to readers with a reasonable level of
knowledge and sophistication. This doesn’t seem to be the case for FIN 46.
Many auditors and financial executives have told me that only a few
individuals in the country truly know how to apply FIN 46. And those few
individuals often disagree among themselves!
Such complications make it difficult to get decisions
on many accounting matters from an audit engagement team. Decisions on VIEs,
derivatives, and securitization transactions, to name a few, must routinely be
cleared by an accounting firm’s national experts. And with section 404 of
the Sarbanes-Oxley Act (SOA) and new concerns about auditor independence,
getting answers is now even harder. For example, in the past, companies would
commonly consult with their auditors on difficult accounting matters. But now
the PCAOB may view this as a control weakness, under the assumption that the
company lacks adequate internal expertise. And if auditors get too involved in
technical decisions before a complex transaction is completed, the SEC or the
PCAOB might decide that the auditors aren’t independent, because they’re
auditing their own decisions.
When things become this complicated, I wonder whether
it’s time for a new approach. Maybe we do need to go back to the Good Old
Days.
Internal Controls
Today, financial executives are probably more
concerned about internal controls than new accounting requirements. For the
first time, all public companies must report on the adequacy of their internal
controls over financial reporting, and outside auditors must express their
opinion on the company’s controls. Many people have questioned whether this
incredibly expensive activity is worth the presumed benefit to investors.
While one might argue that the section 404 rules are a regulatory
overreaction, shareholders should expect good internal controls. And audit
committees, as shareholders’ representatives, must demand those good
controls. So this has been by far the most time-consuming topic at all audit
committee meetings I’ve attended in the past couple of years.
Companies and auditors are spending huge sums this
year to ensure that transactions are properly processed and controlled. Yet
the most perfect system of internal controls and the best audit of them might
not catch an incorrect interpretation of GAAP. A good example of this was
contained in the PCAOB’s August 2004 report on its initial reviews of the
Big Four’s audit practices. The report noted that all four firms had missed
the fact that some clients had misapplied EITF Issue 95-22. As the New York
Times (August 27, 2004) noted, “The fact that all of the top firms had been
misapplying it raised issues of just how well they know the sometimes
complicated rules.”
Responding to a different criticism in that same
PCAOB report, KPMG noted, “Three knowledgeable informed bodies—the firm,
the PCAOB, and the SEC—had reached three different conclusions on proper
accounting, illustrating the complex accounting issues registrants, auditors
and regulators all face.”
Fair Value Accounting
Even those who are very confident about their
understanding of the current accounting rules shouldn’t get complacent: Fair
value accounting is right around the corner, making things even harder. In
fact, it is already required in several recent standards.
To be clear, I’m not opposed in general to fair
value accounting. It makes sense for marketable securities, derivatives, and
probably many other financial instruments. But expanding the fair value
concept to many other assets and liabilities is a challenge.
Consider this sentence from FASB’s recent exposure
draft on fair value measurements: “The Board agreed that, conceptually, the
fair value measurement objective and the approach for applying that objective
should be the same for all assets and liabilities.” In that same document,
FASB said, “Users of financial statements generally have agreed that fair
value information is relevant.”
So the overall objective of moving toward a fair
value accounting model seems clear. Of course, that doesn’t necessarily mean
that we will get there soon. In fact, in the same exposure draft the board
said that it would continue to use a project-by-project approach to decide on
fair value or some other measure. But in reality the board has been adopting a
fair value approach in most recent decisions:
SFAS 142, on goodwill, requires that impairment
losses for certain intangible assets be recognized based upon a decline in the
fair value of the asset. SFAS 143, on asset retirement obligations, requires
that these liabilities be recorded initially at fair value rather than what
the company expects to incur. SFAS 146, on exit or disposal activities, calls
for the fair value of exit liabilities to be recorded, not the amount actually
expected to be paid. FIN 45, on guarantees, says that a fair value must be
recorded even when the company doesn’t expect to have to make good on a
guarantee. A fair value approach is also integral to other pending projects,
including the conditional asset retirement obligation exposure draft. Under
such a standard, a company might have to record a fair value liability even
when it doesn’t expect to incur an obligation. Fair value is also key to
projects on business combination purchase procedures; differentiating between
liabilities and equity; share-based payments (stock options); and the
tremendously important revenue recognition project.
I have three major concerns about such pervasive use
of fair value accounting. First, in many cases determining fair value in any
kind of objective way will be difficult if not impossible. Second, the
resulting accounting will produce answers that won’t benefit users of
financial statements. Third, those answers will be very difficult to explain
to business managers, with the result that accounting will be further
discredited in their minds.
The approach that FASB is using for what I would call
operating liabilities is particularly troubling. Take, for example, a company
that owns and operates a facility that has some asbestos contamination. The
facility is safe and can be operated indefinitely, but if the company wanted
to sell the property it would have to remediate that contamination. The
company has no plans to sell the property. But FASB’s exposure draft on
conditional asset retirement obligations calls for the company to estimate and
record a fair value liability. This would be based on what someone else would
charge now to assume the obligation to clean up the problem at some
unspecified future date. The board admits that it might be difficult to
determine what the fair value would be in this case, and companies could omit
the liability if they simply couldn’t make a reasonable estimate.
Although FASB and the SEC expect most companies to be
able to make a reasonable estimate, in reality I think that will be possible
only rarely. Even more important, does it really make sense to record a
liability when the company might believe that there is only a 5% chance that
it will have to be paid? Consider how this line of reasoning might apply to
litigation. Presently, liabilities are recorded only when it’s probable that
a loss has been incurred and that a reasonable estimate of the loss can be
made. So if a company were sued for $1 billion but there were only a 1% chance
that it would lose, nothing would be recorded. The fair value approach would
seem to call for a liability of $10 million in this case, based on 1% of $1
billion.
One might think this kind of accounting will apply
only in the distant future, but FASB is due to release its proposal on
purchase accounting procedures in the next few months, and I understand that
the proposal will require exactly this kind of accounting.
In addition to the very questionable relevance of
this, I don’t know how anyone would ever be able to reasonably determine the
1% likelihood I assumed. How would an auditor attest to the reliability of
financial statements whose results depend significantly on such assumptions?
And where would an auditor Go to obtain objective audit evidence against which
to evaluate such assumptions?
Fair value definitely makes sense in certain
instances, but FASB seems intent on extending the notion beyond the boundaries
of common sense. FASB also seems to have an exaggerated notion of what
companies and auditors are actually capable of doing. Perhaps we should
consider FASB’s faith in the profession to be a compliment. Rather than
feeling complimented, however, I think that this just makes many of us long
for the Good Old Days.
Fair Value Accounting and Revenue Recognition
Currently, asset retirement obligations and exit
costs apply to only a few companies, and even guarantees are not an everyday
issue. All companies, however, have revenues—or at least they hope to have
them. And for the past year or so, FASB has been engaged in a complete
rethinking of revenue recognition. This, of course, was precipitated by the
numerous SEC enforcement cases on improper revenue recognition. Most cases,
however, involved failure to follow existing standards, and most cases also
resulted in premature recognition of revenue.
Now there’s no doubt that the current revenue
accounting rules are overly complicated, with many specific rules depending on
the type of product or service being sold. But FASB’s current thinking would
replace these rules with an asset and liability–oriented approach based on
fair value accounting. This may well make revenue accounting even more
complicated than the detailed rules that we are at least used to working with.
For example, assume product A is being sold to a
customer. It costs $50 to produce product A and the customer has agreed to pay
a nonrefundable $100 in exchange for the company’s promise to deliver this
hot product next month. What should the company record at month-end?
Most accountants would probably think first of the
traditional approach and conclude that the earnings process had not been
completed. Because product A hasn’t been completed and shipped to the
customer, the $100 credit is unearned income. Some aggressive accountants
would probably say that the company should record the sale now because the
$100 is nonrefundable. In that case the company would probably also record a
liability for the $50 cost that will be incurred next month.
FASB has a surprise for both. The board is presently
thinking about whether revenue for what it calls the “selling activity”—the
difference between the $100 received and the assumed fair value of the
obligation to deliver the product—should be recorded now. This assumed fair
value would be the estimated amount that other companies would charge to
produce product A. In other words, it’s the hypothetical amount a company
would have to pay someone else to assume the obligation to produce the
product. The company would have to make this assumption even though it is 100%
sure that it will make the product itself rather than have someone else make
it.
If one could ever determine what other companies
would charge, I suspect that the amount would be higher than the $50 expected
cost, because another company probably would require a risk premium to produce
a product that it isn’t familiar with. It would want to earn a profit as
well. Let’s assume in this case that the fair value could be determined as
$80. If so, the company would record now $20 of revenue and profit for what
FASB calls the selling activity. Next month it would record the $80 remaining
amount of revenue, along with the $50 cost actually incurred. It’s unclear
when the company would record sales commissions, delivery costs, and similar
expenses, but I assume these would have to be allocated somehow.
Given that this project was added to FASB’s agenda
in large part because of premature recognition of revenue in some SEC cases—Enron
recognized income based on the supposed fair value of energy contracts
extending 30 years into the future—it is ironic that the project may well
mandate recognition earlier than most accountants would consider appropriate.
That kind of premature revenue recognition is now generally prohibited, but
other examples could follow, depending on the outcome of this FASB project.
Although the revenue recognition project is still in
an early stage and both my understanding and the board’s positions could
change, FASB seems determined to use some sort of fair value approach to
revenue recognition in many cases. If this happens, we will all be wishing for
the Good Old Days to return.
Is All That EITF Guidance Really Necessary?
In early 2004, FASB’s board members began reviewing
all EITF consensus positions. A majority of board members now have to “not
disagree” with the EITF before those positions become final and binding on
companies. This gives FASB more control over the EITF process, and it should
prevent the task force from developing positions that the board sees as
inconsistent with existing GAAP.
Although I think the task force has done a great deal
of good over its 20-year existence (I was a charter member), I think it’s
time to challenge whether everything that the EITF does is necessary or even
consistent with its original purpose. Too many of the task force’s topics in
recent years can’t really be called “emerging issues.” Rather, the task
force often takes up long-standing issues where it thinks that some
limitations need to be placed on professional judgment.
For example, a couple of years ago the SEC became
concerned about the accounting for certain investments in other companies. For
years we’ve had standards that call for recognition of losses when market
value declines are “other than temporary.” The EITF discussed this matter
at eight meetings over two years and also relied on a separate working group
of accounting experts. Earlier this year, a final consensus position was
issued. It includes a lengthy abstract that tells companies what factors to
consider, including the following matters:
Evidence to support the ability and intent to
continue to hold the investment; The severity of the decline in value; How
long the decline has lasted; and The evidence supporting a market price
recovery. So now we have a “detailed rule” on this matter. Will this
result in more consistency in practice? Will investors and other users of
financial statements receive better information as a result? Is the result
worth the additional effort?
Moreover, after two years of effort on this project,
FASB had to reconsider the whole thing because no one had considered the
effect on debt securities held as available for sale by financial
institutions. So now the board is developing even more specifics to deal with
the unintended consequences of the rule.
Again, I support the EITF, and I believe it has
generally done a great job. The members try to develop practical ways to deal
with current problems. Nonetheless, both the task force and FASB may need to
more carefully challenge whether all of the EITF’s projects are really
needed. If FASB actually issued relatively broad standards, there probably
would be a need for the EITF to provide supplemental guidance on some issues.
But we now seem to have the worst of all worlds, with quite detailed
accounting standards being accompanied by even more detailed EITF guidance.
A Multitude of Challenges
I don’t intend to seem overly critical of FASB and
others who are working to improve financial reporting. It’s a tough job, and
the brickbats always outnumber the bouquets. If I didn’t strongly support
accounting standards setting I wouldn’t have spent 10 Qs years on the inside
of the process. Still, those years at FASB, as well as my time before and
after, have caused me to develop strong views on these issues. And I truly do
believe that standards have gotten just too complicated.
The announced move to broader principles is one I
fully support. That job won’t be easy, but it has to be tried or the sea of
detail will become even deeper in the near future. FASB needs to actually
start doing this and not allow its actions to speak otherwise. And companies,
auditors, and regulators need to support such a move and resist the temptation
to seek answers to every imaginable question. Furthermore, companies and
auditors may have to become more principled before a principles-based approach
will work.
Part of this process could be for the EITF to be more
judicious in what it takes on. Also, I urge FASB to reevaluate its attitude
toward fair value accounting. I believe FASB is moving much faster in this
area than preparers, auditors, and users of financial statements can
accommodate. Furthermore, the SEC and other regulators may not yet be on board
with this new thinking.
In the final analysis, we won’t be able to return
to my so-called Good Old Days. But we have to make sure that what accounting
and accountants can do is meaningful and operational. We never want to look
back and ask, “Remember the Good Old Days, when accounting was important?”
-------------------------------------------------------------------------------- CPA Journal Editorial Board member Dennis R. Beresford, CPA, was recently
named the 2005 recipient of the Gold Medal for Distinguished Service from the
AICPA. He received the award on October 26, during the fall meeting of the
Institute’s governing council in Orlando. Beresford is the Ernst & Young
Executive Professor of Accounting at the J.M. Tull School of Accounting at the
University of Georgia, Terry College of Business. From 1987 to 1997, he was
chairman of FASB. Prior to joining FASB, he was national director of
accounting standards for Ernst & Young.ecently I visited my pharmacy to
pick up eyedrops for my two golden retrievers. Before he would give me the
prescription, the pharmacist insisted I sign a form on behalf of Murphy and
Millie, representing that they had been apprised of their rights under the new
medical privacy rules. This ludicrous situation is a good illustration of how
complicated life has gotten.
In July 2003, the staff of the
Securities and Exchange Commission (SEC) submitted to
Congress its Study
Pursuant to Section 108(d) of the Sarbanes-Oxley Act of 2002 on theAdoption by the United States
Financial Reporting System of a Principles-BasedAccounting
System (the Study). The Study
includes the following recommendations to the
Financial Accounting Standards Board (FASB or Board):
1. The FASB should issue
objectives-oriented standards.
2. The FASB should address
deficiencies in the conceptual framework.
3. The FASB should be the only
organization setting authoritative accounting
guidance in the United States.
4. The FASB should continue its
convergence efforts.
5. The FASB should work to redefine
the GAAP hierarchy.
6. The FASB should increase access to
authoritative literature.
7. The FASB should perform a
comprehensive review of its literature to identify
standards that are more rules-based and adopt
a transition plan to change those standards.
The Board welcomes the SEC’s Study and
agrees with the recommendations. Indeed, a number of those recommendations
relate to initiatives the Board had under way at the time the Study was
issued.1 The Board is committed to continuously improving its standard-setting
process. The Board’s specific responses to the recommendations in the Study
are described in the following sections of this paper.
Objectives-Oriented Standards
In the Study, the SEC staff recommends
that "those involved in the standard-setting
process more consistently develop
standards on a principles-based or objectives-oriented
basis" (page 4).
2
According to the
Study (page 4), an objectives-oriented standard would
have the following characteristics:
•
Be
based on an improved and consistently applied conceptual framework;
•
Clearly
state the accounting objective of the standard;
•
Provide
sufficient detail and structure so that the standard can be operationalized
and applied on a consistent basis;1
•
Minimize
exceptions from the standard;
•
Avoid
use of percentage tests ("bright-lines") that allow financial
engineers to achieve technical compliance with
the standard while evading the
intent of the standard.
The “objectives-oriented” approach to setting
standards described above (and expanded
upon in the Study) is similar to the principles-based approach described in the
Board’s
Proposal. After discussing the comments received on its Proposal, the Board
agreed that
its conceptual framework needs to be improved. This is because an internally
consistent
and complete conceptual framework is critical to a standard-setting approach
that places
more emphasis on the underlying principles that are based on that framework.
Pages 8
and 9 of this paper further describe the Board’s activities related to the
conceptual
framework; the following sections address the other characteristics of an
objectivesoriented
approach addressed in the Study.
Format and Content of Standards
The Board agrees with the Study’s
recommendation to improve the format and content of
its standards. In particular, The Board agrees
that the objective and underlying principles of
a standard should be clearly articulated and prominently placed in FASB
standards. In response to comments
received on its Proposal, the Board agreed that although its existing
standards are based on concepts and principles, the understandability of its
standards could be improved by writing its
standards in ways that (a) clearly state the accounting
objective(s), (b) clearly articulate the underlying principles, and (c)
improve the explanation of the rationale
behind those principles and how they relate to the conceptual
framework.
The Board is working on developing a
format for its standards that will encompass the
attributes of an objectives-oriented standard
described in the Study, for example, describing
the underlying objective of the standard in the introductory paragraphs, using
bold type to set
off the principles,3 and
providing a glossary for defined terms.
In addition, the Board is working with a
consultant to identify changes in the organization
and exposition of its standards that will
increase the understandability of those standards. Accounting
standards by their nature will include many specific technical terms; however,
the Board believes it can do a better job simplifying the language used in its
standards to describe how to account for
complex transactions. In addition, the Board will
strive to apply other effective writing techniques to enhance constituents’
understanding of
FASB standards.
When discussing proposed accounting
standards or specific provisions of a standard,
many of the Board’s constituents comment on
whether a standard is "operational." Because
that term can mean different things to different people, the Board decided to
define the term operational
for its purposes. The Board uses the term operational
to mean
the following:
•
A
provision/standard is comprehensible by a reader who has a reasonable level
of knowledge
and sophistication,
•
The
information needed to apply the provision/standard is currently available or
can be created, and
•
The
provision/standard can be applied in the manner in which it was intended.
The Board believes that if its standards are
more understandable, they also will be more operational.
Implementation Guidance
As noted in the Board’s Proposal, an
approach to setting standards that places more emphasis on principles will not
eliminate the need to provide interpretive and implementation guidance for
applying those standards. Thus, the Board agrees that some amount of
implementation guidance is needed in objectives-oriented standards in order
for entities to apply those standards in a consistent manner. The Board uses
the term implementation guidance to refer to all of the guidance necessary to
explain and operationalize the principles (that is, the explanatory text in
the standards section, the definitions in the glossary, and guidance and
examples included in one or more appendices that help an entity apply the
provisions in the standards section). The Board believes that the amount of
necessary guidance will vary depending on the nature and complexity of the
arrangements that are the subject of the standard. The Board believes that
there should be enough guidance such that a principle is understandable,
operational, and capable of being applied consistently in similar situations.
Judgment is required to decide how much guidance is needed to achieve those
objectives, without providing so much guidance that the overall standard
combined with its implementation guidance becomes a collection of detailed
rules. Therefore, the amount and nature of implementation guidance will vary
from standard to standard.
The Board believes that its primary
focus should be providing broadly applicable implementation guidance, not
providing guidance on relatively narrow and less pervasive issues, including,
for example, issues that are specific to certain entities or industries. When
developing that implementation guidance, the Board plans to apply the same
guidelines that underpin objectives-oriented standards. For example, rather
than consisting of a list of rules or bright lines, the implementation
guidance would explain or expand on the principle(s) or objectives in the
standard. 4.
FASAC's annual survey
on the priorities of the FASB provides valuable perspectives and observations
about the Board's process and direction. The 2002 survey asked Council
members, Board members, and other interested constituents to provide their
views about the FASB's priorities, the financial reporting issues of tomorrow,
principles-based standards, and the FASB's international activities.
Key observations and
conclusions from the responses to the 2002 survey are:
Council members
most often mentioned revenue recognition as one of the five most important
issues that the Board should address currently. All seven Board members
also included revenue recognition as one of the most important issues for
the Board.
FASAC members
most often cited valuation issues, such as the implication of using fair
value measurements in financial statements, as one of the issues of
tomorrow that the Board should start thinking about today.
FASAC members
generally are prepared to accept differences in interpretation of
principles-based standards. They also are prepared to make the judgments
necessary to apply less-detailed standards despite the risk that their
judgment will be questioned. Some noted that for principles-based
standards to become a reality, the SEC is the primary organization that
needs to support the initiative.
Nearly all
FASAC members agree that the Board's international activities are an
appropriate use of resources. All Board members also believe that those
activities are an appropriate use of resources.
Twenty-two current
Council members, 7 Board members, and 9 other constituents responded to the
survey.
Methods for setting accounting standards all have
advantages and disadvantages. It is not possible to set optimal standards for all
stakeholders. Arrow's Impossibility Theorem applies, which means that what is
optimal for one constituency must be sub-optimal for other constituencies.
Accounting standards are usually expensive to implement, and the benefits of any new
standard must be weighed against its costs to preparers and users of financial statements.
A nice timeline on the development of U.S.
standards and the evolution of thinking about the income statement versus the
balance sheet is provided at:
"The Evolution of U.S. GAAP: The Political Forces Behind Professional Standards
(1930-1973)," by Stephen A. Zeff, CPA Journal, January 2005 ---
http://www.nysscpa.org/cpajournal/2005/105/infocus/p18.htm
Part II covering years 1974-2003
published in February 2005 ---
http://www.nysscpa.org/cpajournal/2005/205/index.htm
The module for 1940 is as follows:
1940 The American Accounting Association (AAA)
publishes Professors W.A. Paton and A.C. Littleton’s monograph An
Introduction to Corporate Accounting Standards, which is an eloquent defense
of historical cost accounting. The monograph provides a persuasive rationale
for conventional accounting practice, and copies are widely distributed to
all members of the AIA. The Paton and Littleton monograph, as it came to be
known, popularizes the matching principle, which places primary emphasis on
the matching of costs with revenues, with assets and liabilities dependent
upon the outcome of this matching.
Comment. The Paton and
Littleton monograph reinforced the revenue-and-expense view in the
literature and practice of accounting, by which
one first determines whether a transaction gives rise to a revenue or an
expense. Once this decision is made, the balance sheet is left with a
residue of debit and credit balance accounts, which may or may not fit the
definitions of assets or liabilities.
The monograph also embraced historical cost
accounting, which was taught to thousands of accounting students in
universities, where the monograph was, for more than a generation, used as
one of the standard textbooks in accounting theory courses.
1940s
Throughout the decade, the CAP frequently allows
the use of alternative accounting methods when there is diversity of
accepted practice.
Comment. Most of the matters taken up by the CAP
during the first half of the 1940s dealt with wartime accounting issues. It
had difficulty narrowing the areas of difference in accounting practice
because the major accounting firms represented on the committee could not
agree on proper practice. First, the larger firms disagreed whether
uniformity or diversity of accounting methods was appropriate. Arthur
Andersen & Co. advocated fervently that all companies should follow the same
accounting methods in order to promote comparability. But such firms as
Price, Waterhouse & Co. and Haskins & Sells asserted that comparability was
achieved by allowing companies to adopt the accounting methods that were
most suited to their business circumstances. Second, the big firms disagreed
whether the CAP possessed the authority to disallow accounting methods that
were widely used by listed companies.
Continued in article
Deductive Accounting Theory (Mathematical
Methods)
Assumes that optimal accounting standards and
reporting rules can be derived by deduction much in the way that Pythagoras derived the
rule for measuring the hypotenuse of a triangle based upon square root of the summed
squares of the other two sides (assuming one angle is a perfect 90-degree angle). Is
there ever a perfect 90-degree angle in the real world?
If we assume that we have perfect definitions of
assets, liabilities, revenues, and expenses, then derivations of optimal accounting rules
will follow. A+E=R+L+E before closing E and R to E.
The FASB's Conceptual Framework is based heavily
upon
Inductive Accounting Theory (Scientific Methods)
Assumes accounting standards are somewhat like evolution of
a species in nature --- survival of the fittest!
Relies heavily upon controlled experimentation (e.g.,
behavioral accounting research) and statistical testing (e.g., capital markets
"events" studies of the impact of accounting information on market prices and
volume of transactions).
Normative theorists tend to advocate their
opinions on accounting based upon subjective opinion, deductive logic, and inductive
methods. In the final analysis, nearly all standards are based upon normative
theory.
Generally conclude that some accounting rule is
better or worse than its alternatives.
Normative theorists tend to rely heavily upon
anecdotal evidence (e.g., examples of fraud) that generally fails to meet tests of
academic rigor. For example, the Wizard reported that Montgomery Ward would
fail. However, the Wizard always reports that every company will fail or lose its
self identity in a pattern of acquisitions and mergers. Eventually, he will always
be correct.
Positive theorists tend to explain why some
accounting practices are more popular than others (e.g., because they increase management
compensation). They tend to support their conclusions with inductive theory and
empirical evidence as opposed to deductive methods.
Generally avoid advocacy of one accounting rule as
being better or worse than its alternatives.
Positivists are inspired by anecdotal evidence,
but anecdotal evidence is never permitted without more rigorous and controlled scientific
investigation.
April 2002 Document on SPEs
and Enron from the International Accounting Standards Board (This Document is Free)
Of the 16 topics on our research
agenda, one warrants special mention here. For several years, there has been an
international debate on the topic of consolidation policy. The failure to consolidate some
entities has been identified as a significant issue in the restatement of Enrons
financial statements. Accountants use the term consolidation policy as shorthand for
the principles that govern the preparation of consolidated financial statements that
include the assets and liabilities of a parent company and its subsidiaries. For an
example of consolidation, consider the simple example known to every accounting student.
Company A operates a branch office in Edinburgh. Company B also operates a branch office
in Edinburgh, but organises the branch as a corporation owned by Company B. Every
accounting student knows that the financial statements of each company should report all
of the assets and liabilities of their respective Edinburgh operations, without regard to
the legal form surrounding those operations.
Of course, real life is seldom as
straightforward as textbook examples. Companies often own less than 100 per cent of a
company that might be included in the consolidated group. Some special purpose entities
(SPEs) may not be organised in traditional corporate form. The challenge for accountants
is to determine which entities should be included in consolidated financial
statements.
There is a broad consensus among
accounting standard-setters that the decision to consolidate should be based on whether
one entity controls another. However, there is much disagreement over how control should
be defined and translated into accounting guidance. In some jurisdictions accounting
standards and practice seem to have gravitated toward a legal or ownership notion of
control, usually based on direct or indirect ownership of over 50 per cent of the
outstanding voting shares. In contrast, both international standards and the standards in
some national jurisdictions are based on a broader notion of control that includes
ownership, but extends to control over financial and operating policies, power to appoint
or remove a majority of the board of directors, and power to cast a majority of votes at
meetings of the board of directors.
A number of commentators,
including many in the USA, have questioned whether the control principle is consistently
applied. The IASB and its partner standard-setters are committed to an ongoing review of
the effectiveness of our standards. If they do not work as well as they should, we want to
find out why and fix the problem. Last summer we asked the UK ASB to help us by
researching the various national standards on consolidation and identifying any
inconsistencies or implementation problems. It has completed the first stage of that
effort and is moving now to more difficult questions.
The particular consolidation
problems posed by SPEs were addressed by the IASBs former Standing Interpretations
Committee in SIC-12. There are some kinds of SPE that pose particular problems for both an
ownership approach and a control-based approach to consolidations. It is not uncommon for
SPEs to have minimal capital, held by a third party, that bears little if any of the risks
and rewards usually associated with share ownership. The activities of some SPEs are
so precisely prescribed in the
documents that establish them that no active exercise of day-to-day control is needed or
allowed. These kinds of SPEs are commonly referred to as running on
auto-pilot. In these cases, control is exercised in a passive way. To discover
who has control it is necessary to look at which party receives the benefits and risks of
the SPE.
SIC-12 sets out four particular
circumstances that may indicate that an SPE should be consolidated:
(a) in substance, the activities
of the SPE are being conducted on behalf of the enterprise according to its specific
business needs so that the enterprise obtains benefits from the SPEs
operation.
(b) in substance, the enterprise
has the decision-making powers to obtain the majority of the benefits of the activities of
the SPE or, by setting up an autopilot mechanism, the enterprise has delegated
these decision-making powers.
(c) in substance, the enterprise
has rights to obtain the majority of the benefits of the SPE and therefore may be exposed
to risks incidental to the activities of the SPE.
(d) in substance, the enterprise
retains the majority of the residual or ownership risks related to the SPE or its assets
in order to obtain benefits from its activities.
The IASB recognises that we may
be able to improve our approach to SPEs. With this in mind, we have already asked our
interpretations committee if there are any ways in which the rules need to be strengthened
or clarified.
Current criticisms and
concerns about financial reporting
There some common threads that
pass through most of the topics on our active and research agendas. Each represents a
broad topic that has occupied the best accounting minds for several years. It is time to
bring many of these issues to a conclusion.
Off balance sheet items
When a manufacturer sells a car
or a dishwasher, the inventory is removed from the balance sheet (a process that
accountants refer to as derecognition) because the manufacturer no longerowns the item.
Similarly, when a company repays a loan, it no longer reports that loan as a liability.
However, the last 20 years have seen a number of attempts by companies to remove assets
and liabilities from balance sheets through transactions that may obscure the economic
substance of the companys financial position. There are four areas that warrant
mention here, each of which has the potential to obscure the extent of a companys
assets and liabilities.
Leasing transactions
A company that owns an asset, say
an aircraft, and finances that asset with debt reports an asset (the aircraft) and a
liability (the debt). Under existing accounting standards in most jurisdictions (including
ASB and IASB standards), a company that operates the same asset under a lease structured
as an operating lease reports neither the asset nor the liability. It is possible to
operate a company, say an airline, without reporting any of the companys principal
assets (aircraft) on the balance sheet. A balance sheet that presents an airline without
any aircraft is clearly not a faithful representation of economic reality.
Our predecessor body, working in
conjunction with our partners in Australia, Canada, New Zealand, the UK and the USA,
published a research paper that invited comments on accounting for leases. The UK ASB is
continuing work on this topic and we are monitoring its work carefully. As noted above, we
expect to move accounting for leases to our active agenda at some point in the future.
There is a distinct possibility that such a project would lead us to propose that
companies recognise assets and related lease obligations for all leases.
Securitisation transactions
Under existing accounting
standards in many jurisdictions, a company that transfers assets (like loans or
credit-card balances) through a securitisation transaction recognises the transaction as a
sale and removes the amounts from its balance sheet. Some securitisations are
appropriately accounted for as sales, but many continue to expose the transferor to many
of the significant risks and rewards inherent in the transferred assets. In our project on
improvements to IAS 39 (page 5), we plan to propose an approach that will clarify
international standards governing a companys ability to derecognise assets in a
securitisation. Our approach, which will not allow sale treatment when the
seller has a continuing involvement with the assets, will be significantly
different from the one found in the existing standards of most jurisdictions.
Creation of unconsolidated
entities
Under existing accounting
standards in many jurisdictions, a company that transfers assets and liabilities to a
subsidiary company must consolidate that subsidiary in the parent companys financial
statements (see page 6). However, in some cases (often involving the use of an SPE), the
transferor may be able (in some jurisdictions) to escape the requirement to consolidate.
Standards governing the consolidation of SPEs are described on page 7.
Pension obligations
Under existing standards in many
jurisdictions (including existing international standards) a companys obligation to
a defined benefit pension plan is reported on the companys balance sheet. However,
the amount reported is not the current obligation, based on current information and
assumptions, but instead represents the result of a series of devices designed to spread
changes over several years. In contrast, the UK standard (FRS 17) has attracted
significant recent attention because it does not include a smoothing mechanism. The IASB
plans to examine the differences among the various national accounting standards for
pensions (in particular, the smoothing mechanism), as part of our ongoing work on
convergence.
Items not included in the profit
and loss account
Under existing accounting
standards in some jurisdictions, a company that pays for goods and services through the
use of its own shares, options on its shares, or instruments tied to the value of its
shares may not record any cost for those goods and services. The most common form of this
share-based transaction is the employee share option. In 1995, after what it called an
extraordinarily controversial debate, the FASB issued a standard that, in most
cases in the USA, requires disclosure of the effect of employee share options but does not
require recognition in the financial statements. In its Basis for Conclusions, the FASB
observed:
The Board chose a
disclosure-based solution for stock-based employee compensation to bring closure to the
divisive debate on this issuenot because it believes that solution is the best way
to improve financial accounting and reporting.
Most jurisdictions, including the
UK, do not have any standard on accounting for share-based payment, and the use of this
technique is growing outside of the USA. There is a clear need for international
accounting guidance. Last autumn, the IASB reopened the comment period on a discussion
document Accounting for Share-based Payment. This document was initially published by our
predecessor, in concert with standard-setters from Australia, Canada, New Zealand, the UK
and the USA. We have now considered the comments received and have begun active
deliberation of this project. Accounting measurement
Under existing accounting
standards in most jurisdictions, assets and liabilities are reported at amounts based on a
mixture of accounting measurements. Some measurements are based on historical transaction
prices, perhaps adjusted for depreciation, amortisation, or impairment. Others are based
on fair values, using either amounts observed in the marketplace or estimates of fair
value. Accountants refer to this as the mixed attribute model. It is increasingly clear
that a mixed attribute system creates complexity and opportunities for accounting
arbitrage, especially for derivatives and financial instruments. Some have suggested that
financial reporting should move to a system that measures all financial instruments at
fair value.
Our predecessor body participated
in a group of ten accounting standard-setters (the Joint Working Group or JWG) to study
the problem of accounting for financial instruments. The JWG proposal (which recommended a
change to measuring all financial assets and liabilities at fair value) was published at
the end of 2000. Earlier this year the Canadian Accounting Standards Board presented an
analysis of comments on that proposal. The IASB has just begun to consider how this effort
should move forward.
Intangible assets
Under existing accounting
standards in most jurisdictions, the cost of an intangible asset (a patent, copyright, or
the like) purchased from a third party is capitalised as an asset. This is the same as the
accounting for acquired tangible assets (buildings and machines) and financial assets
(loans and accounts receivable). Existing accounting standards extend this approach to
self-constructed tangible assets, so a company that builds its own building capitalises
the costs incurred and reports that as the cost of its self-constructed asset. However, a
company that develops its own patent for a new drug or process is prohibited from
capitalising much (sometimes all) of the costs of creating that intangible asset. Many
have criticised this inconsistency, especially at a time when many view intangible assets
as significant drivers of company performance.
The accounting recognition and
measurement of internally generated intangibles challenges many long-cherished accounting
conventions. Applying the discipline of accounting concepts challenges many of the popular
conceptions of intangible assets and intellectual capital. We have this topic
on our research agenda. We also note the significant work that the FASB has done on this
topic and its recent decision to add a project to develop proposed disclosures about
internally generated intangible assets. We plan to monitor those efforts closely.
IMAGINE a company that makes a practice of keeping
two sets of accounts. One version is revealed to the public through periodic
Securities and Exchange Commission filings and public announcements. The
other is never made public and conveys a markedly different picture.
Does it sound scandalous? Actually, it's common
practice.
It isn't as if companies are breaking the law.
Public companies are required by the S.E.C. to keep their books in
accordance with generally accepted accounting principles, or GAAP, and to
announce their results each quarter. At the same time, companies keep a
separate and confidential set of books according to rules established by the
Internal Revenue Service. These accounts seldom match. After all, companies
typically have an incentive to state the highest possible earnings under
GAAP and the lowest possible under tax rules.
Economists have long understood that profits
reported to the I.R.S. may be a more reliable guide than those reported to
the S.E.C. and scrutinized on Wall Street. The public presentation of
accounts involves the exercise of an accountant's judgment on such topics as
the useful life of assets, the probability of uncertain events and the fair
value of property. Each exercise of judgment, on which reasonable people may
differ, offers a degree of flexibility in the final reporting of results.
In general, tax rules are less lenient. That is
because allowing companies too much leeway in stating how much tax they owe
would make collecting taxes difficult. So when economists analyze corporate
profits, they tend to focus on a measure derived from corporate tax returns.
Unfortunately, the government publishes only aggregate data, so it is
impossible to know what any particular company made, or paid, under I.R.S.
rules.
It doesn't have to be that way. Companies already
have basic tax information at hand that could be released to the public
without imposing significant costs. And some experts say they believe that
the benefits to investors, regulators and the overall tax system could be
substantial.
A study published in 2003 concluded that the
benefits of disclosing additional tax information would outweigh any costs.
It was conducted by David L. Lenter, a lawyer now on the staff of the
Congressional Joint Committee on Taxation; Joel B. Slemrod, an economist at
the University of Michigan; and Douglas A. Shackelford, an accountant at the
University of North Carolina.
In the study, published in the National Tax
Journal, they quickly agreed that corporate tax returns, which can run into
thousands of pages, should not be exposed in their entirety. That could
reveal sensitive information that companies have a legitimate need to keep
private, they said.
But a simple presentation of summary information —
the bottom-line numbers, for example — would have many attractions. Even
better, companies could release a simplified version of a schedule that they
already prepare. The I.R.S. currently requires companies to reconcile the
differences between the numbers on their financial reports and the
corresponding amounts on their tax return, but so far those reconciliations
have not been made public.
Greater disclosure of tax information would allow
investors and analysts to better appreciate the true economic condition of a
company. More transparent tax figures would also give analysts a tool to cut
through the sometimes confusing tax disclosures currently provided under
S.E.C. rules. Even more significantly, investors could track a company's
performance under an accounting system believed to be less susceptible to
manipulation than GAAP. Together, these effects would permit investors to
value securities with greater confidence. Over all, the researchers say they
believe that it would help financial markets function more efficiently.
Another significant benefit could be to improve the
transparency of the tax system to the voting public. Despite all the
information embedded in accounting footnotes, some basic questions go
unanswered. Under current S.E.C. rules, a public company does not have to
reveal precisely what it paid in taxes for a specific year. "Right now the
tax numbers companies release can contain things like taxes on audits 20
years ago," Professor Shackelford said. "What they don't tell us is how much
they paid the government in taxes in 2005, for instance. You can't find that
anywhere."
The study argued that if companies revealed that
figure, it would help clarify how much tax a company was paying relative to
its income and relative to other companies. And that would yield positive
benefits. For instance, the study says, it could put pressure on legislators
to improve the tax system. And it could discourage corporations from
aggressive tax-reduction strategies if they feared public criticism.
THERE is good cause for trying to understand what
is really going on with corporate taxes, company by company. The aggregate
figures suggest a disturbing trend. While companies have reported rising
profits in recent years, corporate tax receipts have been dwindling. In the
late 1990's, corporate tax receipts hovered between 2 percent and 2.2
percent of the country's overall gross domestic product. But from 2000 to
2004, the last year for which figures are available, the ratio of corporate
tax receipts to G.D.P. has dropped, ranging between 1.2 and 2 percent.
Without reliable tax information, we can only guess
at what companies are really up to. During the late 1990's, company profits
based on tax return information — the profit figure most watched by
economists — grew at a much slower rate than reported profits. The
divergence between the two measures implied that either companies were
finding new ways to minimize their tax bills or they were finding new ways
to overstate their accounting earnings. We now know that at least some
companies were indeed bolstering their earnings, through both legal and
illegal maneuvers.
After a brief reconciliation in 2001 and 2002,
reported earnings and taxed earnings are again diverging. While disclosing
some basic tax information won't by itself prevent the kinds of abuses that
multiplied in the 1990's, it is a step in the right direction. And that's
what good public policy is all about.
From The Wall Street Journal Weekly Accounting Review on August 15, 2008
TOPICS: Advanced
Financial Accounting, Financial Accounting, Income Tax, Income
Taxes, Tax Avoidance, Tax Havens, Taxation
SUMMARY: In
a recent report filed in response to a request by two senators,
Carl Levin of Michigan and Byron Dorgan of North Dakota, the
Government Accountability Office (GAO) found that "...at least
23% of large U.S. corporations don't pay federal income taxes in
any given year." Large corporations are defined as companies
generating at least $50 million in sales or with $250 million in
total assets. But smaller firms also frequently report no income
tax liability: "in a given year at least 60% of all U.S.
corporations studied ... reported no federal income-tax
liability during the period...1998 to 2005. In the study, the
GAO analyzed samples of Internal Revenue Service data covering
both publicly traded and closely held corporations, including
U.S.-based and foreign corporations operating in the U.S."
CLASSROOM
APPLICATION: The article may be used to introduce book/tax
differences, and items generating the differences such as net
operating losses, in either a financial accounting or a
corporate income tax class.
QUESTIONS:
1. (Introductory) Research "...has looked at the gap
between the earnings that companies report to their shareholders
and the smaller profits they report to the Internal Revenue
Service." What causes these differences? Where can investigators
find out about the nature of these differences?
2. (Introductory) Summarize the major findings of the
GAO study in your own words. Do the results surprise you?
Specifically explain why.
3. (Advanced) What was the original question asked by
Senators Carl Levin of Michigan and Byron Dorgan of North
Dakota? Be sure to clearly define the items these senators asked
about. Did the study investigate the specific topic of their
concern?
4. (Advanced) What did the GAO find regarding the use
of net operating losses and tax credits in driving the reported
amounts showing no tax liabilities owed? Why this result
unexpected? In your answer, define each of these tax reporting
items. Explain when you expect each of these items to show on a
tax return in terms of economic cycles.
Reviewed By: Judy Beckman, University of Rhode Island
Radical Changes in Financial
Reporting ---
http://faculty.trinity.edu/rjensen/Theory01.htm#ChangesOnTheWay
Yipes! Net earnings and eps will no longer be derived and presented. It's like
getting your kids report card with summaries of his/her weekly activities and no
final grade
And congratulations on choosing Walter Teets as a co-author. I used to
correspond with Walter Teets quite a lot in the early days of FAS 133. He has a
PhD in finance from the University of Chicago and is a genuine expert on
derivative financial instruments.
Also see
"Hicksian Income in the Conceptual Framework" ---
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1576611
Michael Bromwich London School of Economics
Richard H. Macve London School of Economics & Political Science (LSE) -
Department of Accounting and Finance
Shyam Sunder Yale School of Management
March 22, 2010
Abstract:
In seeking to replace accounting ‘conventions’ by ‘concepts’ in the pursuit
of principles-based standards, the FASB/IASB joint project on the conceptual
framework has grounded its approach on a well-known definition of ‘income’
by Hicks. We welcome the use of theories by accounting standard setters and
practitioners, if theories are considered in their entirety.
‘Cherry-picking’ parts of a theory to serve the immediate aims of standard
setters risks distortion. Misunderstanding and misinterpretation of the
selected elements of a theory increase the distortion even more. We argue
that the Boards have selectively picked from, misquoted, misunderstood, and
misapplied Hicksian concepts of income. We explore some alternative
approaches to income suggested by Hicks and by other writers, and their
relevance to current debates over the Boards’ conceptual framework and
standards. Our conclusions about how accounting concepts and conventions
should be related differ from those of the Boards. Executive stock options (ESOs)
provide an illustrative case study.
Be that as it may, let me look a little closer at the illustrations provided
by you and Walter.
I'm a little confused by your example Tom. Since you report a cash holding
loss of ($17.33) it would appear that there really has not been an increase in
replacement costs other than due to general price level changes (16/12) and no
increase in replacement costs apart from the change in general purchasing power
of a dollar. Thus this is not really a very good example of replacement cost
accounting where specific price index changes should differ from general price
index changes as is clearly what FAS 33, before it was rescinded, was all about.
FAS 133 used a single general price level index to price level adjust historical
cost financial statements and multiple specific prices indices to adjust
constant-dollar (PLA) financial statements to current cost (replacement cost)
financial statements. My favorite example is the 1981 U.S. Steel annual report:
From the CFO Journal's Morning Ledger on May 8, 2011
The largest U.S. companies are booking their strongest
quarterly profits in five years,
as firms reap the benefits of years of belt tightening and finally see a
pickup in demand. But part of the improvement has come from keeping a lid on
spending, and many CEOs remain reluctant to change and open their wallets
for new projects, plants and people, Thomas Gryta and Theo Francis write.
Profits at S&P 500 companies jumped an estimated 13.9% in the first quarter,
growing nearly twice as fast as revenue. The gains stretched across
industries, from Wall Street’s banks to Silicon Valley’s web giants, and
were helped by a rebound in the battered energy sector. The picture was a
marked improvement from a year ago, when profits fell 5%, and was the best
performance since the third quarter of 2011.
ensen Comment
Accounting standard setters cannot even operationally define the calculation of
earnings other than to make it a plug that makes the balance sheet balance. And
yet this plug remains as an exceedingly important driver of share prices in the
stock markets.
From the CFO Journal's Morning Ledger on May 5, 2017
Avon under pressure
Avon Products Inc.
Chief Executive Sheri McCoy faces new pressure following a surprise loss
that sent the cosmetics seller’s stock tumbling
Thursday.
Jensen Comment
Accounting standard setters cannot even operationally define the calculation of
earnings other than to make it a plug that makes the balance sheet balance. And
yet this plug remains as an exceedingly important driver of share prices in the
stock markets.
May 9, 2017 Question from Tom Selling
I’d like to brush up on the shortcomings of
Hicksian “income” for measuring the earnings of a business entity. Do
you (or anyone else on AECM, of course) have a reference (e.g., an article
or book chapter) to help me out?
Here is one of references that I recommend that are in the accounting
literature. The main take away here is that fair value accounting takes us
closer to the Hicksian concept of income at the expense of reliability. I
might note that Professor Schipper over the years is a proponent of falr
value accounting. This is not a defense of historical cost accounting as
might have been written by AC Littleton or Yuji Ijiri.
Especially note the references at the end of the commentary.
The main problem is that Hicksian Income in theory assumes all changes is
"wealth" or "well offness" where wealth includes much more than accountants
put on balance sheets. Examples include the many intangibles and contingent
liabilities that are left off balance sheets due to inability to measure
reliably such as the value of human resources and changes thereof. Also
accountants have never figured out how to measure the requisite "value in
use: as opposed to disposal value in a yard sale.
Bob Jensen
It would seem that, if the constraint of double-entry bookkeeping is removed as
a basis of financial reporting, the operational definitions of the major
performance indicator of "profit" for for-profit businesses will have to become
much more precise and operational than "profit" is presently defined as a
residual phenomenon in a double-entry bookkeeping system.
Some alternative approaches to income suggested by
Hicks and by other writers and their relevance to conceptual frameworks for
accounting
"Hicksian Income in the Conceptual Framework" ---
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1576611
Michael Bromwich London School of Economics
Richard H. Macve London School of Economics & Political Science (LSE) -
Department of Accounting and Finance
Shyam Sunder Yale School of Management
March 22, 2010
Abstract:
In seeking to replace accounting ‘conventions’ by ‘concepts’ in the pursuit
of principles-based standards, the FASB/IASB joint project on the conceptual
framework has grounded its approach on a well-known definition of ‘income’
by Hicks. We welcome the use of theories by accounting standard setters and
practitioners, if theories are considered in their entirety.
‘Cherry-picking’ parts of a theory to serve the immediate aims of standard
setters risks distortion. Misunderstanding and misinterpretation of the
selected elements of a theory increase the distortion even more. We argue
that the Boards have selectively picked from, misquoted, misunderstood, and
misapplied Hicksian concepts of income. We explore some alternative
approaches to income suggested by Hicks and by other writers, and their
relevance to current debates over the Boards’ conceptual framework and
standards. Our conclusions about how accounting concepts and conventions
should be related differ from those of the Boards. Executive stock options (ESOs)
provide an illustrative case study.
The International
Accounting Standards Board, or IASB, which sets reporting standards in more
than 120 countries, said Wednesday it would look at providing new
definitions of common financial terms such as earnings before interest and
taxes, or ebit.
The new definitions
will be introduced over the next five years, in order to provide sufficient
time for suggestions and comment from market participants.
The changes will not
result in new standards but will require the board to overhaul existing
ones.
At the moment, terms
like operating profit are not defined by the IASB. The aim is to help market
participants judge the suitability of a particular investment.
“We want to give
investors the right handles to look at a balance sheet,” said IASB chairman
Hans Hoogervorst.
Up until now,
International Financial Reporting Standards, known as IFRS, leave companies
too much flexibility in defining such terms, which often makes it difficult
to compare financials, Mr. Hoogervorst said.
“Even within sectors,
there is a lack of comparability,” Mr. Hoogervorst said. This affects both
investors and companies, he added.
It is too early to tell
what the changes will mean for companies reporting under IFRS, according to
Mr. Hoogervorst. “They should be less revolutionary than the introduction of
new standards but every change results in work”, he said.
Some firms might find
that they have less latitude when reporting financial results, he said. That
could mean more work.
Firms that decide
against adopting the new IASB definition for ebit, for example, could be
required to reconcile their own ebit calculation into one based on the
IASB’s definition.
The IASB in 2017 also
plans to finalize a single accounting model that would be applied to all
forms of insurance contracts.
Besides that, the board
will work on updating the system through which filers add disclosures to the
electronic versions of their financial statements. The system is updated on
a regular basis and the IASB produces an annual compilation of all changes
each year.
Jensen Comment
It would seem that, if the constraint of double-entry bookkeeping is removed as
a basis of financial reporting, the operational definitions of the major
performance indicator of "profit" for for-profit businesses will have to become
much more precise and operational than "profit" is presently defined as a
residual phenomenon in a double-entry bookkeeping system.
FAS 33 had
a significant impact on some companies. The adjustments were not trivial! For
example the earnings reported by United States Steel in the 1981 Annual Report
as required under FAS 33 were as follows:
1981 United States Steel Income Before Extraordinary items and
Changes in Acctg. Principles
Historical Cost (Non-PLA Adjusted)
Historical Cost (PLA Adjusted)
Replacement Cost (Current Cost)
$1,077,000,000 Income
$475,300,000 Income
Plus $164,500,000 PLA gain due to decline in purchasing power of
debt
$446,400,000 Income
Plus $164,500,000 PLA Gain
Less $168,000,000 Current cost increase less effect of increase in
the general price level
One assumptions that I read into your example is that sales were made at the
beginning of the second day when the price was $20 per keg. In terms of
period-end dollars the sales are then $53.33. Similarly the FIFO cost of goods
sold of $24 becomes $32 in end of period dollars. Normally these would be
averaged for the day but since sales only took place at the beginning of the day
there's no need to average this out. .
The general price level adjusted historical cost income statement using
end-of-period dollar purchasing power becomes:
$53.33 Sales
32.00 CGS
$21.33 Operating income
(17.33)
Purchasing power loss on monetary items
$ 4.00 Net income which is identical to your net income under replacement
cost accounting
This is the same net income that you derived, because you really not have had
any increase in keg production costs aside from general price level increases. .
Hence I don't think your example is a very good illustration of replacement cost
accounting since the constant-dollar replacement cost of kegs really did not
change throughout the example.
Hence I think you should improve your illustration with both general price
level increases and specific keg production price increases apart from price
changes in the units of purchasing power. I might quibble with the $17.33
number, but production timing assumptions can be made to make this number
acceptable in terms of cash outlays for new kegs and consumption.
A simplifying example would be to have no change in general purchasing power
of the dollar and make all the price changes apply only to kegs of beer
production costs during the second day after sales of the two kegs early in the
morning.
$ 40.00 Sales
24.00 CGS (Fifo)
$ 16.00 Operating income
( 0.00) Purchasing power loss on
monetary items
$ 16.00 Net income (realized)
12.00 Unrealized
replacement cost gain assuming inventory produced at sunrise 84.00 BOP equity
$ 112.00 EOP before dividends (beer consumption)
Maximum Hicksian consumption = $28.
If he consumed no beer until sunset that he produced at sunrise we would allow
the guy to consume $28 worth of beer at the end of the period to have the
BOP and EOP equity be identical at $84.00 since the value of the dollar remains
constant.
Of course this will get complicated if the guy is consuming the beer while
he's producing the beer throughout the period since we have to know the cost of
each swallow as factor prices increase during a production run. .
The Hicksian Concept of Income
In any case the Hicksian criterion is a very weak economic criterion since in a
real company there are many alternative portfolios of assets that have very
different discounted cash flow net income based upon discounted future cash
flows even though they have the same Hicksian income. Also the Hicksian concept
of income is simplistic because it provides no information about portfolio risk
differences such as when speculations versus hedges give the same Hicksian
outcomes in different portfolios.
As a final note I don't think FAS 157 was written for inventory valuations.
To my knowledge this standard applies only to financial assets and liabilities.
Presumably it could be extended to inventories, but this was not its original
intent. I think many amendments would be required for valuing most non-financial
assets such portfolios of real estate.
But I have to admit this illustration has some great potential if it is
extended to different assumptions about timings of revenues and expenses along
with combinations of general and specific price index movements.
Balance Sheet Versus the Income Statement Focus of Standard Setters
Early theorists like Professors Littleton and Ijiri focused heavily on the
income statement as do financial analysts and investors who track net income as
a primary indicator of economic performance. This focus built upon the Revenue
Realization Principle and the Matching Principle leads to weak
conceptualizations of assets and liabilities.
Largely because they cannot define net income on anything other than
cherry-picked Hicksian theory, the FASB and IASB standard setters instead focus
on the balance sheet where think they are on more solid footing conceptualizing
assets and liabilities. This, however, is not without its troubles.
See
"The Asset and Liability View: What It Is and What It Is Not—Implications for
International Accounting Standard Setting from a Theoretical Point of View"
Jens Wüstemann, University of Mannheim; Sonja Wüstemann, Goethe University
Frankfurt am Main
American Accounting Association Annual Meetings, August 4, 2010
http://aaahq.org/AM2010/display.cfm?Filename=SubID_2022.pdf&MIMEType=application%2Fpdf
I would like you, Tom, and Patricia to especially note the reference to the
"stewardship function" below in the context of historical cost accounting.
ABSTRACT
In their current standard setting projects the FASB and the IASB seek to
enhance consistency in the application of accounting standards and
comparability of financial statements by fully implementing the asset and
liability view. However, neither in standard setting nor in the accounting
literature is there agreement on what the asset and liability view
constitutes. In this paper, we show that the asset and liability view is
compatible with different, sometimes even opposing concepts, such as
historical cost accounting and fair value accounting, and thus cannot ensure
internal consistency on its own. By means of the example of revenue
recognition we point out the difficulty to determine the changes in assets
and liabilities that shall give rise to revenue. We argue that the increase
in assets that leads to revenue is the obtainment of the right to
consideration and thus should be focused on by the
Boards.
1. Introduction
A major aim of the FASB and the IASB
in their current standard setting projects is to achieve internal
consistency of the accounting regimes U.S. GAAP and IFRS (IASB 2008c,
BC2.46; IASB 2008a, S3; IASB 2008d, par. 5; IASB 2009, p. 5). One of the
reasons for inconsistencies in present U.S. GAAP and IFRS is that
recognition and measurement principles and rules are developed on the basis
of two competing concepts − the asset and liability view and the revenue and
expense view (Wüstemann and Wüstemann 2010).
Until the 1970s the so called revenue
and expense view had been prevailing in international accounting standard
setting. In the U.S. this view was introduced by Paton and Littleton in the
American Accounting Association Monograph No. 3 in 1940 (Paton and Littleton
1940: 1956) and soon became the state of the art in U.S. accounting theory
and practice. Similar developments took place in other countries, e.g.
Germany, where Schmalenbach (1919) was the main driver for the establishment
of the comparable ’dynamic accounting theory’
(Dynamische
Bilanztheorie)
According to the revenue and expense view the principal purpose of
accounting is to determine periodic net income as a measure of an entity’s
effectiveness in using inputs to obtain and sell output (stewardship
function) by recognising revenue
when it is earned or realised and by matching the related costs with those
revenues (FASB 1976, par. 38−42; Paton and Littleton 1940: 1956, p. 10 et
sqq.; see for the tradition of the stewardship function Edwards, Dean and
Clarke 2009). Some proponents of the revenue and expense view see net income
as an indicator of an entity’s ‘usual, normal, or extended performance’
(‘earning power’) (FASB 1976, par. 62) that may help users not only to
assess management’s performance but also to estimate the value of the firm
(Black 1980, p. 20; Breidleman 1973, p. 654). This requires irregular and
random events that distort net periodic profit, such as the receipt of
grants and losses from bad debt, to be smoothed out (Beidleman 1973, p. 653
et sqq.; Bevis 1965: 1986, p. 104−107; FASB 1976, par. 59; Schmalenbach
1919, p. 32−36). Under the revenue and expense view the function of the
balance sheet is to ‘store’ residuals resulting from the matching and
allocation process; the deferred debits and credits depicted in the balance
sheet do not necessarily represent resources and obligations (Paton and
Littleton 1940: 1956, p. 72−74; Schmalenbach 1919, p. 26; Sprouse 1978, p.
68).
In the 1970s the FASB realised that
the key concepts under the revenue and expense view − revenues and expenses
− are not precisely definable making earnings ‘unduly subject to the effects
of personal opinion about what earnings of an enterprise for a period should
be’ (FASB 1976, par. 60). In order to limit arbitrary judgements and to
achieve a more consistent income determination the FASB decided to shift the
focus to the more robust concepts of assets and liabilities and thus to the
asset and liability view as evidenced by the issuance of SFAC 3
Elements of
Financial Statements
(now SFAC 6) in 1980 (Storey 2003, p. 35 et sqq.;
Miller 1990, p. 26 et seq.; see for a similar development in Germany around
the same time Moxter 1993). The so called asset and liability view in the
U.S. has its origins in the Sprouse and Moonitz monograph that was published
in 1962 as part of the AICPA’s Accounting Research Studies.
Under this view all financial
statement elements are derived from the definitions of assets and
liabilities. Income resulting from changes in assets and liabilities
measures an entity’s increase in net assets (FASB 1976, par. 34; Johnson
2004, p. 1; Ronen 2008, p. 184; Sprouse and Moonitz 1962, par. 11, 46, 49).
The asset and liability view can serve the purpose to objectify income
measurement by restricting recognition in the balance sheet to those items
that embody resources and obligations (Sprouse 1978, p. 70). Alternatively,
the asset and liability view can be adopted in order to inform users about
future cash flows that are expected to flow from an entity’s assets and
liabilities, which are supposed to help them in estimating firm value (Scott
1997, p. 159−162; Hitz 2007, p. 333 and 336−338).
Despite the declared shift from the
revenue and expense view to the asset and liability view in the 1970s,
certain U.S. standards and also the ‘older’ IFRS, for example those on
revenue recognition, still follow the revenue and expense view (Ernst &
Young 2009, p. 1558; Wüstemann and Kierzek 2005, p. 82 et seq.). In the
beginning of the 21st century the FASB and the IASB have begun several
projects, above all the Conceptual Framework Project, that shall lead to an
all-embracing implementation of the asset and liability view (Wüstemann and
Wüstemann 2010).
We observe that both in the accounting
literature and the standard setting processes, there is confusion about the
meaning and implications of the asset and liability view, especially as
regards the role of the realisation principle and the matching principle as
well as fair value measurement (see literature review below). A second
problem is that the asset and liability view does not provide clear guidance
on how assets and liabilities shall be defined and which changes in assets
and liabilities shall give rise to income. The FASB and the IASB have − up
to now − been struggling with the problem of bringing current revenue
recognition guidance in conformity with the asset and liability view for
seven years. In December 2008, they finally published a Discussion Paper
‘Preliminary Views on Revenue Recognition in Contracts with Customers’, but
the issuance of the new standard is not yet foreseeable.
The aim of this paper is to shed light
on the conceptual underpinnings of the asset and liability view, to clarify
misunderstandings in the accounting literature and standard setting about
its meaning and to discuss implications for international accounting
standard setting. The remainder is organised as follows: In the first part
of the paper we depict the different opinions that exist with regard to the
asset and liability view and then clarify the concept by defining
recognition and measurement principles as well as purposes of financial
statements that are compatible with this view. Subsequently, we analyse in
how far the asset and liability view is implemented in present U.S. GAAP and
IFRS and in which areas accounting principles still exist that oppose the
asset and liability view. In the final part we point out the difficulty to
define assets and liabilities taking the current FASB’s and IASB’s joint
project on revenue recognition as an example and make suggestions for
improvement.
I think the major problem, aside from the cost of generating more
relevant and reliable information, is that standards setters never look beyond
single-column financial statements that inevitably lead them to horrid mixed
model measurements that destroy aggregations into summary measures like "Total
Assets" and "Net Income." Bob Herz recommends doing away with aggregating net
income metrics. I recommend having multiple columns and multiple net income
aggregations.
See
http://faculty.trinity.edu/rjensen/theory02.htm#ChangesOnTheWay
See Bob Herz's recommendations below.
Respectfully,
Bob Jensen
Opportunity for Deep Down and Dirty Bayesians
"Quantitative Legal Prediction – or – How I Learned to Stop Worrying and
Start Preparing for the Data Driven Future of the Legal Services Industry,"
by Daniel Martin Katz, SSRN, December 11, 2013
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2187752
Abstract:
Do I have a case? What is our likely exposure? How much is this going to
cost? What will happen if we leave this particular provision out of this
contract? How can we best staff this particular legal matter? These are core
questions asked by sophisticated clients such as general counsels as well as
consumers at the retail level. Whether generated by a mental model or a
sophisticated algorithm, prediction is a core component of the guidance that
lawyers offer. Indeed, it is by generating informed answers to these types
of questions that many lawyers earn their respective wage.
Every single day lawyers and law firms are
providing predictions to their clients regarding their prospects in
litigation and the cost associated with its pursuit (defense). How are these
predictions being generated? Precisely what data or model is being
leveraged? Could a subset of these predictions be improved by access to
outcome data in a large number of 'similar' cases. Simply put, the answer is
yes. Quantitative legal prediction already plays a significant role in
certain practice areas and this role is likely increase as greater access to
appropriate legal data becomes available.
This article is dedicated to highlighting the
coming age of Quantitative Legal Prediction with hopes that practicing
lawyers, law students and law schools will take heed and prepare to survive
(thrive) in this new ordering. Simply put, most lawyers, law schools and law
students are going to have to do more to prepare for the data driven future
of this industry. In other words, welcome to Law's Information Revolution
and yeah - there is going to be math on the exam.
Jensen Comments
It seems to me that much of this paper can also be extended to quantitative
analysis (e.g., Bayesian) of clauses in a set of financial statements.
Question
If the media insists on reporting one earnings number, which of the alternative
earnings numbers should be reported?
In particular, should net earnings be reported before or after remeasuring
financial instruments for unrealized changes in fair value?
Hint
The following paper has a great summary of the history of OCI and problems
facing the FASB and IASB as we look to the future of financial reporting of
business firms.
"Academic Research and Standard-Setting: The Case of Other Comprehensive
Income," by Lynn L. Rees and Philip B. Shane, Accounting Horizons,
December 2012, Vol. 26, No. 4, pp. 789-815. ---
http://aaajournals.org/doi/full/10.2308/acch-50237
This paper links academic accounting research on
comprehensive income reporting with the accounting standard-setting efforts
of the Financial Accounting Standards Board (FASB) and the International
Accounting Standards Board (IASB). We begin by discussing the development of
reporting other comprehensive income, and we identify a significant weakness
in the FASB's Conceptual Framework, in the lack of a cohesive definition of
any subcategory of comprehensive income, including earnings. We identify
several attributes that could help allocate comprehensive income between net
income, other comprehensive income, and other subcategories. We then review
academic research related to remaining standard-setting issues, and identify
gaps in academic research where hypotheses could be developed and tested.
Our objectives are to (1) stimulate standard-setters to better conceptualize
what is meant by other comprehensive income and to distinguish it from
earnings, and (2) stimulate researchers to develop and test hypotheses that
might help in that process.
. . .
Potential Alternative Definitions of Earnings
Table 1 summarizes and categorizes various
standard-setting issues related to reporting comprehensive income, and
provides the organizing structure for our literature review later in the
paper. The most important of these issues is the definition of earnings, or
what makes up earnings and how it is distinguished from OCI. This is a
“cross-cutting” issue because it arises when the Boards deliberate on
various topics. The Boards cooperatively initiated the financial statement
presentation project intending, in part, to solve the comprehensive income
composition problem, but the project was subsequently delayed.
Table 2 presents a list of the specific
comprehensive income components under current U.S. GAAP that require
recognition as OCI. The second column presents the statement that provided
financial reporting guidance for the OCI component, along with its effective
date. The effective dates provide an indication as to how the OCI components
have expanded over time. Since the issuance of Statement No. 130, which
established formal reporting of OCI, new OCI-expanding requirements were
promulgated in Statement No. 133. Financial instruments, insurance, and
leases are three examples of topics currently on the FASB's agenda where OCI
has been discussed as an option to report various gains and losses. In all
these discussions, a framework is lacking that can guide standard-setter
decisions. The increased use of accumulated OCI to capture various changes
in net assets and the likely expansion of OCI items reinforce the notion
that standard-setters must eventually come to grips with the distinction
between OCI and earnings, or even whether the practice of reporting OCI with
recycling should be retained.7
Presumably, elements with similar informational
attributes should be classified together in financial statements. It is
unclear what attributes the items listed in Table 2 possess that result in
their being characterized differently from other components of income.
Notably, the basis for conclusions of the FASB standards gives little to no
economic reasoning for the decision to place these items in OCI. While not
exhaustive, Table 2 presents four attributes that standard-setters could
potentially use to distinguish between earnings and OCI: (1) the degree of
persistence of the item, (2) whether the item results from a firm's core
operations, (3) whether the item represents a change in net assets that is
reasonably within management's control, and (4) whether the item results
from remeasurement of an asset/liability. We discuss in turn the merits and
potential problems of using these attributes to form a reporting framework
for comprehensive income.
Degree of Persistence.
The degree of persistence of various comprehensive
income components has significant implications for firm value (e.g.,
Friedman 1957; Kormendi and Lipe 1987; Collins and Kothari 1989). Ohlson's
(1995, 1999) valuation model places a heavy emphasis on earnings
persistence, which suggests that a reporting format that facilitates
identifying the level of persistence across income components could be
useful to investors. Examples abound as to how the concept of income
persistence has been used in standard-setting, including separate
presentation in the income statement for one-time items, extraordinary
items, and discontinued operations. Standard-setters have justified several
footnote disclosures (segmental disclosures) and disaggregation requirements
(e.g., components of pension expense) on the basis of providing information
to financial statement users about the persistence of various income
statement components.
Thus, the persistence of revenue and expense items
potentially could serve as a distinguishing characteristic of earnings and
OCI. Table 2 shows that we regard all the items currently recognized in OCI
as having relatively low persistence. However, several other low-persistence
items are not recognized in OCI; for example, gains/losses on sale of
assets, impairments of assets, restructuring charges, and gains/losses from
litigation. To be consistent with this definition of OCI, the current
paradigm must change significantly, and the resulting total for OCI would
look substantially different from what it is now.
Using persistence of an item to distinguish
earnings from OCI would create significant problems for standard-setters.
Persistence can range from completely transitory (zero persistence) to
permanent (100 percent persistence). At what point along this range is an
item persistent enough to be recorded in earnings? While restructuring
charges are typically considered as having low persistence, if they occur
every two to three years, is this frequent enough to be classified with
other earnings components or infrequent enough to be classified with OCI?
Furthermore, the relative persistence of an item likely varies across
industries, and even across firms.
In spite of these inherent difficulties,
standard-setters could establish criteria related to persistence that they
might use to ultimately determine the classification of particular items. In
addition, standard-setters would not be restricted to classifying income
components in one of two categories. As an example, highly persistent
components could be classified as part of “recurring earnings,”
medium-persistence items could go to “other earnings,” and low-persistence
items to OCI (or some other nomenclature). Standard-setters could create
additional partitions as needed.
Core Operations.
Classifying income components as earnings or OCI
based on whether they are part of a firm's core operations is intuitively
appealing. This criterion is related to income persistence, as we would
expect core earnings to be more persistent than noncore income items.
Furthermore, classifying income based on whether it is part of core
operations has a long history in accounting.
In current practice, companies and investors place
primary importance on some variant of earnings. However, it is not clear
which variant of earnings is superior. Many companies report pro forma net
income, which presumably provides investors with a more representative
measure of the company's core income, but definitions of pro forma earnings
vary across firms. Similarly, analysts tend to forecast a company's core
earnings (Gu and Chen 2004). Evidence in prior research indicates that pro
forma earnings and actual earnings forecasted by analysts are more closely
associated with share prices than income from continuing operations based on
current U.S. GAAP (e.g., Bradshaw and Sloan 2002; Bhattacharya et al. 2003).
The problems inherent with this attribute are
similar to those of the earnings-persistence criterion. No generally
accepted definition of core operations exists. At what point along a
continuum does an activity become part of the core operations of a business?
As Table 2 indicates, classifying gains/losses from holding
available-for-sale securities as part of core earnings depends on whether
the firm operates in the financial sector. Different operating environments
across firms and industries could make it difficult for standard-setters to
determine whether an item belongs in core earnings or OCI.8 In addition,
differences in application across firms may give rise to concerns about
comparability and potential for abuse on the part of managers in exercising
their discretion (e.g., Barth et al. 2011).
The FASB's (2010) Staff Draft on Financial
Statement Presentation tries to address the definitional issue by using
interrelationships and synergies between assets and liabilities as a
criterion to distinguish operating (or core) activities from investing (or
noncore) activities. Specifically, the Staff Draft states:
An entity shall classify in the operating category:
Assets that are used as part of the entity's
day-to-day business and all changes in those assets Liabilities that arise
from the entity's day-to-day business and all changes in those liabilities.
Operating activities generate revenue through a
process that requires the interrelated use of the entity's resources. An
asset or a liability that an entity uses to generate a return and any change
in that asset or liability shall be classified in the investing category. No
significant synergies are created for the entity by combining an asset or a
liability classified in the investing category with other resources of the
entity. An asset or a liability classified in the investing category may
yield a return for the entity in the form of, for example, interest,
dividends, royalties, equity income, gains, or losses. (FASB 2010, paras.
72, 73, 81)
The above distinction between operating activities
and investing activities could similarly be used to distinguish between core
activities and noncore activities. Alternatively, standard-setters might
develop other definitions. Similar to the degree of persistence attribute,
standard-setters would not be restricted to a simple core versus noncore
dichotomy when using this definition.
Another possible solution is to allow management to
determine which items belong in core earnings. Companies exercise this
discretion today when they choose to disclose pro forma earnings.
Furthermore, the FASB established the precedent of the “management approach”
when it allowed management to determine how to report segment disclosures.
In several other areas of U.S. GAAP, management is responsible for
establishing boundaries that define its operating environment. FASB
Accounting Standards Codification Topic 320 (formerly Statement 115) permits
different measurements for identical investments based on management's
intent to sell or hold the instrument. Other examples where U.S. GAAP allows
for management discretion include determining the rate to discount pension
liabilities, defining reporting units, and determining whether an impairment
is other than temporary. However, the management approach accentuates the
concern about comparability and potential for abuse.
Management Control.
Given a premise that evaluating management's
stewardship is a primary role of financial statements, a possible rationale
for excluding certain items from earnings is that they do not provide a good
measure to evaluate management.9 Management can largely control the firm's
operating costs and can influence the level of revenues generated. However,
some decisions that affect comprehensive income can be established by
company policy or the company mission statement and, thus, be outside the
control of management. For example, a company policy might be to invest
excess cash in marketable securities with the objective of maximizing
returns. Once the board of directors establishes this policy, management has
little influence over how market-wide fluctuations in security prices affect
earnings, and hedging the gains/losses would be inconsistent with the
objective of maximizing returns. Similarly, a company's mission statement
might include expansion overseas, or prior management might have already
decided to establish a foreign subsidiary. The resulting gains/losses from
foreign currency fluctuations would seemingly be out of management's
control, and hedging these gains/losses would not make economic sense if the
subsidiary's functional currency is its local currency and the parent has no
intention of repatriating the subsidiary's cash flows.
Of course, determining what is and is not
ostensibly under management's control becomes highly subjective and would
probably differ across industries, and perhaps even across firms within
industries. For example, gains/losses from investment holdings might not be
relevant in evaluating management of some companies, but might be very
relevant for managers of holding companies. In addition, the time horizon
affects what is under management's control. That is, as the time horizon
lengthens, more things are under management's control.
In Table 2, we classify items as not under
management's control if they are based on fluctuations in stock prices or
exchange rates, which academic research shows to be largely random within
efficient markets. Using this classification model, most, but not all, of
the OCI items listed in Table 2 are classified as not under the management's
control. Some of the pension items currently recognized in OCI are within
the control of management, because management controls the decision to
revise a pension plan. While management has control over when to harvest
gains/losses on available-for-sale (AFS) securities by deciding when to sell
the securities, it cannot control market prices. Thus, under this criterion,
unrealized gains/losses on AFS securities are appropriately recognized in
OCI. However, gains/losses on trading securities and the effects of tax rate
changes are beyond management's control, and yet, these items are currently
included as part of earnings. Thus, “management control” does not
distinguish what is and is not included in earnings under current U.S. GAAP.
Remeasurements.
Barker (2004) explains how the measurement and
presentation of comprehensive income might rely on remeasurements. The
FASB's (2010) Staff Draft on Financial Statement Presentation defines
remeasurements as follows:
A remeasurement is an amount recognized in
comprehensive income that increases or decreases the net carrying amount of
an asset or a liability and that is the result of:
A change in (or realization of) a current price or
value A change in an estimate of a current price or value or A change in any
estimate or method used to measure the carrying amount of an asset or a
liability. (FASB 2010, para. 234)
Using this definition, examples of remeasurements
are impairments of land, unrealized gains/losses due to fair value changes
in securities, income tax expenses due to changes in statutory tax rates,
and unexpected gains/losses from holding pension assets. All of these items
represent a change in carrying value of an already existing asset or
liability due to changes in prices or estimates (land, investments, deferred
tax asset/liability, and pension asset/liability, respectively).
Table 3 reproduces a table from Barker (2004) that
illustrates how a firm's income statement might look using a “matrix format”
if standard-setters adopt the remeasurement approach to reporting
comprehensive income. Note that the presentation in Table 3 does not employ
earnings as a subtotal of comprehensive income; however, the approach could
be modified to define earnings as the sum of all items before remeasurements,
if considered useful. Tarca et al. (2008) conduct an experiment with
analysts, accountants, and M.B.A. students to assess whether the matrix
income statement format in Table 3 facilitates or hinders users' ability to
extract information. They find evidence suggesting that the matrix format
facilitates more accurate information extraction for users across all
sophistication levels relative to a typical format based on IAS 1.
Table 3: Illustration of Matrix Reporting Format
Employing remeasurements to distinguish between
earnings and other comprehensive income largely incorporates the criterion
of earnings persistence. Most remeasurements result from price changes,
where the current change has little or no association with future changes
and, therefore, these components of income are transitory. In contrast,
earnings components before remeasurements generally represent items that are
likely more persistent.
Perhaps the most significant advantage of the
remeasurement criterion is that it is less subjective than the other
criteria previously discussed. Most of the other criteria in Table 2 are
continuous in nature. Drawing a bright line to differentiate what belongs in
earnings from what belongs in OCI is challenging and will likely be
susceptible to income manipulation. In contrast, determining whether a
component of income arises from a remeasurement is more straightforward.
Yet another advantage of this approach is it allows
for a full fair value balance sheet that clearly discloses the effects of
fair value measurement on periodic comprehensive income, while also showing
earnings effects under a modified historical cost system (i.e., before
remeasurements). This approach could potentially provide better information
about probable future cash flows.
Other.
The attributes standard-setters could use to
classify income components into earnings or OCI are not limited to the list
in Table 2. Ketz (1999) suggests using the level of measurement uncertainty.
As an example, gains/losses from Level 1 fair value measurements might be
viewed as sufficiently certain to include in earnings, while Level 3 fair
value measurements might generate gains/losses that belong in OCI. Song et
al. (2010) provide some support for this partition in that they document the
value relevance of Level 1 and Level 2 fair values exceeds the value
relevance of Level 3 fair values.
Another potential attribute might be the horizon
over which unrealized gains/losses are ultimately realized. That is,
unrealized gains/losses from foreign currency fluctuations, term life
insurance contracts, or holding pension assets that will not be realized for
many years in the future might be disclosed as part of OCI, whereas
unrealized gains/losses from trading and available-for-sale securities could
be part of earnings.
As previously discussed, the attributes of
measurement uncertainty and timeliness create similar problems in
determining where to draw the line. Which items are sufficiently reliable
(or timely) to include in earnings, and will differences in implementation
across firms and industries impair comparability?
The overriding purpose of the discussion in this
subsection is to point out that several alternative attributes could
potentially guide standard-setters in establishing criteria to differentiate
earnings from OCI. Ultimately, the choice regarding whether/how to
distinguish net income from OCI is a matter of policy. However, academic
research can inform policy decisions, as described in the fourth and fifth
sections.
Summary
Reporting OCI is a relatively recent phenomenon
that presumes financial statement users are provided with better information
when specific comprehensive income components are excluded from
earnings-per-share (EPS), and recycled back into net income only after the
occurrence of a specified transaction or event. The number of income
components included in OCI has increased over time, and this expansion is
likely to continue as standard-setters address new agenda items (e.g.,
financial instruments and insurance contracts). The lack of a clear
definitional distinction between earnings and OCI in the FASB/IASB
Conceptual Frameworks has led to: (1) ad hoc decisions on the income
components classified in OCI, and (2) no conceptual basis for deciding
whether OCI should be excluded from earnings-per-share (EPS) in the current
period or recycled through EPS in subsequent periods. In this section, we
discussed alternative criteria that standard-setters could use to
distinguish earnings from OCI, along with the advantages and challenges of
each criterion. Further, due to the inherent difficulties in drawing bright
lines between earnings that are persistent versus transitory, core versus
noncore, under management control or not, and amenable to remeasurement or
not, standard-setters might consider eliminating OCI; that is, they might
decide to adopt an all-inclusive income statement approach, where
comprehensive income is reporte
. . .
Continued in article
Jensen Comment
I like this paper. Table 3 could be improved by adding bottom line net earnings
before and after remeasurement.
The paper does not provide all the answers, but it is well written in terms
of history up to this point in time and alternative directions for
consideration.
Added Jensen Comment
Most investors track earnings as an index for making
decisions as to whether to buy or sell the stock or bond of Company XYZ for
their portfolios. This begs the question of how earnings
(or eps or P/E ratios) scores are being used by investors.
I think of an earnings number much like I think of a
golf score. The PGA scores golf for 18 hole combinations much like accounting
standard setters score audited income/earnings numbers
for one-year periods. Each 18-hole qualifying score before a golf tournament
becomes like the annual earnings performance of a firm
before its securities are in an investor's portfolio.
The purpose of golf qualifying scores is to predict how well each player will
perform in a tournament. It's arbitrary whether qualifying scores are based on
18, 36, 54 or 72 hole performances before the tournament. Similarly, investors
look at a sequence of annual earnings scores as possibly
the most important qualifying scores for admitting company shares or bonds into
a portfolio.
The analogy here, however, only goes so far. The PGA only looks at total
qualifying scores and not trends during the qualification process. Investors,
however, are also interested in trends over time and in variations. Golf scores
of 76, 67, and 62 in any permutation may qualify a player for a PGA tournament.
Earnings per share numbers 3.46, 2.47, and 2.23 may not
qualify a stock for a portfolio whereas 2.23, 2.47, and 3.46 may make an
investor salivate.
In golf and in investing, it's not so much how a competing unit performs in
absolutes as it is how a competing unit performs in comparison with the
competition. A golf score of 68 may put a player in first place or 20th place
depending on the competition. An eps change of 12% may put a company in first
place or 20th place depending on the competition.
In golf, how the game is scored affects the strategy. For example, in medal
competition each player is looking for the lowest possible sequence of 18-hole
scores. One or two bad holes with high scores can ruin the player's chances in
the entire tournament. Hence, in medal competition players are less likely to
take risks such as shooting over ponds and clusters of trees. They often aim
short of two bunkers rather than an narrow strip between two bunkers.
In match play the players tend to take more risks because a bad score on a
few holes has almost no impact on winning or losing a tournament. The objective
is to win the most holes in each round.
Companies seeking to smooth earnings with accounting
creativity have a medal-play strategy. They are also more likely to hedge like
airlines hedge fuel prices way into the future. They may put less investment in
R&D. Companies seeking speculators are more like match-tournament players. They
may speculate in derivatives markets rather require only hedging in derivatives.
So what is the main point I'm trying to make?
My main point is that if we adopted a zero-based conceptual framework from
scratch that has earnings primacy (rather than
asset-liability primacy) we would probably have two or more concepts of
earnings for different types of "play" by investors.
Similarly, we have at least two types of scoring in golf tournaments. Or we
might, as Bob Herz once suggested, present accounting data in disaggregated form
and let investors perform aggregations to suit their own conceptualizations of
earnings.
As it stands, the asset-liability primacy that evolved in the FASB's
conceptual framework and the pending IASB's conceptual framework is a primacy
that totally destroyed the ability to form a concept of net
earnings that is tied to investor strategies. The good news is that
investors are now receiving better information regarding values and risks that
are also important in their portfolio decisions. The bad news is that investors
are now receiving earnings numbers and
earnings ratios like eps and P/E ratios /.
After defining assets,
the statement moves to liabilities (obligations to transfer assets or
perform services), and from there to equity (assets minus liabilities).
It then defines investments and distributions to owners, so that it can
create a definition of comprehensive income.
From the ‘highlights’ page:
Comprehensive income is the change in
equity (net assets) of an entity during a period from transactions
and other events and circumstances from nonowner sources. It
includes all changes in equity during a period except those
resulting from investments by owners and distributions to owners.
Now, here is what I find interesting: after
defining revenues, expenses, gains and losses,
the statement stops short of definingearnings. Again from the highlights:
The Statement does not
define the term earnings, which is
reserved for possible use to designate a significant intermediate
measure or component that is part of comprehensive income.
Here is where I think we academics tend to get
confused. We assume that because earnings are
not even yet defined at this point in the CF,
the FASB doesn’t care about them. But the political perspective yields a
different conclusion: the FASB couldn’t defend a
definition of earnings without further
conceptual grounding.
Message to the AECM from Bob Jensen on September 1, 2013
Hi Zane and Marc,
It's not clear that the Conceptual Framework is intended to help
operationalize standards. There are too many problems with non-operational
definitions in the Conceptual Framework. Take for example, a
company's effort to make operational decisions on the presentation of "Other
Comprehensive Income."
Conceptual
Framework does not currently include specific guidance on
presentation of financial performance in the statement of comprehensive
income1.
2. Respondents to the IASB’s
Agenda Consultation 2011 identified the reporting of financial
performance, (including the use of other comprehensive income (OCI) and
recycling) as a key topic that the IASB should address. Views expressed
by respondents included:
(a) The use of non-GAAP measures by many
preparers to explain their results is an indication that profit or loss
may not be a useful measure of the entity’s performance;
(b) Lack of clear definition for OCI has meant
it has become a "dumping ground" for anything controversial;
(c) There is a lack of clarity on the roles of
profit or loss and OCI in measuring and reporting an entity’s
performance;
(d) Many investors/analysts ignore OCI as the
changes reported in this caption are not caused by operating flows from
which long-term trends can be inferred; and
(e) The interaction between profit or loss and
OCI is unclear, especially the notion of recycling and when or which OCI
items should be recycled.
Many of the questions and views raised by
respondents involving profit or loss and OCI stem from the fundamental
question: "How can financial statements best portray the entity’s
performance during the period?"
Continued in article
Jensen Comment
Applying formal logic between the Conceptual Framework and IFRS
Standards and real-world financial statements is probably an exercise in
futility. The same problems arise in setting and enforcing laws. The
Constitution is supposed to guide the writing of laws and the enforcing of
those laws. But applying the Constitution to guide court decisions and
settlements defies logic, at least formal logic.
In accounting the Conceptual Framework cannot be relied upon for
answering this question:
"How can financial statements best portray the
entity’s performance during the period?"
Five General Categories of Aggregation "The Sums of All Parts: Redesigning Financials: As part of radical
changes to the income statement, balance sheet, and cash flow statement, FASB
signs off on a series of new subtotals to be contained in each," by Marie
Leone, CFO Magazine, November 14, 2007 ---
http://www.cfo.com/article.cfm/10131571?f=rsspage
In another large step towards the most dramatic
overhaul of financial statements in decades, the Financial Accounting
Standards Board Wednesday laid out a series of subtotal figures that
companies would be required to include on their balance sheets, income
statements and cash flow statements.
The new look for financials will break all three
statements into five general categories: business, discontinued operations,
financing, income taxes, and equity (if needed). Each of those groupings
will carry its own total. In addition, the business, financing, and income
tax categories will be segmented into even more narrow sections, each of
which will include a subtotal. For example, the business category will be
broken down into operating assets, operating liabilities and a subtotal; and
investing assets, investing liabilities, and a second subtotal.
(Although FASB will not officially release its
proposal until the second quarter of 2008, it has made public some initial
peeks at the proposed format.)
The addition of totals and subtotals is an
extension of FASB's broader principle on disaggregating financial statement
line items. It is the board's belief that separating line items into their
components gives investors, creditors, analysts and other financial
statement users a better view of a company's financial health. For example,
the new format should make it easier for an investor to see how much cash a
company generates by selling its products versus how much it generates by
selling-off a business unit or through financial investments made by the
corporate treasurer.
FASB staffers say buy- and sell-side analysts
typically scrutinize financial statements by breaking them down into
categories similar to the ones the board is proposing.
In keeping with its promise to strip accounting
standards of complexity, the board also agreed to issue two overarching
principles in its draft document on financial statement presentation. One
principle instructs preparers to keep the category order consistent in each
of the three financial statements. For example, if income tax is the last
category shown in on the balance sheet, then it should also be the final
category on the cash flow and income statement. "We're not going to tell you
what order [to use], just that you should use the same order in all three
statements," noted FASB Chairman Robert Herz during the meeting.
In addition, the board wants companies to "clearly
distinguish" between operating assets and operating liabilities, as well as
short-term assets and liabilities and their long-term counterparts. But the
board is not going to prescribe how that should be done. Regarding the issue
of common sums, "the only requirement will be that totals and subtotals are
segmented by activities," noted board member George Batavick, "the rest will
be principles."
Updating the look and functionality of financial
statements is one of the joint projects that FASB is working on with the
International Accounting Standards Board as the two organizations work to
converge U.S. and global accounting rules. On Thursday, IASB will discuss
the common totals issue and is expected to release its recommendations.
FASB expects the draft proposal to spark a healthy
debate among users and preparers, and staffers are planning for a four- to
six-month comment period to follow its release. One issue that will have to
be thrashed out, for example, is whether discontinued operations should be
relegated to its own category, or run through the income statement or
financing activities.
To avoid any last-minute confusion with the
Securities and Exchange Commission, Herz asked the FASB accountants working
on the project to "touch base with the SEC staff just to get their input."
Herz noted that last time the two groups discussed disaggregation
principles, Scott Taub, not James Kroeker, was the SEC's deputy chief
accountant.
Earlier this year, Google rolled out “Art
Project,” a tool that lets you access 1,000 works of art appearing in 17
great museums across the world, from the Met
in New York City to the Uffizi
Gallery in Florence. (More
on that here.) Now, as part of a broader effort to put art in your
hands, the company has produced a new smartphone
app (available in Android and iPhone) that enriches the museum-going
experience, and it’s being demoed at the
Getty Museum in Los Angeles.
The concept is pretty simple. You’re wandering through the Getty. You
spot a painting that deeply touches you. To find out more about it, you open
the
Google Goggles app on your phone, snap a photo, and instantly download
commentary from artists, curators, and conservators, or even a small image
of the work itself.
Sample this, and you’ll see what we mean. And, for more on the story,
turn to Jori Finkel, the ace arts reporter for the LA Times.
The concept is pretty simple. You’re wandering through the annual report
of Bank of America. You spot a reference to hedging of interest rates with
swaps that confuses you. To find out more about it, you open
the
Google Goggles app on your phone, find a reference to interest rate
swaps, and instantly download commentary interest rate hedging strategies
and accounting with comparisons of accounting under IFRS versus FAS 133. The
link might elaborate in detail on the very portion of the Bank of America
annual report that you are examining.
No Bottom Line
Question
Is a major overhaul of accounting standards on the way?
Hint
There may no longer be the tried and untrusted earnings per share number to
report! Comment
It would be interesting to see a documentation of the academic research, if any,
that the FASB relied upon to commence this blockbuster initiative. I recommend
that some astute researcher commence to probe into the thinking behind this
proposal.
Pretty soon the bottom line may not be, well, the
bottom line.
In coming months, accounting-rule makers are
planning to unveil a draft plan to rework financial statements, the bedrock
data that millions of investors use every day when deciding whether to buy
or sell stocks, bonds and other financial instruments. One possible result:
the elimination of what today is known as net income or net profit, the
bottom-line figure showing what is left after expenses have been met and
taxes paid.
It is the item many investors look to as a key
gauge of corporate performance and one measure used to determine executive
compensation. In its place, investors might find a number of profit figures
that correspond to different corporate activities such as business
operations, financing and investing.
Another possible radical change in the works:
assets and liabilities may no longer be separate categories on the balance
sheet, or fall to the left and right side in the classic format taught in
introductory accounting classes.
ACCOUNTING OVERHAUL
Get a glimpse of what new financial statements
could look like, according to an early draft recently provided by the
Financial Accounting Standards Board to one of its advisory groups. The
overhaul could mark one of the most drastic changes to accounting and
financial reporting since the start of the Industrial Revolution in the 19th
century, when companies began publishing financial information as they
sought outside capital. The move is being undertaken by accounting-rule
makers in the U.S. and internationally, and ultimately could affect
companies and investors around the world.
The project is aimed at providing investors with
more telling information and has come about as rule makers work to one day
come up with a common, global set of accounting standards. If adopted, the
changes will likely force every accounting textbook to be rewritten and
anyone who uses accounting -- from clerks to chief executives -- to relearn
how to compile and analyze information that shows what is happening in a
business.
This is likely to come as a shock, even if many
investors and executives acknowledge that net income has flaws. "If there
was no bottom line, I'd want to have a sense of what other indicators I
ought to be looking at to get a sense of the comprehensive health of the
company," says Katrina Presti, a part-time independent health-care
contractor and stay-at-home mom who is part of a 12-woman investment club in
Pueblo, Colo. "Net income might be a false indicator, but what would I look
at if it goes away?"
The effort to redo financial statements reflects
changes in who uses them and for what purposes. Financial statements were
originally crafted with bankers and lenders in mind. Their biggest question:
Is the business solvent and what's left if it fails? Stock investors care
more about a business's current and future profits, so the net-income line
takes on added significance for them.
Indeed, that single profit number, particularly
when it is divided by the number of shares outstanding, provides the most
popular measure of a company's valuation: the price-to-earnings ratio. A
company that trades at $10 a share, and which has net profit of $1 a share,
has a P/E of 10.
But giving that much power to one number has long
been a recipe for fraud and stock-market excesses. Many major accounting
scandals earlier this decade centered on manipulation of net income. The
stock-market bubble of the 1990s was largely based on investors' assumption
that net profit for stocks would grow rapidly for years to come. And the
game of beating a quarterly earnings number became a distraction or worse
for companies' managers and investors. Obviously it isn't known whether the
new format would cut down on attempts to game the numbers, but companies
would have to give a more detailed breakdown of what is going on.
The goal of the accounting-rule makers is to better
reflect how businesses are actually run and divert attention from the one
number. "I know the world likes single bottom-line numbers and all of that,
but complicated businesses are hard to translate into just one number," says
Robert Herz, chairman of the Financial Accounting Standards Board, the U.S.
rule-making body that is one of several groups working on the changes.
At the same time, public companies today are more
global than local, and as likely to be involved in services or lines of
business that involve intellectual property such as software rather than the
plants and equipment that defined the manufacturing age. "The income
statement today looks a lot like it did when I started out in this
profession," says William Parrett, the retiring CEO of accounting firm
Deloitte Touche Tohmatsu, who started as a junior accountant in 1967. "But
the kind of information that goes into it is completely different."
Along the way, figures such as net income have
become muddied. That is in part because more and more of the items used to
calculate net profit are based on management estimates, such as the value of
items that don't trade in active markets and the direction of interest
rates. Also, over the years rule makers agreed to corporate demands to
account for some things, such as day-to-day changes in the value of pension
plans or financial instruments used to protect against changes in interest
rates, in ways that keep them from causing swings in net income.
Rule makers hope reformatting financial statements
will address some of these issues, while giving investors more information
about what is happening in different parts of a business to better assess
its value. The project is being managed jointly by the FASB in the U.S. and
the London-based International Accounting Standards Board, and involves
accounting bodies in Japan, other parts of Asia and individual European
nations.
The entire process of adopting the revised approach
could take a few years to play out, so much could yet change. Plus, once
rule makers adopt the changes, they would have to be ratified by regulatory
authorities, such as the Securities and Exchange Commission in the U.S. and
the European Commission in Europe, before public companies would be required
to follow them.
As a first step, rule makers expect later this year
to publish a document outlining their preliminary views on what new form
financial statements might take. But already they have given hints of what's
in store. In March, the FASB provided draft, new financial statements at the
end of a 32-page handout for members of an advisory group. (See an example.)
Although likely to change, this preview showed an
income statement that has separate segments for the company's operating
business, its financing activities, investing activities and tax payments.
Each area has an income subtotal for that particular segment.
There is also a "total comprehensive income"
category that is wider ranging than net profit as it is known today, and so
wouldn't be directly comparable. That is because this total would likely
include gains and losses now kept in other parts of the financial
statements. These include some currency fluctuations and changes in the
value of financial instruments used to hedge against other items.
Comprehensive income could also eventually include
short-term changes in the value of corporate pension plans, which currently
are smoothed out over a number of years. As a result, comprehensive income
could be a lot more difficult to predict and could be volatile from quarter
to quarter or year to year.
As for the balance sheet, the new version would
group assets and liabilities together according to similar categories of
operating, investing and financing activities, although it does provide a
section for shareholders equity. Currently, a balance sheet is broken down
between assets and liabilities, rather than by operating categories.
Such drastic change isn't likely to happen without
a fight. Efforts to bring now-excluded figures into the income statement
could prompt battles with companies that fear their profit will be subject
to big swings. Companies may also balk at the expense involved.
"The cost of this change could be monumental," says
Gary John Previts, an accounting professor at Case Western Reserve
University in Cleveland. "All the textbooks are going to have to change,
every contract and every bank arrangement will have to change." Investors in
Europe and Asia, meanwhile, have opposed the idea of dropping net profit as
it appears today, David Tweedie, the IASB's chairman, said in an interview
earlier this year.
Analysts in the London office of UBS AG recently
published a report arguing this very point -- that even if net income is a
"simplistic measure," that doesn't mean it isn't a valid "starting point in
valuation" and that "its widespread use is justification enough for its
retention."
Such opposition doesn't surprise many accounting
experts. Net income is "the basis for bonuses and judgments about what a
company's stock is worth," says Stephen A. Zeff, an accounting professor at
Rice University. "I just don't know what the markets would do if companies
stopped reporting a bottom line somewhere." In the U.S., professional
investors and analysts have taken a more nuanced view, perhaps because the
manipulation of numbers was more pronounced in U.S. markets.
That said, net profit has been around for some
time. The income statement in use today, along with the balance sheet,
generally dates to the 1940s when the SEC laid out regulations on financial
disclosure. But many companies have included net profit in one form or
another since the 1800s.
In its fourth annual report, General Electric Co.
provided investors with a consolidated balance sheet and consolidated
profit-and-loss account for the year ended Jan. 31, 1896. The company, whose
board at the time included Thomas Edison, generated "profit of the year" --
what today would be called net income or net profit -- of $1,388,967.46.
For the moment, net profit will probably exist in
some form, although its days are likely numbered. "We've decided in the
interim to keep a net-income subtotal, but that's all up for discussion,"
the FASB's Mr. Herz says.
Question
What do CFO's think of Robert Herz's (Chairman of the FASB) radical proposed
format for financial statements that have more disaggregated financial
information and no aggregated bottom line?
As we moved to fair value accounting for
derivative financial instruments (FAS 133) and financial instruments (FAS 157
and 159) coupled with the expected new thrust for fair value reporting on the
international scene, we have filled the income statement and the retained
earnings statement with more and more instability due to fluctuating unrealized
gains and losses.
But if we must live with more and more fair
value reporting, the bottom line has to go. But CFOs are reluctant to give up
the bottom line even if it may distort investing decisions and compensation
contracts tied to bottom-line reporting.
Last summer, McCormick & Co. controller Ken Kelly sliced
and diced his financial statements in ways he had never
before imagined. For starters, he split the income
statement for the $2.7 billion international
spice-and-food company into the three categories of the
cash-flow statement: operating, financing, and
investing. He extracted discontinued operations and
income taxes and placed them in separate categories,
instead of peppering them throughout the other results.
He created a new form to distinguish which changes in
income were due to fair value and which to cash. One
traditional ingredient, meanwhile, was conspicuous by
its absence: net income.
Kelly wasn't just indulging a whim. Ahead of a public
release of a draft of the Financial Accounting Standards
Board's new format for financial statements in the
second quarter of 2008, the McCormick controller was
trying out the financial statements of the future, a
radical departure from current conventions. FASB's
so-called financial statement presentation project is
ostensibly concerned only with the form, or the "face,"
of financial statements, but it's quickly becoming clear
that it will change and expand their content as well.
"This is a complete redefinition of the financial
statements as we know them," says John Hepp, a former
FASB project manager and now senior manager at Grant
Thornton.
Some of the major changes under discussion:
reconfiguring the balance sheet and the income statement
to follow the three categories of the cash-flow
statement, requiring companies to report cash flows with
the little-used direct method; and introducing a new
reconciliation schedule that would highlight fair-value
changes. Companies will also likely have to report more
about their segments, possibly down to the same level of
detail as they currently report for the consolidated
statements. Meanwhile, net income is slated to disappear
completely from GAAP financial statements, with no
obvious replacement for such commonly used metrics as
earnings per share.
FASB, working with the International Accounting
Standards Board (IASB) and accounting standards boards
in the United Kingdom and Japan, continues to work out
the precise details of the new financial statements. "We
are trying to set the stage for what financial
statements will look like across the globe for decades
to come," says FASB chairman Robert Herz. (Examples of
the proposed new financial statements can be viewed at
FASB's Website.) If the standard-setters stay their
course, CFOs and controllers at every publicly traded
company in the world could be following Kelly's lead as
soon as 2010.
It's too early to predict with confidence which changes
will ultimately stick. But the mock-up exercise has made
Kelly wary. He considers the direct cash-flow statement
and reconciliation schedule among the "worst aspects" of
the forthcoming proposal, and expects they would require
"draconian exercises" from his finance staff, he says.
And he questions what would result from the additional
details: "If all of a sudden your income statement has
125 lines instead of 25, is that presentation more
clarifying, or more confusing?"
Other financial executives share Kelly's skepticism. In
a December CFO survey of more than 200 finance
executives, only 17 percent said the changes would offer
any benefits to their companies or investors (see "Keep
the Bottom Line" at the end of this article). Even some
who endorsed the basic aim of the project and like the
idea of standardizing categories across the three major
financial statements were only cautiously optimistic.
"It may be OK, or it may be excessive." says David
Rickard, CFO of CVS/Caremark. "The devil will be in the
details."
Net Loss From the outset, corporate financial officers
have been ambivalent about FASB's seven year-old
project, which was originally launched to address
concerns that net income was losing relevance amid a
proliferation of pro forma numbers. Back in 2001,
Financial Executives International "strongly opposed"
it, while executives at Philip Morris, Exxon Mobil,
Sears Roebuck, and Microsoft protested to FASB as well.
(Critics then and now point out that FASB will have
little control over pro forma reporting no matter what
it does. Indeed, nearly 60 percent of respondents to
CFO's survey said they would continue to report pro
forma numbers after the new format is introduced.)
Given the project's starting point, it's not surprising
that current drafts of the future income statement omit
net income. Right now that's by default, since income
taxes are recorded in a separate section. But there is a
big push among some board members to make a more
fundamental change to eliminate net income by design,
and promote business income (income from operations) as
the preferred basis for investment metrics.
"If net income stays, it would be a sign that we
failed," says Don Young, a FASB board member. In his
mind, the project is not merely about getting rid of net
income, but rather about capturing all income-related
information in a single line (including such volatile
items as gains and losses on cash-flow hedges,
available-for-sale securities, and foreign-exchange
translations) rather than footnoting them in other
comprehensive income (OCI) as they are now. "All changes
in net assets and liabilities should be included," says
Young. "Why should the income statement be incomplete?"
He predicts that the new subtotals, namely business
income, will present "a much clearer picture of what's
going on."
Board member Thomas Linsmeier agrees. "The rationale for
segregating those items [in OCI] is not necessarily
obvious, other than the fact that management doesn't
want to be held accountable for them in the current
period," he says.
Whether for self-serving or practical reasons, finance
chiefs are rallying behind net income. Nearly 70 percent
of those polled by CFO in December said it should stay.
"I understand their theories that it's not the be-all
and end-all measure that it's put up to be, but it is a
measure everyone is familiar with, and sophisticated
users can adjust from there," says Kelly. Adds Rickard:
"They're treating [net income] as if it's the scourge of
the earth, which to me is silly. I think the logical
conclusion is to make other things available, rather
than hiding the one thing people find most useful."
Jensen Comment
As we moved to fair value accounting for derivative
financial instruments (FAS 133) and financial instruments (FAS
157 and 159) coupled with the expected new thrust for fair
value reporting on the international scene, we have filled
the income statement and the retained earnings statement
with more and more instability due to fluctuating unrealized
gains and losses.
But if we must live with
more and more fair value reporting, the bottom line has to
go. But CFOs are reluctant to give up the bottom line even
if it may distort investing decisions and compensation
contracts tied to bottom-line reporting.
"Academic Research and Standard-Setting: The Case of Other Comprehensive
Income,"
by Lynn L. Rees and Philip B. Shane, Accounting Horizons,
December 2012, Vol. 26, No. 4, pp. 789-815. ---
http://aaajournals.org/doi/full/10.2308/acch-50237
This paper links academic accounting research on
comprehensive income reporting with the accounting standard-setting efforts
of the Financial Accounting Standards Board (FASB) and the International
Accounting Standards Board (IASB). We begin by discussing the development of
reporting other comprehensive income, and we identify a significant weakness
in the FASB's Conceptual Framework, in the lack of a cohesive definition of
any subcategory of comprehensive income, including earnings. We identify
several attributes that could help allocate comprehensive income between net
income, other comprehensive income, and other subcategories. We then review
academic research related to remaining standard-setting issues, and identify
gaps in academic research where hypotheses could be developed and tested.
Our objectives are to (1) stimulate standard-setters to better conceptualize
what is meant by other comprehensive income and to distinguish it from
earnings, and (2) stimulate researchers to develop and test hypotheses that
might help in that process.
. . .
Potential Alternative Definitions of Earnings
Table 1 summarizes and categorizes various
standard-setting issues related to reporting comprehensive income, and
provides the organizing structure for our literature review later in the
paper. The most important of these issues is the definition of earnings, or
what makes up earnings and how it is distinguished from OCI. This is a
“cross-cutting” issue because it arises when the Boards deliberate on
various topics. The Boards cooperatively initiated the financial statement
presentation project intending, in part, to solve the comprehensive income
composition problem, but the project was subsequently delayed.
Table 2 presents a list of the specific
comprehensive income components under current U.S. GAAP that require
recognition as OCI. The second column presents the statement that provided
financial reporting guidance for the OCI component, along with its effective
date. The effective dates provide an indication as to how the OCI components
have expanded over time. Since the issuance of Statement No. 130, which
established formal reporting of OCI, new OCI-expanding requirements were
promulgated in Statement No. 133. Financial instruments, insurance, and
leases are three examples of topics currently on the FASB's agenda where OCI
has been discussed as an option to report various gains and losses. In all
these discussions, a framework is lacking that can guide standard-setter
decisions. The increased use of accumulated OCI to capture various changes
in net assets and the likely expansion of OCI items reinforce the notion
that standard-setters must eventually come to grips with the distinction
between OCI and earnings, or even whether the practice of reporting OCI with
recycling should be retained.7
Presumably, elements with similar informational
attributes should be classified together in financial statements. It is
unclear what attributes the items listed in Table 2 possess that result in
their being characterized differently from other components of income.
Notably, the basis for conclusions of the FASB standards gives little to no
economic reasoning for the decision to place these items in OCI. While not
exhaustive, Table 2 presents four attributes that standard-setters could
potentially use to distinguish between earnings and OCI: (1) the degree of
persistence of the item, (2) whether the item results from a firm's core
operations, (3) whether the item represents a change in net assets that is
reasonably within management's control, and (4) whether the item results
from remeasurement of an asset/liability. We discuss in turn the merits and
potential problems of using these attributes to form a reporting framework
for comprehensive income.
Degree of Persistence.
The degree of persistence of various comprehensive
income components has significant implications for firm value (e.g.,
Friedman 1957; Kormendi and Lipe 1987; Collins and Kothari 1989). Ohlson's
(1995, 1999) valuation model places a heavy emphasis on earnings
persistence, which suggests that a reporting format that facilitates
identifying the level of persistence across income components could be
useful to investors. Examples abound as to how the concept of income
persistence has been used in standard-setting, including separate
presentation in the income statement for one-time items, extraordinary
items, and discontinued operations. Standard-setters have justified several
footnote disclosures (segmental disclosures) and disaggregation requirements
(e.g., components of pension expense) on the basis of providing information
to financial statement users about the persistence of various income
statement components.
Thus, the persistence of revenue and expense items
potentially could serve as a distinguishing characteristic of earnings and
OCI. Table 2 shows that we regard all the items currently recognized in OCI
as having relatively low persistence. However, several other low-persistence
items are not recognized in OCI; for example, gains/losses on sale of
assets, impairments of assets, restructuring charges, and gains/losses from
litigation. To be consistent with this definition of OCI, the current
paradigm must change significantly, and the resulting total for OCI would
look substantially different from what it is now.
Using persistence of an item to distinguish
earnings from OCI would create significant problems for standard-setters.
Persistence can range from completely transitory (zero persistence) to
permanent (100 percent persistence). At what point along this range is an
item persistent enough to be recorded in earnings? While restructuring
charges are typically considered as having low persistence, if they occur
every two to three years, is this frequent enough to be classified with
other earnings components or infrequent enough to be classified with OCI?
Furthermore, the relative persistence of an item likely varies across
industries, and even across firms.
In spite of these inherent difficulties,
standard-setters could establish criteria related to persistence that they
might use to ultimately determine the classification of particular items. In
addition, standard-setters would not be restricted to classifying income
components in one of two categories. As an example, highly persistent
components could be classified as part of “recurring earnings,”
medium-persistence items could go to “other earnings,” and low-persistence
items to OCI (or some other nomenclature). Standard-setters could create
additional partitions as needed.
Core Operations.
Classifying income components as earnings or OCI
based on whether they are part of a firm's core operations is intuitively
appealing. This criterion is related to income persistence, as we would
expect core earnings to be more persistent than noncore income items.
Furthermore, classifying income based on whether it is part of core
operations has a long history in accounting.
In current practice, companies and investors place
primary importance on some variant of earnings. However, it is not clear
which variant of earnings is superior. Many companies report pro forma net
income, which presumably provides investors with a more representative
measure of the company's core income, but definitions of pro forma earnings
vary across firms. Similarly, analysts tend to forecast a company's core
earnings (Gu and Chen 2004). Evidence in prior research indicates that pro
forma earnings and actual earnings forecasted by analysts are more closely
associated with share prices than income from continuing operations based on
current U.S. GAAP (e.g., Bradshaw and Sloan 2002; Bhattacharya et al. 2003).
The problems inherent with this attribute are
similar to those of the earnings-persistence criterion. No generally
accepted definition of core operations exists. At what point along a
continuum does an activity become part of the core operations of a business?
As Table 2 indicates, classifying gains/losses from holding
available-for-sale securities as part of core earnings depends on whether
the firm operates in the financial sector. Different operating environments
across firms and industries could make it difficult for standard-setters to
determine whether an item belongs in core earnings or OCI.8 In addition,
differences in application across firms may give rise to concerns about
comparability and potential for abuse on the part of managers in exercising
their discretion (e.g., Barth et al. 2011).
The FASB's (2010) Staff Draft on Financial
Statement Presentation tries to address the definitional issue by using
interrelationships and synergies between assets and liabilities as a
criterion to distinguish operating (or core) activities from investing (or
noncore) activities. Specifically, the Staff Draft states:
An entity shall classify in the operating category:
Assets that are used as part of the entity's
day-to-day business and all changes in those assets Liabilities that arise
from the entity's day-to-day business and all changes in those liabilities.
Operating activities generate revenue through a
process that requires the interrelated use of the entity's resources. An
asset or a liability that an entity uses to generate a return and any change
in that asset or liability shall be classified in the investing category. No
significant synergies are created for the entity by combining an asset or a
liability classified in the investing category with other resources of the
entity. An asset or a liability classified in the investing category may
yield a return for the entity in the form of, for example, interest,
dividends, royalties, equity income, gains, or losses. (FASB 2010, paras.
72, 73, 81)
The above distinction between operating activities
and investing activities could similarly be used to distinguish between core
activities and noncore activities. Alternatively, standard-setters might
develop other definitions. Similar to the degree of persistence attribute,
standard-setters would not be restricted to a simple core versus noncore
dichotomy when using this definition.
Another possible solution is to allow management to
determine which items belong in core earnings. Companies exercise this
discretion today when they choose to disclose pro forma earnings.
Furthermore, the FASB established the precedent of the “management approach”
when it allowed management to determine how to report segment disclosures.
In several other areas of U.S. GAAP, management is responsible for
establishing boundaries that define its operating environment. FASB
Accounting Standards Codification Topic 320 (formerly Statement 115) permits
different measurements for identical investments based on management's
intent to sell or hold the instrument. Other examples where U.S. GAAP allows
for management discretion include determining the rate to discount pension
liabilities, defining reporting units, and determining whether an impairment
is other than temporary. However, the management approach accentuates the
concern about comparability and potential for abuse.
Management Control.
Given a premise that evaluating management's
stewardship is a primary role of financial statements, a possible rationale
for excluding certain items from earnings is that they do not provide a good
measure to evaluate management.9 Management can largely control the firm's
operating costs and can influence the level of revenues generated. However,
some decisions that affect comprehensive income can be established by
company policy or the company mission statement and, thus, be outside the
control of management. For example, a company policy might be to invest
excess cash in marketable securities with the objective of maximizing
returns. Once the board of directors establishes this policy, management has
little influence over how market-wide fluctuations in security prices affect
earnings, and hedging the gains/losses would be inconsistent with the
objective of maximizing returns. Similarly, a company's mission statement
might include expansion overseas, or prior management might have already
decided to establish a foreign subsidiary. The resulting gains/losses from
foreign currency fluctuations would seemingly be out of management's
control, and hedging these gains/losses would not make economic sense if the
subsidiary's functional currency is its local currency and the parent has no
intention of repatriating the subsidiary's cash flows.
Of course, determining what is and is not
ostensibly under management's control becomes highly subjective and would
probably differ across industries, and perhaps even across firms within
industries. For example, gains/losses from investment holdings might not be
relevant in evaluating management of some companies, but might be very
relevant for managers of holding companies. In addition, the time horizon
affects what is under management's control. That is, as the time horizon
lengthens, more things are under management's control.
In Table 2, we classify items as not under
management's control if they are based on fluctuations in stock prices or
exchange rates, which academic research shows to be largely random within
efficient markets. Using this classification model, most, but not all, of
the OCI items listed in Table 2 are classified as not under the management's
control. Some of the pension items currently recognized in OCI are within
the control of management, because management controls the decision to
revise a pension plan. While management has control over when to harvest
gains/losses on available-for-sale (AFS) securities by deciding when to sell
the securities, it cannot control market prices. Thus, under this criterion,
unrealized gains/losses on AFS securities are appropriately recognized in
OCI. However, gains/losses on trading securities and the effects of tax rate
changes are beyond management's control, and yet, these items are currently
included as part of earnings. Thus, “management control” does not
distinguish what is and is not included in earnings under current U.S. GAAP.
Remeasurements.
Barker (2004) explains how the measurement and
presentation of comprehensive income might rely on remeasurements. The
FASB's (2010) Staff Draft on Financial Statement Presentation defines
remeasurements as follows:
A remeasurement is an amount recognized in
comprehensive income that increases or decreases the net carrying amount of
an asset or a liability and that is the result of:
A change in (or realization of) a current price or
value A change in an estimate of a current price or value or A change in any
estimate or method used to measure the carrying amount of an asset or a
liability. (FASB 2010, para. 234)
Using this definition, examples of remeasurements
are impairments of land, unrealized gains/losses due to fair value changes
in securities, income tax expenses due to changes in statutory tax rates,
and unexpected gains/losses from holding pension assets. All of these items
represent a change in carrying value of an already existing asset or
liability due to changes in prices or estimates (land, investments, deferred
tax asset/liability, and pension asset/liability, respectively).
Table 3 reproduces a table from Barker (2004) that
illustrates how a firm's income statement might look using a “matrix format”
if standard-setters adopt the remeasurement approach to reporting
comprehensive income. Note that the presentation in Table 3 does not employ
earnings as a subtotal of comprehensive income; however, the approach could
be modified to define earnings as the sum of all items before remeasurements,
if considered useful. Tarca et al. (2008) conduct an experiment with
analysts, accountants, and M.B.A. students to assess whether the matrix
income statement format in Table 3 facilitates or hinders users' ability to
extract information. They find evidence suggesting that the matrix format
facilitates more accurate information extraction for users across all
sophistication levels relative to a typical format based on IAS 1.
Table 3: Illustration of Matrix Reporting Format
Employing remeasurements to distinguish between
earnings and other comprehensive income largely incorporates the criterion
of earnings persistence. Most remeasurements result from price changes,
where the current change has little or no association with future changes
and, therefore, these components of income are transitory. In contrast,
earnings components before remeasurements generally represent items that are
likely more persistent.
Perhaps the most significant advantage of the
remeasurement criterion is that it is less subjective than the other
criteria previously discussed. Most of the other criteria in Table 2 are
continuous in nature. Drawing a bright line to differentiate what belongs in
earnings from what belongs in OCI is challenging and will likely be
susceptible to income manipulation. In contrast, determining whether a
component of income arises from a remeasurement is more straightforward.
Yet another advantage of this approach is it allows
for a full fair value balance sheet that clearly discloses the effects of
fair value measurement on periodic comprehensive income, while also showing
earnings effects under a modified historical cost system (i.e., before
remeasurements). This approach could potentially provide better information
about probable future cash flows.
Other.
The attributes standard-setters could use to
classify income components into earnings or OCI are not limited to the list
in Table 2. Ketz (1999) suggests using the level of measurement uncertainty.
As an example, gains/losses from Level 1 fair value measurements might be
viewed as sufficiently certain to include in earnings, while Level 3 fair
value measurements might generate gains/losses that belong in OCI. Song et
al. (2010) provide some support for this partition in that they document the
value relevance of Level 1 and Level 2 fair values exceeds the value
relevance of Level 3 fair values.
Another potential attribute might be the horizon
over which unrealized gains/losses are ultimately realized. That is,
unrealized gains/losses from foreign currency fluctuations, term life
insurance contracts, or holding pension assets that will not be realized for
many years in the future might be disclosed as part of OCI, whereas
unrealized gains/losses from trading and available-for-sale securities could
be part of earnings.
As previously discussed, the attributes of
measurement uncertainty and timeliness create similar problems in
determining where to draw the line. Which items are sufficiently reliable
(or timely) to include in earnings, and will differences in implementation
across firms and industries impair comparability?
The overriding purpose of the discussion in this
subsection is to point out that several alternative attributes could
potentially guide standard-setters in establishing criteria to differentiate
earnings from OCI. Ultimately, the choice regarding whether/how to
distinguish net income from OCI is a matter of policy. However, academic
research can inform policy decisions, as described in the fourth and fifth
sections.
Summary
Reporting OCI is a relatively recent phenomenon
that presumes financial statement users are provided with better information
when specific comprehensive income components are excluded from
earnings-per-share (EPS), and recycled back into net income only after the
occurrence of a specified transaction or event. The number of income
components included in OCI has increased over time, and this expansion is
likely to continue as standard-setters address new agenda items (e.g.,
financial instruments and insurance contracts). The lack of a clear
definitional distinction between earnings and OCI in the FASB/IASB
Conceptual Frameworks has led to: (1) ad hoc decisions on the income
components classified in OCI, and (2) no conceptual basis for deciding
whether OCI should be excluded from earnings-per-share (EPS) in the current
period or recycled through EPS in subsequent periods. In this section, we
discussed alternative criteria that standard-setters could use to
distinguish earnings from OCI, along with the advantages and challenges of
each criterion. Further, due to the inherent difficulties in drawing bright
lines between earnings that are persistent versus transitory, core versus
noncore, under management control or not, and amenable to remeasurement or
not, standard-setters might consider eliminating OCI; that is, they might
decide to adopt an all-inclusive income statement approach, where
comprehensive income is reporte
. . .
Continued in article
Jensen Comment
I like this paper. Table 3 could be improved by adding bottom line net earnings
before and after remeasurement.
The paper does not provide all the answers, but it is well written in terms
of history up to this point in time and alternative directions for
consideration.
Teaching case from The
Wall Street Journal Accounting Weekly Review on July 27,
2012
SUMMARY: "Microsoft posted a rare loss
due to a charge for its Internet business, but still
showed signs of strength in selling software to
corporations." According to the related video, the $6.2
billion charge amounts to almost the entire $6.3 billion
purchase price of aQuantive in a 2007 business
combination. The video also includes discussion of the
interpretation of a goodwill impairment charge in
layman's terms.
CLASSROOM APPLICATION: The article is
useful to introduce the reporting implications of
goodwill impairment charges. NOTE TO INSTRUCTORS: YOU
SHOULD DELETE THIS SECTION OF THE SUMMARY BEFORE
DISTRIBUTING TO STUDENTS AS IT CONTAINS ANSWERS TO
QUESTIONS BELOW. ASC references: ASC 350-20-35-1 through
35-19 provides the overall requirements for goodwill
impairment assessment (under the subsequent measurement
category). ASC 350-20-35-3c (subsequent measurement
related to Goodwill) covers the events and circumstances
that should be used in evaluating whether it is more
likely that not that the fair value of a reporting unit
is less than its carrying amount.
QUESTIONS:
1. (Introductory) Based on the description in
the article, summarize the results reported by Microsoft
for the quarter ended June 30, 2012? What is your sense
of the overall implications of these results for the
company's business?
2. (Introductory) Have you used the Microsoft
Bing search engine? How does it compare to other search
engines you use?
3. (Advanced) Access the Microsoft filing on
Form 8-K for the announcement of their operating results
for the quarter ended June 30, 2012 made on July 19,
2012 and available on the SEC web site at
http://www.sec.gov/Archives/edgar/data/789019/000119312512307447/d379850dex991.htm
How large was the goodwill impairment charge relative to
their overall operations? Clearly state how you assess
the size of this charge.
4. (Advanced) Scroll down the report to review
the Fourth Quarter Financial Highlights. What operating
segments does MicroSoft report?
5. (Introductory) In which operating segment
was the goodwill impairment charge recorded? How large
was the charge relative to this operating segment? As in
question 1 above, clearly state how you assess the size
of this charge.
6. (Introductory) Summarize the accounting
process for determining a goodwill impairment charge. In
your answer, include a reference to the required
assessment of events and circumstances frequently
leading to asset impairment charges. Also include a
reference the FASB Accounting Standards Codification (ASC)
sections supporting your answer.
7. (Advanced) What particular factors led
Micrsoft to report this impairment charge? How do those
factors compare to the requirements under the FASB ASC?
8. (Introductory) Refer to the related video.
What is the meaning of the term non-cash charge? How do
these journalists interpret this write down?
Reviewed By: Judy Beckman, University of Rhode Island
Microsoft Corp.posted a rare quarterly loss because of a
previously announced charge for its money-losing
Internet business, but the software giant continued to
show signs of strength in selling software to
corporations.
The $492
million loss reflected a $6.19 billion charge for
Microsoft's online division, which includes the Bing
search engine business and MSN Web portal. The unit
hasn't met the company's expectations for advertising
sales and the company opted to write down the value of a
major acquisition.
Microsoft's total revenue rose nearly 4%, while revenue
in the unit that sells software for server systems and
related products rose nearly 13%. The division posted a
24% jump in operating income.
"I feel
very good about the enterprise demand for our products,"
said Peter Klein, Microsoft's chief financial officer,
in an interview.
Revenue
for the company's Windows division declined by nearly
13%, after subtracting about $540 million in deferred
revenue—tied to an offer to give buyers of personal
computers the option to upgrade their machines to
Windows 8, the next version of Microsoft's computer
operating system.
The loss
for the fiscal period ended June 30 came to six cents a
share. In the year-earlier period, Microsoft posted net
income of $5.9 billion, or 69 cents a share. Revenue
rose to $18.1 billion from $17.4 billion.
For
Microsoft and Chief Executive Steve Ballmer, the fourth
quarter is a transition period ahead of several
milestone product launches. Starting this fall,
Microsoft is rolling out new versions of two of its
biggest cash cows, Windows and the Office bundle of
email and document software, along with an overhaul of
programs for computer servers and for Microsoft's
fledgling Windows Phone software.
The
stakes are high for Microsoft to prove it can catch up
to rivals such as Apple Inc. AAPL +2.58% that have a
head start in fast-growing computing areas such as
tablets.
By
contrast, Microsoft said the market for personal
computers was roughly flat in the fourth quarter, with
sales of business PCs up 1% and consumer PCs down 2%.
Its comments echo what third-party research firms and
some other computing companies have been saying in
recent weeks.
Operating income in the division that includes the
Windows operating system fell 17.5%. Some analysts
believe consumers and businesses may be holding off on
buying new PCs ahead of this October's launch of Windows
8, Microsoft's first operating software designed with
touch-screen computing devices in mind.
In the
division anchored by the Office line of email and
document software, operating income rose 9%. Microsoft's
Internet division, and the business that includes the
Xbox videogame console, again were money-losers during
the fiscal fourth quarter.
Microsoft said it kept a tight lid on expenses, helping
boost profit growth higher than revenue growth.
For the
fiscal year ending next summer, Microsoft said it
expects Windows revenue to essentially match the overall
PC market. The company said its estimate excludes
deferred revenue for a Windows 8 upgrade, and excludes
sales of the recently announced Surface tablet computer,
Microsoft's first foray into making a computer on its
own.
Continued in article
Jensen Comment
One problem with reports focusing on profits or losses is
that the IASB and the FASB accounting standard setters
adopted a balance sheet focus that turned the income
statement into a black hole. The IASB and FASB can no longer
even define profits and losses.
This led Bob Herz, when
he was Chairman of the FASB, to suggest that perhaps we
should use disaggregated reporting without reporting bottom
line profits and losses. Perhaps this applies to the way IBM
income statements should be presented ---
http://faculty.trinity.edu/rjensen/theory01.htm#ChangesOnTheWay
We first voiced our
concern about an obscure accounting rule that allows
companies to “create” profits when purchasing other
businesses in the “Curious Case of Miller Energy’s 10-K
and Its Huge Bargain Purchase.” The offending tenet
relates to the treatment of something called “negative
goodwill” which purportedly is created when a company
makes an acquisition, and pays less than what the assets
are worth. This fantastic “bargain purchase” creates a
negative goodwill anomaly because the acquirer
supposedly gets more assets than it pays for, as in this
example:
Continued in article
Jensen Comment
Yet another illustration of how the FASB and IASB made a
black hole out of bottom-line earnings.
You get Revealed 3D: the Shape of
Financials, a
new way to see multiple years of a company’s
financial statement in one simple form. Trends
and patterns pop out because the graph is an
overview. And being an overview it becomes easy
to compare companies. In fact you can scan a
whole industries.
Revealed 3D is a time saver.
The graph is very simple. It is based on the
pie chart…with a difference, the diameter of the
pie chart is also a variable. So as the balance
sheet grows, so does the pie chart. The Income
Statement is graphed around the inner Balance
Sheet pie chart like a growth ring on a tree.
Then the market cap is graphed around the
outside. The result is a slice that represents
one period of financial statements. The other
periods are also graphed. They are stacked and
the periods are connected together. The result
is a 3D form showing the company over time.
Revealed can be used by analysts as a way to get
a quick understanding of a company’s financial
story and direction. Whole groups of companies
are easy to compare. Truly a door opener.
This is our first release. So if you would take
a look and let us know your thoughts we’d
greatly appreciate hearing them.
Jensen Comment
Now if we add more columns for Historical Cost Versus Fair
Value Adjusted Financial Items Versus Fair Value Adjusted
Non-Financial Items we may be in business helping investors
analyze financial condition and performance.
TOPICS: FAS
160, FASB, Financial Accounting, Income Statement,
International Accounting Standards, Net Income
SUMMARY: A
new FASB standard requires companies to disclose
income related to minority stakes in other firms.
U.S. accounting-standard setters threw some
observers of corporate profits a curveball this
earnings season by fiddling with what companies mean
by "net income." It requires companies to disclose
income related to so-called noncontrolling interests
-- investments in other firms in which a company
owns only a minority stake. That would make such
income easier to see and bring U.S. rules more into
line with international accounting standards.
CLASSROOM APPLICATION: This
article helps to notify students of the coming
changes to the income statement. It also can serve
as a basis for discussion regarding the role of the
FASB and how changes to many aspects of accounting
are possible. Finally, the mention of international
accounting standards can generate some discussion
about the differences between the U.S. system and
systems in other countries, as well as the changes
on the horizon.
QUESTIONS:
1. (Introductory)
What is the FASB? What is its authority and it
corresponding responsibilities? Who is on the FASB?
2. (Advanced)
What is the change that the FASB is making to
financial statements? Why is the FASB making these
changes? How will the changes impact U.S.
corporations from a practical standpoint?
3. (Introductory)
What are the benefits of the changes? What are some
of the problems that could come from these changes?
Do you think that these changes will achieve the
goals of the FASB in this instance? Why or why not?
4. (Introductory)
How will The Wall Street Journal report net income
in the future? Why would The Journal take that
approach?
5. (Advanced)
The article states that the change would bring U.S.
rules more in line with international accounting
standards. Why is that important? Why is accounting
in the U.S. different from that in other countries?
Should the rules be the same throughout the world?
Why or why not? What changes are on the horizon?
Reviewed By: Linda Christiansen, Indiana University
Southeast
U.S.
accounting-standard setters threw some observers of
corporate profits a curveball this earnings season by
fiddling with what companies mean by "net income."
The
decision to replace the time-honored bottom line -- the
most basic measurement of corporate performance -- with
formulations like "net income attributable to the
company" has changed the familiar look of earnings
statements at a time when corporate profits are being
closely scrutinized for signs of the economy's health.
The move
by the Financial Accounting Standards Board is aimed at
giving investors more detail about companies'
investments. But E.J. Atorino, a media and publishing
analyst for Benchmark Research, said the improvement is
marginal at best.
"I think
these accountants have gone crazy," he said. "They're
just making life more complicated."
A FASB
spokesman declined to comment. The changes are a result
of Financial Accounting Standard 160, which took effect
with the first quarter for most companies. It requires
companies to disclose income related to so-called
noncontrolling interests -- investments in other firms
in which a company owns only a minority stake. That
would make such income easier to see and bring U.S.
rules more into line with international accounting
standards.
So far
so good. But the change also requires companies to
report net income before and after income from
noncontrolling interests. As a result, "net income" is
no longer the bottom line.
What
used to be simply called "net income" at a company
holding minority stakes is now called "net income
attributable to" the parent company -- even though it is
the same figure, calculated the same way. The
presentation and terminology change, but not the numbers
themselves.
For
instance, McGraw-Hill Cos. on Tuesday reported
first-quarter "net income" of $66.0 million. It then
deducted $3 million from noncontrolling interests and
reported "net income attributable to The McGraw-Hill
Companies, Inc." of $63 million -- compared with $81.1
million a year earlier. That $81.1 million was
originally reported last year as simply "net income."
Colgate-Palmolive Co., seeking to avoid possible
confusion when it reported earnings Thursday, took a
different tack. It started with "net income including
noncontrolling interests," allowing it to keep "net
income" as its bottom line. Colgate spokeswoman Hope
Spiller said the company chose the wording for the
purpose of "simplicity and consistency."
When
writing about corporate earnings, The Wall Street
Journal will focus on "net income attributable" to the
company or the equivalent. Earnings per share -- the
figure closely watched by analysts -- are also based on
the "attributable" number.
The change has no effect on the bottom-line number, as
companies have always excluded income from minority
stakes. There may be a greater effect on the balance
sheet, however, where noncontrolling interests will now
figure into calculations of shareholder equity.
Corrections and
Amplifications:
A company's "noncontrolling
interests" are minority stakes in its subsidiaries that
are owned by outside parties. This article incorrectly
defined noncontrolling interests as investments in other
firms in which a company owns only a minority stake.
Question
Should your paycheck be impacted contractually by FAS 133?
I was contacted by the representative of a
major and highly reputable transportation company union concerning possible
manipulation of FAS 133 accounting (one of the many tools for creative
accounting) for purposes of lowering compensation payments to employees. He
wanted to engage me on a consulting basis to examine a series of financial
statements of the company. It would be great if I could inspire some public
debate on the following issue. The message below follows an earlier message
to XXXXX concerning how hedging ineffectiveness works under FAS 133
accounting rules ---
http://faculty.trinity.edu/rjensen/acct5341/speakers/133glosf.htm#Ineffectiveness
_________________
Hi XXXXX,
You wrote:
“Does the $502 million hedging ineffectiveness pique your interest?”
My answer is most
definitely yes since it fits into some research that I am doing at the
moment. But the answers cannot be obtained from financial statements.
Financial statements are (1) too aggregated (across multiple derivative
hedging contracts) and (2) snapshots at particular points in time.
Answers lie in tracing each contract individually (or at least a
sampling of individual contracts) from inception to settlement. Results
of effectiveness testing throughout the life of each hedging contract
must be examined (on a sampling basis).
Recall that there were
enormous scandals concerning financial instruments derivatives that led
up to FAS 133 and IAS 39. See
http://faculty.trinity.edu/rjensen/FraudRotten.htm#DerivativesFrauds
The SEC pressured the FASB to come up with a new standard that would
overcome the problem of so much unbooked financial liability risk due to
derivative financial instruments. FAS 133 and IAS 39 got complicated
when standard setters tried to book the derivative assets and
liabilities on the balance sheet without impacting current earnings for
qualified effective hedges of financial risk.
When the FASB issued
FAS 133, The FASB and the SEC were concerned about unbooked financial
risk of every active derivative contract if the contract was settled on
the interim balance sheet date. When a contract like an option is valued
on a balance sheet date, its premature settlement value that day may
well be deemed ineffective relative to the value of the hedged item. The
reason is that derivative contracts are traded in different markets
(usually more speculative markets) than commodities markets themselves
(where buyers actually use the commodities). But the hedging contracts
deemed ineffective on interim dates may not be ineffective at all across
the long haul. Usually they are perfectly effective on hedging maturity
dates.
Temporal
ineffectiveness more often than not works itself out such that all those
gains and losses due to hedging ineffectiveness on particular interim
dates exactly wash out such there is no ultimate cash flow gain or loss
when the contracts are settled at maturity dates. I attached an Excel
workbook that explains how some commodities hedges work out over time.
The Graphing.xls file can also be downloaded from
http://www.cs.trinity.edu/~rjensen/Calgary/CD/FAS133OtherExcelFiles/
Note in particular the “Hedges” spreadsheet in that file. These explain
the outcomes at the settlement maturity dates that yield perfect hedges.
But at any date before maturity (not pictured in the graphs), the hedges
may not be perfect if settled prematurely on interim balance sheet
dates.
I illustrate the
accounting for ineffective interim hedges in both the 03forfut.pps and
05options.ppt PowerPoint files at
http://www.cs.trinity.edu/~rjensen/Calgary/CD/JensenPowerPoint/
The hedges may deemed ineffective under FAS 133 at interim balance sheet
dates with gains and losses posted to current earnings. However, over
time the gains and losses perfectly offset such that the hedges are
perfectly effective when they are settled at maturity dates.
The real problem with
FAS 133 is that compensation contracts are generally tied to particular
balance sheet dates where interim hedging contracts may be deemed
ineffective and thereby affect paychecks. But some of those FAS 133
interim gains and losses may in fact never be realized in cash over the
life of the each commodity hedging contract.
What has to happen is
for management to be very up front about how FAS 133 and other
accounting standards may give rise to artificial gains and losses that
are never realized unless the hedging contracts are settled prematurely
on balance sheet dates. Compensation contracts should be hammered out
with that thought in mind rather than blindly basing compensation
contracts on bottom-line earnings that are mixtures of apples, oranges,
toads, and nails due to accounting standards.
Of course management
is caught in a bind because investors follow bottom-line as the main
indicator of performance of a company. The FASB recognizes this problem
and is now trying to work out a new standard that will eliminate
bottom-line reporting. The idea will be to provide information for
analysts to derive alternative bottom-line numbers based upon what they
want included and excluded in that bottom line. XBRL may indeed make
this much easier for investors and analysts ---
http://faculty.trinity.edu/rjensen/XBRLandOLAP.htm
If I were working out
a compensation contract based on accounting numbers, I would probably
exclude FAS 133 unrealized gains and losses.
In any case, back to
your original question. I would love to work with management to track a
sampling of fuel price hedging contracts from beginning to end. I would
like to see what effectiveness tests were run on each reporting date and
how gains and losses offset over the life of each examined contract. But
this type of study cannot be run on aggregated financial statements.
If I can study some of
those individual hedging contracts over time I would be most interested.
It will take your clout with management, however, to get me this data. I
have such high priors on the integrity of your company's management that
I seriously doubt that there is any intentional manipulation going on
witth FAS 133 implementation. Rather I suspect that management is just
trying to adhere as closely as possible with FAS 133 rules. What I would
like to do is help enlighten the world about the bad things FAS 133 can
do with compensation contracts and investment decisions by users of
statements who really do not understand the temporal impacts of FAS 133
on bottom-line earnings.
I fear that my study would, however, be
mostly one of academic interest that I can report to the public. Only an
inside whistleblower could pinpoint hanky-pank within a company, and I
seriously doubt that your company is engaged in disreputable FAS 133
hanky-pank beyond that of possibly not fully explaining to unions how
FAS 133 losses in general may be phantom losses over the long haul.
Singapore Exchange (“SGX”) introduced today a
Sustainability Reporting Guide (the “Guide”) for its listed companies.
This follows a public consultation, issued in August 2010 that received
widespread attention and positive feedback in support of disclosure and
accountability for operating and developing businesses in a sustainable
manner.
It has long been recognised that the way businesses
operate can have long terms effects on the environment and society. More
recently concerns about climate change, biodiversity, social and
environmental risks have been heightened by crises and natural disasters.
Global investors and other important stakeholders have called for companies
to espouse sustainability and report what they do. SGX, as a responsible
Exchange with global reach, has responded with a Guide for listed companies.
Within the Guide, the Policy Statement sets out the
principles and the Questions and Answers guide listed companies in extending
their reporting beyond financial governance to sustainability aspects. A
more holistic reporting will be achieved, with companies reporting their
financials as well as the environmental and social risks, and strengths as
relevant.
“The Sustainability Reporting Guide is the first
step for listed companies who are new to sustainability reporting. A few
are already practising and reporting fully on sustainability matters. Among
them are even award-winners because they see the need to adopt such
reporting. With time, more SGX companies will join the ranks of these with
international acclaim,” said Mr Magnus Böcker, Chief Executive Officer,
Singapore Exchange.
The Policy Statement and Sustainability Reporting
Guide are applicable to Mainboard and Catalist companies listed on SGX.
Both Policy Statement and the Guide are available on
www.sgx.com
under “Rule Books”.
More Detailed Differences
(Comparisons) between FASB and IASB Accounting Standards
2011 Update
"IFRS and US GAAP: Similarities and Differences" according to PwC
(2011 Edition)
http://www.pwc.com/us/en/issues/ifrs-reporting/publications/ifrs-and-us-gaap-similarities-and-differences.jhtml
Note the Download button!
Note that warnings are given throughout the document that the similarities and
differences mentioned in the booklet are not comprehensive of all similarities
and differences. The document is, however, a valuable addition to students of
FASB versus IASB standard differences and similarities.
It's not easy keeping track of what's changing and
how, but this publication can help. Changes for 2011 include:
Revised introduction reflecting the current
status, likely next steps, and what companies should be doing now (see page 2);
Updated convergence timeline, including
current proposed timing of exposure drafts, deliberations, comment
periods, and final standards
(see page 7);
More current analysis of the differences
between IFRS and US GAAP -- including an assessment of the impact
embodied within the differences
(starting on page 17); and
Details incorporating authoritative standards
and interpretive guidance issued through July 31, 2011
(throughout).
This continues to be one of PwC's most-read
publications, and we are confident the 2011 edition will further your
understanding of these issues and potential next steps.
For further exploration of the similarities and
differences between IFRS and US GAAP, please also visit our
IFRS Video Learning Center.
To request a hard copy of this publication, please contact your PwC
engagement team or
contact us.
Jensen Comment
My favorite comparison topics (Derivatives and Hedging) begin on Page 158
The booklet does a good job listing differences but, in my opinion, overly
downplays the importance of these differences. It may well be that IFRS is more
restrictive in some areas and less restrictive in other areas to a fault. This
is one topical area where IFRS becomes much too subjective such that comparisons
of derivatives and hedging activities under IFRS can defeat the main purpose of
"standards." The main purpose of an "accounting standard" is to lead to greater
comparability of inter-company financial statements. Boo on IFRS in this topical
area, especially when it comes to testing hedge effectiveness!
One key quotation is on Page 165
IFRS does not specifically discuss the methodology
of applying a critical-terms match in the level of detail included within
U.S. GAAP.
Then it goes yatta, yatta, yatta.
Jensen Comment
This is so typical of when IFRS fails to present the "same level of detail" and
more importantly fails to provide "implementation guidance" comparable with the
FASB's DIG implementation topics and illustrations.
I have a
huge beef with the lack of illustrations in IFRS versus the many illustrations
in U.S. GAAP.
I have a
huge beef with the lack of illustrations in IFRS versus the many illustrations
in U.S. GAAP.
I have a huge beef with the lack of illustrations in
IFRS versus the many illustrations in U.S. GAAP.
"Canadian regulator decides against allowing early adoption of recent
IFRSs by certain entities," IAS Plus, November 1, 2011 ---
http://www.iasplus.com/index.htm
. . .
In making its decision, the OSFI considered a
number of factors such as industry
consistency, OSFI policy positions on
accounting and capital, operational capacity and resource constraints of
Federally Regulated Entities (FREs), the ability to benefit from improved
standards arising from the financial crisis and the
notion of a level playing field with other Canadian
and international financial institutions.
OSFI concluded that FREs should not early adopt the following new or amended
IFRSs, but instead should adhere to their mandatory effective dates:
Continued
Jensen Comment
The clients, auditors, and the AICPA clamoring that U.S. firms should be able to
voluntarily choose IFRS instead of U.S. GAAP even before it has not been decided
that IFRS will ever replace FASB standards seem to ignore the problems that
voluntary choice of IFRS might cause for investors and analysts. The above
reasoning by the OSFI makes sense to me.
But then outfits like the AICPA have a self-serving interest in earning
millions of dollars selling IFRS training courses and materials.
November 2, 2011 reply from Patricia Walters
Does that mean you oppose options to early adopt standards in general,
not just IFRSs?
Pat
November 2, 2011 reply from Bob Jensen
Hi Pat,
It's hard to say regarding early adoption of a particular national or
international standard, because there can be unique circumstances. For
example, FAS 123R simply altered how to make disclosures rather than alter
the disclosures themselves since employee option expenses had to be
disclosed before the FAS 123R adoption date. But even here early adoption of
FAS 123R by Company A versus late adoption by Company B made simple
comparisons of eps and P/E ratios between these companies less easy.
There's a huge difference between early adoption of a particular standard
and early adoption of an entire system of standards like switching from FASB
accounting standards to IFRS.
I think the Canadian position of early adoption of IFRS is probably correct
because of the mess early adoption of IFRS makes with comparisons of
companies using different accounting standards and the added costs of
regulation of more than one set of standards. Also think of the added burden
placed upon the courts to adjudicate disputes when differing sets of
standards are being used.
Even though we allow IFRS for SEC registered foreign companies, I think it
would be a total mess for the SEC, the PCAOB, investors, analysts,
educators, trainers, auditing, and even the IRS (where tax and reporting
treatments must sometimes be reconciled) if our domestic corporations could
choose between FASB versus IASB standards.
There are hundreds of differences between FASB and IASB standards. Allowing
companies domestic companies to cherry pick which system they choose before
it is even known if there will ever be official replacement of FASB
standards by IASB standards would be very, very confusing. What if there
never is a decision to replace FASB standards? Do want to simply allow
companies to choose to bypass FASB standards at their own discretion?
Of course, if information were costless it might be ideal to require
financial reporting where FASB and IASB outcomes are reconciled. But clients
and auditors generally contend that the cost of doing this greatly exceeds
benefits. And teaching financial accounting would become exceedingly
complicated if we had to teach two sets of standards on an equal basis.
I would certainly hate to face a CPA examination that had nearly equal
coverage of both FASB and IASB standards simultaneously. I say this
especially after viewing the hundreds of pages of complicated differences
between the two standards systems.
Days Inns of
America
(As Reported September 30, 1987)
Market
Value of the Entire Block of Common Shares at Today's Price Per Share
(Ignoring Blockage Factors)
Not
Available
Day Inns of America
Was Privately Owned
Exit
Value of Firm if Sold As a Firm
(Includes synergy factors and unbooked intangibles)
Not
Available for
Days Inns of America
Sum of
Exit Values of Booked Assets Minus Liabilities & Pref. Stock
(includes unbooked and unrealized gains and
losses)
$194,812,000
as Reported by Days Inns
Book
Value of the Firm as Reported in Financial Statements
$87,356,000
as Reported
Book Value of the Firm as
Reported in the Financial Statements After General Price Level
Adjustments
Not Available
for Days Inns
Analysts often examine the market to book ratios which is the green value
above divided by the book value. Usually the book value is not adjusted
for general price levels in calculating this ratio, but there is not reason
why it could not be PLA book value. But the green value often widely
misses the mark in measuring the value of the firm as a whole (the blue value
above). The green value is based upon marginal trades of the day that do
not adjust for blockage factors (large purchases that give total ownership or
effective ownership control of the company). Usually it is impossible to
know whether the green value above is higher or lower than the blue
value. In addition to the blockage factor, there is the huge problem
that the stock market prices have transitory movements up and down due to
changing moods of speculators that create short-term bubbles and bursts.
Buyers and sellers of an entire firm are looking at the long term and
generally ignore transitory price fluctuations of daily trades of relatively
small numbers of shares. For example, daily transaction prices on
100,000 shares in a bubble or burst market are hardly indicative of the long
term value of 100 million shares of a corporation.
Replacement Cost Accounting Experiments in
Practice in the United States
Replacement cost (entry-value, current cost)
accounting is more than price-level adjusted (PLA) historical cost accounting.
Whereas PLA only tries to adjust historical cost book values over time for the
changed purchasing power of unit of measurement (e.g., the U.S. dollar),
replacement cost accounting attempts to adjust for relative differences in
changed prices of balance sheet items. For example, PLA would make the same
adjustment to 1981 purchases of tractors and buildings whereas replacement cost
accounting would re-price tractors at tractor new prices and buildings at
building new prices.
It should be noted that replacement cost (entry
value, current cost ) accounting is not considered fair value accounting. It is
in fact a modified form of historical cost accounting where original costs are
adjusted to what it would cost to replace the items at their current prices. But
those "replacement costs" are adjusted for depreciation and amortization such
that replacement cost accounting does not take much of the period-to-period cost
allocation arbitrariness out of the financial statements.
Beginning in 1979, FAS 33 required large
corporations to provide a supplementary schedule of condensed balance sheets
and income statements comparing annual outcomes under three valuation bases
--- Unadjusted Historical Cost, Price Level Adjusted (PLA) Historical Cost,
and Current Cost Entry Value (adjusted for depreciation and
amortization). Companies complained heavily that users did not obtain
value that justified the cost of implementing FAS 33. Analysts
complained that the FASB allowed such crude estimates that the FAS 33
schedules were virtually useless, especially the Current Cost estimates.
The FASB rescinded FAS 33 when it issued FAS 89 in 1986.
FAS 33 had a significant impact on some
companies. The
adjustments were not trivial! For example the earnings reported by United States
Steel in the 1981 Annual Report as required under FAS 33 were as follows:
1981 United States Steel Income Before Extraordinary items and
Changes in Acctg. Principles
Historical Cost (Non-PLA
Adjusted)
Historical Cost (PLA
Adjusted)
Replacement Cost (Current
Cost)
$1,077,000,000
Income
$475,300,000
Income
Plus $164,500,000 PLA gain due to decline in purchasing power of debt
$446,400,000
Income
Plus $164,500,000 PLA Gain
Less $168,000,000 Current cost increase less effect of increase in the
general price level
Companies are no longer required to generate
FAS 33-type comparisons. The primary basis of accounting in the U.S. is
unadjusted historical cost with numerous exceptions in particular
instances. For example, price-level adjustments may be required for operations in hyperinflation nations. Exit value accounting is required
for firms deemed highly likely to become non-going concerns. Exit value
accounting is required for personal financial statements (whether an
individual or a personal partnership such as two married people).
Economic (discounted cash flow) valuations are required for certain types of
assets and liabilities such as pension liabilities. Exit value
accounting is required for impaired items such as damaged inventories and
inoperable machinery.
One of the criticisms of FAS 33 is that, in
order to make adherence less costly for financial reporting, the FASB allowed
rather crude indices of sector price changes to be used that were often highly
inaccurate in terms of specific items at specific locales. Hence FAS 33
replacement costs were subject to enormous margins of error. This is one of the
reasons financial analysts tended to ignore the supplemental balance sheet
reports required under FAS 33.
Long before the FAS 33 (1979-1986), there were
some questionable attempts by selected companies to voluntarily provide
replacement cost information. Professor Zeff reported several case studies in
replacement cost accounting in 1962:
"Replacement Cost: Member of the Family, Welcome Guest, or Intruder," by
Stephen A. Zeff, The Accounting Review, October 1962, pp. 611-723.
These early attempts at replacement cost
adjustment frustrated analysts because the companies were generally vague about
details regarding how they made the adjustments. Analysts could not be certain
how they went about estimating replacement costs and even what they meant by
imprecise mention of "fair value" adjustments.
Firstly Zeff contrasted Type A price
adjustments that were PLA adjustments and not replacement cost adjustments.
Hence TypeA=PLA. Type B adjustments are specific-item replacement cost
adjustments that are, in turn, adjusted again for depreciation and amortization
and changing prices levels. Hence Type B=RC in its purist form. Steve also
defines Type C to be replacement cost accounting that does not factor out
general price level changes in the purchasing power of the dollar. Hence Type C
does not take into account the fact that if there is price inflation/deflation,
some of the Type C adjustment may not reflect the fact that part of the changed
price of the item is due only to the changing purchasing power of the currency.
Zeff then writes as follows between pages
615-616 about long-term fixed assets cost adjustments;
"Replacement Cost: Member of the Family, Welcome Guest, or Intruder," by
Stephen A. Zeff, The Accounting Review, October 1962:
Indiana Telephone
Corporation has, since 1955, used Type C and Type A indices concurrently.
With the assistance of a consulting engineer, the company classifies "gross
plant additions" on a FIFO basis by years of acquisition, selects an
appropriate Type C index for each plant category, and then applies the
derived multiplier to each year's cost of acquisition. Since this
plant-account analysis is undertaken only once every three or four years, as
needed, financial-statement amounts for interim years are found by applying
a final multiplier to the Type C-adjusted figures. This final multiplier is
based on the "all commodities other than farm and foods" component of the
Wholesale Price Index.
Beginning in 1957, the
Sacramento Municipal Unility District and Ayrshire Collieries Corporation
recorded "supplementary" depreciation charges. Sacramento uses the term
"fair value depreciation," while Ayrshire calls it "price level
depreciation." Iowa-Illinois Gas and Electric Company, in response to a 1957
Iowa Supreme Court decision that allowed the company's rate base to reflect
"fair value depreciation," began to record in 1958 a supplementary "fair
value depreciation" charge on property located in Iowa districtrs in which
the court decision had been implemented.
None of these latter three
companies discloses the manner by which the supplementary depreciation
charged is computed. Although they occasionally refer in their annual
reports to "current purchasing power of the dollar" and "inflation," they
uniformly contend that the new basis of accounting replaces "historical
cost." Further, the key adjectives "general" and "specific" as well as
equivalents thereto are not used. "Fair value" is hardly a definitive term.
Zeff goes on to write the following on Page 617:
Indeed, prominent foreign companies utilize
replacement cost in the determination of their net income. N.V. Phillips'
Gloeilamphenfabrieken, of The Netherlands, employs replacement cost for
valuing long-lived assets adn inventories. Imperial Tobacco Co. of Canada,
Ltd., converted in its 1961 annual report to full-fledged replacement cost
accounting for long-lived assets. Previously, it had not revalued long-lived
assets, but since 1955 had shown supplementary replacement-cost depreciation
charge. The one-shot revaluation of its long-lived assets did not, however,
affect the carrying value of the company's total assets. Conveniently, the
$25 million write-up in long-lived assets was more than offset by a
concurrent write-down in goodwill. Imperial had charged operations with an
inventory-replacement increment, but this practice was apparently abandoned
in 1961.
A replacement-cost adjustment should hardly be
viewed as an alternative to Type A restatement. Both the Philips and
Imperial adjustments, for example, are recognition of Type C price movement,
implying that these companies fail to disclose the important distinction
between the fictitious (i.e., general) and real (i.e., specific) price
changes.
Question
What is the difference between "replacement cost" and "factor replacement cost?"
Answer
It is much like a make versus buy decision. As an illustration, the "replacement
cost" of a computer is the price one would pay for a computer in the market to
replace an existing computer. That presumably includes the mark up profits of
vendors in the supply chain. The "factor replacement cost" excludes such mark up
profits to the extent possible by estimating what it would cost in the
"transformation process" to purchase the components for transformation of those
components into a computer. The "factor replacement cost" adds in labor and
manufacturing overhead. It excludes vendor profits in the computer supply chain
but not necessarily vendor profits in the purchase price of components. It
becomes very complicated in practice, however, because computer vendors do such
things as include warranty costs in the pricing of computers. Assembled
computers in house probably have no such warranties. A more detailed account of
factor replacement costing is provided in Chapters 3 and 4 of Edwards and Bell.
Edgar O. Edwards and Philip W. Bell, theory and Measurement of Business
Income (Berkeley: University of California Press, 1961).
Of course this does not solve the fundamental problem of replacement cost
accounting that arises when there are no current assets or component parts of
assets that map directly into older assets still being used by the company. For
example, old computers and parts for those computers are probably no longer
available. Newer computers have many more enhancements that make them virtually
impossible to compare with older computers such using prices of current
computers is a huge stretch when estimating replacement costs of older computers
that, for example, may not even have had the ability to connect to local
networks and the Internet.
Zeff writes as follows on Page 623:
Edwards and Bell, in their provocative volume,
propound a measure called "business profit," which is predicated on what
might be termed "factor replacement cost." "Business profit" is the sum of
(1) the excess of current revenues over the factor replacement cost of that
portion of assets that can be said to have expired currently, and (2) the
enhancement during the current period of the factor replacement cost.
The FASB and the IASB state that "value in use"
is the ideal valuation measure if it can be measured reliably at realistic
estimation costs. Exit value and economic (discounted cash flow) generally do
not meet these two criteria for value in use of non-financial items. There is
nearly always no practical means of estimating higher order covariances. and additivity aggregations are meaningless without such covariances. In the
case of economic valuation, estimation of future cash flows and discount rates
enters the realm of fantasy for long-lived items. Also reliable exit value
estimation of some items like all the hotel properties of Days Inns can be very
expensive, which is a major reason Days Inns only did it once for financial
reporting purposes in 1987. Accordingly, "value in use" is an ideal which cannot
be practically achieved under either exit or economic valuation methods.
The FASB and the IASB state that "value in use"
is the ideal valuation measure, but this ideal can never be achieved with cost
allocation methods. Both historical cost and replacement (current, entry) value
"valuation" methods are not really valuation methods at all. These are cost
allocation methods that for items subject to depreciation or amortization in
value are reliant upon usually arbitrary estimates of non-financial item useful
lives, value decline assumptions such as straight line or double declining
balance declines, and salvage value estimates. Under historical cost, the book
value thus becomes an arbitrary residual of the rationing of original cost by
arbitrary cost allocation formulas. Under replacement (current, entry) cost
allocation the estimated current replacement costs are subjected to n arbitrary
residual of the rationing of replacement cost by arbitrary cost allocation
formulas.
Although both historical and replacement cost
allocations over time avoid covariance problems in additive aggregations of book
values, the meanings of such aggregations are of very dubious utility to
investors and other decision makers. For example suppose the $10 million 2008
book value of a fleet of passenger vans is added to the $200 million 2008 book
value of Days Inn hotel properties, what does the $210 million aggregation mean
to anybody?
Both the passenger vans and hotel buildings have
been subjected to arbitrary estimates of economic lives, salvage values, and
depreciation patters such as double declining balance depreciation for vans and
straight-line depreciation for hotel buildings. This is the case whether
historical cost or current replacement costs have been allocated by depreciation
formulas.
Hence it is not clear that for going concern companies that have heavy
investments in non-financial assets that any known addition of individual items
makes any sense under economic, exit, entry, or historical cost book value
estimation process. Aggregations might make some sense for financial items with
negligible covariances, but for non-financial items. Attempts to estimate total
value itself basted upon stock market marginal trades are misleading since
marginal trades of a small proportion of shares ignores huge blockage factors
valuations, especially blockage factors that carry managerial control along with
the blockage purchase. Countless mergers and acquisitions repeatedly illustrate
that estimations of total values of companies are generally subject to huge
margins of error, especially when intangibles play an enormous part of the value
of an enterprise.
Both the FASB
and the IASB require in many instances that exit value accounting be used for
financial items. In part that is because for financial items it is often more
reasonable to assume zero covariances among items. The recent banking failures
caused by covariance among toxic mortgage investments lends some doubt to this
assumption, but the issue of David Li’s faltering and infamous Gaussian copula
function is being ignored by both the IASB and the FASB in recommending exit
value accounting for many (most) financial items ---
http://en.wikipedia.org/wiki/Gaussian_copula#Gaussian_copula
For how the defect in this formula contributed to the 2008 fall of many banks
see ---
http://financeprofessorblog.blogspot.com/2009/03/recipe-for-disaster-formula-that-killed.html
You said: "The FASB and the IASB state that "value
in use" is the ideal valuation measure if it can be measured reliably at
realistic estimation costs."
Given that, for many years now, they have both been
working toward reliable external measurements rather than internal
measurements, could you point me to where in the literature "value in use"
is considered the "ideal"?
Value in use
originates in the concept that a firm computing net present value of an
asset will use its own optimal use future stream of cash flows where that
stream may not be attainable by any other company ---
http://en.wikipedia.org/wiki/Value-in-use
The Glossary of the FASB’s Accounting Standards Database Codification
database defines “value in use” as
“The amount
determined by discounting the future cash flows (including the ultimate
proceeds of disposal) expected to be derived from the use of an asset at an
appropriate rate that allows for the risk of the activities concerned”
All too often
Value in Use (VIU) is equated to discounted future cash flows of an item in
optimal use. Discounted cash flow estimation may be a fantasyland ideal that
is not altogether necessary. For example, if IBM has a factory robot
assembling computer components, it is virtually impossible to trace future
computer sale cash flows to the portion of cash flows attributed to one
assembly robot. Exit value is probably a useless surrogate for an installed
factory robot since exit value is absurdly low relative to VIU of the robot.
Other surrogate valuations may be much closer to VIU, including the
replacement cost appropriately adjusted for differences in economic life of
the present robot versus a now robot. The thing about VIU is that, when exit
value is highly misleading, then other valuation estimates are possible,
including replacement cost based upon current entry values for an IBM
purchase of a new robot plus engineering estimates of current installation
cost of a replacement robot.
Another
approach to measure value in use is to have engineers estimate the cost
savings of an assembly robot vis-a-vis the production costs without the
robot. Of course this requires some subjectivity. Some of this data may have
been generated at the time the decision was made to invest in the robot.
Exit value is
generally considered an exchange price that’s agreed upon by a buyer and a
seller. Both buyer and seller may have different values in use such as when
Days Inn sells 200 hotels to Holiday Inn. Covariance with brand name and
other intangibles means that the value in use of each hotel differs for Days
Inn versus Holiday Inn.
Both the FASB
and the IASB generally consider exit value to be the worst possible
seller’s use (e.g., forced liquidation) of the item in liquidation
rather than use in a going concern. It is very misleading when a going
concern owner has zero intention to sell the item. The ideal is value in use
rather than exit value for a going concern having an item that is
operational. The presumption is that the exit value may be the worst
possible use value for the seller but is almost certainly not the best
possible use value for the buyer. Otherwise the buyer would not agree on
that exchange price.
In the August
2008 annual American Accounting Association meetings Tom Linsmeier and
another speaker from BYU put great emphasis on how exit value is the worst
possible value for present owners that are going concerns. They both claimed
preference for Value in Use.
Neither the FASB
nor the IASB is entirely consistent on value in use being the ideal.
Paragraphs A5-A12 in FAS 157 illustrate how value in use (VIU) may be used
in fair value measurement. However, keep in mind that current fair value
accounting requirements apply mostly to financial items except in a few
isolated instances of non-financial items such as precious metal
inventories. VIU measurement controversies are usually much greater for
non-financial items such as fixed operating assets and real estate
investments. The controversy has and always will be the trade-off between
objectivity of valuation versus the possibility that the more objective
valuations may be less useful or even very misleading. For example, a forced
liquidation exchange value of an item may be very misleading if the owner
has zero intention of selling. On the other hand, a VIU that depends heavily
on subjective estimates subject to wide measurement error may also highly
misleading and make fraud easier.
A6. Highest
and best use is a valuation concept that refers broadly to the use of an
asset that would maximize the value of the asset or the group of assets in
which the asset would be used by market participants. For some assets, in
particular, nonfinancial assets, application of the highest-and-best-use
concept could have a significant effect on the fair value measurement.
Examples 1–3
illustrate the application of the highest-and-best-use concept in situations
in which nonfinancial assets are newly acquired.
Paragraph A6 of FAS 157 ---
http://www.fasb.org/pdf/aop_FAS157.pdf
Traditionally, value in-use fairly reflects the economics of a specific
transaction. But the FASB has indicated in recently issued guidelines, that
it prefers looking to the market, rather than company-specific valuations.
Regardless of which approach is chosen, future income statements will be
affected. The value in-use approach will generally result in higher
depreciation expense and lower reported earnings. The value in-exchange
approach will usually result in more of the initial purchase price being
allocated to goodwill, which must be tested for impairment every year.
“SFAS 141 Impacts Choice of Method Used to Value PP & E” ---
http://www.valuationresearch.com/content/Knowledge_center/back_issues/35_2002_2.htm
C38. In the
context of the related guidance included in the Exposure Draft, some
respondents referred to possible conflicts between the in-use valuation
premise and the exchange notion encompassed within the definition of fair
value. In this Statement, the Board clarified that the exchange notion
applies regardless of the valuation premise used to measure the fair value
of an asset. Whether using an in-use or an in-exchange valuation premise,
the measurement is a market-based measurement determined based on the use of
an asset by market participants, not a value determined based solely on the
use of an asset by the reporting entity (a value-in-use or entity-specificmeasurement).
Paragraph C38 of FAS 157 ---
http://www.fasb.org/pdf/aop_FAS157.pdf
Jensen Comment
Hence the FASB offers ambiguous guidance on exchange value versus value in
use. The FASB likes exchange value (VIE) in terms of objectivity relative to
the dastardly subjectivity of value in use (VIU). At the same time the FASB
hates exchange valuation that puts asset values at the worst possible use of
the asset, e.g. forced liquidation valuation of an asset that a going
concern has every intention of using at much higher value. Also there’s
absolutely no forced liquidation value for portions of fixed assets such as
enormous installation costs of ERP and other database systems, blast or
electric furnaces producing steel, factory robots, and assets requiring
millions of dollars in winning governmental permits, many of which are not
transferrable in liquidation sales. . Of
course at present, neither the FASB nor the IASB require fair value
accounting for most types of non-financial assets, including steel furnaces,
ERP, factory robots, etc. If the FASB extends fair value accounting to all
non-financial items, the FASB will most certainly have to back off priority
for objective exchange values for items having zero exchange value such as
non-transferable components of fixed assets such as installation costs.
The AICPA provides lots of
resources for fair value measurement but the AICPA is of little use in
providing resources for estimating value in use.
The AICPA's Fair Value Accounting Resources ---
http://www.journalofaccountancy.com/Web/FairValueResources.htm
The IASB is as inconsistent
as the FASB on issues of VIU versus VIE. The ideal is VIU that can be
objectively determined such as an asset or liability with contractual future
cash flows and minimal loss risk. As VIU becomes more subjective in terms
managerial choices as to the future cash flow stream of 200 hotels in the
hands of Days Inns versus Holiday Inns, then VIE is probably going to be
preferred by the FASB and the IASB. But this can be misleading, because
valuing hotels at a forced liquidation exit value may be more misleading
than historical cost book value when there’s no intention whatsoever for the
owner to sell the hotel. This would be especially misleading if Holiday
Inns had to use forced liquidation exit values in this period of distressed
real estate values where owners have no intention of selling out at
distressed real estate values. Of course
at present, neither the FASB nor the IASB require fair value accounting for
most types of non-financial assets, including real estate. If fair value
accounting is extended to all non-financial assets, I think that preferences
for VIE will have to give way to VIU. VIE likely to be highly misleading
(overly conservative) when trying to evaluate investment potential of a
successful going concern.
Value in use
issues also rear up in standards involving value impairment tests such as
Value in use [IAS 36, par. 18; IAS 38, par. 83]
Below are my responses to the replacement cost
disadvantages you listed. Along these lines, you circulated Bob Sack’s
review of David Mosso’s book. Here is what Mosso says of the mess he helped
create through his decades-long association with the FASB (the quote is from
an unpublished working paper):
“The GAAP model does not serve well the goal of
investor protection. It serves instead to protect the ability of corporate
financial reporters to delay and obscure the reporting of bad financial
news, the kind of news that would alert capital markets and financial
regulators of potential crises ahead.”
Surely, you don’t want to perpetuate the kind of
crap we currently dish out as “financial statements.” Surely, you would want
to base financial statements on principles of wealth and changes in wealth.
I know you defend it, but apples and oranges accounting is a joke (or maybe
hundreds of jokes); as I wrote in my penultimate blog post, lots of the time
it doesn’t even get cash right. The cavils against replacement cost pale in
comparison.
By the way, Bob’s review doesn’t mention it, but
Mosso in his heart of hearts, has also become a replacement cost guy.
Tom
June 30, 2010 reply from Bob Jensen
Hi Tom,
I think
you are being a bit cavalier and off the wall.
For
example, you state that
“Response: Yeah, so what?
If all we cared about was realization, then cash would be the only asset on
the balance sheet.”
We’ve known for a long time that legally realized earned
revenue is a better performance measure than realized cash. Management and
customers can manipulate the timings of cash flows such as delaying all cash
collections in December 2010 (customers won’t mind the delays) for a short
time so as to distort cash collections in 2011 by not delaying cash
collections in December 2011. That way we have a 13-month year in 2011 to
show earnings growth over an 11-month year in 2010. In general, cash flow
timings are more manipulative than contractual earnings realization
irrespective of payment schedules.
Also, you do not seem to be concerned about fluctuating fictional
revenues for hypothetical transactions that never happen. For example a
factory can be idled by a labor strike for a year with no product sales and
show great hypothetical replacement cost “revenues” three years before the
factory is finally torn down to make way for a housing development. At least
historical cost does won’t report hypothetical revenues that never happened.
And your replacement cost approach just cannot circumvent problem
of arbitrary cost allocation over time and faces the same frustrating
problem of arbitrary depreciation accruals that plague historical cost
accounting.
Neither Mosso nor anybody else has ever shown us why investors
are better off with replacement cost as the basis of primary financial
statements. Replacement cost financial statements can be supplementary, as
they were under FAS 33, and capital markets researchers could not find
significant value added in even the supplementary replacement cost financial
statements for investors. As I recall the FASB hired one of the best capital
markets researchers in the world to try to find value added in FAS 33
replacement cost reporting. The conclusion was that value added was
negligible.
And I’m more concerned about accuracy. Some analysts speculate that one of
the reasons for the demise of FAS 33 is that the replacement costs were too
inaccurate to be of much use. Indeed they were highly inaccurate ostensibly
because the cost of greater accuracy was exceedingly enormous in very large
corporations with millions of varied assets around the world (only very
large corporations were scoped into FAS 33).
Valuation Premises Fair value measurements
of assets must consider the highest and best use of the asset, which is
determined from the perspective of market participants rather than the reporting
entity’s intended use. Under current U.S. GAAP, the asset’s highest and best use
determines the valuation premise. The valuation premise determines the nature of
the fair value measurement; that is, whether the fair value of the asset will be
measured on a stand-alone basis ("in-exchange") or measured based on an
assumption that the asset will be used in combination with other assets
("in-use"). The proposed ASU would remove the terms in-use and in-exchange
because of constituents’ concerns that the terminology is confusing and does not
reflect the objective of a fair value measurement. The proposed ASU would also
prohibit financial assets from being measured as part of a group. The FASB
decided that the concept of highest and best use does not apply to financial
assets, and therefore their fair value should be measured on a stand-alone
basis. Entities would still have the ability to measure fair value for a
nonfinancial asset either on a stand-alone basis or as part of a group,
consistent with the nonfinancial asset’s highest and best use.
Bob Jensen's other threads on fair value accounting are at various other
links:
More Detailed
Differences
(Comparisons) between FASB and IASB Accounting Standards
2011 Update
"IFRS and US GAAP: Similarities and Differences" according to PwC
(2011 Edition)
http://www.pwc.com/us/en/issues/ifrs-reporting/publications/ifrs-and-us-gaap-similarities-and-differences.jhtml
Note the Download button!
Note that warnings are given throughout the document that the similarities and
differences mentioned in the booklet are not comprehensive of all similarities
and differences. The document is, however, a valuable addition to students of
FASB versus IASB standard differences and similarities.
It's not easy keeping track of what's changing and
how, but this publication can help. Changes for 2011 include:
Revised introduction reflecting the current
status, likely next steps, and what companies should be doing now (see page 2);
Updated convergence timeline, including
current proposed timing of exposure drafts, deliberations, comment
periods, and final standards
(see page 7);
More current analysis of the differences
between IFRS and US GAAP -- including an assessment of the impact
embodied within the differences
(starting on page 17); and
Details incorporating authoritative standards
and interpretive guidance issued through July 31, 2011
(throughout).
This continues to be one of PwC's most-read
publications, and we are confident the 2011 edition will further your
understanding of these issues and potential next steps.
For further exploration of the similarities and
differences between IFRS and US GAAP, please also visit our
IFRS Video Learning Center.
To request a hard copy of this publication, please contact your PwC
engagement team or
contact us.
Jensen Comment
My favorite comparison topics (Derivatives and Hedging) begin on Page 158
The booklet does a good job listing differences but, in my opinion, overly
downplays the importance of these differences. It may well be that IFRS is more
restrictive in some areas and less restrictive in other areas to a fault. This
is one topical area where IFRS becomes much too subjective such that comparisons
of derivatives and hedging activities under IFRS can defeat the main purpose of
"standards." The main purpose of an "accounting standard" is to lead to greater
comparability of inter-company financial statements. Boo on IFRS in this topical
area, especially when it comes to testing hedge effectiveness!
One key quotation is on Page 165
IFRS does not specifically discuss the methodology
of applying a critical-terms match in the level of detail included within
U.S. GAAP.
Then it goes yatta, yatta, yatta.
Jensen Comment
This is so typical of when IFRS fails to present the "same level of detail" and
more importantly fails to provide "implementation guidance" comparable with the
FASB's DIG implementation topics and illustrations.
I have a
huge beef with the lack of illustrations in IFRS versus the many illustrations
in U.S. GAAP.
I have a
huge beef with the lack of illustrations in IFRS versus the many illustrations
in U.S. GAAP.
I have a huge beef with the lack of illustrations in
IFRS versus the many illustrations in U.S. GAAP.
"Canadian regulator decides against allowing early adoption of recent IFRSs
by certain entities," IAS Plus, November 1, 2011 ---
http://www.iasplus.com/index.htm
. . .
In making its decision, the OSFI considered a
number of factors such as industry
consistency, OSFI policy positions on
accounting and capital, operational capacity and resource constraints of
Federally Regulated Entities (FREs), the ability to benefit from improved
standards arising from the financial crisis and the
notion of a level playing field with other Canadian
and international financial institutions.
OSFI concluded that FREs should not early adopt the following new or amended
IFRSs, but instead should adhere to their mandatory effective dates:
Continued
Jensen Comment
The clients, auditors, and the AICPA clamoring that U.S. firms should be able to
voluntarily choose IFRS instead of U.S. GAAP even before it has not been decided
that IFRS will ever replace FASB standards seem to ignore the problems that
voluntary choice of IFRS might cause for investors and analysts. The above
reasoning by the OSFI makes sense to me.
But then outfits like the AICPA have a self-serving interest in earning
millions of dollars selling IFRS training courses and materials.
November 2, 2011 reply from Patricia Walters
Does that mean you oppose options to early adopt standards in general,
not just IFRSs?
Pat
November 2, 2011 reply from Bob Jensen
Hi Pat,
It's hard to say regarding early adoption of a particular national or
international standard, because there can be unique circumstances. For
example, FAS 123R simply altered how to make disclosures rather than alter
the disclosures themselves since employee option expenses had to be
disclosed before the FAS 123R adoption date. But even here early adoption of
FAS 123R by Company A versus late adoption by Company B made simple
comparisons of eps and P/E ratios between these companies less easy.
There's a huge difference between early adoption of a particular standard
and early adoption of an entire system of standards like switching from FASB
accounting standards to IFRS.
I think the Canadian position of early adoption of IFRS is probably correct
because of the mess early adoption of IFRS makes with comparisons of
companies using different accounting standards and the added costs of
regulation of more than one set of standards. Also think of the added burden
placed upon the courts to adjudicate disputes when differing sets of
standards are being used.
Even though we allow IFRS for SEC registered foreign companies, I think it
would be a total mess for the SEC, the PCAOB, investors, analysts,
educators, trainers, auditing, and even the IRS (where tax and reporting
treatments must sometimes be reconciled) if our domestic corporations could
choose between FASB versus IASB standards.
There are hundreds of differences between FASB and IASB standards. Allowing
companies domestic companies to cherry pick which system they choose before
it is even known if there will ever be official replacement of FASB
standards by IASB standards would be very, very confusing. What if there
never is a decision to replace FASB standards? Do want to simply allow
companies to choose to bypass FASB standards at their own discretion?
Of course, if information were costless it might be ideal to require
financial reporting where FASB and IASB outcomes are reconciled. But clients
and auditors generally contend that the cost of doing this greatly exceeds
benefits. And teaching financial accounting would become exceedingly
complicated if we had to teach two sets of standards on an equal basis.
I would certainly hate to face a CPA examination that had nearly equal
coverage of both FASB and IASB standards simultaneously. I say this
especially after viewing the hundreds of pages of complicated differences
between the two standards systems.
A Lesson in Simplifying Financial Instrument Reporting
Can a single "fair value" number such as the "fair price" of a used car be a
surrogate for all the risks under the hood?
In a 2008 exposure draft the International Accounting Standards Board (IASB)
argues that "fair value is the only measure appropriate for all types of
financial instruments" --- http://snipurl.com/ias39simplification
The argument does not apply to non-financial items that presumably are to be
accounted for based upon more traditional generally accepted accounting
principles (GAAP).
The huge problems that I find most disturbing about fair value accounting are
as follows:
The problem of mixing realized earnings with unrealized ups and downs of
fair values is an age-old problem that is either ignored (as in FAS 159) or
allocated in a confusing way to Other Comprehensive Income (OCI) as in FAS
115/130 and cash flow/FX hedging under FAS 133, or posting to a "Firm
Commitment" equity account that almost nobody understands in FAS 133. IAS 39
buys into the same hedge accounting alternatives but differs (for the
better) in terms of basis adjustment back to realized earnings. Issues with
unrealized value changes of derivatives are mostly newer problems in the
21st Century after FAS 133 and IAS 39 required fair value accounting for
nearly all derivative financial instruments. However, the oretical
problem of unrealized value changes dates way back to Kenneth McNeal, John
Canning, and DR Scott in history as later extended by Bob Sterling, Edwards
and Bell, and especially Ray Chambers who leaned toward exit value relative
to current (replacement) cost alternatives ---
http://faculty.trinity.edu/rjensen/Theory01.htm#UnderlyingBases
Exit (fair) value, however, is no panacea. "Value in use" generally
differs greatly from exit (liquidation) values. Exit values can be
highly misleading in terms of value of assets in going concerns. Exit value
accounting properly should be relegated to personal estates and
assets/liabilities approaching a liquidation state except possibly for
financial assets where exit values are usually much closer to value in use.
For operating assets it is quite another matter. For example a huge farm
tractor costing $250,000 new may lose almost half its exit value in the
first 500 hours of use because it is then reclassified as a "used tractor"
even though it might have 30,000 or more hours of usage life remaining. One
problem with exit values is that the "new" market is often restricted to
dealers such that buyers of equipment must sell in a "used" market where
products each unique are no longer fungible commodities like they are in
"new" markets. Another problem with exit values is that they're often very
difficult to estimate and appraisals are prone to fraud as witnessed in real
estate appraisals during the Savings and Loan scandals of the 1980s and the
subprime mortgage scandals in the early part of the 21st Century.
A related problem of exit values is that "transactions costs" are
sometimes enormous. New robotics machines may cost $10 million to buy and
another $10 million to install. If they're to be valued for reporting
purposes in the used robots market, the entire $10 million of installation
cost must be viewed as down the drain and cannot be recovered in exit
values. Investors are misled if all installation costs are expensed
immediately when new robots are installed in going concerns. Can you imagine
what it actually cost to dismantle the London Bridge, transport it to its
new location in Arizona, and reassemble the bridge? What would be the cost
of taking it back to London at fuel prices today? Also the selling costs of
some types of equipment and real estate can be enormous such that exit
values are distorted when estimates of selling costs are netted out for
going concerns. What would it cost for Arizona just to negotiate a sale of
the London Bridge, apart from all other relocation costs, back to investors
in London?
Exit values are costly to obtain on an annual basis. In 1987, when Cecil
Day's family was considering an IPO, their Days Inns of America company
incurred an enormous expense to have all of their nationwide properties
appraised with the appraisals each being independently reviewed by Landhauer
Associates. Reported appraised values in the 1987 annual report were
$194,812,000 versus book values of $87,356,000. If its reliable such exit
value reporting might be useful information even though it tells little
about value of this real estate in use as Days Inn motels. But obtaining
subsequent real estate appraisals reliably on an annual basis was much too
expensive. Days Inns of America did not, to my knowledge, report exit values
in the ensuing years. Incidentally, the 1987 Days Inn Annual Report is
interesting for some other pedagogical reasons (I still have my prized
copy). In addition to the exit value reporting, the Price Waterhouse
auditing firm also did a PW-signed "Review of Forecasts" which was and still
is allowed by the AICPA but has not been a popular service of CPA firms
since the AICPA, in the 1980s, approved CPA firm reviews of forecasts. Over
the years I had my students contemplate why this proposed CPA firm "review
of forecasts" airplane never really took off. Of course it would've taken
off if the SEC had required such reviews to be signed by CPA firms.
Reporting of current (replacement) costs and price-level adjustments was
required in FAS 33 beginning in 1979, for very large U.S. companies. The
unrealized changes in current cost, however, were not mixed in with
traditional GAAP financial statements. Instead footnote schedules were
required in FAS 33 where current cost and price-level adjustment data were
summarized. This supplementary information purportedly was ignored by
analysts and the investing public, even though some of the adjustments were
enormous. In 1981 United States Steel, for example, wiped out nearly a
billion dollars of earnings with such adjustments ---
http://faculty.trinity.edu/rjensen/Theory01.htm#UnderlyingBases
The FASB ultimately decided that FAS 33 did not meet the cost-benefit test.
The FASB rescinded FAS 33 when it issued FAS 89
in 1986. No companies are now required to report balance sheet and income
statements on a replacement cost basis.
Renewed interest in fair value (actually
exit value) reporting of financial instruments got new life when something
had to be done about derivative financial instruments exploding in
popularity in the 1980s (when interest rate swaps were invented) that were
not even being disclosed let alone booked. For example, forward contracts
and interest rate swaps were not even being disclosed and were becoming the
off-balance-sheet financing contracts of choice. The history of derivatives
scandals and ensuing accounting standards can be found in a timeline at
http://faculty.trinity.edu/rjensen/FraudRotten.htm
Derivatives financial instruments, unlike other types of financial
instruments, are unique in that they either have zero historical cost (as in
forward, futures, and swap contracts) or only a nominal historical cost (as
in options premiums) relative to enormous risks and potential rewards.
Traditional amortized historical cost is nonsense for derivatives such that
fair value was the only logical choice. For financial instruments in general
such is not the case, and now firms worldwide may choose from the new and
controversial "Fair Value Options" of the FASB and IASB.
Exit value reporting of financial assets and liabilities is where the
IASB, FASB, and most national accounting standard setters are now leaning
for financial items as opposed to operating items. This is largely because
there is less or a problem between value in use versus value in liquidation
for financial items as opposed to operating items. The financial securities
markets are also better organized with more value information for both
listed and unlisted items in financial markets. For example,
interest-rate-indexed (called underlyings) forward contracts and swaps tend
to be unique private contracts, but valuation is somewhat reliable because
of the depth of yield curve data provided by futures and options trading
markets. Both the IASB and the FASB now have a Fair Value Option (FVO)
that allows firms to cherry pick what financial assets and liabilities,
aside from derivatives, will be carried at fair value and what items will be
carried at traditional amortized cost. Fair value reporting of financial
items is not required, other than for derivatives, by standard setters
largely for political reasons. Corporations worldwide would actively lobby
to "carve out" fair value reporting requirements just like the banks in
Europe succeeded in legislating carve outs of two parts of IAS 39.
So where to we go from here
(in June 2008 when I'm writing these remarks)?
All financial accountants should pay close attention to the exposure draft "Reducing
Complexity in Reporting Financial Instruments" that for a very limited
time may be downloaded without charge from the International Accounting
Standards Board (IASB) ---
http://snipurl.com/ias39simplification [www_iasb_org] . This exposure
draft should be viewed as both an IASB and a FASB document since both standard
setting bodies, along with the standard setting bodies of many other nations,
are working feverishly to simplify the accounting rules for financial
instruments in general and derivative financial instruments in particular. This
exposure draft really represents the current leanings of virtually all
accounting standard setting bodies.
Be warned, however, that proposed alternatives for simplifying complexity are
really trade-offs in complexity since exit value reporting has many
controversies and complexities. Huge and complicated financial risks of
contracts are proposed, in the exposure draft, to be broad-brush simplified with
"fair value accounting." This is a little like relying on the price of a used
car to serve as a single index of all the risks that lie under the hood (the
British say bonnet) of the used car. The analogy to a used car is appropriate
since in many instances a financial instrument is unique, like a particular used
car, and cannot be valued reliably from either active trading markets or
extrapolations of past valuations of the item following events that may
seriously alter the value of an item.
Although the above exposure draft is intended to "reduce
complexity" with fair value accounting for financial instrument reporting, the
exposure draft is very honest in admitting that fair value accounting by
itself cannot eliminate many complexities, especially many complexities in hedge
accounting.
The bottom line in the IASB's exposure draft is that fair
value accounting is no panacea for reducing financial reporting complexity,
especially in reducing much of the complexity of hedge accounting using
derivative financial instruments.
The
exposure draft then launches into, beginning in Paragraph 2.55, alternatives
to simplifying hedge accounting other than to attempting fair value accounting
alternatives that hit the wall when hedging with derivative financial
instruments.
With respect to hedge accounting, the IASB in the exposure
draft seeks your input regarding the following:
Questions for respondents
Question 1
Do current requirements for reporting financial instruments,
derivative instruments and similar items require significant change
to meet the concerns of preparers and their auditors and the
needs of users of financial statements? If not, how should the IASB
respond to assertions that the current requirements are too
complex?
Question 2
(a) Should the IASB consider intermediate
approaches (short of the fair value option) to address
complexity arising from measurement and hedge accounting? Why or
why not? If you believe that the IASB should not make any
intermediate changes, please answer questions 5 and 6, and the
questions set out in Section 3.
(b) Do you agree with the criteria set out in
paragraph 2.2? If not, what criteria would you use and why?
Question 3
Approach 1 is to amend the existing measurement requirements
(without the fair value option). How would you suggest existing
measurement requirements should be amended? How are your suggestions
consistent with the criteria for any proposed intermediate changes
as set out in paragraph 2.2?
Question 4 Approach 2 is to replace the existing measurement requirements
with a fair value measurement principle with some optional
exceptions.
(a) What restrictions would you suggest on the
instruments eligible to be measured at something other than fair
value? How are your suggestions consistent with the criteria set
out in paragraph 2.2?
(b) How should instruments that are not measured
at fair value be measured?
(c) When should impairment losses be recognised
and how should the amount of impairment losses be measured?
(d) Where should unrealised gains and losses be recognised on
instruments measured at fair value? Why? How are your
suggestions consistent with the criteria set out in paragraph
2.2? (e) Should reclassifications be permitted? What types of
reclassifications should be permitted and how should they be
accounted for? How are your suggestions consistent with the
criteria set out in paragraph 2.2?
Question 5
Approach 3 sets out possible simplifications of hedge
accounting.
(a) Should hedge accounting be eliminated? Why
or why not?
(b) Should fair value hedge accounting be
replaced? Approach 3 sets out three possible approaches to
replacing fair value hedge accounting.
(i) Which method(s) should the IASB
consider, and why?
(ii) Are there any other methods not
discussed that should be considered by the IASB? If so, what
are they and how are they consistent with the criteria set
out in paragraph 2.2? If you suggest changing measurement
requirements under approach 1 or approach 2, please ensure
that your comments are consistent with your suggested
approach to changing measurement requirements.
Question 6
Section 2 also discusses how the existing hedge accounting
models might be simplified. At present, there are several
restrictions in the existing hedge accounting models to maintain
discipline over when a hedging relationship can qualify for hedge
accounting and how the application of the hedge accounting models
affects earnings. This section also explains why those restrictions
are required. (
a) What suggestions would you make to the IASB
regarding how the existing hedge accounting models could be
simplified?
(b) Would your suggestions include restrictions that
exist today? If not, why are those restrictions unnecessary?
(c)
Existing hedge accounting requirements could be simplified if
partial hedges were not permitted. Should partial hedges be
permitted and, if so, why? Please also explain why you believe the
benefits of allowing partial hedges justify the complexity.
(d) What
other comments or suggestions do you have with regard to how hedge
accounting might be simplified while maintaining discipline over
when a hedging relationship can qualify for hedge accounting and how
the application of the hedge accounting models affects earnings
Question 7
Do you have any other intermediate approaches for the IASB to
consider other than those set out in Section 2? If so, what are they
and why should the IASB consider them?
Having noted all the problems with fair value accounting when
hedging for derivative financial instruments in Section 2 of the exposure draft,
the
exposure draft in Section 3 tries to nevertheless make a case that fair
value accounting is the best of all the bad alternatives for accounting for
financial instruments in general, including derivative financial instruments. No
attempt is made to advocate fair value accounting for non-financial instruments
such as operating assets where value in use versus exit
values present enormous problems for exit (fair value) accounting.
Section 3 is quite good about mentioning the problems of fair value
accounting as well as the reasons the IASB (and the FASB) is leaning in theory
and in practice for requiring fair value accounting of all financial instruments
be they assets or liabilities or both in the case of some compound instruments.
Section 3 is changing the minds of fair value accounting skeptics like me!
Questions for respondents
Question 8
To reduce today’s measurement-related problems, Section 3 suggests
that the long-term solution is to use a single method to measure all
types of financial instruments within the scope of a standard for
financial instruments. Do you believe that using a single method to
measure all types of financial instruments within the scope of a
standard for financial instruments is appropriate? Why or why not?
If you do not believe that all types of financial instruments should
be measured using only one method in the long term, is there another
approach to address measurement-related problems in the long term?
If so, what is it
Question 9
Part A of Section 3 suggests that fair value seems to be the only
measurement attribute that is appropriate for all types of financial
instruments within the scope of a standard for financial
instruments.
(a) Do you believe that fair value is the only
measurement attribute that is appropriate for all types of
financial instruments within the scope of a standard for
financial instruments?
(b) If not, what measurement attribute other
than fair value is appropriate for all types of financial
instruments within the scope of a standard for financial
instruments? Why do you think that measurement attribute is
appropriate for all types of financial instruments within the
scope of a standard for financial instruments? Does that
measurement attribute reduce today’s measurement-related
complexity and provide users with information that is necessary
to assess the cash flow prospects for all types of financial
instruments?
Question 10
Part B of Section 3 sets out concerns about fair value
measurement of financial instruments. Are there any significant
concerns about fair value measurement of financial instruments other
than those identified in Section 3? If so, what are they and why are
they matters for concern?
Question 11
Part C of Section 3 identifies four issues that the IASB needs
to resolve before proposing fair value measurement as a general
requirement for all types of financial instruments within the scope
of a standard for financial instruments.
(a) Are there other issues that you believe the
IASB should address before proposing a general fair value
measurement requirement for financial instruments? If so, what
are they? How should the IASB address them?
(b) Are there any issues identified in part C of
Section 3 that do not have to be resolved before proposing a
general fair value measurement requirement? If so, what are they
and why do they not need to be resolved before proposing fair
value as a general measurement requirement?
Question 12
Do you have any other comments for the IASB on how it could
improve and simplify the accounting for financial instruments?
Valuation Premises Fair value measurements
of assets must consider the highest and best use of the asset, which is
determined from the perspective of market participants rather than the reporting
entity’s intended use. Under current U.S. GAAP, the asset’s highest and best use
determines the valuation premise. The valuation premise determines the nature of
the fair value measurement; that is, whether the fair value of the asset will be
measured on a stand-alone basis ("in-exchange") or measured based on an
assumption that the asset will be used in combination with other assets
("in-use"). The proposed ASU would remove the terms in-use and in-exchange
because of constituents’ concerns that the terminology is confusing and does not
reflect the objective of a fair value measurement. The proposed ASU would also
prohibit financial assets from being measured as part of a group. The FASB
decided that the concept of highest and best use does not apply to financial
assets, and therefore their fair value should be measured on a stand-alone
basis. Entities would still have the ability to measure fair value for a
nonfinancial asset either on a stand-alone basis or as part of a group,
consistent with the nonfinancial asset’s highest and best use.
Jensen Warning
Taking some of the statements in the above exposure draft can be misleading when
taken out of context. For example, in Paragraph 3.14 it is stated that:
"If initial cash flows for a particular instrument (eg costs to acquire the
instrument) are not highly correlated with ultimate cash flows, cost-based
measures have little or no value for assessing future cash flow prospects."
Obviously this is nonsense in terms of many bonds payable and other notes
payable, especially those with fixed interest rates. If there is negligible
credit risk, historical cost is a perfect predictor of all cash flows of future
interest and principles of fixed rate notes and bonds. Paragraph 3.14 must be
taken in the context of securities that are not intended to be held to maturity
or notes that have variable interest returns of interest and/or principal.
Jensen Commentary
Without doubt the most complicated, confusing, and hated accounting standards
are those concerning new rules for booking and carrying deivative financial
instruments, particularly FAS 133 in the U.S. and IAS 39 internationally along
with their even more complicating amendments and implementation guidelines. Companies, with the blessings of
international auditing firms, have made many blunders in implementing these
particular standards, and these errors have led to more revisions to previously
published financial statements than any other standards. Probably
the best known revisions are those of Fannie Mae that led to the firing of
KPMG as the external auditor, to over a million correcting journal entries, and
to millions of dollars spent in finding and correcting FAS 133 implementation
errors that took over a year to correct using over 600 accounting and finance
specialists. But virtually every other company that uses derivative financial
instruments to hedge price, interest rate, and credit risk has encountered
numerous and costly troubles trying to get the accounting right under the
complex 133/39 standards.
The FAS 133 and IAS 39 complex standards were necessary to counter a rising
tide of derivative instruments frauds and inadvertent deception in financial
statements that exploded exponentially with newer types of derivatives
speculations and hedging strategies commencing in the 1980s and 1990s. A
timeline of the scandals and revisions of accounting standards can be found at
http://faculty.trinity.edu/rjensen/FraudRotten.htm
For example, interest rate swaps now used for hundreds of trillions of dollars
of interest rate risk hedging were not even invented until the 1980s. Prior to
1994, companies did not even have to disclose their forward contracts and
interest rate or commodity swaps even when the financial risks of those
undisclosed contracts greatly exceeded all the booked liabilities of companies.
FAS 133 beginning in Year 2000 required booking nearly all derivatives contracts
as assets or liabilities and adjusting the carrying values to fair values at
least every three months and on all reporting dates. IAS 39 followed
internationally soon afterwards.
If the preparers of financial statements, along with their auditors, are
confused by the newer accounting rules for derivative financial instruments,
imagine how hopeless it is for users of financial instruments to evaluate
returns and risks after such added complexity appeared in financial statements.
In addition to the confusing booked numbers such as hedge accounting
accumulations in the Other Comprehensive Income (OCI) account, there are
paragraphs full of technical hedging strategy jargon contained in nearly
unreadable, albeit required, footnote disclosures that supplement the booked
numbers in financial statements.
The derivative financial instrument contracts are usually purchased options (market exchanged), written
options (market exchanged), futures contracts (market exchanged), forward
contracts (privately exchanged) and swaps (portfolios of privately acquired
forward contracts). Most derivatives have zero historical cost except for
options where a relatively small premium is passed from the option purchaser to
the option writer. As speculations, only purchased options have bounded risk
limited to the premium paid. Other derivatives can have unbounded risk unless
risk is bounded by other items (hedged items) by the hedging process.
The Concern is How to Get Hedge Accounting (read that
relief from earnings volatility caused by unrealized changes in derivatives'
fair value)
The FASB originally intended FAS 133 to be a simple standard in which derivative
financial instruments, many of which were previously unbooked and undisclosed,
be booked at cost (usually zero except for options) and than adjusted for often
wildly fluctuating fair value until the options are settled or otherwise
derecognized. The simple intended standard would've simply offset all changes in
fair value of derivatives to current earnings. theoretical and practical
problem for derivatives used as hedges is that interim earnings, before
derivatives are settled, typically fluctuates for unrealized changes in value
that usually wash out when the derivatives are finally settled. Companies,
particularly banks, objected wildly to such interim earnings fluctuations when
hedges were intended to reduce financial risk. The FASB responded by adding over
1,000 highly technical pages to FAS 133 and its amendments dictating how and
when companies could use special "hedge accounting" to essentially reduce or
eliminate earnings volatility to the extent that the hedges meet "hedge
effectiveness tests."
Not all economic hedges entered into by management qualify for hedge
accounting in cash flow, fair value, or foreign exchange (FX) hedges. Not all
qualifying hedges fully qualify for hedge accounting throughout the life of the
hedge if hedging ineffectiveness arises. Hedging ineffectiveness may arise at
interim points in time for hedges that are assured of being perfect hedges when
settled at maturity. This, in particular, confuses management until it is
explained those "perfect" hedges can be risky if settled before maturity. For
example, a year-long hedging forward contract that locks in a fuel purchase
price of $5 per gallon on ten million gallons on December 31 may shift in value
wildly between January 1 and December 31, On March 31 the forward contract could
be an enormous asset (when spot prices of fuel are soaring) and on June 30 it
could become an enormous liability (with drastically plunging spot prices).
Those "perfect cash flow hedges" at the December 31 maturity may not be perfect
in terms of value and risk changes before maturity. Before Year 2000 and FAS
133, a company might have $100 million in undisclosed forward contract and swap
exposures relative to $10 million in booked debt on the balance sheet. This is
no longer the case due to FAS 133 and IAS 39.
Unbooked Purchase Contracts and Loan Obligations are Particularly
Problematic
Companies often hedge firm commitments and forecasted transactions that are
not yet booked in ledge accounts. In Accounting 101 and again in Accounting 301
courses, instructors repeatedly explain why executory purchase and sales
contracts are not booked. Loan obligations are somewhat similar. For example, a
firm commitment on January 1 for Airline A to buy 10 million gallons of fuel
from Refiner R is not booked as an asset or liability by Airline A. It is also
not booked as deferred revenue (a liability) by Refiner R until the purchase
transaction actually transpires. However, both Airline A and Refiner R may enter
into a derivative contract, such as a forward contract, to hedge this unbooked
firm commitment contract for fair value risk. FAS 133 and IAS 39 require that
the hedging contract be booked and carried at fair value even if the hedged item
(the purchase/sale) contract is unbooked. Without hedge accounting relief,
reported earnings will fluctuate due to value shifts in the booked derivative
contract that are not offset by unbooked value shifts in the purchase/sale
contract (the hedged item). This is why companies fought so hard to build hedge
accounting relief into FAS 133 and IAS 39. Hedge accounting in this fair value
risk situation allows changes in derivative contract value to be offset by
debits or credits to a special equity account called "Firm Commitment"
rather than current earnings, thereby not corrupting earnings per share with
unrealized fluctuations in hedging contract fair values.
The above purchase/sale contract is a firm commitment since the $5 price per
gallon was contracted a year in advance. If the price was instead contracted as
the December 31 spot price, the purchase/sale contract no longer has fair value
risk, but it does have cash flow risk since neither Refiner R nor Airline A know
what will be paid for the 10 million gallons of fuel until December 31. This
change in the contract changes it from a "firm commitment" purchase/sale
contract to a "forecasted transaction" purchase sale contract. Airline A might
hedge such a forecasted transaction even without a written contract to purchase
10 million gallons of fuel from any supplier. Both Airline A and Refiner R may
enter into a derivative contract, such as a forward contract, to hedge this
unbooked forecasted tranaction contract for cash flow risk. FAS 133 and IAS 39
require that the hedging contract be booked and carried at fair value even if
the hedged item (the purchase/sale) contract is unbooked. Without hedge
accounting relief, reported earnings will fluctuate due to value shifts in the
booked derivative contract that are not offset by unbooked value shifts in the
purchase/sale contract (the hedged item). This is why companies fought so hard
to build hedge accounting relief into FAS 133 and IAS 39. Hedge accounting in
this cash flow risk situation allows changes in derivative contract value to be
offset by debits or credits to a special equity account called "Other
Comprehensive Income (OCI)" rather than current earnings, thereby not corrupting
earnings per share with unrealized fluctuations in hedging contract fair values.
Loan obligations may be similar to unbooked purchase/sale contracts if they
do not net settle. For example, suppose a bank is obligated to loan $1 million
at 14% in three months. This firm commitment was signed when the spot rate of
interest was 12%. If interest rates soar, the bank is still obligated to make
the full loan at 14% unless there is a net settlement clause that allows the
bank to instead provide a net settlement in cash in lieu of making the full
loan. If the loan obligation has such a net settlement clause it has to be
booked as a derivative financial instrument under either FAS 133 or IAS 39. If
it does not net settle, then it might remain unbooked if certain other
conditions are met.
Where the FVO Succeeds and Fails to Simplify Hedge Accounting
Both the FASB and the IASB are looking toward fair value accounting (now called
the financial instrument Fair Value Option (FVO) now available in both the U.S.
and International GAAP) to make it unnecessary to go through the complexities of
qualifying for hedge accounting and continually testing for hedge hedging
ineffectiveness that disqualifies some or all the hedge accounting at certain
interim points of time. The FVO works pretty well for booked hedged items such
as booked investments and booked liabilities for which changes in fair value
under the FVO automatically offset changes of value in their hedging
derivatives. It is no longer necessary to seek out special hedge accounting if
the FVO is applied to such hedged items. Since the FVO is not available for
non-financial hedged items such as operating assets (e.g., inventories,
vehicles, factory machines, land, and buildings), the FVO only simplifies hedge
accounting for hedged items that are booked financial assets or liabilities.
But unbooked hedged items create greater problems since the FVO cannot be
applied to a hedged item that is not even booked, e.g., an unbooked loan
obligation. The IASB exposure draft cited above recognizes this problem in the
following quotation from the IASB exposure draft:
22.7
Cash flow hedge accounting is an exception (with no basis in
accounting concepts) that permits management to recognise gains
and losses on hedging instruments in earnings in a period other
than the one in which they occur. Unlike fair value hedge accounting, the
‘mismatch’ that gives rise to the desire for cash flow hedge accounting is
not an accounting anomaly. The economic effect of changes in fair
value of the hedging instrument used as a hedge occurs before the
hedged cash flows occur or are contracted for or committed to. This is
illustrated as follows:
(a) If the hedged cash flows are anticipated to
result from a forecast transaction, there are no assets, liabilities,
gains, losses, or cash flows to account for at the time the gains and
losses on the hedging instrument occur. There is no conceivable change in
financial reporting standards that would result in recognising
gains or losses on future cash flows arising from a forecast
transaction. (
b) The hedged cash flows could also be payments or
receipts on variable rate financial instruments. Variable rate
instruments are designed to protect the holder from changes in the
fair value of the instrument (the cash flows of the instrument vary in
a way that causes the instrument’s fair value to remain
constant or nearly constant). Again, there is no accounting anomaly
that can be eliminated by changing a financial reporting
standard.
2.28
In either case, the hedging entity is
deliberately exposing itself to gains and losses on a hedging instrument in order to
offset changes in cash flows that have not yet occurred. Therefore, those
cash flows cannot affect earnings until they occur (or they may not
affect earnings at all if the cash flows relate to an acquisition of
an asset) 2.29 For these reasons, the desire for cash flow
hedge accounting will not be affected by changing the general measurement
requirement for financial instruments.
2.29
For these reasons, the desire for cash flow hedge accounting will
not be affected by changing the general measurement requirement for
financial instruments. * IAS 39 also permits some firm commitments
to be hedged using cash flow hedge accounting. SFAS 133 does not.
Also recall that the FVO only applies to financial assets and liabilities.
Even though it will simplify hedge accounting for booked financial items, it
does nothing to simplify hedge accounting for booked and unbooked non-financial
items. Below is a section of the
exposure draft regarding fair value hedging for items that are not permitted
to be accounted for at fair value such as custom furniture inventory:
A fair value option
2.37
One way of reducing complexity might be to permit fair value hedge
accounting for only those assets and liabilities that are not
permitted to be measured at fair value using a fair value option.
Hence, fair value hedge accounting might still be permitted for
particular financial instruments and many non-financial assets and
liabilities.
2.38
An entity can use a fairvalue option, if available, to address
accounting mismatches. A fair value option need not be complex, and
the results areeasier to understand.
2.39
However, preparers may not view a fair value option as comparable to
fair value hedge accounting. This is because the fair value option
is less flexible than fair value hedge accounting. For example:
(a) Fair value hedge accounting can be started
and stopped at willprovided that thequalification requirements
for hedge accountingare met. However, the fair value option
designation is availableonly at initial recognition and
isirrevocable.
(b) Fair value hedge accounting can be applied
to specific risks or partsof a hedged item. However, the fair
value option must be applied tothe entire asset or liability.
(c) Hedged items under fair value hedge
accounting can be financialinstruments or non-financial items.
However, in general, the fair value option can be applied to
financial instruments only.
2.40
To address these issues, the following changes could be made to the
fair value option:
(a) allowing the fair value option to be applied
to more non-financial assets and liabilities.
(b) allowing the fair value option to be applied
to specific risks or parts of the designated item.
(c) allowing the fair value option to be applied
at any date after initial recognition.
2.41
However, adding flexibility similar to fair value hedge accounting
as described in the previous paragraph could add complexity and
defeat the purpose of making a change.
2.42
For example, allowing the fair value option to be applied to
specific risks or parts of an item may result in problems similar to
those associated with partial hedges, as discussed later in this
section. 2.43 In addition, allowing the fair value option to be
applied at any date after initial recognition would raise another
issue—whether dedesignation of an item should also be permitted. If
dedesignation is permitted, the fair value option would give the
same flexibility to start and stop as fair value hedge accounting
does today (but without the restrictions surrounding hedge
accounting). Giving such flexibility (but without any restrictions)
would not improve comparability or result in more relevant
andunderstandable information for financial statement users.
Recognition outside earnings of gains and losses on
hedging instruments (similar to cash flow hedge accounting)
2.44
Unlike fair value hedge accounting, cash flow hedge accounting does
not result in adjusting the carrying amount of a hedged asset or
liability. Instead, gains and losses on the hedging instrument are
initially recognised in other comprehensive income and subsequently
reclassified into earnings when the hedged cash flows affect
earnings.
2.45
A similar technique might be used for fair value hedge accounting.
Gains and losses on the hedging instrument that arise from an
effective hedge would be recognised in other comprehensive income
and measurement of the hedged item would not be affected.
2.46
That approach would have the following benefits:
(a) The carrying amount of the hedged item would
not be affected.
(b) The measurement attribute of the hedged item
would be the same whether it was hedged or not.
(c) There would be fewer ongoing effects on
earnings. For example, there would be no ongoing effects on
earnings because the effective interest rate of a financial
asset would not need to be recalculated following the
dedesignation of a fair value hedging relationship.
2.47
However, gains and losses on the hedging instrument that are
initially recognised in other comprehensive income would need to be
reclassified to earnings to offset the effect on earnings of the
hedged item. For example, the cumulative gains or losses on an
interest rate swap designated as hedging a fixed rate bond would be
reclassified to earning when the bond was sold or settled, and not
throughout the life of the bond. However, the net swap settlements
would be recognised in earnings as they accrue.
2.48
As noted, using a cash flow hedging technique for fair value
exposures has some benefits. However, many of the restrictions that
exist today would be needed. That might not result in a significant
reduction incomplexity.
Recognition outside earnings of gains and losses on
hedged items
2.49 This suggestion has the following features:
(a) All (or at least many) financial instruments
would be measured at fair value.
(b) Gains and losses on derivatives, instruments
held for trading and instruments designated in their entirety at
initial recognition to be measured at fair value are recognised
in earnings. (c) For financial instruments other than those
described in (b), entities would be
permitted
to recognise all unrealised
gains and losses or unrealised gains and losses attributable to
specified risks in either earnings or other comprehensive
income, subject to one exception. The exception is that
unrealised gains and losses on interestbearing financial
liabilities attributable to changes in the entity’s own credit
risk must be recognised in other comprehensive income. An entity
could also choose to report a specified
percentage of the gains
or losses on these financial instruments in earnings and the
remainder in other comprehensive income.
2.50
The choice described in paragraph 2.49(c) would be made instrument
by instrument at inception (when the instrument is acquired,
incurred, issued or originated) and would be revocable. If an entity
initially chooses to recognise gains and losses on a financial
instrument in other comprehensive income and later changes that
choice, the cumulative net gain or loss on the instrument would be
reclassified to earnings in some systematic way over the remaining
life of the instrument. Alternatively, if an entity initially
chooses to recognise gains and losses on a financial instrument in
earnings and later changes that choice, the fair value of the
instrument on the date of the new choice would determine the
effective interest rate.
2.51
For those instruments described in paragraph 2.49(c) interest on
interestbearing instruments would be separately presented using an
effective interest rate. Movements in the fair value due to changes
in foreign exchange rates of all monetary items described in
paragraph 2.49(c) would also be recognised in earnings in accordance
with IAS 21
The Effects of Changes in Foreign Exchange
Rates and IAS 39. 2.52 Moreover,
if a derivative is used to hedge the changes in fair value of a
particular financial instrument, the entity could choose to
recognise in earnings future gains and losses on that hedged
instrument. The gains and losses on the hedged instrument and the
hedging instrument would be offset in earnings in a way that is
similar to fair value hedge accounting. Unlike fair value hedge
accounting, this approach would not require an effectiveness test at
inception or later.
2.53
This approach would result in more financial instruments being
measured at fair value. In addition, hedged items would generally be
measured at fair value instead of being adjusted for some fair value
changes but not others.
2.54
However, this approach has the following disadvantages:
(a) It includes few restrictions about the
choice of where to recognise gains and losses. If restrictions
comparable to existing hedge accounting requirements were added,
there would be little or no reduction in complexity
(b) Recognising part of the gains and losses on
a financial instrument in other comprehensive income and part in
earnings (and being able to change that choice) would create
complexity for users trying to understand the financial
statements.
The bottom line is that fair value accounting is no panacea for reducing
financial reporting complexity, especially in reducing much of the complexity of
hedge accounting using derivative financial instruments.
The
exposure draft then launches into, beginning in Paragraph 2.55, alternatives
to simplifying hedge accounting other than to attempting fair value accounting
alternatives that hit the wall when hedging with derivative financial
instruments.
Having noted all the problems with fair value accounting when
hedging for derivative financial instruments in Section 2 of the exposure draft,
the exposure draft in Section 3 tries to nevertheless make a case that fair
value accounting is the best of all the bad alternatives for accounting for
financial instruments in general, including derivative financial instruments. No
attempt is made to advocate fair value accounting for non-financial instruments
such as operating assets where value in use versus exit
values present enormous problems for exit (fair value) accounting.
Section 3 in the IASB's
exposure draft is quite good about mentioning the problems of fair value
accounting as well as the reasons the IASB (and the FASB) is leaning in theory
and in practice for requiring fair value accounting of all financial instruments
be they assets or liabilities or both in the case of some compound instruments.
Questions for respondents
Question 8
To reduce today’s measurement-related problems, Section 3 suggests
that the long-term solution is to use a single method to measure all
types of financial instruments within the scope of a standard for
financial instruments. Do you believe that using a single method to
measure all types of financial instruments within the scope of a
standard for financial instruments is appropriate? Why or why not?
If you do not believe that all types of financial instruments should
be measured using only one method in the long term, is there another
approach to address measurement-related problems in the long term?
If so, what is it
Question 9
Part A of Section 3 suggests that fair value seems to be the only
measurement attribute that is appropriate for all types of financial
instruments within the scope of a standard for financial
instruments.
(a) Do you believe that fair value is the only
measurement attribute that is appropriate for all types of
financial instruments within the scope of a standard for
financial instruments?
(b) If not, what measurement attribute other
than fair value is appropriate for all types of financial
instruments within the scope of a standard for financial
instruments? Why do you think that measurement attribute is
appropriate for all types of financial instruments within the
scope of a standard for financial instruments? Does that
measurement attribute reduce today’s measurement-related
complexity and provide users with information that is necessary
to assess the cash flow prospects for all types of financial
instruments?
Question 10
Part B of Section 3 sets out concerns about fair value
measurement of financial instruments. Are there any significant
concerns about fair value measurement of financial instruments other
than those identified in Section 3? If so, what are they and why are
they matters for concern?
Question 11
Part C of Section 3 identifies four issues that the IASB needs
to resolve before proposing fair value measurement as a general
requirement for all types of financial instruments within the scope
of a standard for financial instruments.
(a) Are there other issues that you believe the
IASB should address before proposing a general fair value
measurement requirement for financial instruments? If so, what
are they? How should the IASB address them?
(b) Are there any issues identified in part C of
Section 3 that do not have to be resolved before proposing a
general fair value measurement requirement? If so, what are they
and why do they not need to be resolved before proposing fair
value as a general measurement requirement?
Question 12
Do you have any other comments for the IASB on how it could
improveand simplify the accounting for financial instruments?
In Section 3 of the exposure draft, the IASB's arguments for fair value
accounting are very compelling. I applaud this effort. However, some underlying
and unmentioned assumptions disturb me. Implicitly the IASB assumes that "value
in use" and exit (fair) value are perfectly correlated for financial
instruments. This is admittedly not true for non-financial assets such as farm
tractors where the correlation between recently-purchased tractors and value in
use has negligible correlation because of kinks between markets for new versus
used tractors. The additional problem is that new tractors are fungible
commodities whereas used tractors are entirely unique. No two used tractors are
exactly alike in terms of quality and expected life. In addition the markets for
new versus used tractors are entirely different even for pre-owned tractors that
have never been used or were only used for little old farm ladies to get to and
from church.
Now consider the IASB's assumption there's no difference between a customized
derivative financial instrument and a similar instrument traded in exchange
markets. There is in fact a huge unmentioned problem for financial instruments
like customized interest rate swaps for which there is no external market.
Interest rate swaps are generally unique, customized, and cannot be sold by
parties and counterparties without prohibitive transactions costs. The FASB and
the IASB require that they be "marked-to-market" without providing guidance on
how to do so without a market. You can read about how such valuation takes place
in a complicated manner at
http://faculty.trinity.edu/rjensen/acct5341/speakers/133swapvalue.htm
But is this supposedly "fair valuation" process really reflective of value in
use of interest rate swaps?
Clearly historical cost (zero) is not relevant for a customized $10 million
interest rate swap that XYZ Company acquired in Example 5 of Appendix B in FAS
133 commencing in Paragraph 131. Jensen and Hubbard explain how such a swap is
valued by banks using a Bloomberg database of forward exchange transactions ---
http://www.cs.trinity.edu/~rjensen/133ex05.htm .
The illustrative Excel workbook can be downloaded from
http://www.cs.trinity.edu/~rjensen/133ex05a.xls
But is this "fair value" derived from market transactions really the fair value
of XYZ's unique and customized interest rate swap? Probably not! It might be
better to simply assume that value changes in the swap are perfectly and
negatively correlated with value changes in the hedged item which in this
example are $10 million in corporate variable rate bonds. But in order to assign
a fair value to the interest rate swap an elaborate estimation process is
required to derive the swap value estimates shown (but not explained) in
Paragraph 137 of FAS 133. It is not clear that these fair values clearly reflect
"value in use" of this unique customized swap that most likely cannot be sold or
terminated with the swap's counter party without huge transactions penalties.
This is an example of a financial instrument whose value in use may be entirely
different from its true and totally unknown exit (fair) value.
The way firms must derive fair values for many financial instruments is truly
fanciful for unique financial instruments that are not like any other market
traded instruments and cannot be disposed of without enormous transactions
costs. In the case of Example 5, the values given by the FASB (and never
explained) and flip flop between positive and negative are probably widely
divergent from value in use of this swap by XYZ Company.
The implicit assumption in fair value accounting that value in use is equal
to extrapolated market valuations is not usually true in reality. This does not
make fair value accounting necessarily worse than other alternatives, but it
might unduly complicate hedge accounting. For example, the IASB does not permit
the Shortcut Method for hedge effectiveness testing of interest rate swaps that
is explained for XYZ Company in Paragraph 132 of FAS 133. The FASB allows the
Shortcut Method, but the IASB refuses to allow it, and all sorts of anomalies
might arise in hedge effectiveness testing that can be avoided by the Shortcut
Method.
Public Insurance Companies versus Mutual Insurance Companies
David Schiff, an industry gadfly and publisher of
Schiff's Insurance Observer, has been warning since the late 1990s that
earnings-per-share pressures would drive insurers to do dumb things. He was
right. Since going public Prudential has spent $11 billion buying back shares at
an average cost of $63, Schiff estimates. Those shares are now worth $19.
Hartford spent $2 billion the past two years buying back stock. That's as much
as the entire company is now worth. The mutuals aren't geniuses at
investing--proportionally they own more mortgage securities than do public
insurers, according to Etti Baranoff, a professor of insurance at Virginia
Commonwealth University and former Texas insurance regulator.
It's just that mutuals don't have the same incentives to
boost net income. Baranoff also notes that mutuals don't have to file financials
under Generally Accepted Accounting Principles.
Those principles require public companies to mark down investment securities,
some of them distressed and thinly traded, to current market values. The rule
has given rise to $40 billion in unrealized losses as of Sept. 30. Perhaps the
market has overcorrected, and shares of Hartford and Prudential are a bargain.
But their mutual rivals will be snickering for quite a while.
Bernard Condon and Daniel Fisher, "Mutual Respect, Forbes, December
22, 2008
---
http://www.forbes.com/forbes/2008/1222/036.html?partner=magazine_newsletter
Advanced Derivatives Accounting Question
On June 27, 2001 the FASB's Derivatives Implementation Group (DIG) issued
Statement FAS 133 Implementation Issue No. G20
Title: "Cash Flow Hedges: Assessing and Measuring the Effectiveness of a
Purchased Option Used in a Cash Flow Hedge Paragraph"
References FAS 133 Paragraphs 28(b), 30, 63, and 140
Date cleared by Board: June 27, 2001 Date posted to website: August 10, 2001
Do you think the
IASB exposure draft is in direct conflict with G20, and if so, why?
All of you have a wonderful opportunity to express
your views on the subject of relevance vs. reliability to the FASB and IASB.
The exposure draft on "The Objective of Financial Reporting and Qualitative
Characteristics and Constraints of Decision-Useful Financial Reporting
Information" is available at
http://www.fasb.org/draft/ed_conceptual_framework_for_fin_reporting.pdf
Comments are being solicited through September 29.
I commented on the Preliminary Views document that preceded this exposure
draft and probably will comment on this exposure draft too. This document is
a key building block for the future of financial reporting and I urge all of
you to consider participating formally in the debate.
Speak to Me Only With Thine Eyes: The Sound of Colors for the Blind Researchers at the Balearic Islands University in Spain
are developing a device that will allow blind children to distinguish colors by
associating each shade to a specific sound. The project, dubbed COL-diesis, is
based on the synesthesia principle--a confusion of senses where people
involuntarily relate the real information gathered by one sense with a different
sensation. "Only 4 percent of the population are true synesthetes, but everybody
else is influenced by associations between sounds and colors," said Jessica
Rossi, one of the coordinators of the project. For example, people tend to
associate light colors with high-pitched sounds. "We want to give the user a
device that allows [blind children] to chose specific associations of colors and
sounds based on each user's sensitivity," Rossi said. The device will include a
sensor the blind kids will wear on their fingertips Go touch the objects they
want to know the colors of, and a bracelet that will transform the color into a
sound. The researchers expect to have their prototype ready by September.
Maria José Viñas, Chronicle of Higher Education, June 23, 2008 ---
http://chronicle.com/wiredcampus/index.php?id=3109&utm_source=wc&utm_medium=en
Jensen Question
Do we need multiple sounds for some colors? For example, there's Wall Street
green, Al Gore's green, vegetable green, freshman green, and seasick green.
Jensen Comment for Accountants
Proposed (actually now optional) fair value financial statements have so many
shades of accuracy regarding measurements of financial items. Cash counts are
highly accurate along with cash received from sales of financial instruments.
Unrealized earnings on actively traded bonds and stocks are quite accurate
according to FAS 157. Value estimates of interest rate swaps may be inaccurate
but inaccuracy doesn't matter much since these value changes will all wash out
to zero when the swaps mature. Color them blah. Value estimates of most anything highly unique,
like parcels of real estate, are highly subjective and prone to fraud among
appraisal sharks. Color them scarlet!
Our Students
Might Actually Like Color Book Accounting
Could we add information to fair value financial statements by colorizing them
according to degrees of uncertainty and accuracy? And could we add sounds of
uncertainty so that SEC-recommended bracelets could listen to the soothing
waltzes Strauss (read that cash) and the rancorous hard rock-sounding shares in
a REIT. What sounds and colors might you give to FIN 41 items Amy?
Bob Jensen's threads on visualization of multivariate data are at
http://faculty.trinity.edu/rjensen/352wpvisual/000datavisualization.htm
I think the above document is interesting, but I never get any feedback about
it. There are all sorts of research opportunities in visualization of
multivariate fair value financial performance!
Synthetics Asset and Liability Accounting
Is it possible to teach this transaction from an IFRS perspective?
Denny Beresford made a helpful suggestion that one way to teach IFRS is to
first look at the transaction itself and then reason out how to account for it
under IFRS standards and interpretations. So here's a challenge for your
advanced-level accounting students: How would you account for this one
under IFRS?
What this illustrates is the type of thing that the IASB will have to tackle
all alone, without a FASB research staff, when the U.S. depends upon the IASB
for its accounting standards. I don't think the IASB fully understands what it
is getting into by so desperately wanting to set accounting standards for U.S.
companies.
From the financial rounds blog on December 29, 2008
How Do You Use Credit Default Swaps (CDS) To Create "Synthetic Debt"?
There's been a lot of talk in recent months about
"synthetic debt". I just read a pretty good explanation of synthetics in
Felix Salmon's column, so I thought I'd give a brief summary of what it is,
how it's used, and why.
First off, let's start with Credit Default Swaps (CDS). A CDS has a lot of
similarities to an insurance policy on a bond (it's different in that the
holder of the CDS needn't own the underlying bond or even suffer a loss if
the bond goes into default).
The buyer (holder) of a CDS will make yearly payments (called the
"premium"), which is stated in terms of basis points (a basis point is 1/100
of one percent of the notional amount of the underlying bond). The holder of
the CDS gets paid if the bond underlying the CDS goes into default or if
other stated events occur (like bankruptcy or a restructuring).
So, how do you use a CDS to create a synthetic bond? here's the example from
Salmon's column:
Let's assume that IBM 5-year bonds were yielding 150 basis points over
treasuries. In addition, Let' s assume an individual (or portfolio manager)
wanted to get exposure to these bonds, but didn't think it was a feasible to
buy the bonds in the open market (either there weren't any available, or the
market was so thin that he's have to pay too high a bid-ask spread). Here's
how he could use CDS to accomplish the same thing:
First, buy $100,000 of 5-year treasuries and
hold them as collateral
Next, write a 5-year, $100,000 CDS contract
he's receive the interest on the treasuries,
and would get a 150 basis point annual premium on the CDS
So, what does he get from the Treasury plus writing
the CDS? If there's no default, the coupons on the Treasury plus the CDS
premium will give him the same yearly amount as he would have gotten if he's
bought the 5-year IBM bond, And if the IBM bond goes into default, his
portfolio value would be the value of the Treasury
less what he would have to pay on
the CDS (this amount would be the default losses on the IBM bond). So in
either case (default or no default), his payoff from the portfolio would be
the same payments as if he owned the IBM bond.
So why go through all this trouble? One reason might be that there's not
enough liquidity in the market for the preferred security (and you'd get
beaten up on the bid-ask spread). Another is that there might not be any
bonds available in the maturity you want. The CDS market, on the other hand,
is very flexible and extremely liquid.
One thing that's interesting about CDS is that (as I mentioned above), you
don't have to hold the underlying asset to either buy or write a CDS. As a
result, the notional value of CDS written on a particular security can be
multiple times the actual amount of the security available.
I know of at least one hedge fund group that bought CDS as a way of betting
against housing-sector stocks (particularly home builders). From what i
know, they made a ton of money. But CDS can also be used to hedge default
risk on securities you already hold in a portfolio.
To read Salmon's column, click
here,
and to read more about CDS, click
here
Credit Default Swap (CDS) This is an insurance policy that essentially "guarantees" that if a CDO goes bad
due to having turds mixed in with the chocolates, the "counterparty" who
purchased the CDO will recover the value fraudulently invested in turds. On
September 30, 2008 Gretchen Morgenson of The New York Times aptly
explained that the huge CDO underwriter of CDOs was the insurance firm called
AIG. She also explained that the first $85 billion given in bailout money by
Hank Paulson to AIG was to pay the counterparties to CDS swaps. She also
explained that, unlike its casualty insurance operations, AIG had no capital
reserves for paying the counterparties for the turds they purchased from
Wall Street investment banks.
What Ms. Morgenson failed to explain, when Paulson eventually gave over $100
billion for AIG's obligations to counterparties in CDS contracts, was who were
the counterparties who received those bailout funds. It turns out that most of
them were wealthy Arabs and some Asians who we were getting bailed out while
Paulson was telling shareholders of WaMu, Lehman Brothers, and Merrill Lynch to
eat their turds.
Over the past few days, two very smart people have
asked me about a passage in Michael Lewis's
cover story for Portfolio in which he talks about synthetic CDOs without actually using
the term. They said that they didn't quite understand it, so I'm going to
try to explain what a synthetic bond is. Once I've done that, the Lewis
passage should be a lot more comprehensible.
Let's start with a simple single-credit synthetic
bond. You're an investor, and looking at the credit markets, you see that
IBM debt is trading at attractive levels, especially around the 5-year mark,
where they yield about 150bp over Treasuries. You'd really like to buy $100
million of IBM bonds maturing in five years, but IBM isn't returning your
calls (they have no desire to borrow money at these spreads), and there
aren't any IBM bonds with exactly the maturity you want. What's more, even
the bonds with maturities nearby are illiquid, and closely held: there's no
way you can just blunder into the market and buy up that many bonds without
massively skewing the market, since the overwhelming majority of the bonds
are just not for sale.
So you buy a synthetic IBM five-year bond instead,
taking advantage of the much more liquid CDS market. Essentially, you take
the $100 million that you were going to spend on IBM bonds, and you put it
into a special-purpose entity called, say, Fred. (In reality, it'll be
called something really boring like Synthetic Technology Invetments Cayman
III Limited, but Fred is easier to remember.) First, Fred takes the $100
million and invests it in 5-year Treasury bonds.
Next thing, Fred goes out and sells $100 million of
credit protection on IBM in the CDS market, using the $100 million of
Treasury bonds as collateral. The buyer of protection will pay $1.5 million
per year (150 basis points) to Fred, and in return Fred promises to pay $100
million to the buyer in the event IBM defaults, less the value of IBM's
bonds at the time. The buyer knows that Fred is good for the money, because
it's already there, tied up in Treasury bonds.
So long as IBM doesn't default, you get not only
the $1.5 million per year from the buyer of protection, but also the
interest on the Treasury bonds. You wanted to buy IBM bonds yielding 150bp
over Treasuries, and that's exactly what you're getting: the 150bp from the
CDS counterparty, and the Treasury interest from the Treasury bonds. At
maturity, assuming IBM still hasn't defaulted, you get your $100 million
back, the CDS contract has expired, and Fred has no contingent liability any
more.
The effect is identical to holding an IBM bond --
and you can even sell your interest in Fred, just like you could sell an IBM
bond. If IBM defaults, you lose your $100 million, but you get back the
value of an IBM bond -- which again is the same outcome as if you'd bought
an IBM bond for $100 million and IBM defaulted.
But the key thing to note is that IBM itself is not
involved in the transaction at all. It doesn't matter how few bonds IBM has
issued, there can be many times that amount in synthetic IBM bonds, just so
long as there are enough people out there willing to buy and sell credit
protection on IBM.
And just as you can create a synthetic IBM bond,
you can create a synthetic bond portfolio, made up of credit default swaps
on any number of corporate names or even mortgage-backed securities. The
special purpose vehicles in those cases sometimes sell protection on a lot
of different names; sometimes they just sell protection on a liquid CDS
index. Either way, the returns that those vehicles offer are basically the
same as the returns on buying the underlying securities -- if those
securities were easily available.
Now that we've understood all that, we can return
to Michael Lewis's piece, where he's talking about a chap called Steve
Eisman, who was buying protection in the CDS market, and is sat at dinner
next to one of his counterparties, who was selling protection.
Whatever rising anger Eisman felt was offset by
the man's genial disposition. Not only did he not mind that Eisman took
a dim view of his C.D.O.'s; he saw it as a basis for friendship. "Then
he said something that blew my mind," Eisman tells me. "He says, 'I love
guys like you who short my market. Without you, I don't have anything to
buy.'¿" That's when Eisman finally got it. Here he'd been making these side bets
with Goldman Sachs and Deutsche Bank on the fate of the BBB tranche
without fully understanding why those firms were so eager to make the
bets. Now he saw. There weren't enough Americans with shitty credit
taking out loans to satisfy investors' appetite for the end product. The
firms used Eisman's bet to synthesize more of them. Here, then, was the
difference between fantasy finance and fantasy football: When a fantasy
player drafts Peyton Manning, he doesn't create a second Peyton Manning
to inflate the league's stats. But when Eisman bought a credit-default
swap, he enabled Deutsche Bank to create another bond identical in every
respect but one to the original. The only difference was that there was
no actual homebuyer or borrower. The only assets backing the bonds were
the side bets Eisman and others made with firms like Goldman Sachs.
Eisman, in effect, was paying to Goldman the interest on a subprime
mortgage. In fact, there was no mortgage at all. "They weren't satisfied
getting lots of unqualified borrowers to borrow money to buy a house
they couldn't afford," Eisman says. "They were creating them out of
whole cloth. One hundred times over! That's why the losses are so much
greater than the loans. But that's when I realized they needed us to
keep the machine running. I was like, This is allowed?"
What Eisman is saying is that there were
mortgage-backed securities, and then there were synthetic mortgage-backed
securities; when the banks ran out of actual MBS to sell to investors, they
sold them synthetic MBS instead. And yes, that was allowed.
There is some hyperbole here, though. While there
were undoubtedly a lot of synthetic MBS issued, they weren't a large
multiple of the real MBS issued, as the "one hundred times over" quote would
suggest. Which is quite obvious, if you think about it: there weren't a lot
of people like Steve Eisman willing to short the MBS market -- and you need
them, to take the other side of the trade.
In fact, most of the synthetic MBS issued were
issued by banks which kept the underlying mortgages on their own balance
sheet. Rather than put the mortgages directly into a CDO and sell that to
investors, they kept the mortgages themselves and bought protection from the CDO on them -- creating a synthetic CDO which mirrored
(and which they could sell to hedge) their own holdings. Why did they do
that? That's the story of the super-senior tranche, and will have to wait
for another day.
Question How does accounting for time differ from accounting for money? Remember those
Taylor
and Gilbreth time and motion studies in cost accounting. How has time accounting changed in the workplace (or should change)?
Studies have shown the alarming extent of the
problem: office workers are no longer able to stay focused on one specific task
for more than about three minutes, which means a great loss of productivity. The
misguided notion that time is money actually costs us money. "Time Out of Mind," by Stefan Klein,
The New York Times, March 7,
2008 ---
Click Here
IN 1784, Benjamin Franklin composed a satire,
“Essay on Daylight Saving,” proposing a law that would oblige Parisians to
get up an hour earlier in summer. By putting the daylight to better use, he
reasoned, they’d save a good deal of money — 96 million livres tournois —
that might otherwise Go to buying candles. Now this switch to daylight
saving time (which occurs early Sunday in the United States) is an annual
ritual in Western countries.
Even more influential has been something else
Franklin said about time in the same year: time is money. He meant this only
as a gentle reminder not to “sit idle” for half the day. He might be
dismayed if he could see how literally, and self-destructively, we take his
metaphor today. Our society is obsessed as never before with making every
single minute count. People even apply the language of banking: We speak of
“having” and “saving” and “investing” and “wasting” it.
But the quest to spend time the way we do money is
doomed to failure, because the time we experience bears little relation to
time as read on a clock. The brain creates its own time, and it is this
inner time, not clock time, that guides our actions. In the space of an
hour, we can accomplish a great deal — or very little.
Inner time is linked to activity. When we do
nothing, and nothing happens around us, we’re unable to track time. In 1962,
Michel Siffre, a French geologist, confined himself in a dark cave and
discovered that he lost his sense of time. Emerging after what he had
calculated were 45 days, he was startled to find that a full 61 days had
elapsed.
To measure time, the brain uses circuits that are
designed to monitor physical movement. Neuroscientists have observed this
phenomenon using computer-assisted functional magnetic resonance imaging
tomography. When subjects are asked to indicate the time it takes to view a
series of pictures, heightened activity is measured in the centers that
control muscular movement, primarily the cerebellum, the basal ganglia and
the supplementary motor area. That explains why inner time can run faster or
slower depending upon how we move our bodies — as any Tai Chi master knows.
Time seems to expand when our senses are aroused.
Peter Tse, a neuropsychologist at Dartmouth, demonstrated this in an
experiment in which subjects were shown a sequence of flashing dots on a
computer screen. The dots were timed to occur once a second, with five black
dots in a row followed by one moving, colored one. Because the colored dot
appeared so infrequently, it grabbed subjects’ attention and they perceived
it as lasting twice as long as the others did.
Another ingenious bit of research, conducted in
Germany, demonstrated that within a brief time frame the brain can shift
events forward or backward. Subjects were asked to play a video game that
involved steering airplanes, but the joystick was programmed to react only
after a brief delay. After playing a while, the players stopped being aware
of the time lag. But when the scientists eliminated the delay, the subjects
suddenly felt as though they were staring into the future. It was as though
the airplanes were moving on their own before the subjects had directed them
to do so.
The brain’s inclination to distort time is one
reason we so often feel we have too little of it. One in three Americans
feels rushed all the time, according to one survey. Even the cleverest use
of time-management techniques is powerless to augment the sum of minutes in
our life (some 52 million, optimistically assuming a life expectancy of 100
years), so we squeeze as much as we can into each one.
Believing time is money to lose, we perceive our
shortage of time as stressful. Thus, our fight-or-flight instinct is
engaged, and the regions of the brain we use to calmly and sensibly plan our
time get switched off. We become fidgety, erratic and rash.
Tasks take longer. We make mistakes — which take
still more time to iron out. Who among us has not been locked out of an
apartment or lost a wallet when in a great hurry? The perceived lack of time
becomes real: We are not stressed because we have no time, but rather, we
have no time because we are stressed.
Studies have shown the alarming extent of the
problem: office workers are no longer able to stay focused on one specific
task for more than about three minutes, which means a great loss of
productivity. The misguided notion that time is money actually costs us
money.
And it costs us time. People in industrial nations
lose more years from disability and premature death due to stress-related
illnesses like heart disease and depression than from other ailments. In
scrambling to use time to the hilt, we wind up with less of it.
Continued in article
A Cost Accounting/Decision Case
From The Wall Street
Journal Accounting Weekly Review on May 7, 2009
SUMMARY: Glenn
Beck, in a wide-ranging contract with Simon & Schuster, will accept
smaller book advances in exchange for a share in the profits. The
arrangement lets Simon & Schuster experiment with formats, genres and
categories because there is less cost up front in an uncertain market,
giving the author the comfort of knowing he'll be compensated if sales
go up, while also protecting the company.
CLASSROOM APPLICATION: This
article is a good illustration of a business incorporating fixed and
variable cost information in strategic management decisions. You can
discuss the traditional model of a higher advance vs. this new approach
of reducing fixed costs to address the challenges in the current
recession and state of the book industry.
QUESTIONS: 1. (Advanced)
What are fixed costs? What are variable costs? Why do managers need to
be aware of the differences? How do these costs impact planning and
budgeting?
2. (Introductory)
How are fixed costs impacted by this new arrangement? How are variable
costs changed in this new arrangement?
3. (Introductory)
In what situations are low fixed costs and high variable costs favorable
for a company? When are high fixed costs and low variable costs more
favorable?
4. (Advanced)
What are the benefits for the publisher with this new deal? What are the
benefits to the author? Which arrangement - high or low fixed costs -
seems to be better for the publisher? What arrangement is better for an
author? As a publisher, what factors would you take into consideration
in deciding whether to offer this kind of deal? As an author, what
factors would you consider?
5. (Advanced)
Why is this particular compensation arrangement so important in the
current economy? Do you think that this type of deal will be similarly
attractive when the economy rebounds? Why or why not?
6. (Introductory)
From a financial accounting standpoint, how would the publishing company
book an advance? What would be the journal entries at the time of
contract and at the time of payment? Would there be any adjusting
entries involved? Why or why not? If so, what would they be?
7. (Advanced)
What other industries or businesses could benefit from a change in cost
structure? Give several specific examples and explain why they should
change.
Reviewed By: Linda Christiansen, Indiana University Southeast
Author and talk-show host Glenn Beck has signed a
wide-ranging contract with CBS Corp.'s Simon & Schuster publishing arm that
gives him profit participation in each new book, a perk the publisher has
traditionally reserved solely for its most important writers, such as
Stephen King.
The deal reduces the publisher's risk by paring Mr.
Beck's advances at a time when the book business is rocky.
The move also locks in an author whose media
presence has helped make him a best-selling writer. According to Simon &
Schuster, Mr. Beck's first book, the 2003 nonfiction work "The Real
America," sold 50,000 hardcovers; 2007's nonfiction "An Inconvenient Book"
sold 500,000 hardcovers; and his novel "The Christmas Sweater," published in
2008, sold 775,000 hardcovers.
Authors typically receive a royalty of 15% of the
publisher's suggested retail price on hardcover titles and a 7% to 10%
royalty on paperbacks, money paid out after publishers have recouped their
advance. Mr. Beck will accept smaller advances in exchange for a share in
the profits. The deal will also provide him with more creative control over
how his books are designed and marketed.
"I'd rather take a lower advance and have a
partnership," Mr. Beck, 45 years old, said. "I'll bet on myself and a smart
person on the other side of the table every time." Mr. Beck said he took
satisfaction in having a deal similar to that of Mr. King, noting that Mr.
King described him in a magazine column as "Satan's mentally challenged
younger brother."
This year, Mr. Beck will offer three new titles:
"America's March to Socialism," which will be issued in May as an original
audiobook read by the author; "Glenn Beck's Common Sense," which will be
published as an ebook original in June and later as a fancy paperback; and
"Arguing with Idiots," a nonfiction title that arrives in September from
Simon & Schuster's Threshold Editions. A children's picture book of "The
Christmas Sweater" is also expected to hit bookshelves this fall.
The arrangement lets Simon & Schuster experiment
with formats, genres and categories because there is less cost up front,
said Carolyn Reidy, CEO of Simon & Schuster. "In an uncertain market, it
gives the author the comfort of knowing he'll be compensated if sales go up,
while also giving us protection," she said.
Mr. Beck's radio show, "The Glenn Beck Program," is
syndicated nationwide. His eponymous talk show on the Fox News Channel,
which premiered in January, draws an average of 2.2 million viewers,
according to Nielsen Co. Fox is owned by News Corp., which also owns The
Wall Street Journal publisher Dow Jones & Co. "There was a time when I had
to explain who he was," said Louise Burke, publisher of Simon & Schuster's
Pocket Books imprint, which issued his first book. "That's no longer the
case."
Theory
Disputes Focus Mainly on the Tip of the Iceberg (Intangibles, Contingencies, and Other Assets and Liabilities Beneath the Surface)
The big stuff lies below the surface where
it is powerful and invisible.
What is important to ship navigators is the giant mass that lies below the
icebergs. If we make an analogy that the financial statements contain only what
appears above the surface, over 99% of the accounting theory disputes have centered on the
top of the icebergs. We endlessly debate how to value what is seen above the surface
and provide investors virtually nothing about the really big stuff beneath the surface.
For example, what difference does it make how Microsoft Corporation values its tangible
assets if 98% of its value lies in intangible assets such as intellectual property, human
resources, market share, and other items of value that accountants do not know how to
value? One can argue that the difference between the capitalized value of
Microsoft's outstanding shares and the reported value of Shareholders' Equity is mostly
due to intangibles that accountants have no idea how to detect and value. If the
goal of accounting is to help investors value a company, it is backwards to value
intangibles from market prices. Our job is to help investors set those prices.
CPA Journal
Editors’ Note: Published this past June, Baruch Lev and Fang Gu’s The End
of Accounting and the Path Forward for Investors and Managers (Wiley)
has generated a great deal of controversy within the profession. The CPA
Journal presents two contrasting perspectives on this thought-provoking
book: Arthur J. Radin questions whether the authors are right about the
conclusions they draw from the data, and Thomas I. Selling agrees with some
of their recommendations but disagrees about the linkages to value creation.
Jensen Comment 1
This is my Comment 1 since I want to reflect more on the Radin and Selling
review of the Lev and Gu arguments. Let me say that I really like parts Radin
and Selling review. I've always been disappointed in Baruch Lev's many writings
on intangibles. Lev is great at finding fault but offers nothing (as far as I
can tell it's zero) to find a better way to reliably measure or even disclose
intangibles. Lev writes so much, and for me Lev's attempted positive
contributions are always a huge disappointment.
If Lev's proposals (actually unrealistic dreams) really lowered
cost of capital more firms would be routinely applying Lev's proposals.
Like Ijiri's "Force Accounting" Lev is reaching into the clouds
to touch the angels.
The title "The End of Accounting" seems to be an attempt to
attract attention with an absurd title just like political economist Francis
Fukuyama tried to attract attention with his book "The End of History."
Obviously neither accounting nor history will come to an "end." Accounting will
come to an end when audited financial statements no longer impact portfolio
decisions of investors and employment decisions of business firms such as the
firing of a CEO who fails to meet "earnings" targets. Fukuyama later wrote that
history did not end after all. I wish Lev and Gu would write an article that
admits accounting did not end after all (no thanks to them).
Let me come back to
Comment 2 on these matters once I have more time to think about Comment
2.
Comment 2
Added on December 19, 2017
Comment 2
Accountancy evolved over thousands of years to become what it is rather than
what some academic theorists would like it to be. The best example is the most
popular index used by financial analysts and investors, namely the accounting
net income of a business or some variation thereof such as earnings-per-share (eps)
or other comprehensive income (OCI). Economic theorists would prefer economic
income defined as the amount of discounted net cash flows of a business over all
future time. But neither economists nor accountants have ever been able to
measure economic income reliably because only soothsayers estimate all future
net cash flows, and those soothsayers never agree on the numbers appearing in
their fortune-telling crystal balls.
Traditional for-profit (business) and not-for-profit (e.g., governmental)
accountancy now guided by either national standard setters (e.g., the FASB and
GASB in the USA) or international accounting standard setters (e.g., the
IASB) survived Darwinian-styled evolution over thousands of years because
multiple stakeholders find it to have utility for predicting financial futures
of an organization, stewardship and inputs into macroeconomic analyses. Today
accounting traditions and rules are rooted in the past (e.g. historical cost
book values), present (e.g., market values of derivatives and other marketable
securities), and future (e.g., discounted values of pension obligations).
Baruch Lev's many writings suggest that the biggest controversy in
accountancy is how intangibles are measured and disclosed. See the many books
and papers cited at his home page at
http://www.stern.nyu.edu/faculty/bio/baruch-lev
Baruch writes very well when it comes to emphasizing the importance of
intangibles in predicting a firm's financial future and laying out criticisms of
the present accounting traditions and standards in measuring and otherwise
disclosing such standards. But the world pretty much ignores his soothsayer
suggestions for intangibles measurement and disclosure.
Question:
Where were Enron's intangible assets? In particular, what was
its main intangible asset that has been overlooked in terms of
accounting for intangibles?
Lev's answer essentially was that since he could not find Enron's intangibles
there weren't any intangible assets. My answer is that there were highly
significant intangible assets that could neither be measured in any meaningful
way nor even disclosed without self-incrimination since many of them arose from
illegal bribes and other crimes that gave Enron power around the world and most
importantly inside USA government. Most of Enron's future revenues derived
from the intangible asset of political power. To the extent this intangible
asset arises from shady political activities Enron could not disclose, let alone
measure, the massive value of its political power intangible asset.
Tom Selling leans toward replacement cost valuation of intangible and
tangible assets. I would contend that only soothsayers can measure the
replacement cost of political power.
However, as Radin and Selling suggest not being able to disclose and measure
all important intangibles does not destroy the utility of accountancy or cause
the "end of accountancy" as we know it today. Just because the medical
profession cannot prevent cancer or even save the majority of Stage 4 cancer
patients does not destroy the utility of what the medical profession can do for
such patents. Accountancy is what it is and I do not
think it will "end" because of things it cannot yet do and probably will never
be able to do such as measure and disclose the intangible asset of political
power of a multinational company.
Jensen Comment
As we watch the many rounds thus far in the Apple Verus Samsung intellectual
property war (with Samsung winning the latest but not the last battle) we
realize even more how it's impossible to measure and disclose the hidden costs
of intellectual property rights. Add this to the vague listing of the many
intangibles that accountants don't know how to measure or even disclose since
even known disputes (let alone unknown future disputes) and you begin to
question the sum total of assets and liabilities that are reported on a balance
sheet, especially for technology firms.
From the
CFO Journal's Morning Ledger on December 6, 2016
SEC accounting chief wants increased disclosures
U.S. companies should increase disclosures about their progress toward
implementing new revenue accounting rules to help investors assess the
impact, said Wesley Bricker, chief accountant at the SEC. The new rules,
which govern when companies can record revenue for the goods and services
they sell, become effective for public companies after Dec.
15, 2017,
a year later than the original implementation date. Separately, the SEC
won’t switch
to International Financial Reporting Standards in the near term, but will
continue reviewing a proposal to allow IFRS information to supplement U.S.
financial filings, said Mr. Bricker. The SEC has been mulling for years
whether to switch U.S. companies over to using IFRS instead of generally
accepted accounting principles.
Abstract
Accounting standards require disclosure of estimable losses from contingent
liabilities such as litigation expenses. However, revelation of the firm’s
private estimates of the probability of loss and possible legal damages can
be detrimental to the firm by encouraging litigation and increasing the
costs of settlement. In this paper, I propose a model (the US-patented TMTM)
that uses publicly-available data to provide accurate and unbiased estimates
of litigation damages without requiring firms to publicly disclose their
private assessments or litigation reserves. This provides valuable
information to the users of financial statements without undermining the
firm’s right to preserve sensitive internal information.
From the CFO Journal's
Morning Ledger on March 16, 2016
Some of companies’ most valuable assets cannot be
listed on their books under current U.S. accounting rules. Intangible
assets—brand value, customer data, even algorithms—are of great interest to
investors, as businesses these days tend to invest more in their nonphysical
assets than they do in building new factories,
CFO Journal’s Vipal Monga reports.
But the problem of how to value such intangible assets
has vexed accountants for decades.
The absence of
abstractions like brand value on corporate balance sheets prevents investors
from properly gauging their risks, said Baruch Lev, an accounting and
finance professor at New York University’s Stern School of Business. “It’s
an incredibly important issue,” he said. “Investment in intangibles is
almost completely obscured from investors.”
Altogether, companies in the U.S. could have more than $8 trillion in
intangible assets, according to Leonard Nakamura, an economist at the
Federal Reserve Bank of Philadelphia. That’s nearly half of the combined
$17.9 trillion market capitalization of the S&P 500 index
Teaching Case on Contingent Liabilities
From The Wall Street Journal Accounting Weekly Review on February 21,
2014
SUMMARY: This article describes fiscal second quarter results for
Cisco Systems. The company reported a charge of $655 million to repair
faulty chips. The press release is available at
http://www.sec.gov/Archives/edgar/data/858877/000119312514048150/d675402dex991.htm
In it, the company reports non-GAAP results which exclude this charge.
CLASSROOM APPLICATION: The article may be used to discuss
contingent liabilities, quarterly reporting requirements resulting in the
charge for defective chip repairs in one quarter, and non-GAAP reporting
issues in financial accounting classes. The managerial accounting topic of
quality cost also is covered. This product-related issue might be compared
to coverage of Target's woes covered under another article in this review
QUESTIONS:
1. (Introductory) Define the term contingent liability.
2. (Advanced) Based on the description in the article, is the "$655
million charge to cover the costs of addressing the memory-chip problem" a
contingent liability? Support your answer.
3. (Advanced) Access the Cisco press release of its fiscal second
quarter results for the period ended January 25, 2014, filed with the SEC on
February 12, 2014, and available at
http://www.sec.gov/Archives/edgar/data/858877/000119312514048150/d675402dex991.htm
Refer to the statement that "GAAP net income for the second quarter of
fiscal 2014 included a pre-tax charge of $655 million related to the
expected cost of remediation of issues with memory components in certain
products sold in prior fiscal years." Why must the $655 million cost be
recorded in one quarter's financial statements when it relates to chips sold
in prior fiscal years? Identify all relevant areas of financial reporting
requirements that you consider in answering this question.
4. (Advanced) In its press release, Cisco says "this [$655 million]
charge was excluded from non-GAAP net income and earnings per share." Do you
agree this is a relevant treatment to identify the company's performance? In
your answer, include a brief definition of reporting non-GAAP results by
U.S. companies.
Reviewed By: Judy Beckman, University of Rhode Island
Cisco Systems Inc. CSCO -0.55% continues to face
sagging demand for some important products, a problem exacerbated in its
fiscal second quarter by some faulty memory chips.
The network-equipment giant on Wednesday reported a
55% drop in income for the quarter, blaming a $655 million charge to cover
the costs of addressing the memory-chip problem. Cisco's revenue declined
7.8%,
That's a bit better than its forecast in November
for an 8% to 10% revenue decline. Cisco predicted Thursday revenue would
decline an additional 6% to 8% in the current quarter.
Cisco's shares slid 4% in after-hours trading to
$21.94.
John Chambers, Cisco's chief executive, said the
company faces a slowdown in orders from emerging economies and "product
transition" issues, as customers hold up purchases to evaluate its latest
switching and routing equipment.
The company said switching revenue declined 12% in
the second quarter, while revenue from routers declined 11%.
Cisco faces stiff competition in those markets,
including new rivals that are attempting to shift some switching chores to
general-purpose server systems. Mr. Chambers said the company is actually
gaining market share in some segments of the switching market, and said
orders are picking up for its new products.
On another positive note, Mr. Chambers predicted
that a broad trend of connecting everyday products to the Internet—which
Cisco calls the Internet of Everything—would begin to impact its business
positively soon.
"The Internet of Everything has moved from an
interesting concept to a business imperative," Mr. Chambers said during a
conference call with analysts, predicting that 2014 will be an "inflection
point" for sales of such technologies.
But Bill Kreher, an analyst at Edward Jones, said
he sees stiffening competition and other issues making it tougher for Cisco
to return to growth in its current fiscal year. "There was some hope, but
now it appear that that's evaporating," he said.
The Silicon Valley company, which is seen as a
bellwether for corporate technology spending, in November reported a sharp
drop in orders in China, Brazil, Mexico, India and Russia. Cisco said the
picture improved somewhat in the second period, with aggregate orders from
such emerging economies declined 3%, compared with 12% in the first quarter.
Cisco, whose routers and switching gear funnel
traffic on corporate campuses and over the Internet, has also built up a
fast-growing line of servers. But the company signaled last year that it
expected business to slow and said it was moving to trim some 4,000 jobs, or
5% of its workforce.
For the period ended Jan. 25, Cisco reported a
profit of $1.43 billion, or 27 cents a share, down from $3.14 billion, or 59
cents a share, a year earlier. Excluding stock-based compensation,
acquisition-related costs and other items, adjusted profit slipped to 47
cents from 51 cents. Revenue dropped to $11.2 billion.
Analysts on that basis had expected per share
earnings of 46 cents on revenues of about $11 billion, according to Thomson
Reuters.
In the current quarter, Cisco predicted adjusted
earnings per share of 47 cents to 49 cents. Analysts had been expected 48
cents.
Cisco said the memory chips were used in a number
of products it sold to customers between 2005 and 2010, and were purchased
from a single supplier it didn't identify. The company said the majority of
the affected hardware is beyond Cisco's warranty terms, and failure rates
are low, but said Cisco is nevertheless working with customers to mitigate
the problem. A company spokesman declined to comment on whether Cisco would
get any compensation from the chip company.
The company on Wednesday boosted its quarterly
dividend to 19 cents a share, up two cents.
Minnesota Twins heirs fight IRS over team
valuation ---
http://www.accountingweb.com/article/minnesota-twins-heirs-go-bat-against-irs-tax-court/222153
Minnesota Twins owner Carl Pohlad's heirs -- sons
Robert, James and William -- are battling the Internal Revenue Service in
U.S. Tax Court over estate taxes. The argument centers on the valuation of
the major league baseball team. The IRS says the stake was grossly
undervalued and is adding a $48 million penalty on the taxes it says the
heirs still owe.
Jensen Comment
This is an example of where a balance sheet prepared in accordance with GAAP is
useless for valuation. The bulk of the value resides in unbooked intangibles,
especially human resources and reputation for future television deals.
Some Thoughts on Fair Value Accounting
Our recent AECM regarding why accounting standard setters require
mark-to-market (fair value) adjustments of marketable securities (except for HTM
securities) and do not generally allow mark-to-market adjustments to inventories
(except for precious metals and LCM downward adjustments for permanent
impairments).
Fungible ---
http://en.wikipedia.org/wiki/Fungible
I think this "inconsistency" in the accounting standards hinges on the concept
of fungible. Marketable securities are generally fungible. A General Motors
share of stock NYC is identical to other GM shares in Bavaria versus Hong Kong
versus Sugar Hill, New Hampshire. One advantage of fair value accounting for
marketable securities is that these securities are fungible until they become
unique such as when companies go bankrupt.
The classic example for fungible inventories that I always used in class is
the difference between new cars in a dealer's lot and used cars in that same lot
is that new cars are fungible (there are thousands or tens of thousands in the
world exactly like that new car) and used cars are not fungible. There is no
other car in the world exactly like any of the used cars in a dealer's parking
lot. We have Blue Book pricing of used cars of every make and model, but these
are only suggested prices before serious negotiations between buyers and a
seller of used models with varying mileage, accident histories, flooding
histories such as being trapped while being parked in flood waters, new parts
installed such as a new engine or new transmission, etc.
My point here is that it's almost impossible to accurately value a used car
until a buyer and seller have negotiated a purchase price. And the variation
from Blue Book suggested prices can be quite material in amount. Thus we can
value General Motors common shares before we have a buyer, but we can't value
any used car before we have a buyer.
I used to naively claim that this was not the case of new cars because they
were fungible like General Motors common shares. But on second thought I was
wrong. New cars are not fungible items. Consider the case of a particular BMW
selling for $48,963 in Munich. The same car will sell for varying prices in NYC
versus Hong Kong versus Sugar Hill, NH. This variation is due largely to
delivery cost differentials.
Now consider the Car A and Car B BMW models that are exactly alike (including
color) in a Chicago dealership lot. After three months, a buyer and the dealer
agree on a $67.585 price for Car A. Car B sits in the lot for over 11 months
before a buyer and the dealer agree on a price of $58,276. This discount is
prompted mostly by the fact that the new models are out making Car B seem like
its a year old even though it odometer has less than two miles.
My point here is that until a dealer finds a buyer for either a new car or a
used car, we really don't know what the inventory fair value is for those
non-fungible items. Similarly the same grade and quality of corn in Minneapolis
has a different price than identical corn in Chicago. Corn and other commodities
like oil are not really fungible for inventory valuation purposes.
There are numerous examples of where inventory product values really can't be
known until a sales transaction takes place. We can fairly accurately estimate
the replacement costs of some of the new items for sale although FAS 33 found
that the cost of generally doing so accurately for inventory valuation purposes
probably exceeds the value of such replacement cost adjustments at each
financial reporting date.
There's great moral hazards in allowing owners of non-fungible inventories to
estimate fair values before sales transactions actually take place. Creative
accounting would be increasingly serious if accounting standards allowed fair
value accounting for non-fungible items that vary in value depending upon the
buyer and the time and place of sales negotiations.
Thus we can explain to our students that the reason we report marketable
securities at fair value and inventories at transaction or production historical
costs is that marketable securities are fungibles and most inventories are not
fungible. The main reason is that estimating the value of truly fungible
marketable securities is feasible before we have a sales transaction whereas the
value of so many non-fungible (unique) items is not known until we have a sales
transaction at a unique time and place.
Teaching Case: Contingent Liability for Paint Companies Who Obey the
EPA Laws and Rules
From The Wall Street Journal Accounting Weekly Review on December 20, 2013
SUMMARY: A California Superior Court judge in San Jose ordered
Sherwin Williams Co., NL Industries Inc., and Con Agra Grocery Products Co.
to fund $1.1 billion "to be used to clean up hazards from lead paint in
hundreds of thousands of homes in the state." Past litigation in the states
of Rhode Island, Missouri, Illinois, New Jersey and Wisconsin have failed to
produce such results. "The defendants argued that they couldn't have known
50 or more years ago the full risks of lead and that the use of lead paint
began declining after the 1920s as the knowledge of the hazards grew." Du
Pont Co. and Atlantic-Richfield Co. (owned by BP PLC) were dismissed from
the case.
CLASSROOM APPLICATION: The article is an excellent resource to
introduce accounting for contingent liabilities. Questions specifically
direct students to the Sherwin Williams Co. SEC filings since that is the
company most likely to be familiar to them.
QUESTIONS:
1. (Advanced) Define the term contingent liability.
2. (Introductory) Summarize the circumstances surrounding the legal
case described in this article. Explain how these circumstances fit the
definition of contingent liabilities to Sherwin Williams Co., NL Industries
Inc., and Con Agra Grocery Products Co.
3. (Advanced) Access the Sherwin Williams Co. filing of Form 10-Q
for the 9 months ended September 30, 2013, available on the SEC web site at
http://www.sec.gov/cgi-bin/viewer?action=view&cik=89800&accession_number=0000089800-13-000094&xbrl_type=v#
Click on Notes to Financial Statements, then Litigation. Has the company
accrued a liability for this lead pigment and lead-based paint litigation?
What are its reasons for the accounting that has been done regarding these
matters? State your answer in terms of the accounting requirements for
contingent liabilities.
Reviewed By: Judy Beckman, University of Rhode Island
A California Superior Court judge in San Jose
ordered three current or former paint companies to pay $1.1 billion into a
fund to be used to clean up hazards from lead paint in hundreds of thousands
of homes in the state.
The decision of Judge James Kleinberg, handed down
Monday afternoon, requires payments by three defendants in the 13-year-old
case: Sherwin-Williams Co. SHW +0.13% , NL Industries Inc. NL -1.93% and
ConAgra Grocery Products Co. The judge dismissed two other defendants—
DuPont Co. DD +0.84% and Atlantic-Richfield Co., owned by BP BP.LN +0.60%
PLC—from the case. Under California law, the remaining defendants have 15
days to file objections to the decision, described as "proposed."
Bonnie J. Campbell, a spokeswoman for the three
remaining defendants, said they would appeal the decision unless the judge
agrees to hold a new trial or declare a mistrial. Ms. Campbell said the
ruling "violates the federal and state constitutions by penalizing
manufacturers for the truthful advertising of lawful products, done at a
time when government officials routinely specified those products for use in
residential buildings." She added: "The risks to children alleged today were
unknown and unknowable decades ago."
The lawsuit, filed by 10 city and county
governments in California, sought a court order requiring the
defendants—current or former makers or distributors of paint and pigments—to
pay to remove lead-paint hazards from homes in Los Angeles County, San
Franciso and other places whose local governments joined the legal action.
The judge ordered the creation of a fund to achieve those aims. It is to be
administered by California's existing state Childhood Lead Poisoning
Prevention Branch program.
Nancy Fineman, an attorney representing local
government bodies who filed the suit, said the decision would have a
"tremendous impact on the health and welfare of the children of California."
She said Sherwin-Williams, NL and ConAgra would have to decide among
themselves how to divide the $1.1 billion cost of the program.
The use of lead in residential paint has been
banned in the U.S. since 1978 but it lies below layers of other paint and
wall coverings in millions of homes. The cleanup plan doesn't require
removal of all lead paint from homes. It does, however, require work to
remove lead inside homes from such areas as window frames and doors where
friction may release lead dust.
Makers of cigarettes and products containing
asbestos have paid billions of dollars in damages to people hurt by those
items. Until this decision, however, paint companies managed to defeat
lawsuits blaming them for the health problems of people exposed to lead
since 1978. Such suits had failed in Rhode Island, Missouri, Illinois, New
Jersey and Wisconsin.
As a "bench trial," the California case didn't
involve a jury. Motley Rice, a law firm that has reaped large fees in
asbestos and tobacco litigation, advised the California plaintiffs on a
contingency-fee basis.
The suit said lead paint can "severely and
permanently" damage children's mental and physical development and alleges
that the defendants promoted the use of lead paint despite knowing about the
risks. The continuing presence of lead paint in and around houses has
created a "public nuisance" under California's civil code, the suit argues.
The defendants argued that they couldn't have known
50 or more years ago the full risks of lead and that the use of lead paint
began declining after the 1920s as knowledge of the hazards grew. In
addition, they noted, old paint isn't the only source of lead risk to
children; for example, gasoline containing lead, also now banned, left
residues in soil.
Christopher Connor, chief executive officer of
Sherwin-Williams, in July told analysts he was confident of defeating the
California suit. He added that Sherwin-Williams hadn't created a reserve to
pay for a possible court-ordered cleanup.
Jensen Comment
This case will hinge upon just how much the paint manufacturers knew about the
risks of lead in paint. There are not as many smoking guns as in the case of the
tobacco industries phony denials of health risks of smoking. There is also the
issue of adding tens of billions to clean up costs in the other 49 states, This
case could easily destroy the age-old paint companies.
Abstract:
Purpose – Intangible assets are regarded as the future value drivers of
company performance. However, hardly anything is known about the actual
importance and influence of intangible assets. The purpose of this paper is
to fill this gap, so the authors analyse the German stock market index DAX
and accomplish a survey among the German Certified Public Accountants (CPAs)
concerning intangible assets.
Design/Methodology/Approach – In a first step, the authors analyse the
balance sheet data and the corresponding notes of the companies with regard
to reported values of intangible assets and applied valuation methods. The
sample period covers the years from 2005 to 2008. In a second step, the
authors analyse the statements of the German CPAs with regard to intangible
assets. The authors sent a standardised questionnaire to all 180 offices of
the top ten German auditing firms.
Findings – The results indicate that intangible assets have gained in
importance, while information on valuation methods is still scarce.
According to the German CPAs, the current influence of intangible assets on
company performance is on a high level and even will increase during the
next few years. The mostly used valuation approach for the fair value
measurement of patented technologies is the income approach. Furthermore,
the accounting standards leave room for accounting policy – a result which
casts doubt on the reliability of financial statements.
Originality/Value – For the first time not only annual balance sheet data
but also corresponding notes regarding intangible assets are analysed. The
findings are connected with a survey of an expert group for the valuation of
intangibles.
Teaching Case on the Special Problems of Accounting for Intangibles in a
Company that is Mostly Human Resources and Intangible Assets
From The Wall Street Journal Accounting Weekly Review on May 24, 2013
TOPICS: Intangible Assets, Mergers and Acquisitions
SUMMARY: "Valuations placed on social media sites like Tumblr make
little sense under typical financial analysis' concludes the authors in this
piece on Yahoo's biggest acquisition under Chief Executive Marissa Mayer.
Yahoo has faced challenges in competing against Google, Facebook, and other
Internet companies as the market of online activities--that its founders
essentially developed--has grown and matured. Tumblr's value to Yahoo may be
its appeal to a younger audience and the value to be obtained by Yahoo,
which will produce needed financial results, is clearly discussed in the
related video.
CLASSROOM APPLICATION: The article may be used to introduce
strategic reasons for business combinations or accounting for intangible
assets.
QUESTIONS:
1. (Introductory) Based on the description in the article, what are
the strategic reasons for Yahoo to acquire Tumblr? The related video
available on one of the top tabs to the online article is also helpful to
answer this question.
2. (Introductory) Why is consumer attention focused on social media
important for profitability of Internet based companies? Explain the
importance of advertising in this scenario.
3. (Introductory) Why is it valuable for Yahoo to acquire Tumblr
when the management of Tumblr will not change?
4. (Introductory) Yahoo is paying a premium to acquire Tumblr for
$1 billion. How is that premium measured?
5. (Advanced) Explain how the funding invested in Tumblr by the
venture-capital firm in 2011 must have been based on some "typical financial
analysis" model.
6. (Advanced) Despite what the author concludes, how must the price
paid by Yahoo be determined at least partly on the basis of a financial
model?
7. (Advanced) How will the model determining the price paid for
Tumblr lead to the accounting for this $1 billion by Yahoo when this
acquisition eventually closes? What types of assets are most likely to be
recorded from this transaction?
Reviewed By: Judy Beckman, University of Rhode Island
Yahoo Inc. YHOO -1.00% has agreed to pay $1.1
billion for Tumblr, a six-year-old company with more than 100 million users
but very little revenue, a deal that highlights the shifting balance of
power in the technology business.
Veterans like Yahoo have shown they have staying
power—and they have cash to spend. But companies like Yahoo's target, a
blogging site, have something valuable as well: the rapt attention of
fast-growing communities of users. That has pushed up the price tags as more
established companies fear getting left behind as people's online habits
evolve.
Yahoo and Tumblr announced the agreement on Monday.
Tumblr will be independently operated as a separate business, "per the
agreement and our promise not to screw it up," the companies said. CEO and
founder David Karp will stay on as chief executive. More on Tumblr
In a 2012 interview, Tumblr's David Karp spoke to
the Wall Street Journal about how he started the company and where he's
headed with it. Read the interview.
MoneyBeat: Yahoo Promises 'Not to Screw It Up'
Heard on the Street: Tumblr of Opportunity ATD: Board Approves Deal as
Expected Earlier: Will Yahoo Try to Get Its 'Cool Again' Why Yahoo Is Sweet
on Tumblr Yahoo Wants Out of Microsoft Deal (5/7/2013) Yahoo Scraps Deal for
French Video Site (4/30/2013) Yahoo's Ad Struggles Persist (4/16/2013)
Yahoo, Apple Discuss Deeper iPhone Partnership (4/9/2013)
Timeline: A Changing Internet Pioneer
See key dates in the history of Yahoo, which helped
to revolutionize the Web.
View Graphics
More photos and interactive graphics
The transaction adds Yahoo to the list of
established Internet companies, including Google Inc. GOOG -1.47% and
Facebook Inc., FB -3.24% that have spent $1 billion or more apiece to buy
startup companies in hopes of gaining an edge in growth. Facebook, for
instance, last year paid cash and stock initially valued at about $1 billion
to buy revenue-free Instagram, a popular photo-sharing service.
Google famously paid $1.65 billion in stock seven
years ago for YouTube, the online-video behemoth. In a smaller deal, in
dollar terms, but one that reflects the appetite among old-line Internet
companies for fresh blood, AOL bought Huffington Post for $315 million in
2011.
Yahoo Chief Executive Marissa Mayer's deal for
Tumblr gives Yahoo, one of the original big Internet companies, a
fast-growing Web service that could fill one of its many holes—namely, the
lack of a thriving social-networking and communications hub. Tumblr is
popular with many younger adults, in contrast with Yahoo's older customer
base. Tumblr is also growing more quickly on smartphones than Yahoo.
"You only do an acquisition of this size and scale
if you find an exceptional company, which Tumblr is," Ms. Mayer said Monday.
Some Tumblr users will take time to migrate to
Yahoo's core websites and might never join the fold of its parent, Ms. Mayer
said. At the same time, the blogging service offers several advantages Yahoo
executives said could benefit Yahoo, like a successful track record snagging
users on mobile devices.
"Part of our strategy here is to let Tumblr be
Tumblr," Ms. Mayer said.
Yahoo is paying a premium for the company. When
Tumblr last raised money, in late 2011, the $85 million venture-capital
investment it received valued the company at $800 million.
Yahoo already has plans to generate more revenue
from some Tumblr features like its top-of-site "dashboard" by possibly
including some extra ads. Ms. Mayer credited the company for its already
rich base of big-brand advertisers, which include all of the major film
studios.
The deal is a big win for Mr. Karp, who remains a
large shareholder, and the site's early venture investors, which include
Union Square Ventures, Spark Capital and Sequoia Capital.
Ms. Mayer praised Mr. Karp for his enthusiasm for
entertaining and compelling ads on other media, like TV, that can be "every
bit as good as the content" when pitching products like cars.
"Where are the ads that are like that, where are
the ads that are aspirational?" she asked. "We want that kind of richness in
the online atmosphere."
The acquisition is a big bet for Yahoo, given
Tumblr's financial performance so far. But Yahoo needs the growth. Its
annual revenue has been stuck for years around $5 billion, and the company's
big presence on personal computers hasn't translated well to mobile devices,
where it lacks the advantage of Apple Inc.'s AAPL +0.81% coveted hardware or
Google's ubiquitous smartphone operating software, Android.
Yahoo Chief Financial Officer Ken Goldman said
Yahoo expects its acquisition to add "relatively modest" revenue to its top
line in the second half, when the deal is expected to close, with its
contribution ramping up next year.
Questions
Is this math error by some of the best statisticians in the world or is it
simply the planets aligning in a way that was not given much probability of
happening?
How should this risk be accounted for in financial statements of life
insurance companies?
Life insurers in the U.S. face charges against
earnings potentially totaling billions of dollars from miscalculations about
the number of customers who would exercise lifetime-income guarantees sold
with the retirement products known as variable annuities, according to a new
report from Moody's Investors Service MCO +1.70% .
Variable annuities are a tax-advantaged way to
invest in stock and bond funds, and these particular guarantees promise
steady payouts if owners' fund accounts become depleted.
The grim outlook from the New York ratings firm
comes as some insurers are continuing to explore ways to reduce the
liability they face from the big blocks of guarantees on their books. Over
the past couple of years, many insurers have clamped down on fund choices,
raised fees, forbid additional account contributions and sought to buy back
the contracts.
In one of the latest efforts, Hartford Financial
Services Group Inc. HIG +2.32% is requiring owners of certain of its
guarantees to move at least 40% of their money into bond funds—and lose
their guarantee if they fail to transfer the money out of stock funds.
Some financial advisers say they worry that clients
they aren't able to reach will inadvertently lose the valuable guarantees,
possibly exposing the advisers to litigation.
"If you do not allocate your contract value in
accordance with the Investment Restrictions" by Oct. 4, the guarantee "WILL
BE REVOKED," according to a letter Hartford is dispatching to its customers
this month, with the words in boldface type.
Hartford says it needs customers to act because the
company's contracts don't allow the insurer to move customers' money from
one fund to another without authorization, as some other firms have done. A
Hartford spokeswoman said that the insurer plans "a series of reminder
letters to customers," as well as extensive communication to brokers and
advisers. Customers who miss the Oct. 4 deadline will be notified of an
opportunity to reinstate the guarantee, she said.
Scott Stolz, who heads an insurance unit at
brokerage firm Raymond James, is among the critics of the move. "Is it the
right thing to do to put the policyholder in a situation where, if they
don't do something, they will lose a feature they have paid for for years?"
he said. Mr. Stolz says he worries that no matter how good the outreach,
"there will be a number [of clients] we can't get hold of, and now we carry
the potential liability that a feature they bought from Hartford, through
us, no longer exists."
Historically, the biggest risk the guarantees posed
to insurers has been a steep equity-market decline, but most insurers have
learned to effectively hedge the risk of stock-market declines using
financial derivatives, according to the Moody's report.
Insurers now are plagued by "less-easily hedged and
more unpredictable policyholder behavior," with retention of the products
"much greater than expected," the report said.
Insurers including ING U.S VOYA +1.16% .'s
life-insurance units and MetLife Inc. MET +2.05% together have taken more
than $2.75 billion in charges, in part reflecting lower-than-expected
cancellation of the products.
"Lower lapse rates means that higher reserves are
required due to higher potential future guaranteed payments to a larger
remaining customer group," Moody's report says.
The report said "the industry impact could be in
the billions of dollars."
In the early to mid-2000s, insurers competed to
sell ever-more-generous guarantees to older people worried about investment
losses and outliving their savings. The market declines of the financial
crisis showed the value of the products to consumers—and the cost to
insurers, as they were required by regulators to boost reserves and capital
to back the guarantees.
Immediately after the financial crisis, insurers
yanked generous versions of the guarantees from the marketplace and launched
new ones with scaled-back benefits, higher prices and fewer choices. Some
insurers, including once-dominant-player Hartford, have stopped selling
variable annuities.
Continued in article
More focus on Intangibles
These are probably the most systemic problems in theory and in financial
reporting practice
The current model for
financial reporting has long been under discussion; investors and other
stakeholders want more than a historical look back and one that only
focuses on financial measures. They want to see the value companies
create through intangible assets too. Part of the solution is
integrated reporting, which provides a holistic presentation of data and
brings together the many disparate reports that organizations provide
(as opposed to being an add-on to existing reports).
In the AICPA’s
comment letter, it encouraged the IIRC to leverage the preliminary,
high-level
Enhanced Business Reporting Framework. This
framework has been developed through an open-collaborative approach and
additional ongoing work efforts by WICI continue to build upon this
framework. A new integrated reporting framework should be comprehensive
enough so that organizations can find and report the common framework
elements that are most relevant to their stakeholders. The elements
should also be presented in a way that is comparable across companies
and time periods. Finally, the AICPA called upon the IIRC to develop a
framework so that standardized integrated reports could be created using
data standards, such as XBRL, to improve transparency and provide easy
access to and analysis of integrated reporting disclosures.
This is, understandably,
a very large undertaking. The IIRC has done an excellent job of
exploring existing best practices frameworks; however there will need to
be significant involvement from CPAs and CAs with advisory, reporting
and auditing backgrounds to develop a robust, verifiable integrated
reporting framework covering all relevant content areas. As a starting
point, the AICPA has recommended that the IIRC consult with members of
the Accounting Bodies Network, of which the AICPA is a member. The AICPA
is committed to both fulfilling its role and supporting the IIRC both
internationally and through its U.S. efforts.
The Problem in a Nutshell is the Age-Old Problem of Accounting Itself ---
Inability to Value Intangibles (including the enormous Facebook audience)
"The Facebook IPO: What Went Wrong?" Knowledge@Wharton, May 23, 2012 ---
http://knowledge.wharton.upenn.edu/article.cfm?articleid=3007
• The FASB is giving companies the option to
perform a qualitative impairment assessment for their indefinite-lived
intangible assets that may allow them to skip the annual fair value
calculation.
• The qualitative assessment is similar to the
screen companies can use to determine whether they must perform the two-step
goodwill impairment test.
• To perform a qualitative assessment, a company
must identify and evaluate changes in economic, industry and
company-specific events and circumstances that could affect the significant
inputs used to determine the fair value of an indefinite-lived intangible
asset.
• The guidance is effective for annual and interim
impairment tests performed for fiscal years beginning after 15 September
2012. Early adoption is permitted.
Overview
The Financial Accounting Standards Board (FASB or
Board) issued final guidance adding an optional qualitative assessment for
determining whether an indefinite-lived intangible asset is impaired. The
guidance in Accounting Standards Update (ASU) 2012-02
1
is similar to
last year’s goodwill guidance,2
which allows companies to perform a qualitative
assessment to test goodwill for impairment.
Until now, companies have had to calculate the fair
value of their indefinite-lived intangible assets annually. If the carrying
amount of an indefinite-lived intangible asset exceeds its fair value, an
impairment charge must be recorded.
• Companies that use the optional qualitative
assessment and achieve a positive result can avoid the cost and effort of
determining an indefinite-lived intangible asset’s fair value.
• Using the new qualitative assessment will require
significant judgment.
• Companies that use the qualitative assessment
will have to consider positive and negative evidence that could affect the
significant inputs used to determine fair value.
• Companies that have indefinite-lived intangible
assets with fair values that recently exceeded their carrying amounts by
significant margins are likely to benefit from the qualitative assessment.
• Using the qualitative assessment does not affect
the timing or measurement of impairments.
Overview
The Financial Accounting Standards Board (FASB or
Board) introduced an optional qualitative assessment for testing
indefinite-lived intangible assets for impairment that may allow companies
to avoid calculating the assets’ fair value each year.
Accounting Standards Update (ASU) 2012-02
1
allows
companies to use a qualitative assessment similar to the optional assessment
introduced last year for testing goodwill for impairment.2
The goal of both standards is to reduce the cost and
complexity of performing the annual impairment test.
ASC 350
3
requires companies to test indefinite-lived intangible
assets for impairment annually, and more frequently if indicators of
impairment exist. Before ASU 2012-02, the impairment test required a company
to determine the fair value of
More Detailed Differences
(Comparisons) between FASB and IASB Accounting Standards
2011 Update
"IFRS and US GAAP: Similarities and Differences" according to PwC
(2011 Edition)
http://www.pwc.com/us/en/issues/ifrs-reporting/publications/ifrs-and-us-gaap-similarities-and-differences.jhtml
Note the Download button!
Note that warnings are given throughout the document that the similarities and
differences mentioned in the booklet are not comprehensive of all similarities
and differences. The document is, however, a valuable addition to students of
FASB versus IASB standard differences and similarities.
It's not easy keeping track of what's changing and
how, but this publication can help. Changes for 2011 include:
Revised introduction reflecting the current
status, likely next steps, and what companies should be doing now (see page 2);
Updated convergence timeline, including
current proposed timing of exposure drafts, deliberations, comment
periods, and final standards
(see page 7);
More current analysis of the differences
between IFRS and US GAAP -- including an assessment of the impact
embodied within the differences
(starting on page 17); and
Details incorporating authoritative standards
and interpretive guidance issued through July 31, 2011
(throughout).
This continues to be one of PwC's most-read
publications, and we are confident the 2011 edition will further your
understanding of these issues and potential next steps.
For further exploration of the similarities and
differences between IFRS and US GAAP, please also visit our
IFRS Video Learning Center.
To request a hard copy of this publication, please contact your PwC
engagement team or
contact us.
Jensen Comment
My favorite comparison topics (Derivatives and Hedging) begin on Page 158
The booklet does a good job listing differences but, in my opinion, overly
downplays the importance of these differences. It may well be that IFRS is more
restrictive in some areas and less restrictive in other areas to a fault. This
is one topical area where IFRS becomes much too subjective such that comparisons
of derivatives and hedging activities under IFRS can defeat the main purpose of
"standards." The main purpose of an "accounting standard" is to lead to greater
comparability of inter-company financial statements. Boo on IFRS in this topical
area, especially when it comes to testing hedge effectiveness!
One key quotation is on Page 165
IFRS does not specifically discuss the methodology
of applying a critical-terms match in the level of detail included within
U.S. GAAP.
Then it goes yatta, yatta, yatta.
Jensen Comment
This is so typical of when IFRS fails to present the "same level of detail" and
more importantly fails to provide "implementation guidance" comparable with the
FASB's DIG implementation topics and illustrations.
I have a
huge beef with the lack of illustrations in IFRS versus the many illustrations
in U.S. GAAP.
I have a
huge beef with the lack of illustrations in IFRS versus the many illustrations
in U.S. GAAP.
I have a huge beef with the lack of illustrations in
IFRS versus the many illustrations in U.S. GAAP.
"Canadian regulator decides against allowing early adoption of recent
IFRSs by certain entities," IAS Plus, November 1, 2011 ---
http://www.iasplus.com/index.htm
. . .
In making its decision, the OSFI considered a
number of factors such as industry
consistency, OSFI policy positions on
accounting and capital, operational capacity and resource constraints of
Federally Regulated Entities (FREs), the ability to benefit from improved
standards arising from the financial crisis and the
notion of a level playing field with other Canadian
and international financial institutions.
OSFI concluded that FREs should not early adopt the following new or amended
IFRSs, but instead should adhere to their mandatory effective dates:
Continued
Jensen Comment
The clients, auditors, and the AICPA clamoring that U.S. firms should be able to
voluntarily choose IFRS instead of U.S. GAAP even before it has not been decided
that IFRS will ever replace FASB standards seem to ignore the problems that
voluntary choice of IFRS might cause for investors and analysts. The above
reasoning by the OSFI makes sense to me.
But then outfits like the AICPA have a self-serving interest in earning
millions of dollars selling IFRS training courses and materials.
November 2, 2011 reply from Patricia Walters
Does that mean you oppose options to early adopt standards in general,
not just IFRSs?
Pat
November 2, 2011 reply from Bob Jensen
Hi Pat,
It's hard to say regarding early adoption of a particular national or
international standard, because there can be unique circumstances. For
example, FAS 123R simply altered how to make disclosures rather than alter
the disclosures themselves since employee option expenses had to be
disclosed before the FAS 123R adoption date. But even here early adoption of
FAS 123R by Company A versus late adoption by Company B made simple
comparisons of eps and P/E ratios between these companies less easy.
There's a huge difference between early adoption of a particular standard
and early adoption of an entire system of standards like switching from FASB
accounting standards to IFRS.
I think the Canadian position of early adoption of IFRS is probably correct
because of the mess early adoption of IFRS makes with comparisons of
companies using different accounting standards and the added costs of
regulation of more than one set of standards. Also think of the added burden
placed upon the courts to adjudicate disputes when differing sets of
standards are being used.
Even though we allow IFRS for SEC registered foreign companies, I think it
would be a total mess for the SEC, the PCAOB, investors, analysts,
educators, trainers, auditing, and even the IRS (where tax and reporting
treatments must sometimes be reconciled) if our domestic corporations could
choose between FASB versus IASB standards.
There are hundreds of differences between FASB and IASB standards. Allowing
companies domestic companies to cherry pick which system they choose before
it is even known if there will ever be official replacement of FASB
standards by IASB standards would be very, very confusing. What if there
never is a decision to replace FASB standards? Do want to simply allow
companies to choose to bypass FASB standards at their own discretion?
Of course, if information were costless it might be ideal to require
financial reporting where FASB and IASB outcomes are reconciled. But clients
and auditors generally contend that the cost of doing this greatly exceeds
benefits. And teaching financial accounting would become exceedingly
complicated if we had to teach two sets of standards on an equal basis.
I would certainly hate to face a CPA examination that had nearly equal
coverage of both FASB and IASB standards simultaneously. I say this
especially after viewing the hundreds of pages of complicated differences
between the two standards systems.
In recent correspondence Patricia Walters suggested that the FASB and IASB
are dominated by "conservative" accountants who fail in many instances to
represent the wishes of financial analysts and other users of financial
statements.
Here's an example of where she may be correct in some instances.
Project History
In 2007, the FASB added a project to its agenda to address concerns
expressed by the users of financial statements that disclosures about loss
contingencies, particularly litigation contingencies, do not provide
adequate and timely information to assist them in assessing the likelihood,
timing, and amount of future cash outflows associated with loss
contingencies.
The FASB issued two Exposure Drafts, the first in
2008 and the second in 2010, proposing changes to the required disclosures
of loss contingencies. The changes proposed in both Exposure Drafts were
strongly opposed by non-user constituents. The opposition was due, in large
part, to the belief that the imposition of additional disclosures regarding
litigation contingencies could be prejudicial to the reporting entity.
In late 2010, the SEC gave a series of speeches and
issued a "Dear CFO" letter, which put constituents on notice that the SEC
would be focusing on the disclosure of loss contingencies.
A company with a high ratio of assets to
liabilities should, in theory, be better placed to service its debts than
one with fewer assets supporting its obligations. However, the balance sheet
– the primary record of an entity’s assets and liabilities – is rarely
employed by credit analysts as a standalone indicator of credit risk.
The three main shortcomings which limit its
usefulness are that:
Under the historical cost accounting
convention, the amounts shown on the asset side are unlikely to be a
good proxy for the real value of the entity’s resources;
Leased assets, and the related obligation to
pay the lease rentals, are mostly off balance sheet; and
Pension obligations are not reported
consistently.
However, these obstacles are not completely
insurmountable because:
The value of the assets can be estimated by
reference to the earning power of the business;
Off-balance-sheet leased assets can be
factored in using either a multiple of the lease expense, or the
estimated present value of the obligation to pay the lease rentals; and
Inconsistencies in the reporting of pension
obligations can be rectified by including the actuarially-estimated
defined benefit obligation as a liability, and by transferring pension
assets to the asset side of the balance sheet where appropriate.
Using Western Europe’s 10 largest telecoms
operators as an example, this report shows that it is possible to construct
a metric – the ratio of total assets Go total liabilities – which not only
correlates nicely with our credit ratings for the telcos concerned, but also
provides additional insight into the strength of their balance sheets.
However, the adjustments required are not entirely robust, and Moody’s will
continue to focus on metrics which compare the cash generating capability of
the entity with the level of its debt.
Continued in article
Jensen Comment Some of the underlying faults are being corrected such as OBSF lease
obligations. I would say that a much more overwhelming inability of accountants
to deal with intangibles and contingencies --- See below
SUMMARY: Liz Claiborne, Inc., is selling is namesake brand to J.C.
Penney Co. "Claiborne also agreed to sell off other brands to Kohl's Corp.
[the Dana Buchman brand] and Bluestar Alliance [the Kensie, Kensiegirl and
Mac & Jac brands] in deals that are expected to close in the next 30 days
and net the company $308 million in proceeds." These brands had been built
or acquired over the 30 years since "the company...popularized fashions for
working women in the 1980s...." These sales were consummated to eliminate
significant amounts of debt and leave the company with three remaining
brands-Kate Spade, Lucky Brands and Juicy Couture. The company will rename
itself to better represent these three remaining brands.
CLASSROOM APPLICATION: The article is useful to discuss the value
of intangible assets--brand names and trademarks-versus their recorded
amounts. The amounts of intangible asset carrying values that were sold will
not be evident until the transactions close, so likely will be shown in the
4th quarter financial statements. Some disclosure may be shown in the
upcoming third quarter financials for the period ended October 1 or 2, 2011,
but those are not yet filed as of the date of this writing.
QUESTIONS:
1. (Introductory) Based on the discussion in the article, describe
why Liz Claiborne, Inc., is selling the rights to its namesake brand.
2. (Introductory) Access the related article, an opinion page
letter of response from the Liz Claiborne, Inc., General Counsel Nicholas
Rubino. What is Mr. Rubino's concern with the WSJ description of the Liz
Claiborne strategy? Does Mr. Rubino's response change any of your
description in answer to question #1 above?
3. (Advanced) What category of asset is Liz Claiborne selling? In
general, describe the accounting requirements for these assets including
initial recognition and subsequent measurement. Cite your sources from
authoritative accounting literature.
5. (Advanced) Refer again to the Liz Claiborne SEC filing of the
2nd quarter financial statement for 2011. Click on Goodwill and Intangibles
under Notes to Financial Statements on the left hand side of the page. What
categories of intangible assets does the company have? Which category(ies)
do you think include(s) the carrying values of the brands that have been
sold? Support your answer.
6. (Advanced) According to the article, these sales will close
within 30 days. Once the company files its financial statements for the 3rd
and 4th quarters of 2011, how will you be able to determine the carrying
values of the brands that were sold?
Reviewed By: Judy Beckman, University of Rhode Island
Here's
Liz Claiborne Inc.'s latest big move: It's selling
off Liz Claiborne.
The cash-strapped apparel maker said Wednesday that
it has agreed to let J.C. Penney Co. buy its namesake brand as the company
looks to reduce its debt. Claiborne also agreed to sell off other brands to
Kohl's Corp. and Bluestar Alliance in deals that are expected to close in
the next 30 days and net the company $308 million in proceeds.
The moves are Claiborne's latest attempt to get out
from under a strategy gone awry. Under Chief Executive William McComb, the
company that popularized fashions for working women in the 1980s gambled
that it could grow faster by ditching sluggish older brands and focusing on
lines aimed at younger consumers.
In the process, however, it hurt relationships with
core customers and increasingly powerful department stores, shed revenue,
and has posted annual losses since 2006, leaving it struggling to support a
large debt load.
Claiborne said the cash it raises from the sales
will let it cut its net debt to between $270 million and $290 million at the
end of the year, from $548 million in long-term debt at the end of its most
recent quarter. That will give the company some financial flexibility, a
person familiar with the matter said.
"The huge debt load on the horizon scared people,''
this person said. "That bomb has been deactivated.'' The company's moves
also could help shore up Mr. McComb's position following protracted
criticism of his tenure. "This is kind of Day One for him again,'' the
person said.
In a sign of the scale of the change, the company
founded by Liz Claiborne in 1976 now has to find a new name, one it says
will be a better fit with its remaining brands—Kate Spade, Lucky Brands and
Juicy Couture. Under the terms of its deal with Penney, the company has 12
months to find one.
Claiborne officials didn't return repeated requests
for comment. In a statement, Mr. McComb said, "Over the past few years, we
have worked diligently to turn this into a more efficient, dynamic,
brand-centric, retail-based company, and today marks the culmination of
these efforts."
As part of the transaction, Kohl's is buying the
Dana Buchman brand, and affiliates of Bluestar Alliance will receive the
Kensie, Kensiegirl and Mac & Jac Brands.
At its height in the early 1990s, the Liz Claiborne
brand generated $2 billion in annual sales. But it began to lose momentum as
its core customers aged and department stores pushed their own private-label
brands.
Mr. McComb joined the company from Johnson &
Johnson in 2006 and decided to focus on the company's contemporary brands in
an effort to attract a younger audience. In the process, he sold,
discontinued or licensed brands aimed at older audiences that weren't
performing well but still brought in lots of sales.
The result has been a shrinking of the company. In
2005, Claiborne posted $4.8 billion in sales. In its most recent fiscal
year, the total had fallen to $2.5 billion—and sales for Kate Spade, Lucky
Brands and Juicy Couture totaled $1.13 billion.
Investors have been fleeing Claiborne, and its
shares have fallen from about $43 when Mr. McComb became CEO to $6.84 in 4
p.m. composite trading Wednesday on the New York Stock Exchange.
Margaret Mager, a retail industry strategy
consultant at Broadview Advisors LLC, said shedding the brands will help the
company focus on remaining brands that have better growth prospects. "The
businesses provided profit and cash flow but they weren't growing much," Ms.
Mager said.
The acquisition of the Liz Claiborne brand, which
includes lines such as Claiborne, Liz, and Liz & Co., is a coup for J.C.
Penney, which sees the lines as a key growth area. The department-store
chain has been paying Claiborne royalties since landing its exclusive deal
for the brand in August 2010. Penney was originally given the option to buy
the U.S. rights to the brand after five years. The sale comes early,
underscoring Claiborne's cash needs.
J.C. Penney is paying Liz Claiborne $288 million
for the Claiborne and Monet Brands. It's also paying a $20 million advance
for Claiborne to develop additional brands for Penney.
Jensen Comment
I did not see FAS 157 recommendations on how to capitalize and annually adjust
the value of collaboration as an asset.
Investors who rely upon the balance sheet sums of IFRS-FASB fair values as
surrogates of economic value are missing the big picture as much as our
accounting standard setters are helping to mislead those investors. AC Littleton
emphasized that historical cost accounting is not valuation whereas exit value
accounting is valuation.
Teaching Case
From The Wall Street Journal Accounting Weekly Review on September 9,
2011
SUMMARY: The underlying accounting issues in Bartz's ouster as CEO
of Yahoo! Inc. stem from comments about her inability to "create value from
Asian assets." As noted in the related article, "despite having virtually no
enterprise value, Yahoo maintains a $17 billion market cap due to its Asian
assets and cash," said Doug Anmuth, a J.P. Morgan analyst, in a note on
Wednesday. He values Yahoo 's Asian assets currently at about $7.55 a share,
and estimates that Taobao has a current valuation of around $16 billion.
CLASSROOM APPLICATION: Questions relate to the accounting for
brands and for intangible assets arising from business combinations;
accounting for equity method investments; and the usefulness of the fair
value option given the discussion of options available to Yahoo! Inc. to
generate value from its Asian investments. Links to Yahoo!'s SEC filings are
provided.
QUESTIONS:
1. (Introductory) What factors led to Ms. Bartz's ouster as CEO of
Yahoo! Inc.?
2. (Introductory) According to discussion in the related video,
Carol Bartz managed to boost profits-she pushed them for 2010 over
$1billion, but sales were stagnating. Explain the difference between these
two items.
3. (Introductory) What actions likely made this result come about?
What comments in the article and video support your answer?
4. (Advanced) Also noted in the video is that the company has great
brand recognition in Asia. Does the value of the Yahoo! Inc brand show on
its corporate balance sheet? Explain your answer.
5. (Advanced) Access the Yahoo! Inc quarterly financial statements
for the period ended June 30, 2011, filed with the SEC on August 8, 2011 and
available at
http://www.sec.gov/cgi-bin/viewer?action=view&cik=1011006&accession_number=0001193125-11-214306&xbrl_type=v
On the left side of the page, click on Financial Statements, then Condensed
Consolidated Balance Sheets. Where do you think the value of the Yahoo! Inc.
brand name in Asia might be included in the balance sheet? Proceed to the
Notes to Financial Statements to further investigate the balance sheet item
"Intangible Assets." From what type of transactions do you think these
balances arise? What accounting standard requires recording specific
intangible assets for customer relationships, developed technologies, and
tradenames and trademarks? Give specific reference to authoritative
accounting literature in your answer.
6. (Advanced) Based on the discussion in the article, how do you
think that Yahoo! accounts for its investments in Alibaba and Yahoo! Japan?
Return to the Yahoo! Inc. filing accessed above and proceed to the footnote
on linked to "Investments in Equity Interests." Does the information confirm
your answer to the question above? Explain.
7. (Advanced) By how much does Yahoo's Investment Account balance
for Alibaba Group exceed the book value of the underlying investment? What
types of items generate this difference? How is this difference accounted
for in Yahoo!'s financial statements?
8. (Advanced) The related articles add to the information in the
main article on the investment holdings in Asia and indicates that
shareholders' and analysts estimate the value of Yahoo's Asian Assets at
about $7.55 per share. Explain generally how you think this value was
estimated. Can analysts simply use the invesment account balances for these
asset in calculating this component of Yahoo!'s share price value? Explain.
9. (Advanced) What is the fair value option in accounting for
equity method investments? Do you think this option might be considered a
good accounting policy choice by Yahoo! Inc. financial statement users?
Explain your answer.
Reviewed By: Judy Beckman, University of Rhode Island
If ever there was a moment when investment bankers
could prove their value to society, or at least to the business world, this
is it.
Yahoo's overdue firing of Carol Bartz as chief
executive, without a successor in place, puts Yahoo even more firmly in
play. Co-founder Jerry Yang might believe Yahoo is "not for sale" — as
AllThingsD reported he told some employees on Wednesday — but he only owns
3.6% of the stock.
The board's initiation of a "comprehensive
strategic review" suggests it is open to ideas from outsiders.
The only question is whether given all the
complexities involved, anyone is likely to be interested. After all,
speculation of private equity firms or media companies contemplating a move
on Yahoo have swirled over the past 12 months, with nothing concrete
emerging.
And even at its current depressed price, buying
Yahoo requires writing a hefty check. The company has an enterprise value of
about $14.5 billion — more than a private equity firm or most media
companies would likely want to spend.
Of course, a big chunk of Yahoo's value is tied up
in its Asian assets: a 40% stake in Chinese e-commerce firm Alibaba Group
and 35% of Yahoo Japan. The big snag is that selling those likely would
involve big tax hits and, in the case of Alibaba, would mean giving up an
asset of immense strategic value. Yahoo has been looking for months at ways
of unwinding the Yahoo Japan stake tax-effectively, so far without success.
It's time to break the stalemate. Certainly the
business can't afford another protracted period of drifting. Second-quarter
results showed a serious deceleration in Yahoo's display advertising revenue
growth rate, while the search alliance with Microsoft hasn't produced the
results expected of it.
Yahoo should start the process of tax-effectively
selling the Asian assets in order to smooth the way for a sale of the core
business. After all, the Alibaba stake at least likely will get sold as a
result of any deal: A change in control of Yahoo could trigger a right for
Alibaba's other shareholders to buy back Yahoo's stake in the company. And
tax expert Robert Willens says that while there are tax-effective structures
that can be utilized, such deals need to be done before an overall sale of
Yahoo is seriously discussed.
The big problem is realizing the best possible
price for the assets, particularly if Yahoo is a clear seller and potential
buyers limited.
Spring brings April showers, May flowers — and a
flurry of annual reports. Mine have been arriving in the mail, and I am
always interested to see what the companies I own stock in have to say about
themselves in this ritualistic document filled with financial information,
different types of narratives,
and lots of pretty pictures.
The amount of detail and the level of complexity in
the financial section have grown considerably in response to the increasing
onslaught of accounting rules and regulations. What's more, since going
green is now red hot, a growing number of companies — especially in Europe
and Japan — are also starting to issue Corporate Social Responsibility (CSR)
or Sustainability reports. Sometimes these are mailed with the annual
report, but more often they have to be ordered separately or downloaded from
the company's Web site. Unfortunately, the two reports rarely add up to
something greater than the sum of their parts.
This is a huge problem. A sustainable
society requires that all companies be committed to sustainable strategies.
Increasing social expectations regarding a company's commitment to
sustainability mean that firms that ignore this do so at their own risk. BMW
Group has been a leader in recognizing this. Several years ago, it issued a
Sustainable Value Report
detailing energy
consumed, water consumed, waste removed, and volatile organic compounds per
vehicle produced. Scoring high in all these categories, BMW believes that
its reputation as the world's "greenest" car company plays an important role
in brand awareness and customer satisfaction, factors that contribute to
revenue growth.
So how can shareholders and other stakeholders know
if a company's commitment to a sustainable society is contributing to a
sustainable strategy that will create value for shareholders over the long
term? The answer lies in combining the annual and CSR/sustainability reports
into something I call "One Report," which provides the essential information
on a company's financial, environmental, social, and governance performance
and shows the relationships between them. This kind of Integrated reporting
also involves leveraging the Internet to provide more detailed information
to all a company's stakeholders while also providing them with the
opportunity to engage in a virtual dialogue on these matters.
Some major corporations are starting to take the
lead in this effort, including United Technologies Corporation, Philips (the
Dutch electronics and health care giant), the German chemical company BASF,
and Danish pharmaceutical maker Novo Nordisk. At United Technologies, whose products include Carrier air conditioners,
Otis elevators, and Pratt & Whitney aircraft engines, a recent integrated
report focused on such nonfinancial metrics as lower fuel consumption and
noise emissions in a new jet engine and a reduced carbon footprint and water
consumption in the firm's factories. The juxtaposition of information on
both operations and CSR symbolizes the company's commitment to more than
just the bottom line and its belief that both sets of data have a
significant impact on the long-term success and reputation of the company.
In UT's view, CSR is both a reality and necessity, not an addendum.
Novo Nordisk presents stockholders and other
stakeholders with
a multidimensional Web site
that enables visitors
to create a customized version of their annual report, access in-depth
information about sustainability practices, contact company officers, and
even play interactive games showing the challenges and trade-offs the
company faces in making difficult decisions.
Thanks to these kinds of One Report practices,
these companies actually document their commitment to sustainability, make
better decisions based on a broader collection of data, engage more deeply
and effectively with all their stakeholders, and lower reputational risk
through a high level of transparency.
Given the importance of sustainability, I think
companies have an
ethical obligation
to practice integrated
reporting, and
investors have a similar obligation
to demand it. In fact, I believe the SEC should make it a requirement. As we
all try to come up with solutions to the problems of the planet,
integrated reporting is one way to make sure that
companies are part of the process.
Jensen Comment One place to look for sustainability information is in any section of an annual
report that deals with contingencies con --- http://faculty.trinity.edu/rjensen/theory01.htm#TheoryDisputes But this contingency accounting throughout history has probably been the weakest
area of annual reporting. One huge problem is how the value and risk can
monumentally change in an instant.
Accounting for intangibles in general is a huge weakness in annual reporting.
Remember how top executives at MCI let it into bankruptcy, executives that KPMG
agreed had intangible foresight worth millions.
Case on
Contingent Liabilities Dell's Accounting Practices Have Been Under Investigation for Some Time
From The Wall Street
Journal Accounting Weekly Review on June 18, 2010
SUMMARY: "Dell
Inc....may soon help to answer a question that has long puzzled the tech
industry: just what role did rebates from Intel Corp. play in the computer
maker's finances?" Insiders state that the issue to be resolved in
negotiations over a civil suit against both Dell Inc. and founder Michael
Dell center on whether "Dell should have disclosed rebates it received from
Intel to investors."
CLASSROOM APPLICATION: Questions
are useful to have students investing footnote disclosure of the rebates,
located in the annual report's policies and procedures footnote 1, and the
related litigation disclosure under Commitments and Contingencies.
QUESTIONS: 1. (Introductory)
What are rebates from vendors/suppliers of products?
2. (Introductory)
What is wrong with Intel providing rebates to Dell for being a loyal
customer? In your answer, define what are known as antitrust issues.
3. (Advanced)
Access Footnote 1, Description of Business and Summary of Significant
Accounting Policies, to Dell Inc.'s most recent annual report, the 10-K
filed on 3/18/2010 for the 12 months ended January 29, 2010. It is available
at
http://www.sec.gov/cgi-bin/viewer?action=view&cik=826083&accession_number=0000950123-10-025998
Scroll to find the item labeled Vendor Rebates. Summarize how Dell accounts
for these rebates. Provide summary journal entries reflecting this
accounting treatment.
4. (Advanced)
Note that this item on vendor rebates is not included in Dell's quarterly
reporting on Form 10-Q, the most recent one made on 6/10/2010 for the 3
months ended 4/30/2010, available at
http://www.sec.gov/cgi-bin/viewer?action=view&cik=826083&accession_number=0000950123-10-057270
What financial reporting standard allows this limited disclosure treatment?
Cite authoritative literature from the FASB codification in your response.
5. (Advanced)
Again access the 10-Q filing made for the 4/30/2010 quarterly reporting.
Click on "Commitments and Contingencies" in the left hand column of the SEC
filing. Summarize the disclosure about the litigation described in the WSJ
article.
6. (Advanced)
How has Dell, Inc., handled the contingent liability for the issues related
to the vendor rebate matter described in the WSJ article? In your answer,
include a description of required accounting and reporting in this area with
citations to authoritative literature.
7. (Introductory)
According to the WSJ article, Dell and its supplier who issued rebates,
Intel Corp., both deny allegations in a "a civil antitrust lawsuit against
Intel filed in November by New York's attorney general... [that] Dell's
quarterly profit margins became dependent on Intel payments." Explain your
understanding of this assertion.
8. (Advanced)
One piece of evidence cited in the article is an email "that states that the
computer maker need $100 million more from Intel to meet an earnings
forecast." What are earnings forecasts? Relate your answer here about how
Dell could be helped to achieve this milestone through rebates to your
answer to the question above.
9. (Advanced)
The main article and the related one indicate that separate disclosure of
these rebates will provide information about Dell's operations. Explain the
usefulness of this additional disclosure.
Reviewed By: Judy Beckman, University of Rhode Island
Dell Inc. and Michael Dell, its founder and chief
executive, may soon help to answer a question that has long puzzled the tech
industry: just what role did rebates from Intel Corp. play in the computer
maker's finances?
Dell said last week that it and Mr. Dell were in
talks with the Securities and Exchange Commission to settle civil
allegations that they violated securities laws in connection with Dell's
dealings with Intel, a longtime supplier of microprocessor chips. At issue,
people familiar with the situation say, is whether Dell should have
disclosed rebates it received from Intel to investors.
Such rebates have been a focus of government
antitrust suits against Intel in the U.S., Europe, Japan and South Korea,
which allege that the chip giant has improperly used financial incentives to
its customers to discourage major computer makers from buying chips from
rival Advanced Micro Devices. Intel denies the allegations, arguing that the
rebates it gives customers are a lawful form of price discounting to meet
competition.
An AMD spokesman declined to comment.
Jess Blackburn, a Dell spokesman, emphasizes that
his company was never a target of those antitrust cases. He said the
proposed settlements with the SEC would cover allegations that Dell was
negligent with regard to the adequacy of its disclosures about the Intel
rebates. But they won't raise issues regarding the legality of the rebates,
he said, adding that rebates are a common practice in the industry.
Reuters The settlements also won't affect Mr.
Dell's position as the company's chairman and chief executive, the company
said. But they may come with sizable monetary penalties—the company has set
a $100 million reserve for its own potential liability. The settlements
could also shed new light on what effect Intel's subsidies had on Dell's
finances over the years.
Securities lawyers expect any settlements to be
filed along with documents providing some details about the Intel subsidies,
as well as the SEC's arguments for why Dell should have disclosed them.
Public companies are generally required to disclose information about how
they are making profits.
The SEC could take the position that the payments
"were so critical to Dell's success, that they need to break them out" in
financial statements, said Elizabeth Nowicki, a former SEC attorney who is a
visiting associate professor of law at Boston University. An SEC spokesman
declined to comment.
Rebates and other price terms between computer
makers and suppliers are often treated confidentially, since such details
could aid competitors. A finding by the SEC that Intel's rebates to Dell
should be disclosed could affect other computer makers, Ms. Nowicki and
industry executives said, since many have received similar rebates.
Dell's accounting practices have been under
investigation by the SEC since 2005. In 2007, Dell restated four years of
results after an internal investigation prompted by the SEC probe. It didn't
disclose the issues related to Intel until last week.
The Round Rock, Texas, company said Thursday that
the proposed settlement would settle all outstanding issues with the SEC,
including those associated with accounting and financial practices that are
separate from those related to Intel. It won't contain any admission of
wrongdoing, nor will the settlement being negotiated by Mr. Dell, the
company said.
Dell said the proposed settlements involve actions
prior to its 2008 fiscal year, which began in February 2007. That was the
month that Mr. Dell, who had yielded the CEO post to Kevin Rollins, resumed
that role amid problems that included Dell's reliance on direct sales to
businesses at a time when retail computer sales to consumers were booming.
For much of the prior decade, however, Dell's
revenue and profit grew steadily. Its relationship with Intelwas seen as
especially close, partly because Dell used only Intel chips until 2006.
Intel, meanwhile, has faced allegations from
antitrust authorities that it crafted rebates and discount programs to
discourage customers from buying AMD microprocessor chips. A civil antitrust
lawsuit against Intel filed in November by New York's attorney general
states that Dell was the biggest recipient of Intel rebates—under a program
that the companies at times dubbed MOAP, for "mother of all programs." The
suit estimates that Dell got about $6 billion in rebates from Intel from
February 2002 to January 2007.
Intel denies the complaint's allegations. Dell
wasn't named as a defendant.
The complaint, filed in federal court in Delaware,
alleges that Dell's quarterly profit margins became dependent on the Intel
payments. In two quarterly periods in 2006, for example, rebate payments
exceeded Dell's reported net income, according to the lawsuit.
In one incident in 2004, the complaint alleges,
Dell asked Intel to retroactively increase the size of a payment to
stabilize Dell's forecast earnings. The suit quotes an email from an unnamed
Intel negotiator to his superiors—citing data from Mr. Dell—that states that
the computer maker needed $100 million more from Intel to meet an earnings
forecast. "Anything below 90 [is] likely to force them to lower numbers,"
the Intel negotiator wrote, according to the suit.
Dell didn't get all it wanted, according to an
email quoted in the complaint. "We didn't get enough to exceed our earnings
expectations," wrote a Dell negotiator to Messrs. Dell and Rollins. "I think
we got all we could in one 30-day period."
In 2006, Dell followed the lead of rivals and
started using AMD chips in some systems. Mr. Dell, according to the New York
complaint, wrote that his company overestimated Intel's technology,
underestimated AMD's, "and we relied too much on rebates from Intel."
Dell's Mr. Blackburn declined to comment on the
emails or other allegations in the New York complaint. But he said there was
nothing improper about Dell's dealings with Intel.
"The rebates and discounts we negotiated with Intel
were common in our industry and others, and the result of our efforts to
continuously negotiate for best pricing from Intel and other suppliers to be
competitive and deliver value to customers," Mr. Blackburn said.
He said Mr. Dell wasn't available for comment.
Intel, in a detailed response to the New York
complaint, denied issuing discounts to stabilize Dell's forecast earnings
and disputed the characterizations of emails it said were taken out of
context. Most of the financial details of its response were redacted,
however. Intel said it never made payments to Dell that were conditioned on
Dell buying microprocessors exclusively from Intel, but responded to Dell's
efforts to press for more favorable chip discounts.
Teaching Case on the Fragility of Supply Chains: Where do
accountants disclose such contingency risks?
From The Wall Street Journal Accounting Weekly Review on March 18,
2011
SUMMARY: The earthquake
that struck northeast Japan forced shutdowns across a borad spectrum of the
country's industries....The quake has crippled activity for now in a country
that is a critical source of parts for consumer electronics, as well as a
key producer of automobiles, auto parts, steel and other goods.
CLASSROOM APPLICATION: The
article is useful in discussing supply chains and lean manufacturing in a
management accounting class.
QUESTIONS:
1. (Introductory) Define the term supply chain.
2. (Introductory) Why does the author state that "the bigger impact
[of the Japanese earthquake and tsunami] could come in the weeks ahead"?
3. (Advanced) What industries could be affected because of
disruptions in the supply chain? Which are the industries in which Japan is
a dominant player in the world?
4. (Advanced) How can lean manufacturing practices enhance the
negative impact of a supply chain disruption of the magnitude of the
Japanese earthquake/tsunami?
Reviewed By: Judy Beckman, University of Rhode Island
The earthquake that struck northeast Japan Friday
forced shutdowns across a broad spectrum of the country's industries, but
the bigger impact for companies could come in the weeks ahead as the
disruptions make their way through the global supply chain.
The 8.9-magnitude earth quake, one of the largest
on record, has crippled activity for now in a country that is a critical
source of parts for consumer electronics, as well as a key producer of
automobiles, auto parts, steel and other goods.
Plants don't appear to have suffered widespread,
catastrophic damage, but production delays could be enough to affect some
tightly calibrated industries.
The earthquake affected operations at dozens of
semiconductor factories, raising fears of shortages or price increases for a
number of widely used components—particularly the chips known as flash
memory that store data in hit products like smartphones and tablet PCs.
Many key chip plants, including most of the
factories run by companies like Toshiba Corp. and SanDisk Corp. that account
for the bulk of Japan's flash-memory production, were far removed from the
quake's epicenter, and most are designed to withstand such events.
But some manufacturers are likely to be affected by
other issues, particularly disruptions in transportation of finished goods
to airports or ports, as well as the movement of employees and supplies to
production plants. Even relatively short disruptions could further stress a
supply chain already stretched tight in spots over the past year by strong
demand for hot gadgets.
"This could have a pretty substantial impact for
the next quarter on the whole supply chain," said Len Jelinek, an analyst at
IHS iSuppli, a market-research firm that focuses on the electronics
industry.
Jim Handy, another market-watcher at the firm
Objective Analysis, said he expects "phenomenal" price swings and large
near-term shortages as a result of the quake.
Chip companies based in Japan generated about $63.8
billion in revenue in 2010, accounting for about one-fifth of the
semiconductor market, IHS iSuppli said. Their presence is felt most in the
key market for what the industry calls NAND flash memory, chips at the heart
of products like Apple Inc.'s iPhone and iPad. Japanese companies, led by
Toshiba, account for about 35% of global flash revenue.
Continued in article
Jensen Comment
It's good news and bad news for Japanese assembly plants located in the United
States. The good news is that the plants are thousands of miles from the
earthquake zone. The bad news is that the assembly plants may rely upon
components imported from a Japan that is now in the state of tragedy and
turmoil. For example, my Subaru Forrester came from an assembly plant in
Indiana. However, many of the components, possibly even the boxer engine, came
from a manufacturing plant in Japan. The supply chain for this and other
components is likely to be disrupted for some time.
This begs the question about if and how accounting standards should be
re-written to disclose the financial risks of supply chain dependencies.
Teaching Case on Disclosure of Contingent Liabilities
The Financial Accounting Standards Board has tried
twice in the past three years to toughen its rules on loss disclosures. Both
times its attempts were beaten back by opposition from banks and other
companies, who worried stricter rules would force them to disclose too much
and thus tip their hands to legal adversaries.
From The Wall Street Journal's Accounting Review on March 4, 2011
SUMMARY: Goldman Sachs
Group Inc. disclosed the potential for $3.4 billion additional liabilities
from lawsuits related to repurchasing securities it packaged and sold during
the housing boom. Similar disclosures were made by J.P. Morgan Chase & Co,
Citigroup Inc., Bank of America Corp., American Express Co. and Wells Fargo
& Co. The SEC sent letters advising the financial services companies about
"some of the criteria banks should use in determining potential losses,
including those related to mortgages, to comply with disclosures rules."
CLASSROOM APPLICATION: The
article provides an interesting discussion of disclosure by financial firms
of reasonably possible litigation loss contingencies.
QUESTIONS:
1. (Introductory) Who are the financial firms discussed in this
article? What potential losses are they facing? From what transactions are
these issues arising?
2. (Advanced) Under what authoritative standard must these
financial firms disclose potential losses? Provide a specific reference to
the professional citation of this accounting requirement and state the
reporting requirement.
3. (Introductory) Based on the description in the article, what
judgment is involved in deciding on disclosures to be made about potential
losses?
4. (Advanced) What guidance has the SEC given in order to ensure
these financial firms are meeting the authoritative requirements in this
area? Is this guidance included in the accounting standard itself? Explain,
including in your answer a comment on the role of the SEC in publicly-traded
companies' financial reporting.
5. (Introductory) Why does the author speculate that the Financial
Accounting Standards Board "also may have played a role" in forcing these
additional disclosures?
Reviewed By: Judy Beckman, University of Rhode Island
What forced Goldman to make the new disclosure?
Regulatory pressure on big banks, as well as a desire to head off
more-stringent accounting rules, pushed the firm and other companies to
better disclose their potential legal losses.
Goldman's move follows similar disclosures from
J.P. Morgan Chase & Co., Citigroup Inc., Bank of America Corp., American
Express Co. and Wells Fargo & Co. All told, those companies face potential
losses that amount to more than $15 billion.
Companies have long had to disclose legal
liabilities in their regulatory filings. Since 1975, companies have been
required to set reserves for probable losses whose approximate amount is
known. The rule says that when there is a reasonable possibility of a loss,
companies don't have to reserve for it but they must disclose it and do
their best to estimate the amount.
The Securities and Exchange Commission gave
companies a pointed reminder of that rule in October, when it sent a "Dear
CFO" letter to various financial-services companies, and recently followed
up with detailed questions. The letter stressed they must disclose their
potential risks and costs in the wake of the mortgage-foreclosure scandal
and the subsequent repurchase demands from investors. It also spells out
some of the criteria banks should use in determining potential losses,
including those related to mortgages, to comply with disclosure rules.
The amounts disclosed aren't expected losses; they
are worst-case scenarios based on losses that have more than a slight chance
of happening, but are less than likely. But what constitutes "reasonably
possible," as the rule states, is open to interpretation. That may lead
banks to use different standards in determining what potential losses should
be disclosed.
Some banks, such as J.P. Morgan and Citigroup,
disclosed more than $4 billion each in additional potential losses. Morgan
Stanley disclosed it is reasonably possible losses are $518 million, as it
had previously disclosed regarding two individual lawsuits.
Linda Griggs, a partner in the securities practice
of law firm Morgan Lewis & Bockius LLP, said that in addition to the "Dear
CFO" letter, SEC staffers have been asking banks more frequently about
disclosures of potential losses when they scrutinize the banks' regulatory
filings. The commission "made it clear they should be better disclosed," she
said.
An SEC spokesman declined to comment. A Goldman
spokesman also declined to comment.
Accounting rule makers may also have played a role.
The Financial Accounting Standards Board has tried twice in the past three
years to toughen its rules on loss disclosures. Both times its attempts were
beaten back by opposition from banks and other companies, who worried
stricter rules would force them to disclose too much and thus tip their
hands to legal adversaries.
In November, however, when the FASB last put off
consideration of a tougher rule, the board said it would review year-end
2010 filings to see if companies were disclosing enough about possible
litigation losses.
Continued in article
Goodwill Impairment and Liabilities Contingent Upon Uncertain Politics of
the Future
Lehman bought back 100% of its Repo 105/108 poison with the auditor's
blessing that these were truly sales http://faculty.trinity.edu/rjensen/Fraud001.htm#Ernst Bank of America, however, is resisting buying back its dumping off of poisoned
securities
Wouldn't it be a kick if tens of thousands of local Main Street banks and
mortgage companies had to buy back their fraudulent mortgages sold down stream
to Fannie, Freddie, etc.?
Teaching Case from The Wall Street Journal Accounting Weekly Review on
October 22, 2010
TOPICS: Bad Debts, Banking, Flexible Spending Accounts, Loan Loss Allowance
SUMMARY: Bank of America Corp. "..vowed to fight government backed demand
that it repurchase loans that allegedly didn't meet underwriting guidelines
and other promises." Those demanding the repurchases include Freddie Mac and
Fannie Mae as well as other investors such as the Federal Reserve Bank of
New York, Neuberger Bergman Group, BlackRock Inc., Western Asset Management
Co. and Pacific Investment Management Co, or Pimco. These demands were the
first time that Fannie and Freddie have attempted to force banks to buy back
mortgage-backed securities that were issued by Wall Street, not by Freddie
and Fannie themselves. BofA made these statements as it reported a $4.3
billion loss, primarily stemming from a goodwill charge related to a decline
in value of its credit card business that the company says stems from
regulatory changes; otherwise, the company would have earned $3.1 billion.
CLASSROOM APPLICATION: The article covers loan losses and a goodwill
impairment charge, useful for covering these topics in a financial reporting
class.
QUESTIONS: 1. (Introductory) What are mortgage-backed securities? Why might Bank of
America be forced to repurchase these securities or their underlying loans?
2. (Introductory) What is BofA saying it will do in response to investor
requests to repurchase these loans?
3. (Introductory) Refer to the related article and describe the response to
BofA's announcement. In your answer, define the terms Freddie Mac, Fannie
Mae, and government sponsored entities (GSEs).
4. (Advanced) Describe in general the factors that lead to a goodwill
impairment charge. What accounting codification section addresses these
requirements?
5. (Advanced) Access the BofA filing on Form 8-K of the earnings press
release on October 19, 2010, available at http://www.sec.gov/Archives/edgar/data/70858/000119312510231353/0001193125-10-231353-index.htm
It is also available by clicking on the live link to Bank of America in the
online version of the article, then clicking on SEC filings on the left hand
side of the page, then clicking on Form 8-K filed on October 19, 2010.
Review the selected slides used to facilitate the earnings release
conference call with analysts. Describe the goodwill charge.
6. (Advanced) How does a goodwill impairment charge result from "diminished
future debit card profitability"?
Reviewed By: Judy Beckman, University of Rhode Island
RELATED ARTICLES: Regulator for Fannie Set to Get Litigious by Nick Timiraos Oct 21, 2010 Online Exclusive
Bank of America Corp. and some of its largest
mortgage investors clashed on Tuesday as the bank vowed to fight
government-backed demands that it repurchase loans that allegedly didn't
meet underwriting guidelines and other promises.
The bank acknowledged receiving a Monday letter
from investors alleging that a Bank of America unit didn't properly service
115 bond deals. The investors include Freddie Mac, the government-owned
mortgage company. Freddie Mac and Fannie Mae, its larger sibling, have
boosted demands on lenders over the past year to buy back defaulted loans
that had been sold to and guaranteed by the mortgage titans.
Now Reporting Track the performances of 150
companies as they report and compare their results with analyst estimates.
Sort by reporting date and industry. .More Heard: BofA Is Bracing for a Long
War BofA Sues FDIC Over Mortgage Losses Custody Banks Rebound BofA: Not
Worried on Mortgages Buyback .But Tuesday's action marks the first step by
either company to force banks to buy back mortgage-backed securities that
were issued by Wall Street, not by government-backed mortgage giants.
Other investors, some of whom were acting on behalf
of their clients, include the Federal Reserve Bank of New York, Neuberger
Berman Group LLC, BlackRock Inc., Western Asset Management Co. and Allianz
SE's Pacific Investment Management Co., or Pimco, according to people
familiar with the matter.
The Charlotte, N.C., bank hoped the lifting of its
foreclosure sale moratorium would debunk fears that the mortgage process was
flawed. But investors grappled with new concerns Tuesday that the bank could
be overwhelmed with investor requests to repurchase flawed mortgages made
before the U.S. housing collapse. Its shares dropped 54 cents or 4.4% to
$11.80. The shares have declined more than 30% since the end of April amid
worries about regulatory reform, lackluster revenues and weak loan demand.
Experience WSJ professional Editors' Deep Dive:
Banks Face Changing LandscapeFINANCIAL NEWS Banks Must Rethink Their
Strategies .Fund Strategy IMF Warns Finance Is Vulnerable .Financial News
Could Basel III Rescue Banking?. Access thousands of business sources not
available on the free web. Learn More .Chief Executive Brian Moynihan
quickly vowed to push back on the repurchase requests.
"We will diligently fight this," Mr. Moynihan told
analysts Tuesday.
.A spokesman, responding to Monday's letter, added
that "We're not responsible for the poor performance of loans as a result of
a bad economy. We don't believe we've breached our obligations as servicer.
We will examine every avenue to vigorously defend ourselves."
The bank's defiant stance came as it reported a
$7.3 billion loss in the third quarter, or 77 cents per share. The loss was
largely the result of a $10.4 billion goodwill charge tied to a decline in
value of its credit card business. Without the charge, which the company
attributes to a regulatory crimp in its debit-card revenue, the bank would
have earned $3.1 billion.
No U.S. bank is more vulnerable to an array of
political and financial threats posed by home-lending woes. Bank of America
has more repurchase requests than any of its rivals and it services one out
of every five U.S. mortgages, many of them picked up from California lender
Countrywide Financial Corp. in 2008.
Worries about sloppy mortgage underwriting and
servicing practices clouded discussion of the bank's results Tuesday.
The bank on Oct. 1 said it would suspend
foreclosures cases in 23 states where court approval is required and on Oct.
8 said it would halt all foreclosures sales in 50 states. Starting Monday,
the bank will begin resubmitting court documents in the first 23 states
after the company said an internal review of 102,000 cases found no
underlying problems. It and other banks initiated reviews following
revelations that "robo signers" had approved hundreds of foreclosure
documents a day without examining them thoroughly.
Mr. Moynihan said it would take a few more weeks
for the bank to complete its assessment of all 50 states, but so far "we
don't see the issues that people were worried about."
Concerns about the underlying foreclosure documents
amount to "technical issues" that are not a "big deal" for the bank,
although he acknowledged it was a "big issue for people who live in the
homes."
Investors submitted $4 billion in new mortgage
repurchase claims during the third quarter, the bank said. Total claims
amounted to $12.8 billion at the end of the third quarter, up from $7.5
billion in the year-ago quarter. The bank has so far set aside $4.4 billion
in reserves for these putback attempts, including $872 billion in the third
quarter.
A majority of the claims are from Freddie Mac and
Fannie Mae. The bank said it sold $1.2 trillion in loans to the
government-controlled housing giants from 2004 to 2008 and has thus far
received $18 billion in repurchase claims on those loans. The bank has
resolved $11.4 billion of the $18 billion, recording a net loss of $2.5
billion on those putbacks, or 22%.
The bank also could face more losses on claims from
other investors, although Chief Financial Officer Chuck Noski said those
figures are harder to predict.
"This is an area where there is a lot of
speculation and commentary but not a lot of specific claims asserted," he
said in an interview. The bank said it had received $3.9 billion in private
repurchase claims through the end of the third quarter.
Mr. Moynihan said he isn't interested in a large
lump sum payment to make the repurchase issue go away. "We're not going to
put this behind us to make us feel good," he said. "We're going to make sure
that we'll pay when due but not just do a settlement to move the matter
behind us."
Sandler O'Neill + Partners analyst Jeff Harte
said in a note that "the actual level of future repurchase remains both a
key determinant and an unknown." Nomura Securities analyst Glenn Schorr said
in a note it is "tough to convince investors on putback risk."
Some analysts also noted several silver linings in
Bank of America's results Tuesday.
Excluding the $10.4 billion charge, which the bank
attributed entirely to an amendment in the Dodd-Frank financial-overhaul law
that limits debit-card income, the bank's third-quarter results exceeded
Wall Street estimates. Its $3.5 billion in fixed-income revenue also beat
rivals Citigroup Inc. and J.P. Morgan Chase & Co. and credit costs showed
improvement. The amount the bank set side for future loan losses was $5.4
billion, compared with $11.7 billion a year ago.
Teaching Case from The Wall Street Journal Accounting Weekly Review on
October 22, 2010
TOPICS: Banking, Loan Loss Allowance, Securitization
SUMMARY: David Reilly, the author of this article, analyzes the loan loss
reserves and potential loan write-offs facing Bank of America(BofA). These
assessments are based on information in the BoA earnings release and
presentation slides prepared for the related conference call with analysts.
The graphic associated with the article shows the large size of the reserve
balance at the end of the third quarter relative to past quarters.
CLASSROOM APPLICATION: The article is useful to discuss both the latest
developments in the mortgage and banking crisis and then to thoroughly
analyze loss reserves and bank warranties made on securitized loan
portfolios.
QUESTIONS: 1. (Introductory) By how much did BoA stock drop on announcement of the
investor push for the big bank to buy back mortgage loans sold off as
mortgage-backed securities? How much has it dropped since last spring?
2. (Introductory) What are the efforts of investors who bought loans or
mortgage-backed securities made by BofA? In your answer, describe your
understand of the process for selling mortgage-backed securities.
3. (Advanced) Access the BofA filing on Form 8-K of the earnings press
release on October 19, 2010, available at http://www.sec.gov/Archives/edgar/data/70858/000119312510231353/0001193125-10-231353-index.htm
It is also available by clicking on the live link to Bank of America in the
online version of the article, then clicking on SEC filings on the left hand
side of the page, then clicking on Form 8-K filed on October 19, 2010.
Review the selected slides used to facilitate the earnings release
conference call with analysts. What points in the discussion in this article
are taken from those slides?
4. (Advanced) Focus on the author's analysis of BoA sales to Fannie Mae and
Freddie Mac from 2004 to 2008. How does the author use that information to
estimate the impact of possible repurchases and subsequent write-offs of MBS
sold to private investors?
5. (Introductory) What does the author conclude in this article?
Reviewed By: Judy Beckman, University of Rhode Island
RELATED ARTICLES:
BofA Resists Buying Back Bad Loans by Dan Fitzpatrick Oct 20, 2010 Page: C1
Brian Moynihan seemed to be channeling Winston
Churchill on Tuesday. Describing how Bank of America will deal with
mortgage-bond holders trying to force it to repurchase loans, he made clear
the bank shall fight, fight and fight in court.
"We have thousands of people willing to stand and
look at every one of these loans," the chief executive declared on the
bank's earnings call.
Judging by the 4.4% drop in BofA's stock, the tough
talk didn't convince investors. After all, mortgage-bond holders, including
the Federal Reserve Bank of New York, are ratcheting up efforts to return
more loans to the bank as "put-backs." And Mr. Moynihan's chances of winning
this war depend on knotty legal issues related to questions over loan
ownership or the terms on which mortgages were sold to investment pools.
News Hub: BofA Braces for Long Foreclosure War 3:10
David Reilly discusses Bank of America's continuing
foreclosure battle. .Even so, Mr. Moynihan's stance should be taken
seriously. Bank of America, like other big banks, has the resources and the
ability to drag the legal fight out for years. That should reassure the
bank's shareholders. Not only could a war of attrition wear out opponents,
who already face significant legal hurdles in attempts to bring actions, but
it means losses connected to repurchased loans may be stretched over many
years and may not ultimately be as severe as some investors fear.
Tuesday, Bank of America tried to address
shareholder angst by laying out its experience with repurchase claims. That
should help investors think through some scenarios for new claims.
From 2004 to 2008, Bank of America said it sold
$1.2 trillion in loans to Fannie Mae and Freddie Mac. It has received
repurchase requests for $18 billion and believes this represents two-thirds
of expected claims. That would put total expected claims at about $27
billion, or 2.25% of the total. Of loans repurchased, Bank of America
sustained losses of 22%.
Bank of America also sold $750 billion in loans to
private investors, which may become subject to new repurchase claims. It
said 40% have already paid off.
Say, for example, that repurchase requests on the
still-outstanding $450 billion in these loans run at 10 times the rate of
those sold to Fannie and Freddie. That would put repurchase requests at
about $100 billion. Assume, then, that half the requests were approved and
losses ran at 30%. The result would be a hit of about $15 billion.
While a blow, it should be manageable, especially
if spread over four or five years. What's more, Bank of America has already
lost about $15 billion in market value since announcing it would temporarily
halt foreclosures.
Granted, Bank of America and peers still face
plenty of unknown legal risks related to loan ownership and securitization.
But, for now, the market looks to have already priced in much of the risk
facing Bank of America.
Spring brings April showers, May flowers — and a
flurry of annual reports. Mine have been arriving in the mail, and I am
always interested to see what the companies I own stock in have to say about
themselves in this ritualistic document filled with financial information,
different types of narratives,
and lots of pretty pictures.
The amount of detail and the level of complexity in
the financial section have grown considerably in response to the increasing
onslaught of accounting rules and regulations. What's more, since going
green is now red hot, a growing number of companies — especially in Europe
and Japan — are also starting to issue Corporate Social Responsibility (CSR)
or Sustainability reports. Sometimes these are mailed with the annual
report, but more often they have to be ordered separately or downloaded from
the company's Web site. Unfortunately, the two reports rarely add up to
something greater than the sum of their parts.
This is a huge problem. A sustainable
society requires that all companies be committed to sustainable strategies.
Increasing social expectations regarding a company's commitment to
sustainability mean that firms that ignore this do so at their own risk. BMW
Group has been a leader in recognizing this. Several years ago, it issued a
Sustainable Value Report
detailing energy
consumed, water consumed, waste removed, and volatile organic compounds per
vehicle produced. Scoring high in all these categories, BMW believes that
its reputation as the world's "greenest" car company plays an important role
in brand awareness and customer satisfaction, factors that contribute to
revenue growth.
So how can shareholders and other stakeholders know
if a company's commitment to a sustainable society is contributing to a
sustainable strategy that will create value for shareholders over the long
term? The answer lies in combining the annual and CSR/sustainability reports
into something I call "One Report," which provides the essential information
on a company's financial, environmental, social, and governance performance
and shows the relationships between them. This kind of Integrated reporting
also involves leveraging the Internet to provide more detailed information
to all a company's stakeholders while also providing them with the
opportunity to engage in a virtual dialogue on these matters.
Some major corporations are starting to take the
lead in this effort, including United Technologies Corporation, Philips (the
Dutch electronics and health care giant), the German chemical company BASF,
and Danish pharmaceutical maker Novo Nordisk. At United Technologies, whose products include Carrier air conditioners,
Otis elevators, and Pratt & Whitney aircraft engines, a recent integrated
report focused on such nonfinancial metrics as lower fuel consumption and
noise emissions in a new jet engine and a reduced carbon footprint and water
consumption in the firm's factories. The juxtaposition of information on
both operations and CSR symbolizes the company's commitment to more than
just the bottom line and its belief that both sets of data have a
significant impact on the long-term success and reputation of the company.
In UT's view, CSR is both a reality and necessity, not an addendum.
Novo Nordisk presents stockholders and other
stakeholders with
a multidimensional Web site
that enables visitors
to create a customized version of their annual report, access in-depth
information about sustainability practices, contact company officers, and
even play interactive games showing the challenges and trade-offs the
company faces in making difficult decisions.
Thanks to these kinds of One Report practices,
these companies actually document their commitment to sustainability, make
better decisions based on a broader collection of data, engage more deeply
and effectively with all their stakeholders, and lower reputational risk
through a high level of transparency.
Given the importance of sustainability, I think
companies have an
ethical obligation
to practice integrated
reporting, and
investors have a similar obligation
to demand it. In fact, I believe the SEC should make it a requirement. As we
all try to come up with solutions to the problems of the planet,
integrated reporting is one way to make sure that
companies are part of the process.
Jensen Comment One place to look for sustainability information is in any section of an annual
report that deals with contingencies con --- http://faculty.trinity.edu/rjensen/theory01.htm#TheoryDisputes But this contingency accounting throughout history has probably been the weakest
area of annual reporting.
Accounting for intangibles in general is a huge weakness in annual reporting.
Remember how top executives at MCI let it into bankruptcy, executives that KPMG
agreed had intangible foresight worth millions.
Accounting for intangibles in general is a huge weakness in annual reporting.
Remember how top executives at MCI let it into bankruptcy, executives that KPMG
agreed had intangible foresight worth millions.
KPMG’s “Unusual Twist” While KPMG's strategy isn't uncommon among corporations with lots of units in
different states, the accounting firm offered an unusual twist: Under KPMG's
direction, WorldCom treated "foresight of top management" as an intangible asset
akin to patents or trademarks. See http://faculty.trinity.edu/rjensen/FraudEnron.htm#WorldcomFraud
Punch Line This "foresight of top management" led to a 25-year prison sentence for
Worldcom's CEO, five years for the CFO (which in his case was much to lenient)
and one year plus a day for the controller (who ended up having to be in prison
for only ten months.) Yes all that reported goodwill in the balance sheet of
Worldcom was an unusual twist.
Tom Selling wrote privately to
me for more information on the quotation in red below.
Hi Again Tom,
I found the original reference
KPMG’s “Unusual Twist” While KPMG's strategy isn't uncommon among corporations with lots of units in
different states, the accounting firm offered an unusual twist: Under KPMG's
direction, WorldCom treated "foresight of top management" as an intangible asset
akin to patents or trademarks.
The potential claims against KPMG represent the most
pressing issue for MCI. The report didn't have an exact tally of state taxes
that may have been avoided, but some estimates range from $100 million to $350
million. Fourteen states likely will file a claim against the company if they
don't reach settlement, said a person familiar with the matter.
The
examiner in MCI's Chapter 11 bankruptcy case issued a report critical of a
"highly aggressive" tax strategy KPMG LLP recommended to MCI to avoid paying
hundreds of millions of dollars in state income taxes, concluding that MCI has
grounds to sue KPMG -- its current auditor.
MCI
quickly said the company would not sue KPMG. But officials from the 14 states
already exploring how to collect back taxes from MCI could use the report to
fuel their claims against the telecom company or the accounting firm. KPMG
already is under fire by the U.S. Internal Revenue Service for pushing
questionable tax shelters to wealthy individuals.
In a
statement, KPMG said the tax strategy used by MCI is commonly used by other
companies and called the examiner's conclusions "simply wrong." MCI, the former
WorldCom, still uses the strategy.
The
542-page document is the final report by Richard Thornburgh, who was appointed
by the U.S. Bankruptcy Court to investigate legal claims against former
employees and advisers involved in the largest accounting fraud in U.S. history.
It reserves special ire for securities firm Salomon Smith Barney, which the
report says doled out more than 950,000 shares from 22 initial and secondary
public offerings to ex-Chief Executive Bernard Ebbers for a profit of $12.8
million. The shares, the report said, "were intended to and did influence Mr.
Ebbers to award" more than $100 million in investment-banking fees to Salomon, a
unit of Citigroup Inc. that is now known as Citigroup Global Markets Inc.
In the
1996 initial public offering of McLeodUSA Inc., Mr. Ebbers received 200,000
shares, the third-largest allocation of any investor and behind only two large
mutual-fund companies. Despite claims by Citigroup in congressional hearings
that Mr. Ebbers was one of its "best customers," the report said he had scant
personal dealings with the firm before the IPO shares were awarded.
Mr.
Thornburgh said MCI has grounds to sue both Citigroup and Mr. Ebbers for damages
for breach of fiduciary duty and good faith. The company's former directors bear
some responsibility for granting Mr. Ebbers more than $400 million in personal
loans, the report said, singling out the former two-person compensation
committee. Mr. Thornburgh added that claims are possible against MCI's former
auditor, Arthur Andersen LLP, and Scott Sullivan, MCI's former chief financial
officer and the alleged mastermind of the accounting fraud. His criminal trial
was postponed Monday to April 7 from Feb. 4.
Reid
Weingarten, an attorney for Mr. Ebbers, said, "There is nothing new to these
allegations. And it's a lot easier to make allegations in a report than it is to
prove them in court." Patrick Dorton, a spokesman for Andersen, said, "The focus
should be on MCI management, who defrauded investors and the auditors at every
turn." Citigroup spokeswoman Leah Johnson said, "The services that Citigroup
provided to WorldCom and its executives were executed in good faith." She added
that Citigroup now separates research from investment banking and doesn't
allocate IPO shares to executives of public companies, saying Citigroup
continues to believe its congressional testimony describing Mr. Ebbers as a
"best customer." An attorney for Mr. Sullivan couldn't be reached for comment.
The
potential claims against KPMG represent the most pressing issue for MCI. The
report didn't have an exact tally of state taxes that may have been avoided, but
some estimates range from $100 million to $350 million. Fourteen states likely
will file a claim against the company if they don't reach settlement, said a
person familiar with the matter.
While
KPMG's strategy isn't uncommon among corporations with lots of units in
different states, the accounting firm offered an unusual twist: Under KPMG's
direction, WorldCom treated "foresight of top management" as an intangible asset
akin to patents or trademarks. Just as patents might be licensed, WorldCom
licensed its management's insights to its units, which then paid royalties to
the parent, deducting such payments as normal business expenses on state
income-tax returns. This lowered state taxes substantially, as the royalties
totaled more than $20 billion between 1998 to 2001. The report says that neither
KPMG nor WorldCom could adequately explain to the bankruptcy examiner why
"management foresight" should be treated as an intangible asset.
SUMMARY: AT&T
changed its defined benefit pension plan to a cash balance plan in 1998. A
long-running case by 24,000 current and former employees seeks one of the
largest potential claims in pension litigation based on these plaintiffs'
argument that AT&T discriminated against older workers upon implementing
this change. The focus of the accounting question at hand now is not pension
accounting but disclosure of the contingent liability, or lack thereof, by
AT&T. "Last May, the Securities and Exchange Commission asked AT&T why it
hadn't disclosed its potential exposure in the pension case." Legal papers
filed Monday in federal court in Newark, N.J., include the first publicly
disclosed estimate for potential damages.
CLASSROOM APPLICATION: Accounting
and disclosure requirements for contingent liabilities, in this case a
lawsuit related to pension plan benefits, can be covered with this article.
QUESTIONS: 1. (Introductory)
What is a defined benefit pension plan? What is a cash balance plan?
2. (Introductory)
According to the article, what improper action does the lawsuit claim that
AT&T committed against current and former employees when it changed to a
cash balance pension plan?
3. (Advanced)
Even if AT&T loses this case, the company "...would face no cash impact for
the $2.3 billion pension portion of the claim" according to the article.
Does this mean that there would be no financial statement impact from this
lawsuit? Explain.
4. (Introductory)
How did AT&T respond when the SEC "...asked why it hadn't disclosed its
potential exposure in the pension case"?
5. (Advanced)
What are the requirements in accounting for and disclosure of contingent
liabilities from lawsuits? What do you think must be the basis for AT&T's
response to the SEC? In your answer, comment on the fact that Monday's legal
filing included "the first publicly disclosed estimate for potential
damages."
6. (Advanced)
Access AT&T's annual report for 2009 filed with the SEC on 2/25/2010. The
interactive form of the filing is available at
http://www.sec.gov/cgi-bin/viewer?action=view&cik=732717&accession_number=0000732717-10-000013
Alternatively, click on the live link to AT&T in the online article, click
on SEC Filings on the left hand side of the page, scroll to the filing on
2/25/2010 (at least one page back) and click on the interactive data link.
Review the disclosures under Note 11 and Note 15. Does your review confirm
your answer to the question above? Explain.
Reviewed By: Judy Beckman, University of Rhode Island
AT&T Inc. is seeking to dismiss a long-running
pension case alleging age discrimination that seeks $2.3 billion in damages,
according to documents filed this week in a federal court.
The suit alleges a 1998 pension change effectively
froze the pensions of 40,000 older management employees at AT&T, in some
cases for years, but not those of younger employees. AT&T said the pension
didn't discriminate against older workers.
"We believe the conversion to our cash balance plan
was appropriate and in accordance with all legal obligations," said AT&T
spokesman Mark Siegel. "We believe our filing speaks for itself in
explaining why we have no additional liabilities to these retirees."
The suit, filed in 1998, has received little
attention despite the number of plaintiffs—24,000 current and former
employees—and the size of the potential damages, one of the largest ever in
pension litigation. Legal papers filed Monday in federal court in Newark,
N.J., include the first publicly disclosed estimate for potential damages.
The $2.3 billion potential claim dwarfs the
well-publicized $1 billion noncash charge the company will take to reflect
the recent loss of its deductions for health-care subsidies it receives from
the government.
Last May, the Securities and Exchange Commission
asked AT&T why it hadn't disclosed its potential exposure in the pension
case. AT&T responded that it didn't think the case met the reporting
threshold for disclosure, SEC filings show.
Pension cases typically are decided by judges, and
there are no punitive damages. But because this case includes an
age-discrimination claim, under federal law the judge could send it to a
jury trial. If a jury found that the company willfully discriminated against
older workers, it could award punitive damages that would double the size of
the claim to $4.6 billion.
However, if the case went to trial and the company
lost, it would face no cash impact for the $2.3 billion pension portion of
the claim. That is because the additional benefits to current and former
management employees would be paid from the pension plan, which remains
well-funded. In its motion for dismissal, AT&T is asking the judge to throw
out the case without a jury trial.
AT&T was one of dozens of big companies including
International Business Machines Corp. and Xerox Corp. that changed their
traditional pensions to "cash-balance" plans in the 1990s. The change saved
companies money because instead of calculating benefits by multiplying years
of service and salary—which produces rapid pension growth in later years—the
companies converted the pension to a cash-out value. This "balance" would
then grow at a flat annual rate, say 4% of pay.
Among the plaintiffs in the case is Gerald Smit. In
1997, Mr. Smit was 47 and his pension was valued at $1,985 a month when he
reached age 55, according to papers filed in the case. He continued to work
at AT&T for eight more years, and when he retired in 2004, his pension was
still worth $1,985 a month, according to court documents.
Minutes of a 1997 meeting of AT&T's pension
consultants, included in court documents, noted that "employees in 40s could
lose, [and] have to wait 10 years for benefits." Company spreadsheets, which
were among the exhibits submitted by plaintiffs, found that many would wait
three to eight years to begin building a benefit. By contrast, the benefit
would build "immediately for younger employees," according to the meeting
minutes.
AT&T doesn't dispute there were long waiting
periods for benefits to build. But it said in court filings that the older
workers' pensions were affected because the former pension plan included a
formula that boosted benefit growth as employees approached age 55. AT&T
calls this subsidy a "disparity," according to papers filed in the case,
which "benefits older workers."
Many companies established opening "account
balances" for older employees that were lower than the cash-out amounts they
had earned. For example, a worker might have earned a pension that, if
converted to a lump sum, would be worth $150,000. But its opening account
balance would be set at $100,000. The balance would be effectively frozen
until the worker received enough annual credits over the years to restore it
to $150,000. Only then would the pension begin to increase again
The 2006 Pension Protection Act banned companies
from freezing the benefits of older employees when it changes the formula, a
practice called "wearaway." Not all cash-balance plans have wearaway; the
plan covering AT&T union workers is among those that do not.
Documents filed by the plaintiffs' experts estimate
that the average loss to people over age 45 was $65,000. SEC filings show
that under the 2004 severance plan for senior officers, the officers
retained the right to "participate and recover damages or other relief in
the case." The company spokesman declined to comment.
From The Wall Street Journal Accounting Weekly Review on July 10, 2009
SUMMARY: As
Mr. Biggs, a resident scholar at the American Enterprise Institute, puts it,
"public employee pension plans are plagued by overgenerous benefits, chronic
underfunding, and now trillion dollar stock-market losses. Based on their
preferred accounting methods...these plans are underfunded nationally by
around $310 billion. [But] the numbers are worse using market valuation
methods...which discount benefit liabilities at lower interest rates...."
CLASSROOM APPLICATION: Introducing
the importance of interest rate assumptions, and the accounting itself, for
pension plans can be accomplished with this article.
QUESTIONS: 1. (Introductory)
Summarize the accounting for pension plans, including the process for
determining pension liabilities, the funded status of a pension plan,
pension expense, the use of a discount rate, the use of an expected rate of
return. You may base your answer on the process used by corporations rather
than governmental entities.
2. (Advanced)
Based on the discussion in the article, what is the difference between
accounting for pension plans by U.S. corporations following FASB
requirements and governmental entities following GASB guidance?
3. (Introductory)
What did the administrators of the Montana Public Employees' Retirement
Board and the Montana Teachers' Retirement System include in their
advertisements to hire new actuaries?
4. (Advanced)
What is the concern with using the "expected return" on plan assets as the
rate to discount future benefits rather than using a low, risk free rate of
return for this calculation? In your answer, comment on the author's
statement that "future benefits are considered to be riskless" and the
impact that assessment should have on the choice of a discount rate.
5. (Advanced)
What is the response by public pension officers regarding differences
between their plans and those of corporate entities? How do they argue this
leads to differences in required accounting? Do you agree or disagree with
this position? Support your assessment.
Reviewed By: Judy Beckman, University of Rhode Island
Here's a dilemma: You manage a public employee
pension plan and your actuary tells you it is significantly underfunded. You
don't want to raise contributions. Cutting benefits is out of the question.
To be honest, you'd really rather not even admit there's a problem, lest
taxpayers get upset.
What to do? For the administrators of two Montana
pension plans, the answer is obvious: Get a new actuary. Or at least that's
the essence of the managers' recent solicitations for actuarial services,
which warn that actuaries who favor reporting the full market value of
pension liabilities probably shouldn't bother applying.
Public employee pension plans are plagued by
overgenerous benefits, chronic underfunding, and now trillion dollar
stock-market losses. Based on their preferred accounting methods -- which
discount future liabilities based on high but uncertain returns projected
for investments -- these plans are underfunded nationally by around $310
billion.
The numbers are worse using market valuation
methods (the methods private-sector plans must use), which discount benefit
liabilities at lower interest rates to reflect the chance that the expected
returns won't be realized. Using that method, University of Chicago
economists Robert Novy-Marx and Joshua Rauh calculate that, even prior to
the market collapse, public pensions were actually short by nearly $2
trillion. That's nearly $87,000 per plan participant. With employee benefits
guaranteed by law and sometimes even by state constitutions, it's likely
these gargantuan shortfalls will have to be borne by unsuspecting taxpayers.
Some public pension administrators have a strategy,
though: Keep taxpayers unsuspecting. The Montana Public Employees'
Retirement Board and the Montana Teachers' Retirement System declare in a
recent solicitation for actuarial services that "If the Primary Actuary or
the Actuarial Firm supports [market valuation] for public pension plans,
their proposal may be disqualified from further consideration."
Scott Miller, legal counsel of the Montana Public
Employees Board, was more straightforward: "The point is we aren't
interested in bringing in an actuary to pressure the board to adopt market
value of liabilities theory."
While corporate pension funds are required by law
to use low, risk-adjusted discount rates to calculate the market value of
their liabilities, public employee pensions are not. However, financial
economists are united in believing that market-based techniques for valuing
private sector investments should also be applied to public pensions.
Because the power of compound interest is so
strong, discounting future benefit costs using a pension plan's high
expected return rather than a low riskless return can significantly reduce
the plan's measured funding shortfall. But it does so only by ignoring risk.
The expected return implies only the "expectation" -- meaning, at least a
50% chance, not a guarantee -- that the plan's assets will be sufficient to
meet its liabilities. But when future benefits are considered to be riskless
by plan participants and have been ruled to be so by state courts, a 51%
chance that the returns will actually be there when they are needed hardly
constitutes full funding.
Public pension administrators argue that government
plans fundamentally differ from private sector pensions, since the
government cannot go out of business. Even so, the only true advantage
public pensions have over private plans is the ability to raise taxes. But
as the Congressional Budget Office has pointed out in 2004, "The government
does not have a capacity to bear risk on its own" -- rather, government
merely redistributes risk between taxpayers and beneficiaries, present and
future.
Market valuation makes the costs of these potential
tax increases explicit, while the public pension administrators' approach,
which obscures the possibility that the investment returns won't achieve
their goals, leaves taxpayers in the dark.
For these reasons, the Public Interest Committee of
the American Academy of Actuaries recently stated, "it is in the public
interest for retirement plans to disclose consistent measures of the
economic value of plan assets and liabilities in order to provide the
benefits promised by plan sponsors."
Nevertheless, the National Association of State
Retirement Administrators, an umbrella group representing government
employee pension funds, effectively wants other public plans to take the
same low road that the two Montana plans want to take. It argues against
reporting the market valuation of pension shortfalls. But the association's
objections seem less against market valuation itself than against the fact
that higher reported underfunding "could encourage public sector plan
sponsors to abandon their traditional pension plans in lieu of defined
contribution plans."
The Government Accounting Standards Board, which
sets guidelines for public pension reporting, does not currently call for
reporting the market value of public pension liabilities. The board
announced last year a review of its position regarding market valuation but
says the review may not be completed until 2013.
This is too long for state taxpayers to wait to
find out how many trillions they owe.
SUMMARY: As
Mr. Biggs, a resident scholar at the American Enterprise Institute, puts it,
"public employee pension plans are plagued by overgenerous benefits, chronic
underfunding, and now trillion dollar stock-market losses. Based on their
preferred accounting methods...these plans are underfunded nationally by
around $310 billion. [But] the numbers are worse using market valuation
methods...which discount benefit liabilities at lower interest rates...."
CLASSROOM APPLICATION: Introducing
the importance of interest rate assumptions, and the accounting itself, for
pension plans can be accomplished with this article.
QUESTIONS: 1. (Introductory)
Summarize the accounting for pension plans, including the process for
determining pension liabilities, the funded status of a pension plan,
pension expense, the use of a discount rate, the use of an expected rate of
return. You may base your answer on the process used by corporations rather
than governmental entities.
2. (Advanced)
Based on the discussion in the article, what is the difference between
accounting for pension plans by U.S. corporations following FASB
requirements and governmental entities following GASB guidance?
3. (Introductory)
What did the administrators of the Montana Public Employees' Retirement
Board and the Montana Teachers' Retirement System include in their
advertisements to hire new actuaries?
4. (Advanced)
What is the concern with using the "expected return" on plan assets as the
rate to discount future benefits rather than using a low, risk free rate of
return for this calculation? In your answer, comment on the author's
statement that "future benefits are considered to be riskless" and the
impact that assessment should have on the choice of a discount rate.
5. (Advanced)
What is the response by public pension officers regarding differences
between their plans and those of corporate entities? How do they argue this
leads to differences in required accounting? Do you agree or disagree with
this position? Support your assessment.
Reviewed By: Judy Beckman, University of Rhode Island
Here's a dilemma: You manage a public employee
pension plan and your actuary tells you it is significantly underfunded. You
don't want to raise contributions. Cutting benefits is out of the question.
To be honest, you'd really rather not even admit there's a problem, lest
taxpayers get upset.
What to do? For the administrators of two Montana
pension plans, the answer is obvious: Get a new actuary. Or at least that's
the essence of the managers' recent solicitations for actuarial services,
which warn that actuaries who favor reporting the full market value of
pension liabilities probably shouldn't bother applying.
Public employee pension plans are plagued by
overgenerous benefits, chronic underfunding, and now trillion dollar
stock-market losses. Based on their preferred accounting methods -- which
discount future liabilities based on high but uncertain returns projected
for investments -- these plans are underfunded nationally by around $310
billion.
The numbers are worse using market valuation
methods (the methods private-sector plans must use), which discount benefit
liabilities at lower interest rates to reflect the chance that the expected
returns won't be realized. Using that method, University of Chicago
economists Robert Novy-Marx and Joshua Rauh calculate that, even prior to
the market collapse, public pensions were actually short by nearly $2
trillion. That's nearly $87,000 per plan participant. With employee benefits
guaranteed by law and sometimes even by state constitutions, it's likely
these gargantuan shortfalls will have to be borne by unsuspecting taxpayers.
Some public pension administrators have a strategy,
though: Keep taxpayers unsuspecting. The Montana Public Employees'
Retirement Board and the Montana Teachers' Retirement System declare in a
recent solicitation for actuarial services that "If the Primary Actuary or
the Actuarial Firm supports [market valuation] for public pension plans,
their proposal may be disqualified from further consideration."
Scott Miller, legal counsel of the Montana Public
Employees Board, was more straightforward: "The point is we aren't
interested in bringing in an actuary to pressure the board to adopt market
value of liabilities theory."
While corporate pension funds are required by law
to use low, risk-adjusted discount rates to calculate the market value of
their liabilities, public employee pensions are not. However, financial
economists are united in believing that market-based techniques for valuing
private sector investments should also be applied to public pensions.
Because the power of compound interest is so
strong, discounting future benefit costs using a pension plan's high
expected return rather than a low riskless return can significantly reduce
the plan's measured funding shortfall. But it does so only by ignoring risk.
The expected return implies only the "expectation" -- meaning, at least a
50% chance, not a guarantee -- that the plan's assets will be sufficient to
meet its liabilities. But when future benefits are considered to be riskless
by plan participants and have been ruled to be so by state courts, a 51%
chance that the returns will actually be there when they are needed hardly
constitutes full funding.
Public pension administrators argue that government
plans fundamentally differ from private sector pensions, since the
government cannot go out of business. Even so, the only true advantage
public pensions have over private plans is the ability to raise taxes. But
as the Congressional Budget Office has pointed out in 2004, "The government
does not have a capacity to bear risk on its own" -- rather, government
merely redistributes risk between taxpayers and beneficiaries, present and
future.
Market valuation makes the costs of these potential
tax increases explicit, while the public pension administrators' approach,
which obscures the possibility that the investment returns won't achieve
their goals, leaves taxpayers in the dark.
For these reasons, the Public Interest Committee of
the American Academy of Actuaries recently stated, "it is in the public
interest for retirement plans to disclose consistent measures of the
economic value of plan assets and liabilities in order to provide the
benefits promised by plan sponsors."
Nevertheless, the National Association of State
Retirement Administrators, an umbrella group representing government
employee pension funds, effectively wants other public plans to take the
same low road that the two Montana plans want to take. It argues against
reporting the market valuation of pension shortfalls. But the association's
objections seem less against market valuation itself than against the fact
that higher reported underfunding "could encourage public sector plan
sponsors to abandon their traditional pension plans in lieu of defined
contribution plans."
The Government Accounting Standards Board, which
sets guidelines for public pension reporting, does not currently call for
reporting the market value of public pension liabilities. The board
announced last year a review of its position regarding market valuation but
says the review may not be completed until 2013.
This is too long for state taxpayers to wait to
find out how many trillions they owe.
Question Accountants talk a lot about "intangibles" and accountant inability to usefully
measure intangibles of companies. Economists also talk about intangibles and
economist inability build successful models incorporating intangibles and
externalities that give rise to troublesome omitted variables and
non-convexities in mathematical optimization.
What is the World Bank's definition that gives rise to a claim that "the
average American has access to over $418,000 in intangible wealth, while the
stay-at-home Mexican's intangible wealth is just $34,000?"
"The Secrets of Intangible Wealth: For once the World Bank says
something smart about the real causes of prosperity," by Ronald Bailey, Reason Magazine, October 5, 2007 ---
http://www.reason.com/news/show/122854.html
A Mexican migrant to the U.S. is five times more
productive than one who stays home. Why is that?
The answer is not the obvious one: This country has more machinery or tools
or natural resources. Instead, according to some remarkable but largely
ignored research—by the World Bank, of all places—it is because the average
American has access to over $418,000 in intangible wealth, while the
stay-at-home Mexican's intangible wealth is just $34,000.
But what is intangible wealth, and how on earth is it measured? And what
does it mean for the world's people—poor and rich? That's where the story
gets even more interesting.
Two years ago the World Bank's environmental economics department set out to
assess the relative contributions of various kinds of capital to economic
development. Its study, "Where is the Wealth of Nations?: Measuring Capital
for the 21st Century," began by defining natural capital as the sum of
nonrenewable resources (including oil, natural gas, coal and mineral
resources), cropland, pasture land, forested areas and protected areas.
Produced, or built, capital is what many of us think of when we think of
capital: the sum of machinery, equipment, and structures (including
infrastructure) and urban land.
But once the value of all these are added up, the economists found something
big was still missing: the vast majority of world's wealth! If one simply
adds up the current value of a country's natural resources and produced, or
built, capital, there's no way that can account for that country's level of
income.
The rest is the result of "intangible" factors—such as the trust among
people in a society, an efficient judicial system, clear property rights and
effective government. All this intangible capital also boosts the
productivity of labor and results in higher total wealth. In fact,
the World Bank finds, "Human capital and the value of institutions (as
measured by rule of law) constitute the largest share of wealth in virtually
all countries."
Once one takes into account all of the world's natural resources and
produced capital, 80% of the wealth of rich countries and 60% of the wealth
of poor countries is of this intangible type. The bottom line: "Rich
countries are largely rich because of the skills of their populations and
the quality of the institutions supporting economic activity."
What the World Bank economists have brilliantly done is quantify the
intangible value of education and social institutions. According to their
regression analyses, for example, the rule of law explains 57 percent of
countries' intangible capital. Education accounts for 36 percent.
The rule-of-law index was devised using several hundred individual variables
measuring perceptions of governance, drawn from 25 separate data sources
constructed by 18 different organizations. The latter include civil society
groups (Freedom House), political and business risk-rating agencies
(Economist Intelligence Unit) and think tanks (International Budget Project
Open Budget Index).
Switzerland scores 99.5 out of 100 on the rule-of-law index and the U.S.
hits 91.8. By contrast, Nigeria's score is a pitiful 5.8; Burundi's 4.3; and
Ethiopia's 16.4. The members of the Organization for Economic Cooperation
and Development—30 wealthy developed countries—have an average score of 90,
while sub-Saharan Africa's is a dismal 28.
The natural wealth in rich countries like the U.S. is a tiny proportion of
their overall wealth—typically 1 percent to 3 percent—yet they derive more
value from what they have. Cropland, pastures and forests are more valuable
in rich countries because they can be combined with other capital like
machinery and strong property rights to produce more value. Machinery,
buildings, roads and so forth account for 17% of the rich countries' total
wealth.
Overall, the average per capita wealth in the rich Organization for Economic
Cooperation Development (OECD) countries is $440,000, consisting of $10,000
in natural capital, $76,000 in produced capital, and a whopping $354,000 in
intangible capital. (Switzerland has the highest per capita wealth, at
$648,000. The U.S. is fourth at $513,000.)
By comparison, the World Bank study finds that total wealth for the low
income countries averages $7,216 per person. That consists of $2,075 in
natural capital, $1,150 in produced capital and $3,991 in intangible
capital. The countries with the lowest per capita wealth are Ethiopia
($1,965), Nigeria ($2,748), and Burundi ($2,859).
In fact, some countries are so badly run, that they actually have negative
intangible capital. Through rampant corruption and failing school systems,
Nigeria and the Democratic Republic of the Congo are destroying their
intangible capital and ensuring that their people will be poorer in the
future.
In the U.S., according to the World Bank study, natural capital is $15,000
per person, produced capital is $80,000 and intangible capital is $418,000.
And thus, considering common measure used to compare countries, its annual
purchasing power parity GDP per capita is $43,800. By contrast, oil-rich
Mexico's total natural capital per person is $8,500 ($6,000 due to oil),
produced capital is $19,000 and intangible capita is $34,500—a total of
$62,000 per person. Yet its GDP per capita is $10,700. When a Mexican, or
for that matter, a South Asian or African, walks across our border, they
gain immediate access to intangible capital worth $418,000 per person. Who
wouldn't walk across the border in such circumstances?
The World Bank study bolsters the deep insights of the late development
economist Peter Bauer. In his brilliant 1972 book Dissent on
Development, Bauer wrote: "If all conditions for development other than
capital are present, capital will soon be generated locally or will be
available . . . from abroad. . . . If, however, the conditions for
development are not present, then aid . . . will be necessarily unproductive
and therefore ineffective. Thus, if the mainsprings of development are
present, material progress will occur even without foreign aid. If they are
absent, it will not occur even with aid."
The World Bank's pathbreaking "Where is the Wealth of Nations?" convincingly
demonstrates that the "mainsprings of development" are the rule of law and a
good school system. The big question that its researchers don't answer is:
How can the people of the developing world rid themselves of the kleptocrats
who loot their countries and keep them poor?
Trivia Question The fact that open source and free Office Software is getting closer and closer
to quality of MS Office (Word, Excel, PowerPoint, etc.) software is still not
really threatening Microsoft's worldwide monopoly for its relatively expensive
MS Office software. What is the main intangible that gives MS Office products
such value in world markets?
Jensen's Opinion I think the main intangible here is the cost of retraining over 90% of the
computer users of the world. Related to this is the difficulty students and
"white-collar workers" will encounter if they do not know how to use MS Office
software when seeking employment. Whereas most of drivers can drive rental cars
of most any manufacturer, computer users who cannot "drive" Excel, Word,
PowerPoint, etc. face tremendous barriers that give rise to the main intangible
asset of Microsoft Corporation. Organizations spent billions in training that
gave rise to billions in intangible assets of Microsoft.
From The Wall Street Journal Accounting Weekly Review on August 22, 2008
SUMMARY: The
FASB has proposed a change to disclosures associated with
contingent liabilities, including litigation liabilities,
with a document entitled "Disclosure of Certain Loss
Contingencies-an amendment of FASB Statements No. 5 and 141"
and a comment period that ended August 8, 2008. This
proposed Statement would replace and enhance the disclosure
requirements in FASB Statement No. 5, Accounting for
Contingencies, for all outstanding contingencies, both those
recognized on the balance sheet and those contingencies that
would be recognized as liabilities if the criteria for
recognition in paragraph 8 of Statement 5 were met; it as
well applies to contingent liabilities from business
combinations. The proposal would "...(a) expand the
population of loss contingencies that are required to be
disclosed, (b) require disclosure of specific quantitative
and qualitative information about those loss contingencies,
(c) require a tabular reconciliation of recognized loss
contingencies to enhance financial statement transparency,
and (d) provide an exemption from disclosing certain
required information if disclosing that information would be
prejudicial to an entity's position in a dispute." In the
proposal, the FASB states that the project was taken on
because "investors and other users of financial information
have expressed concerns that disclosures about loss
contingencies under the existing guidance ... do not provide
adequate information to assist users of financial statements
in assessing the likelihood, timing, and amount of future
cash flows associated with loss contingencies." Clearly, the
WSJ Opinion page editors disagree with this assessment (see
the related article) and FASB Chairman Bob Herz responds to
their Op-Ed piece.
CLASSROOM
APPLICATION: The article is useful for teaching both the
requirements for reporting loss contingencies and the FASB's
due process for new financial reporting standards, including
addressing international convergence efforts.
QUESTIONS: 1. (Introductory) Describe the FASB's extensive due
process procedures. What document did the FASB issue? At
what stage of discussion is this proposed financial
reporting change?
2. (Advanced) The WSJ Opinion page editors clearly
dislike the proposed accounting and reporting requirements
for loss contingencies. They cite the fact that "...FASB has
been getting an earful. Senior litigators from 13
companies...have signed a letter to FASB Chairman Robert
Herz, objecting to the plan." Do you find it surprising that
a preponderance of those who write comment letters to the
FASB argue against any particular proposal? Support your
answer.
3. (Introductory) What are the current accounting
and disclosure requirements for loss contingencies? How will
the FASB's proposal change those requirements? Put your
answer into your own words. You may access the FASB document
on its web site at http://www.fasb.org/draft/ed_contingencies.pdf
4. (Advanced) In the related article, the WSJ
Opinion page editors pose the question, "...Why mess with
the current system?...Lawyers, accountants and corporations
are all reasonably comfortable with the way things are." Do
you agree with that assessment? Support your answer.
5. (Advanced) In his response, FASB Chairman Herz
states that "the [FASB] is not proposing that companies
change their current accounting for the cost of ongoing
litigation...[and that] the proposal would not require any
estimates of fair value..." To what statements is Mr. Herz
responding? How might the WSJ Editors have determined that
the notion of "fair value" for a lawsuit is part of the new
requirements?
Reviewed By: Judy Beckman, University of Rhode Island
I write in response to your editorial, "FASB's
Lawyer Bonanza" (Review & Outlook, Aug. 7). The Financial Accounting
Standards Board is not proposing that companies change their current
accounting for the cost of ongoing litigation. Rather, our proposal would
require additional disclosure in the footnotes to the financial statements.
It is a proposal, not a "demand," and is subject to our normal extensive
public due process.
Under the proposal, the amount that would be
required to be disclosed is the claim amount, or, if there is no claim
amount, the company's best estimate of its maximum exposure to loss. The
Board attempted to insure the proposal would not require a company to
"[show] its hand to plaintiffs' attorneys" as the editorial says. For
example, the proposal allows companies to aggregate claim amounts, so that
the plaintiffs attorneys would not be able to identify specific cases. We
have also proposed an exemption for certain disclosure situations that would
be clearly prejudicial to the company.
Moreover, the proposed disclosures would not
require any estimates of fair value -- nor does the proposal involve any new
fair value requirements. The words "fair value" are not even contained in
the proposed statement.
It is because of the strong and extensive input
we've received from investors who want greater transparency relating to a
wide range of contingencies -- including litigation -- that we are proposing
these expanded disclosures. The new disclosures are aimed at providing
information earlier to existing and potential investors in order to give
them a greater understanding of the risks companies are facing. We believe
that information would improve their ability to make informed investment
decisions.
Robert H. Herz Chairman Financial Accounting Standards Board
Norwalk, Conn.
Hiding
Government Debt is About the Worst Thing That Ever Happened in Accounting
History
Forget Andrew Cuomo and Carl Paladino. Let us turn instead to a race that
might truly matter in terms of the nation's economic future. It's the most
important 2010 election you've never heard of—for comptroller of New York
State.
"Comptroller" is the second or third most boring word in the English
language. Comptroller: That's the green-eyeshade guy
who keeps the books. He's always adding up columns and somehow it all
balances. But as everyone now knows, in the public sector the books don't
balance. They balloon.
New York, like California and many other once-important states, is sitting
on a public- pension debt bomb. If it blows, it will take great swaths of
the productive American economy with it for years. Harry Wilson thinks he
can defuse the New York bomb.
At
this point the article turns political about unions so I will not quote it
other than to say that NYC Mayor Bloomberg and many of our best bipartisan
leaders think that if the pension bomb is not defused it will explode with
immense repercussions --- far worse than anything al Qaeda can deliver.
Continued in article
"San Francisco's Public Pension Revolt: The city has cut back on almost
every service: Summer schools have been shut, potholes deepen, parks close
early, and services for the poor have been pared to the quick," by Michael
Moritz, The Wall Street Journal, October 22, 2010 --- http://online.wsj.com/article/SB10001424052702304510704575562350166984886.html
The Phoenix and the Guardian, two
antique fireboats moored near the San Francisco Bay Bridge, are operated by
a six-person crew from the city's fire department. A few times a week, the
vessels putter about to provide a visiting cruise ship with a watery salute.
For this, all of the vessels' captains and engineers are paid $172,253 a
year in salary and benefits and are eligible for a city-paid pension after
20 years. Regardless of whether they take a new job, the pension entitles
them to 90% of their annual income, plus annual cost of living adjustments,
for the rest of their lives.
And so it's little wonder that 77,000 San
Franciscans signed a petition to place a measure on the Nov. 2 ballot that
would do what generations of politicians haven't: bring a modicum of sanity
to the pension and benefit programs of San Francisco government employees.
If passed, Proposition B would require all city employees to contribute up
to 10% of their income to their pension plans, and to pay half of the
health-care premiums of their dependents. This will save San Francisco at
least $120 million a year, at a time when its pension tab is $400 million
per year, up from $175 million in 2005.
Every incumbent official in the city opposes
Proposition B except its sponsor, the progressive public defender Jeff
Adachi, who is as far removed from being a tea party member as Wasilla is
from Washington. The Democratic Party has condemned the initiative.
Democratic Mayor Gavin Newsom says that if workers' benefits are trimmed it
will be impossible to find replacements and that, rather than voting through
Proposition B, we should "work together" to bring about change.
But San Franciscans know that unemployment rates
top 20% in parts of California, that 50 years of just "working together" is
what's landed us in this pickle, and that the city's current pension and
benefit programs are unfair to all private-sector workers. On average,
private-sector workers earn half as much as city employees. And as their
savings disappear, they have no option but to continue working until their
teeth fall out.
A typical San Francisco resident with one dependent
pays $953 a month for health care, while the typical city employee pays less
than $10. In 2009, San Francisco's deputy police chief earned $516,000 in
cash compensation and retired with a $230,000-a-year pension—a package that
could cost the city $8 million over the balance of his life. Yet the only
major local political figure who champions Proposition B is Willie Brown, a
former mayor, who admits that decades of backroom deals have led to fiasco.
San Francisco's pension crisis is a miniature
version of what now faces almost every mature economy. The debts accumulated
during the economic crisis of the last few years are tiny compared to the
debts that cities and states have accumulated since the beginning of the New
Deal. Almost a century ago, when life expectancies were much shorter,
pensions and benefits for government workers were a way to cushion the
indignities of a working person's last few years of life. Now they allow
people to retire at age 50 on close to full pay, with annual cost-of-living
increases and complete health-care coverage—plus the choice either to take a
new job or to enjoy a lifetime of Sundays.
As the city's debt has started to bite, San
Francisco has cut back on almost every service: Summer schools have been
shut, potholes deepen, parks close early, and services that help the poor
and vulnerable have been pared to the quick. This month the Board of
Supervisors decided to plant another 1,300 parking meters in another effort
to get the city's 800,000 citizens to pay the benefits and pensions of the
city's 28,665 employees and 26,000 retirees. Only 2% of San Francisco voters
are city employees.
If Proposition B is approved, it will be the
beginning, not the end, of public-sector benefits reform. Proposition B
doesn't raise the retirement age. It doesn't change the way pensions are
calculated (based on employees' income in their final year or two of work,
which is subject to all sorts of perfidious gaming known as "spiking"). The
proposition doesn't increase the length of time a city employee needs to
work before becoming eligible for a pension. It doesn't cap the annual
cost-of-living adjustments taped onto pension plans. And it doesn't forbid a
retired city pensioner from being rehired.
But Proposition B does provide a ray of hope. If
pension reform—which, along with education and health care, is one of the
three crumbling pillars of Western economies—can start in famously liberal
San Francisco, then it can happen anywhere.
More Reasons Why Tom and I Hate Principles-Based Accounting Standards
"Contingent Liabilities: A Troubling Signpost on the Winding Road to a Single
Global Accounting Standard," by Tom Selling, The Accounting Onion, May 26, 2008
---
Click Here
By the logic of others, which I can’t explain,
fuzzy lines in accounting standards have come to be exalted as
“principles-based” and bright lines are disparaged as “rules-based.” One of
my favorite examples (actually a pet peeve) of this phenomenon is the
difference in the accounting for leases between IFRS and U.S. GAAP. The
objective of the financial reporting game is to capture as much of the
economic benefits of an asset as possible, while keeping the contractual
liability for future lease payments off the balance sheet; a win is scored
an “operating lease,” and a loss is scored a “capital lease.” As in tennis,
If the present value of the minimum lease payments turns out to be even a
hair over the 90% line of the leased asset’s fair value, your shot is out
and you lose the point.
The counterpart to FAS 13 in IFRS is IAS 17, a
putative principles-based standard. It’s more a less a carbon copy of FAS 13
in its major provisions, except that bright lines are replaced with fuzzy
lines: if the present value of the minimum lease payments is a “substantial
portion” (whatever that means) of the leased asset’s fair value, you lose
operating lease accounting. If FAS 13 is tennis, then IAS 17 is
tennis-without-lines. Either way, the accounting game has another twist: the
players call the balls landing on their side of the net; and the only job of
the umpire—chosen and compensated by each player—is to opine on the
reasonableness of their player's call. So, one would confidently expect that
the players of tennis-without- lines have a much lower risk of being
overruled by their auditors… whoops, I meant umpires.
Although lease accounting is one example for which
GAAP is bright-lined and IFRS is the fuzzy one, the opposite is sometimes
the case, with accounting for contingencies under FAS 5 or IAS 37 being a
prime exaple. FAS 5 requires recognition of a contingent liability when it
is “probable” that a future event will result in the occurrence of a
liability. What does “probable” mean? According to FAS 5, it means “likely
to occur.” Wow, that sure clears things up. With a recognition threshold as
solid as Jell-o nailed to a tree and boilerplate footnote disclosures to
keep up appearances, there should be little problem persuading one’s
handpicked independent auditor of the “reasonableness” of any in or out
call.
IAS 37 has a similar recognition threshold for a
contingent liability (Note: I am adopting U.S. terminology throughout, even
though "contingent liabilities" are referred to as "provisions" in IAS 37).
But in refreshing contrast to FAS 5, IAS 37 unambiguously nails down the
definition of “probable” to be “more likely than not” —i.e., just a hair
north of 50%. Naively assuming that companies actually comply with the
letter and spirit of IAS 37, then more liabilities should find their way
onto the balance sheet under IFRS than GAAP. And, IAS 37 also has more
principled rules for measuring a liability, once recognized. But, I won’t
get into that here. Just please take my word for it that IAS 37 is to FAS 5
as steak is to chopped liver.
The Global Accounting Race to the Bottom
And so we have the IASB’s ineffable ongoing
six-year project to make a hairball out of IAS 37. If these two standards,
IAS 37 and FAS 5, are to be brought closer together as the ballyhooed
Memorandum of Understanding between IASB and FASB should portend, it would
make much more sense for the FASB to revise FAS 5 to make it more like IAS
37. After all, convergence isn’t supposed to take forever; even if you don’t
think IAS 37 is perfect, there are a lot more serious problems IASB could be
working harder on: leases, pensions, revenue recognition, securitizations,
related party transactions, just to name a few off the top of my head. But,
the stakeholders in IFRS are evidently telling the IASB that they get their
jollies from tennis without lines. And, the IASB, dependent on the big boys
for funding, is listening real close.
Basically, the IASB has concluded that all present
obligations – not just those that are more likely than not to result in an
outflow of assets – should be recognized. It sounds admirably principled and
ambitious, but there’s a catch. In place of the bright-line probability
threshold in IAS 37, there would be the fuzziest line criteria one could
possibly devise: the liability must be capable of “reliable” measurement. We
know that "probable" without further guidance must at least lie between 0
and 1, but what amount of measurement error is within range of “reliable”?
The answer, it seems, would be left to the whim of the issuer followed by
the inevitable wave-your-hands-in-the-air rubber stamp of the auditor.
It’s not as if the IASB doesn’t have history from
which to learn. Where the IASB is trying to go in revising IAS 37, we’ve
already been in the U.S. The result was all too often not a pretty sight as
unrecognized liabilities suddenly slammed into balance sheets like freight
trains. As I discussed in an earlier post, retiree health care liabilities
were kept off balance sheets until they were about to break unionized
industrial companies. Post-retirement benefits were doled out by earlier
generations of management, long departed with their generous termination
benefits, in order to persuade obstreperous unions to return to the assembly
lines. GM and Ford are now on the verge of settling faustian bargains of
their forbearers with huge cash outlays: yet for decades the amount
recognized on the balance sheet was precisely nil. The accounting for these
liabilities had been conveniently ignored, with only boilerplate disclosures
in their stead, out of supposed concern for reliable measurement. Yet,
everyone knew that zero as the answer was as far from correct as Detroit is
from Tokyo – where, as in most developed countries, health care costs of
retirees are the responsibility of government.
Holding the recognition of a liability hostage to
“reliable” measurement is bad accounting. There is just no other way I can
put it. If this is the way the IASB is going to spend its time as we are
supposed to be moving to a single global standard, then let the race to the
bottom begin.
The German
Parliament has passed the Act to Modernise
Accounting Law (in German: Bilanzrechtsmodernisierungsgesetz). A goal of
the legislation is to reduce the financial reporting
burden on German companies. The accounting
requirements under the Act are described as an
alternative to International Financial Reporting
Standards for small and medium-sized companies that
do not participate in capital markets. In announcing
the new law, the German Federal Ministry of Justice
(which administers the Commercial Code (ComC) in
Germany) said:
The
modernised ComC accounting law is also an
answer to the International Financial
Reporting Standards (IFRS), published by the
International Accounting Standards Board (IASB).
The IFRS are geared to suit capital market
oriented enterprises; in other words, they
also serve information needs of financial
analysts, professional investors and other
participants in the capital markets.
By far the majority of those German
enterprises that are required by law to keep
accounts and records do not take part in the
capital market at all. For this reason,
there is no justification for committing all
the enterprises that are required to keep
accounts and records to the cost-intensive
and highly complex IFRS. Also the draft
recently discussed by the IASB of a standard
IFRS for Small and Medium-Sized Entities
is not a good alternative for drawing up an
informative annual financial statement.
Practitioners in Germany have strongly
criticised the IASB draft because its
application – compared with ComC accounting
law – would still be much too complicated
and costly.
The law exempts 'sole
merchants' (prorietorships) with less than €500,000
turnover and Euro 50,000 profit from any obligation
to keep accounts and records. Small companies (less
than 50 employees, assets of €4.8 million, and
annual turnover of €4.8 million) need not have an
audit and may publish only a balance sheet.
Medium-sized companies (less than 250 employees,
assets of €19.2 million, and annual turnover of
€38.5 million) have reduced disclosure requirements
and may combine balance sheet items. Among the new
accounting provisions of the ComC:
Companies
will be permitted to capitalise internally
generated intangible assets, while getting an
immediate tax deduction for the costs.
Financial
institutions will measure financial instruments
designated as 'held for trading' at fair value,
with value changes recognised in a 'special
reserve'. The Ministry of Justice press release
states: 'This special reserve has to be built up
from part of the enterprise's trading profits
when times are good and can then be used to
offset trading losses when times get worse.
Hence this special provision has an anticyclical
effect. Here the necessary steps have been taken
in order to respond to the financial markets
crisis.'
Special
purpose entities that are controlled must be
consolidated.
The new law takes
effect 1 January 2010, with early application for
2009 permitted. Click for
Fantasyland Accounting and the hors de overs risk measurements
"CUOMO REACHES LANDMARK AGREEMENT WITH MAJOR ENERGY COMPANY, XCEL ENERGY, TO
REQUIRE DISCLOSURE OF FINANCIAL RISKS OF CLIMATE CHANGE TO INVESTORS," Press
Release from Andrew M. Cuomo (New York Attorney General), August 27, 2008 ---
http://www.oag.state.ny.us/press/2008/aug/aug27a_08.html
Attorney General Andrew M. Cuomo today announced
the first-ever binding and enforceable agreement requiring a major national
energy company to disclose the financial risks that climate change poses to
its investors. Cuomo’s agreement with Xcel Energy (NYSE: XEL) (“Xcel”) comes
as many power companies, including Xcel, are investing in new coal-burning
power generation that will significantly contribute to global warming
emissions.
“This landmark agreement sets a new industry-wide
precedent that will force companies to disclose the true financial risks
that climate change poses to their investors,” said Attorney General Andrew
Cuomo. “Coal-fired power plants can significantly contribute to global
warming and investors have the right to know all the associated risks. I
commend Xcel Energy for working with my office to establish a standard that
will improve our environment and our marketplace over the long-term.”
The agreement includes binding and enforceable
provisions that require Xcel to provide detailed disclosure of climate
change and associated risks in its “Form 10-K” filings, the annual summary
report on a company’s performance required by the Securities and Exchange
Commission (“SEC”) to inform investors. These required disclosures include
an analysis of financial risks from climate change related to:
present and probable future climate change
regulation and legislation;
climate-change related litigation; and
physical impacts of climate change.
Additionally, the agreement commits Xcel to a broad
array of climate change disclosures, including:
current carbon emissions; •
projected increases in carbon emissions from
planned coal-fired power plants;
company strategies for reducing, offsetting,
limiting, or otherwise managing its global warming pollution emissions
and expected global warming emissions reductions from these actions; and
corporate governance actions related to
climate change, including whether environmental performance is
incorporated into officer compensation.
Substantial financial risks for energy companies
that emit large quantities of carbon dioxide are being created by a number
of new or likely regulatory efforts, such as New York’s newly adopted
regional carbon regulations for power plants, and other future regulatory
efforts, including federal regulation, Congressional action, and
climate-change related litigation. These risks are especially exacerbated
for power companies that are building new coal-burning power plants or other
large new sources of global warming pollution emissions. Knowledge of these
risks is important for investors to make informed financial decisions.
Xcel Energy provides electricity and natural gas to
commercial and residential customers in eight Midwestern and Western States.
Its annual revenues are more than $9 billion. In 2006, Xcel was among the
top ten largest emitters of global warming pollution by utilities in the
United States. Xcel is building a new 750 megawatt, coal-fired power plant
in Pueblo, Colorado.
In September 2007, Attorney General Cuomo
subpoenaed the executives of Xcel and four other major energy companies for
information on whether disclosures to investors in filings with the SEC
adequately described the companies’ financial risks related to their
emissions of global warming pollution. The Attorney General issued subpoenas
under New York State’s Martin Act, a 1921 state securities law that grants
the Attorney General broad powers to access the financial records of
businesses. In addition to Xcel Energy, the companies that received
subpoenas were AES Corporation, Dominion Resources, Dynegy, and Peabody
Energy. The Attorney General’s investigation of the remaining companies is
ongoing.
Cuomo continued, “I will continue to fight for
increased transparency and full disclosure of global warming financial risks
to investors. Selectively revealing favorable facts or intentionally
concealing unfavorable information about climate change is misleading and
must be stopped.”
The Attorney General petitioned the SEC last year
to require better corporate disclosure of climate-related risks in
securities filings. The petition was coordinated by Ceres, a national
coalition of investors and environmental groups. It is supported by more
than $6 trillion of investors, including the treasurers and comptrollers
from New York, California, Florida, Maryland, Rhode Island and five
additional states, and the nation’s largest public pension funds, CalPERS
and CalSTRS. The petition remains pending with the SEC.
Ceres President Mindy S. Lubber said, “This
groundbreaking settlement will send ripples far beyond Xcel Energy. It
serves notice that all companies face financial exposure from climate change
and will be expected to better inform investors of their strategies for
dealing with it.”
Director of the Natural Resources Defense Council’s
State Climate Change Program Dale Bryk said, “As New York and other
Northeastern states move forward with the nation’s first cap and trade
program for global warming, investors need full disclosure of the financial
risks faced by power companies and others with large carbon footprints.
Attorney General Cuomo’s work to create an enforceable model for climate
change disclosure is a game-changer on this important issue.”
Environmental Defense Fund Deputy General Counsel
Vickie Patton said, “Investors from Wall Street to Main Street have a right
to know whether publicly traded companies are responsibly addressing the
financial risks due to global warming. Federal regulators should take a hard
look at the Attorney General’s settlement and standardize companies’
disclosure of climate-related financial risks to ensure a fair marketplace
for all investors.”
This case is being handled by Assistant Attorneys
General Morgan Costello, Michael Myers, and Daniel Sangeap, under the
supervision of Special Deputy Attorney General Katherine Kennedy, Executive
Deputy Attorney General for Social Justice Mylan Denerstein and Executive
Deputy Attorney General for Economic Justice Eric Corngold.
Jensen Comment How do you predict such things as “present
and probable future climate change regulation and legislation” and counter
legislation in Washington DC and the capitol buildings of all 50 states to say
nothing of the United Nations? For one thing, powerful lobbies can swing a vote
with great hors de overs at a political convention
Accounting for Intangibles is
Arguably the Most Difficult Part of Accountancy Theory and Application It's doubly difficult since the uncertain amounts involved may be tenfold larger
than the tangibles to be accounting for under accounting standards. Errors in identification and measurement alone may be larger than aggregated
measures of tangibles. The white paper below does not address intangible and contingent liabilities.
The white paper below does not address intangible and contingent liabilities,
although one company’s l intangible liability may be another company's
intangible asset such that scoping out intangible liabilities may not be
possible.
(Chapter 2) Identification The manner by which an intangible item comes into existence is not relevant
to the determination of whether the item can be identified as an asset.
Therefore, intangible items of the same nature, irrespective of whether they
are acquired in a business combination or internally generated (planned or
unplanned), could be analysed in the same way for the purpose of determining
whether they are assets. In particular, the principles and guidance for
identifying the existence of and describing an intangible asset acquired in
a business combination specified in IFRS 3 Business Combinations (and IAS 38
Intangible Assets) could be adopted for assessing whether internally
generated intangible assets exist. Accordingly, a technique based on a
hypothetical business combination is a possible technique for identifying
internally generated intangible assets. (paragraph 66)
(Chapter 3) Recognition If a cost-based model were adopted
Internally generated intangible assets that satisfy the definition of an
intangible asset in IAS 38/IFRS 3 should be subject to the Framework’s
recognition criteria. Accordingly, only planned internally generated
intangible assets should be contemplated for recognition, on the basis that
the plan identifies the unit of account and it is only those types of
internally generated intangible assets that could satisfy the reliable
measurement (of cost) recognition criterion. They do not warrant more
specific recognition criteria, although guidance on the meaning of a
‘discrete plan that is being or has been implemented to create an internally
generated intangible asset’ would be helpful. (paragraph 87)
If a valuation-based model were adopted Internally generated intangible assets that satisfy the definition of an
intangible asset in IAS 38/IFRS 3 should be subject to the same recognition
requirements for intangible assets acquired in a business combination, using
a technique based on a hypothetical business combination. Accordingly, all
internally generated intangible assets that would be recognised if acquired
in a business combination under IFRS 3 should be recognised. While less
onerous identification techniques or recognition criteria could be adopted,
they have significant conceptual shortcomings. (paragraph 113)
(Chapter 4) Measurement If a cost-based model were adopted
It is reasonable to presume that historical cost can be reliably measured
for planned internally generated intangible assets from the commencement of
implementing the plan up until completion or abandonment of the plan, based
on the principles in IASB standards for allocating costs to other types of
assets. Therefore, the attributable costs of planned internally generated
intangible assets should be required to be recognised (capitalised) as an
asset. A transitional period may be warranted to allow entities time to
develop adequate accounting systems. Cost is not a suitable basis for
measuring unplanned internally generated intangible assets because there is
no basis for reliably attributing costs. (paragraph 134)
If a valuation-based model were adopted Internally generated intangible assets are capable of being reliably
measured at fair value to the same degree that the IFRS 3 presumption (that
the fair value of the same types of intangible assets acquired in a business
combination is capable of reliable measurement) is valid. Subject to the
outcome of the IASB/FASB Fair Value Measurement project, SFAS 157 Fair Value
Measurements provides a possible basis for specifying the determination of
fair value of internally generated intangible assets. Until then, IFRS 3
provides an adequate basis. (paragraph 171)
From a technical conceptual perspective, internally
generated intangible assets should be required to be initially measured at
fair value to enhance the decision-usefulness of financial reports. An
option to adopt cost as an alternative to fair value should not be allowed.
On balance, we also think that this view can be justified on practical
grounds. However, we acknowledge the views of some against our conclusion.
Accordingly, before our conclusion is considered for implementation, we
think that further investigation of the perceived practical impediments is
warranted. (paragraph 190)
(Chapter 5) Presentation/Disclosure The current reporting requirements in IAS 1 Presentation of Financial
Statements can be applied to internally generated intangible assets, and are
sufficient to facilitate the: (a) separate presentation of internally
generated intangible assets that are recognised; and (b) disclosure of
information in relation to the accounting policies adopted and judgements
made by management in relation to internally generated intangible assets
equivalent to the information that is required to be disclosed about other
types of assets. (paragraph 203)
If a cost-based model were adopted The amount of costs incurred in a reporting period and recognised in the
carrying amounts of internally generated intangible assets presented in the
financial statements should be disclosed together with the accounting
policies adopted. In response to users’ comments, management’s rationale for
capitalisation should also be disclosed. (paragraph 214)
If a valuation-based model were adopted The methods and significant assumptions applied in determining an asset’s
fair value, including the extent to which the asset’s fair value was
determined directly by reference to observable prices or was estimated using
other measurement techniques, should be disclosed. In addition, if changing
one or more of the assumptions used to determine the fair value to
reasonably possible alternative assumptions would change the fair value
significantly, the entity should state this fact and disclose the effect of
those changes. (paragraph 225) In response to users’ comments, the costs
reliably attributable to an internally generated intangible asset should
also be disclosed, either on an aggregate or a project-by-project basis.
(paragraph 232) If an internally generated intangible asset does not meet
the relevant recognition criteria, in the interests of providing useful
information to users, entities should be required to disclose a description
of the asset and the reason why the asset fails to meet the relevant
recognition criteria. (paragraph 240) Consistent with the recognition and
disclosure principles in the Framework and IASB standards, disclosure is not
an adequate substitute for recognition and internally generated intangible
items that meet the relevant asset definition and recognition criteria
should be recognised in the financial statements. While a disclosure-only
approach may have some merit as a pragmatic interim step towards the
adoption of a recognition-based accounting approach for internally generated
intangible assets, in the interests of maximising the information content of
financial statements on a timely basis, a recognition-based approach is
preferred. (paragraph 258)
A New Type of Intangible Investment (sort of not yet legal in the U.S.)
--- Litigation How should it be booked and carried in financial statements? I say "sort of" since this intangible asset might be buried (as Purchased
Goodwill") in acquisition prices when firms are purchased purchased or merged.
The notion of litigation as a separate asset class
is a novel one. It's hard to imagine fund managers one day allotting a bit of
their portfolio to third-party lawsuits, alongside shares, bonds, property and
hedge funds. But some wealthy investors are starting to dabble in lawsuit
investment, bankrolling some or all of the heavy upfront costs in return for a
share of the damages in the event of a win. The London-managed hedge fund MKM
Longboat last month revealed plans to invest $100million (£50.5million) to
finance European lawsuits. Today a new company, Juridica, floats on AIM, having
raised £80million to make litigation bets. "The law is now an asset class,"
The London Times, December 21, 2007 ---
http://business.timesonline.co.uk/tol/business/columnists/article3080766.ece
Jensen Comment Under U.S. GAAP, intangible assets are generally booked only when purchased and
are not conducive to fair value accounting afterwards. Probably the most serious
problem in both accounting theory and practice is unbooked value (and in many
cases undisclosed) of intangible assets and liabilities. Do the values of human
capital and knowledge capital ring a bell? Does the cost retraining the world's
workforce to use Office software other than Microsoft Office (Word, Excel,
PowerPoint, etc.) ring a bell?
Contingent liabilities (particularly pending lawsuits) are problematic until
the amount of the liability is both reasonably measurable and highly probable.
Until now, contingent litigation assets were not investment assets. Contingent
liabilities were booked as current or past expenses. Now purchased litigation
assets having future value? Horrors!
In the past when a company purchased another company, some of the "goodwill"
value above and beyond the traceable value to net tangible assets could easily
have been the value of future litigation such as when Blackboard acquired WebCT
and WebCT's patents on online education software. Patents and Copyrights may
have value with respect to fending off future competition.
But patents and copyrights may also have value in future litigation regarding
past infringements. Now hedge funds might invest in bringing litigation to
fruition.
Intangible assets and liabilities are, and will forever remain, the largest
problem in accounting theory and practice! In some cases, such as Microsoft
Corporation, booked assets are so miniscule relative to unbooked intangible
assets that the balance sheets are virtually a bad joke.
An enormous problem, besides the fact that current value of intangibles
cannot be counted, current value can change by enormous magnitudes overnight as
new discoveries are made and new legislation is passed, to say nothing of court
decisions. Tangible asset values can also change, but in general they are not as
volatile.
SFAS 141R (available on the FASB web site)
substantially changes the accounting for both contingent assets and
liabilities in connection with business combinations. In fact, 141R coupled
with SFAS 160 on noncontrolling interests makes major changes to both the
accounting for business combinations and the accounting for consolidation
procedures. While the new rules can't be applied until 2009, anyone teaching
advanced accounting or where ever else these topics are covered should throw
out their old lesson plans and be prepared to enter into an entirely new
world of accounting - not for the better in my humble opinion.
By the way, another interesting thing to read on
the FASB web site is the proposal to reduce the size of the FASB and make
some other changes to improve the standard-setting process. We celebrated
our family Christmas a few days ago because of travel plans and I'm working
on my comment letter to the Financial Accounting Foundation today.
What I found interesting about 141R is the
discussion in the appendices that showed both the FASB and IASB views and
how the Boards reached convergence.
141R also added a couple paragraphs to FIN 48 that
result in goodwill no longer being adjusted if the contingent tax liability
is increased or decreased. Instead the DR is to tax expense, which makes a
lot more sense to me. If I read the statement correctly, the purchased
assets and liabilities are stated at fair value under a recognition, then
measurement principle. Taxes are exempt from those two principles; instead
FAS 109/FIN 48 apply. What I couldn't tell is if the purchaser still has up
to one year (the maximum measurement period) to get the tax contingent
liability right before the DR goes to tax expense. Can anyone help me?
In an earlier
post,
I described how SFAS 141R resulted in
some incremental improvements to the
accounting for business combinations.
However, warts remain, and the purposes
of this post is describe the ugliest and
most painful of them all: the accounting
for so-called 'goodwill.'
Here's a simple example to contemplate:
Company P determines that Company S
has a value of $1,100, and
negotiates an acquisition for 100%
of its outstanding shares for
$1,000.
S has the following assets:
Plant and equipment with a fair
value of $200.
An assembled workforce with a
fair value of $100.
S has no liabilities eligible for
accounting recognition.
Company S will be run independently
from Company P; thus, any synergies
created by the acquisition are
negligible.
The root of the problem is literally
that debits (the assets acquired) do not
equal credits (the purchase price).
Business combination accounting is a
collision of fantasy and reality: the
fantasy is that accounting can fully
reflect the economic impact of past
events on an enterprise, and the reality
is that it cannot be so. A balance sheet
produced by even the most principled of
accounting systems imaginable cannot
possibly comprehend the entire set of
economic assets and liabilities. One
example on the asset side would be that
S has been put together in such a way as
to rapidly and inexpensively expand or
contract capacity as market conditions
change. In other words, S holds 'real
options', and the shareholders of S
would want P to pay for them. On the
liability side, not all obligations are
legal, amounts are highly uncertain, and
the probability of payment may be low.
The FASB's solution to the debit and
credit problem is to plug the shortfall
in debits and to weave a fantasy around
it. The plug is euphoniously dubbed
'goodwill' -- to be classified on the
balance sheet as an asset and tested for
impairment at least once each year. In
the above example, the amount reported
as goodwill would be $800 (=$1,000 -
$200).
Whipped Cream on the Balance
Sheet
As described above, the amount reported
as goodwill is, at its best, a
conglomeration of assets offset by
liabilities. Nowhere else in accounting
would there be permitted such a
hodgepodge, and by no other means other
than a narrowly defined 'business
combination' may it -- whatever it
is -- be recognized. But even granting
that offsetting assets with unrelated
liabilities may be permissible, of what
use to investors is the assignment of a
number to something that, by definition,
is beyond description? (Ironically,
even though the value of S's assembled
workforce may be measurable and
significant, separate recognition of
this asset is streng verboten
and kept a dark secret from investors.)
As I have reported in my earlier post,
Walter Schuetze (former SEC Chief
Accountant and FASB member) derisively
characterizes reported goodwill as "the
lump left over." Actually, I think he
was being generous. FAS 141R contains
some significant exceptions to fair
valuation of assets acquired and
liabilities assumed. Thus, the unknown
difference between recorded amounts and
their fair values are shoveled into the
goodwill muddle. As if that weren't
enough, the math of the goodwill
calculation blithely compares apples
with oranges: prices paid with values
received. "Lump", "goodwill" or
whatever name you can think of implies
that the number is associated with
actual attributes, but what we are
dealing with here is nothing more than
just a number--an arbitrary number.
So, dear readers, I hope you are not
disillusioned to realize that 'goodwill'
is invariably anything but. If it must
be recognized at all, let's drop the
obvious pretension and call it what it
is: in this example, "excess of purchase
price over recognized amounts of
identified assets acquired and
liabilities assumed." However, dropping
the pretension is not as easy as it
seems. If a muddle is to be reported as
an asset, it must be subject to an
impairment test; and without a dressy
name that belies the muddle that is
'goodwill', there can be no pretense for
the charade of an impairment test that
is FAS 142.
The Goodwill Impairment Mess
Recognition of goodwill may seem but a
curious anomaly until you get to the
impairment test specified in FAS 142.
It's a real money pit: goodwill has to
be assigned to "reporting units" (a new
concept rife with opportunities for
manipulation); the fair value of each
reporting unit has to be assessed at
least once a year (another opportunity
for manipulation); and the real mayhem
begins if, heaven forbid, you are
required to estimate the "implied fair
value of goodwill" (another new concept
rife with opportunities for
manipulation). The only good that comes
out of goodwill impairment testing are
the jobs created for valuation
consultants, accountants and attorneys.
A Proposed Solution
In olden days, the British permitted a
charge to contributed capital for the
amount that would otherwise have been
recognized as goodwill. While
imperfect, it may well be the only
reasonable solution to the problem; for
as I have shown above, there can be no
perfect solution. If you
can't describe what something is, than
what possible good can come from
purporting to measure it?
By the way, even though business
combinations rules have been somewhat
converged by the issuance of FAS 141R
and a revised IFRS 3, goodwill
impairment remains one of the most
significant differences between IFRS and
U.S. GAAP. The two approaches are
fundamentally at odds, but it should be
said that IFRS's impairment rules are
much less worse. But that's not the
most important point I want to make.
Whatever the merits of the two
approaches, by eliminating goodwill and
the inevitably screwball impairment
tests, standard setters would not only
be improving financial reporting, they
could also say that they have resolved
one of the thorniest convergence
issues.
A New Type of Intangible Investment (sort of not yet legal in the U.S.)
--- Litigation How should it be booked and carried in financial statements? I say "sort of" since this intangible asset might be buried (as Purchased
Goodwill") in acquisition prices when firms are purchased purchased or merged.
The notion of litigation as a separate asset class
is a novel one. It's hard to imagine fund managers one day allotting a bit of
their portfolio to third-party lawsuits, alongside shares, bonds, property and
hedge funds. But some wealthy investors are starting to dabble in lawsuit
investment, bankrolling some or all of the heavy upfront costs in return for a
share of the damages in the event of a win. The London-managed hedge fund MKM
Longboat last month revealed plans to invest $100million (£50.5million) to
finance European lawsuits. Today a new company, Juridica, floats on AIM, having
raised £80million to make litigation bets. "The law is now an asset class,"
The London Times, December 21, 2007 ---
http://business.timesonline.co.uk/tol/business/columnists/article3080766.ece
Jensen Comment Under U.S. GAAP, intangible assets are generally booked only when purchased and
are not conducive to fair value accounting afterwards. Probably the most serious
problem in both accounting theory and practice is unbooked value (and in many
cases undisclosed) of intangible assets and liabilities. Do the values of human
capital and knowledge capital ring a bell? Does the cost retraining the world's
workforce to use Office software other than Microsoft Office (Word, Excel,
PowerPoint, etc.) ring a bell?
Contingent liabilities (particularly pending lawsuits) are problematic until
the amount of the liability is both reasonably measurable and highly probable.
Until now, contingent litigation assets were not investment assets. Contingent
liabilities were booked as current or past expenses. Now purchased litigation
assets having future value? Horrors!
In the past when a company purchased another company, some of the "goodwill"
value above and beyond the traceable value to net tangible assets could easily
have been the value of future litigation such as when Blackboard acquired WebCT
and WebCT's patents on online education software. Patents and Copyrights may
have value with respect to fending off future competition.
But patents and copyrights may also have value in future litigation regarding
past infringements. Now hedge funds might invest in bringing litigation to
fruition.
Intangible assets and liabilities are, and will forever remain, the largest
problem in accounting theory and practice! In some cases, such as Microsoft
Corporation, booked assets are so miniscule relative to unbooked intangible
assets that the balance sheets are virtually a bad joke.
An enormous problem, besides the fact that current value of intangibles
cannot be counted, current value can change by enormous magnitudes overnight as
new discoveries are made and new legislation is passed, to say nothing of court
decisions. Tangible asset values can also change, but in general they are not as
volatile.
SFAS 141R (available on the FASB web site)
substantially changes the accounting for both contingent assets and
liabilities in connection with business combinations. In fact, 141R coupled
with SFAS 160 on noncontrolling interests makes major changes to both the
accounting for business combinations and the accounting for consolidation
procedures. While the new rules can't be applied until 2009, anyone teaching
advanced accounting or where ever else these topics are covered should throw
out their old lesson plans and be prepared to enter into an entirely new
world of accounting - not for the better in my humble opinion.
By the way, another interesting thing to read on
the FASB web site is the proposal to reduce the size of the FASB and make
some other changes to improve the standard-setting process. We celebrated
our family Christmas a few days ago because of travel plans and I'm working
on my comment letter to the Financial Accounting Foundation today.
What I found interesting about 141R is the
discussion in the appendices that showed both the FASB and IASB views and
how the Boards reached convergence.
141R also added a couple paragraphs to FIN 48 that
result in goodwill no longer being adjusted if the contingent tax liability
is increased or decreased. Instead the DR is to tax expense, which makes a
lot more sense to me. If I read the statement correctly, the purchased
assets and liabilities are stated at fair value under a recognition, then
measurement principle. Taxes are exempt from those two principles; instead
FAS 109/FIN 48 apply. What I couldn't tell is if the purchaser still has up
to one year (the maximum measurement period) to get the tax contingent
liability right before the DR goes to tax expense. Can anyone help me?
February 21, 2008 reply from David Fordham, James Madison University
[fordhadr@JMU.EDU]
I'm not up on SFAS 141R, but I have to wonder why
we accountants even bother dibbling around with non-quantifiable amounts
like "utility" and "expectations" and other "value judgments"? We don't
bother with other similar concepts, such as training, collegiality,
preferences, love, aspirations, etc. which also affect the "value of
assets".
I have a rock that I consider very valuable, and a
few other experts who have analyzed it have declared it very valuable (at
least one thinks its more valuable than I do) and the values vary all over
the map, and yet there are others who believe it is worthless, merely an
interesting-looking rock. While I'm willing to part with it for a princely
sum, and several have offered me near that amount, others think we are
foolish. I would be amused to see what happens if I were to list it on my
net worth statement next time I apply for a loan. How valuable is the name
"Exxon"? How valuable is custom software? How valuable is a gold doubloon
retrieved from the Notre-Dame-de-Deliverance, or a lock of wool from Dolly
the sheep?
Instead of "how much", it seems like the question
we *should* be asking is, "Why?"
Aren't these individualized answers? Why do any of
us pretend there is a single right answer, then?
As an aside, a couple of years ago, my wife was
called for jury duty, on a case involving goodwill. A stonemason had decided
to retire and sold his business to his young apprentice. At the time of
sale, the mason had a state-wide reputation, so the transaction involved
considerable goodwill beyond the tools and other tangible assets. Within a
year, the apprentice had gotten lazy, had botched several high-profile jobs,
had alienated customers, and otherwise ruined the company. Several customers
approached the retired mason and asked him to do personal jobs for them,
which he did since there was no non-compete clause in the contract. When the
apprentice tried to sell out to another mason, he wasn't offered but a
fraction of what he'd originally paid. The apprentice sued the mason,
claiming his actions had "impaired the goodwill of the company". The
interesting thing was, the jury was given no definition (none, nada, zip,
zilch) or guidance of what "goodwill" was supposed ! ! to be, only that it
was an asset that could be impaired. There was no explanation of where it
came from, what created it, why it existed, how it could be destroyed, etc.
The jury begged the judge for more guidance, and he claimed he could only
read the lawbooks to them, and the lawbooks contained no definition or other
information which said what goodwill was or how it could be changed. The
jury at first agreed that they could not reach a verdict without more
information, but the judge demanded that they reach one, without any further
guidance. After three days of working "in the dark" with nothing to go on
but opposing lawyers' recognizably-ridiculous claims, they reached a verdict
agreeing that the goodwill had been impaired and the apprentice had been
harmed by the retiree's taking the new jobs. After the trial, when my wife
learned a little bit about it, she was angered that the jury wasn't told so
they could have made a better decision.
The public is under the impression that if
everything goes right, the accounting reports always show the "correct"
number. Why do we continue to deceive them so?
Dilbert recently ran a series of cartoons in which
the pointy-haired boss opines about raising some cash by selling the
Goodwill. When an ex-engineer/cartoonist can so easily see the silliness of
what we try to foist off as "professional expertise", perhaps the public
isn't so deceived as we have deceived ourselves. Makes one nostalgic for the
old days when we argued about "costs" and "market values (entry or exit)".
One might be able to make a case that sufficient evidence is available to
ascertain what something cost or what it could fetch in some broad market.
But fair value?
In the article we are assured that S has an asset
"assembled workforce" worth $100. Just exactly how would one obtain that
$100 cash? On what market do we buy and sell "assembled workforces?" Even if
that were possible (which it isn't, at least not in the US) how long does a
workforce stay assembled? Our NHL franchise is celebrating its 10th
anniversary as the team (assembled workforce) labeled Carolina Hurricanes.
Only one person (Glen Wesley) has been part of that assembled workforce the
entire time. Dozens and dozens of players have come and gone as part of the
"assembled workforce."
In 2002 the team went to the Stanley Cup finals
and, with the team (assembled workforce) intact finished 30th (dead last) in
2003. They did likewise in 2006 and won the Cup and with virtually the same
"assembled workforce" failed to make the playoffs in 2007. The "fair value"
of an assemble workforce seems to be a rather ephemeral thing. To assign a
single number value to it at an arbitrary point in time does seem to an
active that can be nothing other than deceptive.
David raises a most critical issue for a group that
claims some kind of professional expertise. One can entertain the notion
that there could be a coherent "cost" or "market value" accounting, but a
"fair value" accounting? But in the academy we have been speaking for so
long and so matter of factly about earnings expectations and models that
provide those numbers, which are sufficient for scientific precision, that
we have conned ourselves into believing that we actually can provide "fair
values." We abandoned SFAS #33 because "market values" were too difficult to
ascertain with any degree of reliability. But fair values don't have to be
reliable, only relevant to some hypothetical world populated by persons who
don't actually exist (Joe Doodlebugs, e.g.); we can just make them up.
Accountants have been victimized by finance hubris.
There is a significant historical irony in this since the "positivists" (I
can name names but will not do so publicly) dogma was that accounting was
too normative and that concepts like "true and fair" view were
intellectually vacuous because terms like "true" and "fair" were references
to subjective notions. Yet the influence of positive economics on accounting
has produced a system of financial reporting focused on the manufacture of
"fair" values, which in too many cases are the hypothetical products of the
imaginary world of the positive economists. Normative accounting gave us
positive measures. Positive accounting has provided us with normative
measures. A classic example of unintended consequences?
February 21, 2008 reply from Bob Jensen
Hi Paul and David,
Actually valuation is at last as easy as it can get. Below is an email
that I received today offering to let me try this little black box in which
I feed in financial statements and out pops the value of the firm. I don't
quite know how the black box deals with intangibles, but maybe there's magic
inside that box.
Actually all valuation experts use magic dust. I protested my land and
home valuations at various times in Maine, Texas, and New Hampshire. In each
case, the appraiser carefully documented square footage, construction
quality, location, view quality, landscape, school district, etc. Good work!
Then each initial appraisal, say V dollars, was multiplied by a mysterious M
coefficient such that my property tax appraisal was T=MV. For example, in
Maine the M was 2.85. When I asked where the 2.85 came from, the appraiser
admitted that he stood in front of my house and used magic dust to set the
value of T. Then he divided T by V to get M. In other words M was truly a
magic dust derivation. I don’t even know why the appraisers bother with
calculating V in the first place. I guess it’s just to make naïve property
owners think the appraiser is earning his fee. In reality, he probably rode
slowly through the neighborhood and calculated T values for each house in
about five minutes or less.
When something similar happened in New Hampshire last year, I carefully
compared in a spreadsheet the difference in the M coefficient between me and
my neighbors having identical views and much newer and bigger homes.
Why was my M coefficient so much larger such that my T real estate
appraisal was so much larger than my neighbors’ T values? My wife called me
the Big M Guy!
I was told by the Sugar Hill Selectmen that the magic dust M coefficients
could not be changed. So I hired a property tax pro who actually got this
issue docketed for court down in the State Capitol of Concord. One day
before the first court hearing, the town’s appraiser sheepishly came to my
home and asked if I would accept a lower magic dust coefficient. We finally
agreed on a revised M coefficient so I guess magic dust can be affected by
new magic the closer you get to your day in court.
Note the magic-dust black box described below in a message from XXXXX. He
doesn’t mention magic dust, but I’m sure its floating around in there just
like snowflakes swirl up when you shake a glass-ball paper weight.
I have been spending time absorbing as much as I
can from the many resources you have about the world of accounting. We have
a server based application that we tout as “our application starts where
accounting software ends.” A bit camp, I agree, but, in truth, that’s what
it does. Input an Income Statement and the
basic P&L info, and we can calculate the value of a business.
Take that and adjust with normalizations to forecast where the business will
be in the future. Then adjust expenses, and apply some basic strategies to
get the profits where you want/hope they should be. Then generate reports,
including monthly line by line budgets to track all the line items as you
move forward. Oh, and calculate Burden rates to guide the pricing of your
product/service to achieve your forecast revenue goals. I have no idea
whether you are at all interested in looking at what we have, but, if so,
let me know and I will be happy to provide you with log in ID and Password.
On a slightly different note…have you ever heard of
K2 Enterprises? If so, can you share any feedback about them with me.
On cost (replacement)
versus (fair) value, Walter Teets and I have written a paper that we
recently submitted to FAJ. The basic thrust is that cost can be
associated with principles-based accounting, and value cannot. That’s
why FAS 157 is rules based and filled with anomalies. You can read the
working paper
here,
or read my blog post that it
was based onhere. Comments,
especially on the working paper, would be much appreciated.
The Financial Accounting Standards Board and the
International Accounting Standards Board tentatively decided to define fair
value as an exit price during a three-day joint meeting this week.
Fair value measurement is one of the thornier
issues the two standards-setters are trying to come to an agreement on as
they seek to converge U.S. GAAP with International Financial Reporting
Standards by June 2011. Fair value, or mark-to-market, accounting has been
blamed in some quarters for helping exacerbate the financial crisis.
Standard-setters have come under pressure to revise the standards to give
financial institutions more flexibility in valuing assets such as
mortgage-backed securities that became difficult to trade during the crisis.
The two boards have decided to meet on a monthly basis, both in person and
by video conference, to resolve outstanding issues in areas such as fair
value, revenue recognition, leases and consolidation.
When markets become less active, the two boards
tentatively decided that an entity should consider observable transaction
prices unless there is evidence that the transaction is not orderly. If an
entity does not have enough information to determine whether the transaction
is orderly, it should perform further analysis to measure the fair value.
The boards also tentatively decided that the
transaction price might not represent the fair value of an asset or
liability at initial recognition if, for example, the transaction is between
related parties, the transaction takes place under duress or the seller is
forced to accept the price in the transaction, the unit of account
represented by the transaction is different from the unit of account for the
asset or liability measured at fair value, or the market in which the
transaction takes place is different from the market in which the entity
would sell the asset or transfer the liability.
The boards also tentatively decided to confirm that
a fair value measurement is market based and reflects the assumptions that
market participants would use in pricing the asset or liability. Market
participants should be assumed to have a reasonable understanding about the
asset or liability and the transaction based on all the available
information, including information that might be obtained through due
diligence efforts that are usual and customary. A price in a related-party
transaction may be used as an input to a fair value measurement if the
transaction was entered into at market terms.
Jensen Comment Of course the debate will center on the details. To what degree must buyers and
sellers be under pressures to sell such as in forced liquidations? To what
extend can interactions (covariances, value in use) be ignored? Interactions are
usually less of a problem when valuing financial items than non-financial items
where value is use often varies greatly from piecemeal liquidation value. The
FASB, of course, has considered the exit value hierarchy stumbling blocks such
as broken markets in FAS 157 and FSP 157 (4).
A huge problem is earnings volatility created by unrealized value changes on
earnings, particularly value changes on held-to-maturity items like fixed rate
debt instruments that management may not even have the option of liquidating
before maturity. There also is a huge problem that changes in credit ratings may
have misleading impacts on earnings when debt is revalued. What do you do with
the unrealized gains caused by lowered credit rating scores on your debt or
unrealized losses from increased credit ratings on your debt?
Asymmetry in Reporting the Same Contract Fair Value in Two Separate Firms
Question What happens when PwC's Client A owes Client B in an enormous contractual
obligation in a broken market when both clients are huge auditing clients of
PwC? If the clients want to report widely differing values of the same contract
on their financial statements, what's an auditor to do?
Francine called me yesterday about another matter and our hour-long
conversation drifted to this forthcoming dual-client dilemma, which is not
exactly a prisoner's dilemma, but is very similar.
All I could think of off the top of my head was that this is the kind of
thing "Subject to" opinions were designed for when the amounts involved are very
material in magnitude.
In any case, bravo to Francine for the heads up in writing up this "dilemma."
I think FSP 157 (4) has a huge asymmetry problem here whether or not the two
clients are audited by the same auditing firm. It reminded me of a remark Roman
Weil made years ago regarding the need for booking capital leases. Roman said
that Boeing was reporting sales of airliners to Eastern Airliners, whereas in
the financial statements Eastern Airlines reported no purchases of airliners
from Boeing. Thus there was an asymmetry in accounting for the same contracts.
It has to be very confusing to investors when the same contract is reported
at two values by the contracting companies.
The prisoner's dilemma is between
AIG and Goldman Sachs. They are playing a game of chicken (which is
actually defined in game theory!) and neither want to publicly shame the
other or accuse of fraud of bad faith and yet neither want to give in to the
other because of self interest. The best would be to compromise, but that's
where the prisoner's dilemma comes in - a betrayal only works if only one
does it. In this case, I believe Goldman was the betrayer by pushing PwC to
say AIG was wrong.
I did reach out to Doug
Carmichael as you suggested. Hoping he will get back to me. I found some
comments about the "Subject to" not being applicable to uncertainty or
contingency anymore only a going concern opinion.
A
1972 monograph by Douglas R. Carmichael, who is now chief auditor at the
PCAOB, “The Auditor’s Reporting Obligation, The Meaning and Implementation
of the Fourth Standard of Reporting, Auditing Research Monograph 1,”
represents the only definitive study that reviewed the historical
development of the disclaimer of opinion along with proposed criteria for
its application. Carmichael strongly suggested that, in then-present
reporting practice, auditors generally did not issue a disclaimer of opinion
for an isolated uncertainty, even of very large relative magnitude, unless
the issue imperiled the continued existence of the company. In a recent
exchange of e-mails with Carmichael related to the foregoing statement, he
replied that: “The discussion in the monograph is outdated. The audit
reporting requirements no longer require any modification of the report for
an uncertainty other than one that results in substantial doubt about
ability to continue as a going concern. … Also, it does not reflect my
current thinking. Accounting standards and business developments, e.g.,
derivatives, have introduced a range of uncertainty that is not adequately
dealt with in current auditing standards.”
I welcome other thoughts and
suggestions on how to think about this issue, in particular as they relate
to either standards for valuation of derivatives or auditor independence.
Francine
February 20, 2010 reply from Bob Jensen
Hi Francine,
But there are added considerations between Goldman and AIG.
Firstly, I’m not aware of any Prisoner’s Dilemma (PD) experiment where the
government (read that bailout) can intervene in an unknown way, which is
especially the case since the government has such a huge equity interest in
AIG. The government has to decide how this particular contract will affect
the entire future world of financial risk markets and regulation
implications. How much more will the government bailout AIG?
The real world PD game may be one of the government versus
Goldman Sachs, which of course must make Goldman Sachs very nervous. Goldman
would probably have gotten a better deal if this contract (actually
contracts) was settled quickly and quietly while Paulson was still in
command of the bailout. Paulson was not about to let his old bank fail or
even hurt very badly.
Thirdly, the PD game assumes this decision is a one shot deal
when in the case of Goldman and AIG there are long-term time implications.
For example, how much will an AIG compromise decision impact its credit
derivatives business in the future and the externalities on the impact on
the credit derivatives markets of its customers and friends and future
employee compensation.
Lastly, there are the externalities of media reporting and
reputations and pending regulations. We’re seeing an enormous example of how
negative press about banker bonuses have had real-world impacts on such
things as the greatly revised bonus levels in Goldman Sachs. This could be
compounded in the press when credit derivative contracts are settled. At the
moment voters in general are increasingly unhappy about being robbed by
banksters.
All I’m saying is that the real world is far too complex in most
instances to fit neatly into the simplistic assumptions of any game theory
application model, including all variations of PD games to date. This is
more than a simple game of “chicken” because there are so many stakeholders
now and in the future that are possibly impacted and will eventually squawk.
And the PD game assumes a stationary (equilibrium) state that
just does not fit the AIG versus Goldman Sachs dispute.
The dynamic world generally is not a steady-state game that can
be reduced to a set of equations that we can populate and solve. By populate
I mean fill in all the missing variables and unspecified parameter values.
This is why game theory is still largely confined to the ivory tower where
very smart people mostly play in “Plato’s Caves” rather than real and
constantly changing worlds --- http://faculty.trinity.edu/rjensen/TheoryTAR.htm#Analytics
In any case, thank you for a great article.
Bob Jensen
Jim Fuehrmeyer does not post regularly to our listservs, but he is a lurker who
quite often sends me very informative private messages.
Jim retired after 25 years with Deloitte (audit partner). He’s now an auditing
professor at Notre Dame.
I am forwarding a reply sent by Jim to the CPA-L listserv following the messages
instigated by Francine’s prisoner’s dilemma message regarding two audit clients
at PwC who came to hugely different valuations of the same credit derivatives
contracts (for payoffs owed Goldman Sachs by AIG).
From:
THE Internet Accounting List/Forum for CPAs [mailto:CPAS-L@LISTSERV.LOYOLA.EDU]
On Behalf Of Jim Fuehrmeyer Sent: Monday, February 22, 2010 11:37 AM To: CPAS-L@LISTSERV.LOYOLA.EDU Subject: FW: Asymmetry in Reporting the Same Contract Fair Value in Two
Separate Firms
This is always a tough issue for a firm: knowing that a client is on the other
side of a transaction/valuation issue/revenue recognition issue/leasing issue –
you name it.
The two audit engagement teams can’t share information with each other. In
fact, when these situations arise, if they have been discussing issues related
to their particular industry, best practices, and so on, they’ll have to stop
all communication so as to not potentially breach client confidentiality
standards. The firm’s national office will get deeply involved, but even at
that level there will be two different consultation teams handling the matter
for the two audit engagement teams. There’s likely only one or two people who
will see both sides and their task is to make sure professional standards are
followed, not that the answers are necessarily the same; and they have to walk
the fine line of not breaching client confidentiality.
This is even more difficult in an area as subjective as valuing financial
instruments where the outcomes result from estimation processes with multiple
inputs that all have reasonable ranges of their own. Just imagine what this
would be like with a so-called principles based standard that allows even more
client judgment.
It’s easy sometimes to post a blog and wonder how the auditors didn’t reach the
“right answer” immediately. I don’t think things are ever as simple as they are
portrayed sometimes.
Jim
Jensen Comment What we are seeing is the greater bag of worms that will be opened up when IFRS
replaces FASB standards in the United States. Relative to FASB standards, IFFRs
international standards replace bright line rules with principles-based
judgments on the application of accounting standards. Whereas bright lines can
greatly constrain how far an auditor may go along with client's judgment
regarding the application of a FASB standard, IFRS standards allow much more
leeway such that it becomes much more likely that independent teams of auditors
within a given auditing firm will allow clients to value identical contracts at
greatly different values such as the actual happening for the credit derivatives
written by AIG for Goldman Sachs.
In the AIG-Goldman "prisoner's dilemma" the FASB did not have bright line
valuation standards for the broken markets. FSP 157 (4) is a principled-based
interpretation much like the principles-based IFRS standards. Hence the
inconsistency of standard application that Francine pointed out in her
prisoner's dilemma illustration may well become the "rule" (sorry about that)
rather than the exception.
With IFRS in the U.S. and what Jim explains is an absolute rule in auditing
firms that audit teams maintain independence from one another within a given
firm, I fully expect to see more and more of this type of phenomenon where
clients value absolutely identical contracts at differences in value that are
highly material in amount for clients of the same auditing firm.
Question In their book Valuing Wall Street published in early 2000, Andrew Smithers and
Stephen Wright claim that the q ratio popularized by Nobel laureate James Tobin
reliably identifies periods of extreme overvaluation and undervaluation in stock
prices. Can investors use this indicator to implement a successful market timing
strategy?
This proposition has been tested in several papers,
and the answer is no. The market-to-book ratio for the market (a proxy for
q) shows some ability to predict stock returns during the 1930s, but not
thereafter.
Question A prominent money management firm has recently launched several mutual funds
that seek to exploit the positive momentum effect in stock prices. Why does this
well-publicized anomaly persist and under what circumstances can investors
expect to profit from it?
EFF/KRF: The momentum anomaly has been observed in most major markets
(Japan is the exception). Many academics claim that trading costs will wipe
out any benefits of trying to trade actively on momentum. This will now be
tested by live funds. The results will be interesting. (Read
the full entry)
TIPs are obviously a great hedge against inflation,
but there is still uncertainty about the short-term real return on long-term
TIPS. A long-term TIPS is a long-term loan to the Government at a fixed real
interest rate. Variation through time in the expected real return that
investors require to make this long-term commitment leads to capital gains
and losses that affect short-term real returns. (Read
the full entry)
Two of the world's biggest accounting firms are
reigniting the dispute over the way that banks account for losses - raising
doubts over the long-awaited convergence of global reporting standards.
Two of the world's biggest accounting firms are
reigniting the dispute over the way that banks account for losses - raising
doubts over the long-awaited convergence of global reporting standards.
Jim Quigley, global head of "Big Four" accounting
firm Deloitte Touche Tohmatsu has proposed that banks account for losses in
two radically different ways, to meet the opposing demands of politicians
and accountants.
He has told the Financial Times that he is an
"advocate" of banks making loan loss provisions for "incurred losses"
separately from "expected losses" - and reporting them in two different
lines in their accounts.
However, PwC, the world's largest accounting firm,
has previously criticised a similar proposal, saying it would "muddy the
waters".
Mr Quigley's proposal comes as accountants are
grappling with politicians and regulators over how banks make provision for
their losses, in the wake of the financial crisis. The lack of consensus
threatens agreement on a global set of accounting standards by mid 2011 - an
aim of the group of 20 nations - and follows disputes over the use of fair
value or mark-to-market accounting, experts say.
Politicians and regulators have blamed the current
system of "incurred losses" - whereby companies may make provision for loan
losses only as they occur - for exacerbating the crisis, by encouraging a
cyclical approach to risk management.
But that view is questioned by many accountants and
bankers who say that "incurred losses" give investors clarity. Accountants
and bankers are also are sceptical about the "expected loss" model, as they
fear it raises the risk of "cookie jar" accounting, whereby executives put
funds aside during good years only to release them later to cover up bad
performance.
Mr Quigley said he believed that "one way we can
bridge some of the current conflicts in financial reporting is with
transparency". "The two-line idea accomplishes that transparency objective,"
he told the FT. However, PwC, has said it is opposed to putting two lines in
the income statement.
The debate over the use of "expected losses"
centres on whether banks should judge their provisioning over a matter of
months, or over the life cycle of the loan - and whether the provisions
should be taken through profit and loss.
In a survey conducted among 2,000 participants at
the 2004 Annual Meeting of the World Economic Forum, more CEOs said that
corporate reputation, not profitability, was their most important measure of
success. Fortune Magazine calculates that a one-point change on its scale
used to rank its most admired companies translates to a difference of $107
million to a company’s market value.
Lord Levene, Chairman of Lloyd’s of London,
reported in a 2005 speech at the Philadelphia Club that loss of reputation
is now viewed as the second most serious threat to an organization’s
viability. (Business interruption is the first.)An Economist Intelligence
Unit survey ranked reputational risk as the greatest potential threat to an
organization's value. More than 30% of participating CEOs said that
reputational risk represents the greatest potential threat to their
company's market value. Of this same group of CEOs only 11% said that they
had taken any action against the threat.
If these data are not sufficient to jolt companies
into action, there is enough compelling data linking corporate reputation to
corporate performance that should. Fortune Magazine, which has been
publishing the results of its "America’s Most Admired Companies" survey for
20 years, calculates that a change of 1 point on its scale, either
positively or negatively, affects a company's market value by an average of
$107 million. The results of another study published in 2003 in Management
Today, Britain's leading monthly business magazine, demonstrate a clear
correlation between corporate reputation and equity return. Using existing
data from Fortune’s surveys to construct portfolios of the most and least
admired companies, the authors found that for the five years following
Fortune’s publication of the results, the portfolios of the most admired
companies had cumulative returns of 126% while those of the least admired
had cumulative returns of 80%.
"While executives may choose to spend time
analyzing these data and poking holes in research methodologies in order to
dismiss reputation as a strategic priority," says Wallace, "the effort would
simply provide another diversion from addressing the problem head-on. The
fact that corporate America's sullied reputation has lead to such dramatic
legislative change in the form of the Sarbannes-Oxley Act, and that it has
become routine front-page news, is as telling as any data. No company wants
bad press, but it may finally be what convinces American business that, left
unmanaged, a company’s reputation can become a terminal liability."
Say what? Why bother entering into contracts that are not enforceable? Do unenforceable contracts create emerging problems in accounting theory and in
practice? "The Best Way to Construct Unenforceable Contracts," by Erica Plambeck,
Stanford Graduate School of Business Newsletter, April 2007 ---
http://www.gsb.stanford.edu/news/research/mfg_plambeck_contracts.shtml
Strong relationships are frequently more important
than legally binding contracts when companies outsource key operational
activities.
Researchers say that as more firms form
international relationships—particularly in innovation-intensive industries
such as biopharmaceuticals or high tech—ironclad legal agreements can be
impractical, if not impossible. Overburdened court systems around the world
and the growing complexity of the types of collaborative deals being forged
mean that increasingly firms rely on the threat of loss of future business
rather than the court system to enforce those deals.
“When an innovative product is under development
and a supplier must invest in capacity up front, it can be difficult—if not
impossible—to write a court-enforceable contract that specifies exactly what
will be delivered,” says Erica Plambeck, associate professor of operations,
information, and technology at the Stanford Graduate School of Business.
For example, she says, electronics giant Toshiba is
continually making design changes, frequently substantial ones, throughout
the development process. If Toshiba’s suppliers delayed making capacity
investment for manufacturing a new product until the design was finalized
and a court-enforceable procurement contract could be negotiated, Toshiba
would miss the small windows of opportunity that the consumer electronics
market allows for releasing state-of-the-art products. Therefore, Toshiba
needs suppliers to build capacity early, without a contract. In a one-off
transaction, a supplier would be likely to build far too little capacity,
anticipating that Toshiba would attempt to negotiate a low price for
production once the capacity investment was made. But within the context of
an ongoing, cooperative relationship, Toshiba could offer more generous
compensation, and convince the supplier to expand its capacity—and both
firms’ profits—even without a contract.
Alternatively, she says, there are cases where
assurances about the quality or quantity of output cannot be legally
enforceable. “Frequently, producing a viable product depends on the
collaborative efforts of both parties, and it’s difficult to determine fault
if something goes wrong,” she says. A case in point: A biopharmaceutical
firm could hand over genetically modified cells and the liquid medium in
which to multiply them to a supplier, who then would be responsible for
managing that fermentation process to produce a therapeutic protein. If the
protein yield is unexpectedly low, a court would have difficulty determining
whether the cells and medium were of poor quality or the supplier made
mistakes in managing the fermentation process.
“This kind of complicated business arrangement can
be difficult to specify in a contract in a manner that a court could
enforce,” says Plambeck. “Under such conditions, an ongoing relationship
between partners is critical to cooperation.”
Plambeck has written a series of papers on
so-called relational contracts—agreements enforced by the value of the
ongoing cooperative relationship—research she has conducted with Terry
Taylor, an associate professor in the business school at Columbia
University. Plambeck became interested in relational contracts after
realizing that there was an almost universal assumption in the operations
and supply chain management literature that all contracts were
court-enforced.
“By recognizing that the strength of incentives for
investment in design, capacity, and inventory are limited by the value of
the future business, one obtains qualitatively different managerial insights
and policies for operations and supply chain management,” she says. There is
a rich body of economics research in this area—indeed, it was a Stanford
economics professor, Robert Gibbons (now at MIT) who coined the phrase
“relational contracts.” Plambeck and Taylor build on this existing work by
taking the abstract idea of relational contracts and applying it to dynamic
problems of collaborative product development, capacity, production, and
inventory management.
Plambeck has some high-level recommendations for
managers.
Continued in article
Accounting Theory: The Vexing Problem of
Contingent Liabilities and Environmental Risk
From The Wall Street Journal Accounting Weekly Review
on November 2, 2007
SUMMARY: "[British
Petroleum] BP PLC put a host of legal threats behind it with
far-reaching federal settlements yesterday [10/24/2007] and
$373 million in fines and restitution...The British energy
firm agreed to plead guilty to environmental crimes and
agreed to a three-year probation connected to a fatal
accident in Texas and an oil spill in Alaska." The article
describes the expected impact on BP PLC's operations; the
questions in this review focus on the company's Form 20-F
contingent liability disclosures, including environmental
and other contingent liabilities.
CLASSROOM
APPLICATION: Environmental liabilities and other
contingencies are discussed in this article.
QUESTIONS: 1.) The article states that BP PLC (British Petroleum) "put
a host of legal threats behind it" through a settlement with
U.S. government authorities and fines. Summarize the legal
issues facing the company and the settlement that was
reached.
2.) In general, where can you find information about the
likely financial impact of legal and environmental issues
facing any company? Describe the authoritative literature
requiring disclosure of this information.
3.) BP PLC uses the term "provisions" in their corporate
balance sheet, rather than "contingent liabilities." What is
the meaning of the term "provisions"?
4.) Specifically investigate the extent of the legal and
environmental issues facing BP PLC by examining their annual
report filed on Form 20-F with the Securities and Exchange
Commission, available at:
http://www.sec.gov/Archives/edgar/data/313807/000115697307000346/b848881-20f.htm#p85 How extensive are the liabilities associated with these
issues, as measured on December 31, 2006?
5.) Examine footnote 40 to further investigate these
liabilities. What are the 3 major categories of provisions
for estimated liabilities recorded by BP PLC? How do they
estimate the amounts recorded for these liabilities?
6.) Which category of provisions do you think will be
impacted by the settlement, based on the disclosures in the
December 31, 2006, year end financial statements and the
description of the settlement in the article?
Reviewed By: Judy Beckman, University of Rhode Island
Tom Selling in his Accounting Onion Blog has a really nice piece on
January 24, 2008 entitled "Peeling the Onion on the New Business Combination
Standards: FAS 141R and FAS 160" ---
This post examines the onion skin, if you will, of
the new business combination standards. I'm going to explain the differences
between the so-called 'purchase' method of accounting and the new
'acquisition' method. As is my habit, let's begin with a simple example.
Assume that ParentCo acquires 70% of the
outstanding shares of SubCo for $1,000. Additional facts are as follows:
ParentCo estimates that the fair value of 100% of
SubCo is $1,405: You should note that the fair value of SubCo may not
ordinarily be calculated by extrapolating the purchase price paid to the
remaining shares outstanding (i.e., $1,000/70% = $1,429 is not ordinarily
the fair value). The reason is that a portion of the purchase price contains
a payment for the ability to exercise control. In this case, the control
premium would be $55, calculated as follows: ($1000 - .7($1405))/(1-.7) =
$55
It may be difficult to estimate the control
premium, because it may have to be derived from an estimate of the full fair
value of the acquired company, as above. But the new requirement to do so
has not been controversial. That's because the larger the control premium,
the lower will be goodwill. The book value of SubCo's assets and liabilities
approximate their book value, except for one asset with a remaining useful
life of 10 years. For that asset, the fair value exceeds the book value by
$100.
FINANCIAL REPORTING: MORE SCIENCE, LESS ART Governments and investors alike now demand more
financial transparency from public companies. And, given the impressive
evolution of technology and business practices, there is no excuse for reporting
that is anything but spot-on. Intangible factors that are not taken into account
when following U.S. Generally Accepted Accounting Principles (G.A.A.P.) -- such
as brand value, intellectual capital, growth expectations and forecasts, and
corporate citizenship -- are now being recognized as important drivers of
shareholder value. A new white paper from Accenture explores "Enhanced Business
Reporting" as a means for businesses to gain and communicate a clearer picture
of company goals and performance. Frank D'Andrea, "FINANCIAL REPORTING: MORE SCIENCE, LESS ART,"
Double Entries,
September 21, 2005 ---
http://accountingeducation.com/news/news6481.html
Gore and Blood We see a lot of snide remarks and jokes about Al Gore the conservative media,
and he (like his counterpart George W. Bush) has made some rather dumb remarks
in highly boring speeches. But when teamed up with the former head of Goldman
Sachs Asset Management, Gore and Blood (not the best of last name combinations)
produced a rather good, albeit short, article about some severe accounting
limitations.
I commend The Wall Street Journal for carrying this
piece which I would normally expect to appear in the more liberal media.
Capitalism and sustainability are deeply and
increasingly interrelated. After all, our economic activity is based on the
use of natural and human resources. Not until we more broadly "price in" the
external costs of investment decisions across all sectors will we have a
sustainable economy and society.
The industrial revolution brought enormous
prosperity, but it also introduced unsustainable business practices. Our
current system for accounting was principally established in the 1930s by
Lord Keynes and the creation of "national accounts" (the backbone of today's
gross domestic product). While this system was precise in its ability to
account for capital goods, it was imprecise in its ability to account for
natural and human resources because it assumed them to be limitless. This,
in part, explains why our current model of economic development is
hard-wired to externalize as many costs as possible.
Externalities are costs created by industry but
paid for by society. For example, pollution is an externality which is
sometimes taxed by government in order to make the entity responsible
"internalize" the full costs of production. Over the past century, companies
have been rewarded financially for maximizing externalities in order to
minimize costs.
Today, the global context for business is clearly
changing. "Capitalism is at a crossroads," says Stuart Hart, professor of
management at Cornell University. We agree, and we think the financial
markets have a significant opportunity to chart the way forward. In fact, we
believe that sustainable development will be the primary driver of
industrial and economic change over the next 50 years. The interests of
shareholders, over time, will be best served by companies that maximize
their financial performance by strategically managing their economic,
social, environmental and ethical performance. This is increasingly true as
we confront the limits of our ecological system to hold up under current
patterns of use. "License to operate" can no longer be taken for granted by
business as challenges such as climate change, HIV/AIDS, water scarcity and
poverty have reached a point where civil society is demanding a response
from business and government. The "polluter pays" principle is just one
example of how companies can be held accountable for the full costs of doing
business. Now, more than ever, factors beyond the scope of Keynes's national
accounts are directly affecting a company's ability to generate revenues,
manage risks, and sustain competitive advantage. There are many examples of
the growing acceptance of this view.
In the corporate sector, companies like General
Electric are designing products to enable their clients to compete in a
carbon-constrained world. Novo Nordisk is taking a holistic view of
combating diabetes not only through treatment but also through prevention.
And Whole Foods and others are addressing the demand for quality food by
sourcing local and organic produce. Importantly, the business response is
about making money for shareholders, not altruism.
In the nongovernmental sector, organizations such
as World Resources Institute, Transparency International, the Coalition for
Environmentally Responsible Economies (Ceres) and AccountAbility are helping
companies explore how best to align corporate responsibility with business
strategy.
Over the past five years we have seen markets begin
to incorporate the external cost of carbon dioxide emissions. This is
happening through pricing mechanisms (price per ton of carbon dioxide) and
government-supported trading platforms such as the European Union Emissions
Trading Scheme in Europe. Even without a regulatory framework in the U.S.,
voluntary markets are emerging, such as the Chicago Climate Exchange and
state-level initiatives such as the Regional Greenhouse Gas Initiative.
These market mechanisms increasingly enable companies to calculate project
returns and capital expenditures decisions with the price of carbon dioxide
fully integrated.
The investment community has also started to
respond. For example, the Enhanced Analytics Initiative, an international
collaboration between asset owners and managers, encourages investment
research that considers the impact of extrafinancial issues on long-term
company performance. The Equator Principles, designed to help financial
institutions manage environmental and social risk in project financing, have
now been adopted by 40 banks, which arrange over 75% of the world's project
loans. In addition, the rise in shareholder activism and the growing debate
on fiduciary responsibility, governance legislation and reporting
requirements (such as the Global Reporting Initiative and the EU Business
Review) indicate the mainstream incorporation of sustainability concerns.
While we are seeing evidence of leading public companies adopting
sustainable business practices in developed markets, there is still a long
way to Go to make sustainability fully integrated and therefore truly
mainstream. A short-term focus still pervades both corporate and investment
communities, which hinders long-term value creation.
As some have said, "We are operating the Earth like
it's a business in liquidation." More mechanisms to incorporate
environmental and social externalities will be needed to enable capital
markets to achieve their intended purpose--to consistently allocate capital
to its highest and best use for the good of the people and the planet.
Mr. Gore, a former vice president of the United States, is chairman of
Generation Investment Management. Mr. Blood, formerly head of Goldman Sachs
Asset Management, is managing partner of Generation Investment Management,
which he co-founded with Mr. Gore.
Quite a few of you out there, like me, are trying to teach analysis of
financial statements and business analysis and valuation from books like
Penman
or
Palepu,
Healy, and Bernard. The current task of valuing MCI illustrates
how frustrating this can be in the real world and how financial statement
analysis that we teach, along with the revered Residual Income and Free Cash
Flow Models, are often Titanic tasks in rearranging the deck chairs on sinking
models. If you've not attempted valuations with these models I suggest
that you begin with my favorite case study:
"Questrom vs. Federated Department
Stores, Inc.: A Question of Equity Value," May 2001 edition of
Issues in Accounting Education, by University of Alabama faculty members Gary
Taylor, William Sampson, and Benton Gup, pp. 223-256.
In spite of all the sophistication in
models, it is ever so common for intangibles and forecasting problems to sink
the valuation models we teach. My threads on valuation are at
http://faculty.trinity.edu/rjensen/roi.htm
A question I always ask my students
is: What is the major thing that has to be factored in when valuing
Microsoft Corporation?
The answer I'm looking for is certainly
not product innovation or something similar to that. The answer is also
not customer loyalty, although that probably is a huge factor. The big
factor is the massive cost of retraining the entire working world in something
that replaces MS Office products (Excel, Word, PowerPoint, Outlook, etc.).
It simply costs too much to retrain workers in MS Office substitues even if we
are so sick of security problems in Micosoft's systems. How do you
factor this "customer lock-in" into a Residual Income or FCF
Model? Our models are torpedoed by intangibles in the real world.
MCI's customer base is another torpedo
for valuation models. Here the value seems to lie in a "web of
corporate customers." And nobody seems to be able to value that.
Industry bankers and accountants are trying to answer
just that: What is the value of MCI, a company for which Qwest Communications
has already made a tentative offer of about $6.3 billion, and on which Verizon
Communications has been running the numbers. Conversations between MCI and
Qwest have been suspended since late last week, and Verizon has yet to make a
formal offer, people close to the negotiations say.
Most analysts say MCI's extensive network assets in
this country and Europe may have diminishing value because of the industry's
continued capacity glut. Instead, they say, MCI's
worth lies more in its web of corporate customers.
But as MCI's revenue continues to tumble, the real
trick for the accountants is trying to forecast the future. Can the company meet
its stated goal of achieving profitable growth as a telecommunications company
emphasizing Internet technology before the bottom falls out of its traditional
voice and data business?
Continued in article
What we teach just won't float?
Quite a few of you out there, like me, are trying to teach analysis of
financial statements and business analysis and valuation from books like
Penman
or
Palepu,
Healy, and Bernard. The current task of valuing Amazon illustrates
how frustrating this can be in the real world and how financial statement
analysis that we teach, along with the revered Residual Income and Free Cash
Flow Models, are often Titanic tasks in rearranging the deck chairs on sinking
models.
From The Wall Street Journal Accounting Weekly Review on
February 11, 2005
TITLE: Amazon's Net Is Curtailed by Costs REPORTER: Mylene Mangalindan DATE: Feb 03, 2005 PAGE: A3 LINK:
http://online.wsj.com/article/0,,SB110735918865643669,00.html TOPICS: Financial Accounting, Financial Statement Analysis, Income Taxes,
Managerial Accounting, Net Operating Losses
SUMMARY: Amazon "...had forecast that profit margins would rise in the
fourth quarter, while Wall Street analysts had expected margins to remain
about the same." The company's operating profits fell in the fourth
quarter from 7.9% of revenue to 7%. The company's stock price plunged
"14% in after-hours trading."
QUESTIONS: 1.) "Amazon said net income rose nearly fivefold, to $346.7 million, or
82 cents a share, from $73.2 million, or 17 cents a share a year
earlier." Why then did their stock price drop 14% after this
announcement?
2.) Refer to the related article. How were some analysts' projections borne
out by the earnings Amazon announced?
3.) One analyst discussed in the related article, Ken Smith, disagrees with
the majority of analysts' views as discussed under #2 above. Do you think that
his viewpoint is supported by these results? Explain.
4.) Summarize the assessments made in answers to questions 2 and 3 with the
way in which Amazon's operating profits as a percentage of sales turned out
this quarter.
5.) Amazon's results "included a $244 million gain from tax benefits,
stemming from Amazon's heavy losses earlier in the decade." What does
that statement say about the accounting treatment of the deferred tax benefit
for operating loss carryforwards when those losses were experienced? Be
specific in describing exactly how these tax benefits were accounted for.
6.) Why does Amazon adjust out certain items, including the tax gain
described above, in assessing their earnings? In your answer, specifically
state which items are adjusted out of earnings and why that adjustment might
be made. What is a general term for announcing earnings in this fashion?
Reviewed By: Judy Beckman, University of Rhode Island
Another One from That Ketz Guy "Deferred Income Taxes (Accounting) Should be Put to Rest," by J. Edward
Ketz , AccountingWeb, March 2010 --- http://accounting.smartpros.com/x68912.xml
One of the silliest constructs in the world of
accounting happens to be deferred income taxes. I don't understand why we
bother with deferred tax liabilities and deferred tax assets because they
are neither liabilities nor assets. If the FASB and the IASB are serious
about principles-based accounting -- which I am becoming to believe is
rhetoric without referents -- then they would eliminate these bastard
accounts without delay.
Consider Procter & Gamble’s annual report for 2009,
for instance. They report deferred income tax assets (net) of $5.2 billion
and deferred income tax liabilities of $13.7 billion. But, are the former
really assets and the latter really debts?
The FASB defines liabilities as “probable future
sacrifices of economic benefits arising from present obligations of a
particular entity to transfer assets or provide services to other entities
in the future as a result of past transactions.” The IASB defines them
similarly as “a present obligation arising from a past event, the settlement
of which results in an outflow of resources embodying future economic
benefits.”
Suppose a business enterprise uses accelerated
depreciation for tax purposes and straight-line for financial reporting such
that depreciation for tax purposes amounts to $320,000 and for financial
purposes $200,000. There is a difference of $120,000 and, if we assume a tax
rate of 25%, this leads to an increase in deferred income taxes of $40,000.
But what is the nature of this $40,000?
This $40,000 is not a probable future sacrifice—the
sacrifice will be in the nature of future taxes paid to the U.S. and other
governments. At most, the $40,000 helps one better to predict future cash
flows for taxes. Yet that does not make this $40,000 a liability.
Even if it were a probable future sacrifice, there
is a bigger problem. This future sacrifice is not a present obligation of
the firm. The incremental tax becomes a “present obligation” only when the
next tax year rolls around. Taxes are statutory requirements that arise only
in the year they are imposed. Just because taxes are an unending penalty for
living in advanced societies doesn’t make any of them present obligations
today (the boulder pushed up the mountain by Sisyphus was actually his
income taxes).
Furthermore, these deferred income tax liabilities
are not a result of past transactions between the tax authority and the
taxpayer. We have the transaction when the taxpayer purchased the plant or
equipment and we have past tax transactions. But, it requires a lot of
imagination to think that any of these transactions give rise to some
present obligation.
If they were liabilities, one would expect them to
be discounted. All long-term obligations are measured at the present value
of their future cash flows, including mortgages and bonds and long-term
notes payable. I think the FASB does not require discounting of deferred tax
liabilities because it knows that fundamentally the numbers used in the
computation of deferred taxes are not cash flows. If they were, discounting
would be meaningful; as they aren’t cash flows, discounting only compounds
this monstrosity.
I view Procter & Gamble’s $13.7 billion of deferred
tax liabilities as not representing probable future sacrifices, nor present
obligations, and certainly not resulting from past transactions. Even if
they were, the number is vastly inflated because they are raw, undiscounted
numbers.
The FASB defines assets as “probable future
economic benefits obtained or controlled by a particular entity as a result
of past transactions or events.” The IASB’s definition is again quite
similar: an asset is “a resource controlled by the entity as a result of
past events and from which future economic benefits are expected to flow to
the entity.”
Suppose a firm has estimated warranty expense of $1
million but the tax expense is zero because nobody has filed a warranty
claim by year-end. The FASB asserts that there is a deferred tax asset of
$250,000 (assuming again the marginal tax rate is 25%) because these
represent future deductible amounts.
Note, however, they are not future economic
benefits yet if for no other reason, the government’s tax laws can change.
Even if they were, they are not the result of any past transactions or
event. Nobody has made a warranty claim; there has only been an adjusting
entry that the entity made within itself. It has not contracted or exchanged
anything involving these warranties. And not requiring any discounting is
again telling—there is no discounting because there is no event and no cash
flows.
A corporation must write down the supposed value of
the deferred tax asset if it is more likely than not that it will not
realize some of the asset. If this asset were real, where is the market
valuation (mark-to-model)? As firms cannot conduct such a valuation (even as
a Level 3 estimate per FAS 157), this valuation process is hollow.
I do not view Procter & Gamble’s deferred income
tax assets of $5.2 billion to be real. Just fluff and nonsense. And who
knows what P&G’s valuation allowance of $104 million means. It certainly
says nothing about valuation.
Probably the most illogical aspect of deferred
taxes occurs on the income statement. P&G determines for 2009 that earnings
from continuing operations before income taxes is $15.3 billion. Then it
records income tax expense of $4.0 billion. This close proximity gives the
reader the idea that there is a relationship between the two, but of course,
there is no association. The actual amounts owed to the IRS are computed on
taxable income, not on the financial reporting earnings before taxes.
Expenses are supposed to be sacrifices incurred
during the operating activities of the entity. Ok, the current portion of
the income tax expense is indeed a sacrifice. But, the deferred portion is
clearly not a sacrifice of any resources of the firm. That’s why firms
employ MACRS—they want to reduce their sacrifices to Uncle Sam.
P&G shows the current portion of income tax expense
in its tax footnote. The current portion is $3.4 billion and the deferred
portion is $0.6 billion.
I realize that academics have shown a statistical
association between market returns and deferred income taxes; however, they
usually overstate their conclusions. The correlation between market returns
and deferred income taxes merely indicates that market agents find the
disclosures useful in predicting future cash outflows to the IRS. This
statistical association doesn’t make these constructs assets or liabilities.
If the FASB wants to require these disclosures, it should require firms to
stick them in a footnote rather than contaminate the balance sheet with
their presence.
Analysts and researchers have an easy time dealing
with the problem of deferred income taxes, as the misinformation is in plain
view. We just eliminate the phony assets and liabilities from the balance
sheet and restate income tax expense to the current portion. Nevertheless,
the FASB and the IASB still should eliminate these deferred accounts and
clean up the balance sheet, especially if they are serious about
principles-based accounting. It makes the financial statements more
representationally faithful and thus more reliable.
This essay reflects the opinion of the author and not necessarily the
opinion of The Pennsylvania State University.
Goodwill Impairment and Liabilities Contingent Upon Uncertain Politics of
the Future
Lehman bought back 100% of its Repo 105/108 poison with the auditor's
blessing that these were truly sales http://faculty.trinity.edu/rjensen/Fraud001.htm#Ernst Bank of America, however, is resisting buying back its dumping off of poisoned
securities
Wouldn't it be a kick if tens of thousands of local Main Street banks and
mortgage companies had to buy back their fraudulent mortgages sold down stream
to Fannie, Freddie, etc.?
Teaching Case from The Wall Street Journal Accounting Weekly Review on
October 22, 2010
TOPICS: Bad Debts, Banking, Flexible Spending Accounts, Loan Loss Allowance
SUMMARY: Bank of America Corp. "..vowed to fight government backed demand
that it repurchase loans that allegedly didn't meet underwriting guidelines
and other promises." Those demanding the repurchases include Freddie Mac and
Fannie Mae as well as other investors such as the Federal Reserve Bank of
New York, Neuberger Bergman Group, BlackRock Inc., Western Asset Management
Co. and Pacific Investment Management Co, or Pimco. These demands were the
first time that Fannie and Freddie have attempted to force banks to buy back
mortgage-backed securities that were issued by Wall Street, not by Freddie
and Fannie themselves. BofA made these statements as it reported a $4.3
billion loss, primarily stemming from a goodwill charge related to a decline
in value of its credit card business that the company says stems from
regulatory changes; otherwise, the company would have earned $3.1 billion.
CLASSROOM APPLICATION: The article covers loan losses and a goodwill
impairment charge, useful for covering these topics in a financial reporting
class.
QUESTIONS: 1. (Introductory) What are mortgage-backed securities? Why might Bank of
America be forced to repurchase these securities or their underlying loans?
2. (Introductory) What is BofA saying it will do in response to investor
requests to repurchase these loans?
3. (Introductory) Refer to the related article and describe the response to
BofA's announcement. In your answer, define the terms Freddie Mac, Fannie
Mae, and government sponsored entities (GSEs).
4. (Advanced) Describe in general the factors that lead to a goodwill
impairment charge. What accounting codification section addresses these
requirements?
5. (Advanced) Access the BofA filing on Form 8-K of the earnings press
release on October 19, 2010, available at http://www.sec.gov/Archives/edgar/data/70858/000119312510231353/0001193125-10-231353-index.htm
It is also available by clicking on the live link to Bank of America in the
online version of the article, then clicking on SEC filings on the left hand
side of the page, then clicking on Form 8-K filed on October 19, 2010.
Review the selected slides used to facilitate the earnings release
conference call with analysts. Describe the goodwill charge.
6. (Advanced) How does a goodwill impairment charge result from "diminished
future debit card profitability"?
Reviewed By: Judy Beckman, University of Rhode Island
RELATED ARTICLES: Regulator for Fannie Set to Get Litigious by Nick Timiraos Oct 21, 2010 Online Exclusive
Bank of America Corp. and some of its largest
mortgage investors clashed on Tuesday as the bank vowed to fight
government-backed demands that it repurchase loans that allegedly didn't
meet underwriting guidelines and other promises.
The bank acknowledged receiving a Monday letter
from investors alleging that a Bank of America unit didn't properly service
115 bond deals. The investors include Freddie Mac, the government-owned
mortgage company. Freddie Mac and Fannie Mae, its larger sibling, have
boosted demands on lenders over the past year to buy back defaulted loans
that had been sold to and guaranteed by the mortgage titans.
Now Reporting Track the performances of 150
companies as they report and compare their results with analyst estimates.
Sort by reporting date and industry. .More Heard: BofA Is Bracing for a Long
War BofA Sues FDIC Over Mortgage Losses Custody Banks Rebound BofA: Not
Worried on Mortgages Buyback .But Tuesday's action marks the first step by
either company to force banks to buy back mortgage-backed securities that
were issued by Wall Street, not by government-backed mortgage giants.
Other investors, some of whom were acting on behalf
of their clients, include the Federal Reserve Bank of New York, Neuberger
Berman Group LLC, BlackRock Inc., Western Asset Management Co. and Allianz
SE's Pacific Investment Management Co., or Pimco, according to people
familiar with the matter.
The Charlotte, N.C., bank hoped the lifting of its
foreclosure sale moratorium would debunk fears that the mortgage process was
flawed. But investors grappled with new concerns Tuesday that the bank could
be overwhelmed with investor requests to repurchase flawed mortgages made
before the U.S. housing collapse. Its shares dropped 54 cents or 4.4% to
$11.80. The shares have declined more than 30% since the end of April amid
worries about regulatory reform, lackluster revenues and weak loan demand.
Experience WSJ professional Editors' Deep Dive:
Banks Face Changing LandscapeFINANCIAL NEWS Banks Must Rethink Their
Strategies .Fund Strategy IMF Warns Finance Is Vulnerable .Financial News
Could Basel III Rescue Banking?. Access thousands of business sources not
available on the free web. Learn More .Chief Executive Brian Moynihan
quickly vowed to push back on the repurchase requests.
"We will diligently fight this," Mr. Moynihan told
analysts Tuesday.
.A spokesman, responding to Monday's letter, added
that "We're not responsible for the poor performance of loans as a result of
a bad economy. We don't believe we've breached our obligations as servicer.
We will examine every avenue to vigorously defend ourselves."
The bank's defiant stance came as it reported a
$7.3 billion loss in the third quarter, or 77 cents per share. The loss was
largely the result of a $10.4 billion goodwill charge tied to a decline in
value of its credit card business. Without the charge, which the company
attributes to a regulatory crimp in its debit-card revenue, the bank would
have earned $3.1 billion.
No U.S. bank is more vulnerable to an array of
political and financial threats posed by home-lending woes. Bank of America
has more repurchase requests than any of its rivals and it services one out
of every five U.S. mortgages, many of them picked up from California lender
Countrywide Financial Corp. in 2008.
Worries about sloppy mortgage underwriting and
servicing practices clouded discussion of the bank's results Tuesday.
The bank on Oct. 1 said it would suspend
foreclosures cases in 23 states where court approval is required and on Oct.
8 said it would halt all foreclosures sales in 50 states. Starting Monday,
the bank will begin resubmitting court documents in the first 23 states
after the company said an internal review of 102,000 cases found no
underlying problems. It and other banks initiated reviews following
revelations that "robo signers" had approved hundreds of foreclosure
documents a day without examining them thoroughly.
Mr. Moynihan said it would take a few more weeks
for the bank to complete its assessment of all 50 states, but so far "we
don't see the issues that people were worried about."
Concerns about the underlying foreclosure documents
amount to "technical issues" that are not a "big deal" for the bank,
although he acknowledged it was a "big issue for people who live in the
homes."
Investors submitted $4 billion in new mortgage
repurchase claims during the third quarter, the bank said. Total claims
amounted to $12.8 billion at the end of the third quarter, up from $7.5
billion in the year-ago quarter. The bank has so far set aside $4.4 billion
in reserves for these putback attempts, including $872 billion in the third
quarter.
A majority of the claims are from Freddie Mac and
Fannie Mae. The bank said it sold $1.2 trillion in loans to the
government-controlled housing giants from 2004 to 2008 and has thus far
received $18 billion in repurchase claims on those loans. The bank has
resolved $11.4 billion of the $18 billion, recording a net loss of $2.5
billion on those putbacks, or 22%.
The bank also could face more losses on claims from
other investors, although Chief Financial Officer Chuck Noski said those
figures are harder to predict.
"This is an area where there is a lot of
speculation and commentary but not a lot of specific claims asserted," he
said in an interview. The bank said it had received $3.9 billion in private
repurchase claims through the end of the third quarter.
Mr. Moynihan said he isn't interested in a large
lump sum payment to make the repurchase issue go away. "We're not going to
put this behind us to make us feel good," he said. "We're going to make sure
that we'll pay when due but not just do a settlement to move the matter
behind us."
Sandler O'Neill + Partners analyst Jeff Harte
said in a note that "the actual level of future repurchase remains both a
key determinant and an unknown." Nomura Securities analyst Glenn Schorr said
in a note it is "tough to convince investors on putback risk."
Some analysts also noted several silver linings in
Bank of America's results Tuesday.
Excluding the $10.4 billion charge, which the bank
attributed entirely to an amendment in the Dodd-Frank financial-overhaul law
that limits debit-card income, the bank's third-quarter results exceeded
Wall Street estimates. Its $3.5 billion in fixed-income revenue also beat
rivals Citigroup Inc. and J.P. Morgan Chase & Co. and credit costs showed
improvement. The amount the bank set side for future loan losses was $5.4
billion, compared with $11.7 billion a year ago.
Teaching Case from The Wall Street Journal Accounting Weekly Review on
October 22, 2010
TOPICS: Banking, Loan Loss Allowance, Securitization
SUMMARY: David Reilly, the author of this article, analyzes the loan loss
reserves and potential loan write-offs facing Bank of America(BofA). These
assessments are based on information in the BoA earnings release and
presentation slides prepared for the related conference call with analysts.
The graphic associated with the article shows the large size of the reserve
balance at the end of the third quarter relative to past quarters.
CLASSROOM APPLICATION: The article is useful to discuss both the latest
developments in the mortgage and banking crisis and then to thoroughly
analyze loss reserves and bank warranties made on securitized loan
portfolios.
QUESTIONS: 1. (Introductory) By how much did BoA stock drop on announcement of the
investor push for the big bank to buy back mortgage loans sold off as
mortgage-backed securities? How much has it dropped since last spring?
2. (Introductory) What are the efforts of investors who bought loans or
mortgage-backed securities made by BofA? In your answer, describe your
understand of the process for selling mortgage-backed securities.
3. (Advanced) Access the BofA filing on Form 8-K of the earnings press
release on October 19, 2010, available at http://www.sec.gov/Archives/edgar/data/70858/000119312510231353/0001193125-10-231353-index.htm
It is also available by clicking on the live link to Bank of America in the
online version of the article, then clicking on SEC filings on the left hand
side of the page, then clicking on Form 8-K filed on October 19, 2010.
Review the selected slides used to facilitate the earnings release
conference call with analysts. What points in the discussion in this article
are taken from those slides?
4. (Advanced) Focus on the author's analysis of BoA sales to Fannie Mae and
Freddie Mac from 2004 to 2008. How does the author use that information to
estimate the impact of possible repurchases and subsequent write-offs of MBS
sold to private investors?
5. (Introductory) What does the author conclude in this article?
Reviewed By: Judy Beckman, University of Rhode Island
RELATED ARTICLES:
BofA Resists Buying Back Bad Loans by Dan Fitzpatrick Oct 20, 2010 Page: C1
Brian Moynihan seemed to be channeling Winston
Churchill on Tuesday. Describing how Bank of America will deal with
mortgage-bond holders trying to force it to repurchase loans, he made clear
the bank shall fight, fight and fight in court.
"We have thousands of people willing to stand and
look at every one of these loans," the chief executive declared on the
bank's earnings call.
Judging by the 4.4% drop in BofA's stock, the tough
talk didn't convince investors. After all, mortgage-bond holders, including
the Federal Reserve Bank of New York, are ratcheting up efforts to return
more loans to the bank as "put-backs." And Mr. Moynihan's chances of winning
this war depend on knotty legal issues related to questions over loan
ownership or the terms on which mortgages were sold to investment pools.
News Hub: BofA Braces for Long Foreclosure War 3:10
David Reilly discusses Bank of America's continuing
foreclosure battle. .Even so, Mr. Moynihan's stance should be taken
seriously. Bank of America, like other big banks, has the resources and the
ability to drag the legal fight out for years. That should reassure the
bank's shareholders. Not only could a war of attrition wear out opponents,
who already face significant legal hurdles in attempts to bring actions, but
it means losses connected to repurchased loans may be stretched over many
years and may not ultimately be as severe as some investors fear.
Tuesday, Bank of America tried to address
shareholder angst by laying out its experience with repurchase claims. That
should help investors think through some scenarios for new claims.
From 2004 to 2008, Bank of America said it sold
$1.2 trillion in loans to Fannie Mae and Freddie Mac. It has received
repurchase requests for $18 billion and believes this represents two-thirds
of expected claims. That would put total expected claims at about $27
billion, or 2.25% of the total. Of loans repurchased, Bank of America
sustained losses of 22%.
Bank of America also sold $750 billion in loans to
private investors, which may become subject to new repurchase claims. It
said 40% have already paid off.
Say, for example, that repurchase requests on the
still-outstanding $450 billion in these loans run at 10 times the rate of
those sold to Fannie and Freddie. That would put repurchase requests at
about $100 billion. Assume, then, that half the requests were approved and
losses ran at 30%. The result would be a hit of about $15 billion.
While a blow, it should be manageable, especially
if spread over four or five years. What's more, Bank of America has already
lost about $15 billion in market value since announcing it would temporarily
halt foreclosures.
Granted, Bank of America and peers still face
plenty of unknown legal risks related to loan ownership and securitization.
But, for now, the market looks to have already priced in much of the risk
facing Bank of America.
SUMMARY: The author describes issues on both sides of patent disputes, based
on his experience as general counsel for Intel Corp., and relates them to the
patent infringement suit settlement by RIM.
QUESTIONS: 1.) What have been the events leading up to RIM (the company behind BlackBerry
hand held devices) paying $615 million to NTP? On what basis has that amount
increased over time? You may refer to the related articles to get a sense of
that issue.
2.) What are the accounting issues related to intellectual property? List all
that you can think of. How are these issues related to patent rights and
disputes as described in the article?
3.) How has RIM been accounting for the cost of defending against the patent
infringement suit by NTP? Determine the answer to this question based on
information in the second related article.
4.) What are the author' s proposals for reforming patent infringement law?
Reviewed By: Judy Beckman, University of Rhode Island
RIM, the company that brings BlackBerry service to
four million subscribers, finally caved in to the threat of losing its
business. It paid NTP, a small patent holding company reputedly comprised of
just one inventor and one patent lawyer, $615 million to settle a four-year
patent dispute. For NTP it was like winning the lottery, but for the rest of
us, and for business in particular, it stinks. NTP used the patent system,
and the threat of shutting down BlackBerry service, to play chicken with RIM
and millions of BlackBerry users around the world. Unless the courts or
Congress do something to stop this kind of gamesmanship, we're only going to
see more cases like this.
NTP doesn't have a competitive product. It isn't
even in the business of making products. It's one of a large number of
companies known as patent trolls. Trolls acquire and use patents just to sue
companies that actually make products and generate revenue. A patent without
a product isn't worth much, whereas a patent tied to a revenue stream,
particularly someone else's, is a whole different matter. RIM was the best
thing that ever happened to NTP, because by last Friday the only question
left was how much of RIM's pie NTP could get.
The distressing part of this picture is that RIM's
contribution of complementary technologies, business acumen, product R&D and
marketing is what "enabled" the NTP invention to achieve commercial
relevance. The right question is: What would be a fair royalty for NTP,
given its contribution of the patent and RIM's contribution of everything
else? Unfortunately, that isn't where this case ended up. Because NTP had
the presumptive right to obtain an injunction against RIM and stop it dead
in its tracks, the issue on the table wasn't the value of NTP's patent in
the context of RIM's business; instead, it was the total value of RIM's
business. "Pay me a lot or lose everything" hardly leads to rational
settlements. Is this really what we want from our patent system?
At Intel, I see this problem every day and from
both sides of the fence. Intel owns a considerable portfolio of patents and
we believe strongly that inventors are entitled to fair compensation for
their efforts. But Intel is also a target for patent trolls because we run a
successful business. The fact that success creates leverage for trolls to
extract value above and beyond the true contribution of the patented
invention just doesn't seem quite . . . American.
Things got so lopsided in the world of patent
litigation not on account of the patent statute itself but from case law,
which has become increasingly protective of patent owners and tolerant of
excessive damages arguments by plaintiffs' lawyers. Our patent laws are
supposed to be about proliferation of technology. If there is actual
competition between patent owner and infringer, an injunction may be
appropriate -- it protects the patent owner's right to exclusivity and does
not deprive society of the benefits of the technology. On the other hand, if
the patent owner has not commercialized the invention, blocking others from
using it is a loss for all of us. The right to an injunction also needs to
be tempered by a commonsense look at how much real value the patented
technology adds to the whole commercial product. A fundamental invention
deserves greater value than a relatively minor tweak to work that went
before it. A broad application of the injunction remedy makes all patents
"crucial," whether they are or not.
What I'm suggesting here is not all that radical.
These concepts are already embedded in our patent laws; but unfortunately
they have been buried beneath the wrongheaded notion that all patents should
be treated equally.
There is a glimmer of hope. The Supreme Court will
hear eBay v. MercExchange, in which eBay faces the threat of an injunction
from MercExchange, a patent-holding company without a competitive product in
the online auction space. The eBay case is an opportunity for the highest
court to take the judiciary back to the language of the patent statute and
remind judges that they don't have to grant injunctions in every patent
case. Judges have the right to balance the interests of patent plaintiffs
with those of the defendant, and society at large. It may be with just a
touch of irony that we'll read about the eBay case on our now more costly
BlackBerries.
When do contingencies become liabilities and when should they be booked?
From The Wall Street Journal Accounting Weekly Review on August 25,
2005
TITLE: Merck Loss Jolts Drug Giant, Industry: In Landmark Vioxx Case, Jury
Tuned Out Science, Explored Coverup Angle REPORTER: Heather Won Tesoriero, Ilan Brat, Gary McWilliams, and Barbara
Martinez DATE: Aug 22, 2005 PAGE: A1 LINK:
http://online.wsj.com/article/0,,SB112447069284018316,00.html TOPICS: Contingent Liabilities, Disclosure, Accounting, Disclosure Requirements
SUMMARY: Merck lost its first case defending against a claim of death
stemming from the drug Vioxx. The company faces thousands of lawsuits over Vioxx
following the drug's removal from the market, but many observers had felt the
company had an ironclad defense in this one because the patient's cause of death
was not a risk identified in the drug's clinical trials. The primary article
describes the process of the lawsuit while the related articles post two
viewpoints on investment in the company's stock. (The first of those uses the
term "Stock Dividend" in its title when the author actually is referring to a
cash dividend.) Questions also ask students to examine Merck's most recent
quarterly filing for disclosures about the litigation.
QUESTIONS: 1.) Access Merck's most recent 10-Q filing with the SEC. You may do so through
the on-line version of this article by clicking on Merck & Co. under Companies
in the right hand side of the page, then clicking on SEC Filings under Web
Resources on the left hand side of the page, then choosing the 10-Q filed on
8/8/2005. Find all disclosures related to the recall of Vioxx and summarize the
various financial implications of this drug's withdrawal.
2.) What costs were recorded when the company issued the Vioxx recall?
Prepare summary journal entries based on the information in the financial
statement disclosures.
3.) What information is disclosed about the Ernst case on which the main
article reports? What accounting standard promulgates required accounting for
litigation cases such as these that Merck faces?
4.) Based on their disclosure as of the 8/8/2005 filing date, what do you
think was the company's assessment of the potential outcome of this case?
Support your answer with reference to the accounting standard identified in
answer to question 3 above.
5.) Based on the discussion in the end of the first related article, how are
analysts using the information in Merck's footnote disclosures? What do they
estimate from that information?
6.) Compare the arguments made in the two related articles about the
desirability of holding Merck stock at this point. Which argument do you
believe? Support your answer.
7.) What is incorrect about the use of the term "stock dividend" in the title
of the first related article?
Reviewed By: Judy Beckman, University of Rhode Island
We have posted the Deloitte
Letter of Comment on Proposed Amendments to IAS 37 Provisions,
Contingent Liabilities and Contingent Assets (PDF 47k). On 30 June 2005, the
IASB proposed to amend IAS 37 (and to retitle it Non-financial Liabilities)
and complementary limited amendments to IAS 19 Employee Benefits. The
amendments to IAS 37 would change the conceptual approach to recognising
non-financial liabilities by requiring recognition of all obligations that
meet the definition of a liability in the IASB’s Framework, unless they
cannot be measured reliably. Uncertainty about the amount or timing of
settlement would be reflected in measuring the liability instead of (as is
currently required) affecting whether it is recognised.
Our response states:
With the exception of the proposals for
restructuring provisions, we do not support the ED, which we see as
largely unnecessary. In our view, the majority of the Board's proposals
are premature and pre-judge matters that should be discussed in the
context of the review of the IASB Framework rather than as an amendment
of IAS 37. We think that IAS 37 is operating satisfactorily within the
current operating model and environment. In addition, we do not think
that the Board's choice of a single measurement attribute is
appropriate. As such, we find the majority of the changes proposed in
the ED fail to achieve an improvement in financial reporting.
What lies below the surface of the financial reporting icebergs?
The giant portion of the bulk of value (or negative value in the case of huge pending
liabilities) lies in intangibles such as intellectual property assets and liabilities,
human resource assets and liabilities (including unions who are militant in negotiating
higher benefits every time the company has some success, items valued at virtually zero on
the balance sheet (including in-process R&D, patents, copyrights, trademarks,
franchise rights, etc.)
The knowledge capital estimates that Lev and
Bothwell came up with during their run last fall of some 90 leading companies (see
accompanying table) were absolutely huge.
Microsoft,
for example, boasted a number of $211 billion, while
Intel,
General
Electric and
Merck
weighed in with $170 billion, $112 billion and $110 billion, respectively.
Market share momentum and trend, especially in terms of "rival
assets.". For example, the huge market share of Microsoft Office products makes
it extremely expensive for customers to change. For example, think of the retraining
that would have to take place if Trinity University ordered abandonment of Microsoft
Office products presently used by literally all departments on campus. The American
Airlines Sabre system has the major market share in terms of worldwide databases for
airline ticketing on the major airlines of the world. Lev reports that the SABRE
system accounts for far more market value than all of AMR Corporations other assets.
.In October 1996, AMR Corp. sold 18% of its
computer-reservations system, called SABRE, to the public. It held on to the remaining
82%. That one transaction provides a beautiful way of evaluating tangible and intangible
assets. When I recently checked the market, SABRE constituted 50% of AMR's value. This is
mind-boggling! You have one of the largest airlines in the world, with roughly 700 jets in
its fleet, nearly 100,000 employees, and exclusive and valuable landing rights in the
world's most heavily trafficked airports. On the other hand, you have a
computer-reservation system. It's a good system that's used by a lot of people, but it's
just a computer system nonetheless. And this system is valued as much as the entire
airline. Now, what makes this asset -- the computer system -- so valuable?
One big difference is that when you're dealing with tangible assets, your
ability to leverage them -- to get additional business or value out of them -- is limited.
You can't use the same airplane on five different routes at the same time. You can't put
the same crew on five different routes at the same time. And the same goes for the
financial investment that you've made in the airplane.
But there's no limit to the number of people who can use AMR
Corp.'s SABRE system at once: It works as well with 5 million people as it does with 1
million people. The only limit to your ability to leverage a knowledge asset is the size
of the market.
Economists call physical assets "rival assets" --
meaning that users act as rivals for the specific use of an asset. With an airplane,
you've got to decide which route it's going to take. But knowledge assets aren't rivals.
Choosing isn't necessary. You can apply them in more than one place at the same time. In
fact, with many knowledge assets, the more places in which you apply them, the larger the
return. With many knowledge assets, you get what economists call "increasing returns
to scale." That's one key to intangible assets: The larger the network of users, the
greater the benefit to everyone.
Purchase commitments that are not valued on the balance sheet. Sometimes these are
enormous in terms of contract value. However, long-term purchase commitments can
often be broken for damages amounts far below the contracted values (because the damages
from breach of contract may be very small on very long term contracts).
OBSF items that firms are still able to scheme through clever contract
terminologies. These include employee compensation that is not booked.
Contingency claims may be gigantic relative to booked debt. Even if a company has
a good defense against lawsuits, the frequency of lawsuits may drown it in litigation
costs such as the litigation costs of tobacco companies and pharmaceutical producers.
On August 28, 2002, the FASB met with representatives from the Financial
Valuation Group and the Phillips-Hitchner firm to discuss valuation of
intangible assets. See our news item for access to their presentation. More
details in our full news item at
http://accountingeducation.com/news/news3225.html
Companies will have to place intangible assets, such as customer lists and
customer back orders, in their financial statements, under proposals released
last week by the International Accounting Standards Board ---
http://www.smartpros.com/x36285.xml
Question What is cookie jar accounting and why is it generally a bad thing in financial
reporting?
Answer Cookie jar is more formally known as earnings reserve accounting where
management manipulates the timings of earnings and expenses usually to smooth
reported earnings and prevent shocks up and down in the perceived stability of
the company. European companies in the past notoriously put deferred earnings in
"cookie jars" so as to picture themselves as solid by covering bad times with
deferrals out of the cookie jar that mitigate the bad news and vice versa for
good times. The problem with too much in the way of a good time (in terms of
financial reporting) is that accelerated growth rates in one year cannot
generally be maintained every year and it may be a bad thing, in the eyes of
management, to have investors expecting high rates of growth in revenues and
earnings every year.
What's wrong with cookie jar reporting is that it allows management wide
latitude in discretionary reporting that is a major concern to both investors
and standard setters. Accounting reports become obsolete when they mix stale
cookies from the cookie jar with fresh sweets and lemon balls of the current
period.
You can read more about FAS 106 at
http://www.fasb.org/st/index.shtml Scroll down to FAS 106 on "Employers' Accounting for Postretirement Benefits
Other Than Pensions"
Teaching Case on the Allowance for Doubtful Accounts accrual accounting
(under the Matching Concept) Versus
the Cooke Jar Accounts accounting (under the Profit Smoothing Concept)
Either the banks are illegally using the Allowance for Doubtful Accounts
ledger inappropriately as cookie jar reserves or there is something that I'm not
aware of that suddently allows USA banks to use cookie jar accounts apart from
accounting rules and regulations for other companies.
The Allowance for Doubtful Accounts ledger accounts were never intended to be
cookie jar income smoothing accounts.
The bottom line is that I do not understand the article below by Michael
Rapaport.
Teaching Case From The Wall Street Journal Weekly Accounting
Review on September 28, 2018
TOPICS: Allowance For Doubtful Accounts, Bad Debts, Banking,
Earnings Management, FASB
SUMMARY: The article focuses on bank loan loss reserves, but the
parallel to income effects from any reduction in bad debt provisions can be
highlighted to students. At the end of the article, the FASB's proposed
changes to an impairment model for loan losses-looking to future
expectations of realizable cash flows rather than only past collectability
of receivables-is discussed.
CLASSROOM APPLICATION: The article may be used to cover banking or
any loan loss allowance. It also may be used to cover the FASB/IASB project
on Financial Instruments--Credit Losses.
QUESTIONS:
1. (Introductory) What area of bank reporting has the Wall Street
Journal analyzed for this article? How are bank regulators also looking at
this issue?
2. (Advanced) What are loan loss reserves? What alternate term does
the accounting profession use in place of "reserves"? In your answer,
contrast this term with the word "provision."
3. (Advanced) Summarize the accounting for allowance for
uncollectable accounts. How is an allowance for uncollectable accounts (or
allowance for bad loans or receivables) established? What happens when an
uncollectable account is written off?
4. (Advanced) What happens when an allowance for uncollectable
accounts is reduced because of improving economic conditions leading to
better collectability of receivables? Specifically address the statement in
the article that "accounting rules allow the money to flow directly into
profits."
5. (Introductory) What is the concern with the timing of banks
improving profits with the "release" or reduction in allowances for
uncollectable loans?
6. (Advanced) "Bankers say current accounting rules essentially
compel them to release reserves when loan losses ease..." Explain this
statement.
8. (Advanced) Again return to the FASB proposed ASU. How does an
impairment model consider future cash flows better than traditional methods
of establishing an allowance for uncollectable accounts? To answer, describe
the process of determining an impairment of an asset and compare to the
description you wrote in answer to question 3 above.
Reviewed By: Judy Beckman, University of Rhode Island
Federal regulators have warned banks to be careful
about padding their profits with money set aside to cover bad loans. But
some of the nation's biggest banks did more of it in the third quarter than
earlier this year.
J.P. Morgan Chase JPM -2.02% & Co., Wells Fargo WFC
-0.95% & Co., Bank of America Corp. BAC -1.41% and Citigroup Inc., C -2.21%
the nation's largest banks by assets, tapped a total of $4.9 billion in
loan-loss reserves in the third quarter, up by about a third from both the
second quarter and the year-ago quarter after adjustments. All the banks
except Citigroup showed significant increases compared with the second
quarter.
Accounting rules allow the money to flow directly
into profits. In all, it made up 18% of the banks' third-quarter pretax
income excluding special items, the highest percentage in a year, according
to an analysis by The Wall Street Journal.
The moves come at a time when banks are being
slammed by revenue slowdowns. Big commercial banks have suffered from a
double whammy of plunging mortgage lending and trading activity.
Third-quarter revenue for the four banks dropped an average of 8% from the
previous quarter. The KBW Bank Index has declined 2% in the past three
months, while the S&P 500 stock index has gained 4% over the same period.
The accounting maneuvers show how banks can prop up
earnings when business hits a rough patch.
"You've seen reserve releases improve the stated
numbers," said Justin Fuller, a Fitch Ratings analyst. "Going forward, I
think there's fewer levers to pull for the banks."
Investment banks are feeling the squeeze as well.
Goldman Sachs Group Inc. cut the funds it set aside for compensation in the
third quarter, a move that bolstered its results in the face of a 20%
revenue decline from the same quarter a year earlier.
Such moves are "very emblematic of what's going
on," said Charles Peabody, partner in charge of research at Portales
Partners LLC, a financial-services research firm. The degree to which the
banks' earnings rely on loan-loss reserves "exposes the lack of growth" in
their traditional businesses, he said.
The banks justify the releases. They cite
improvements in credit quality and economic conditions—which make it less
necessary for them to hold large amounts of reserves as a cushion against
loans that go sour—and they say they are following accounting rules that
require them to release funds as losses ease.
A Bank of America spokesman said "the significant
impact in credit quality we've seen in the last 12 months" has driven the
reserve releases. J.P. Morgan, Wells Fargo and Citigroup all pointed to
previous comments their top executives recently made indicating that reserve
releases were merited because of factors like improving credit quality and
the recent increase in housing prices.
But the Office of the Comptroller of the Currency,
which regulates nationally chartered banks and federal savings associations,
is reiterating warnings to banks about overdoing it.
In a statement to the Journal, Comptroller Thomas
Curry said the OCC is monitoring banks' loan-loss allowances "very closely"
and that "we continue to caution banks not to move too quickly to reduce
reserves or become too dependent on these unsustainable releases." He didn't
comment specifically on the banks' third-quarter releases, but said OCC
examiners "will continue to challenge allowances on a bank-by-bank basis if
necessary."
If the regulator finds problems with a bank's
reserves, it can issue a "matter requiring attention," a specific finding of
a deficiency that a bank must address, an OCC spokesman said. The agency has
thousands of such findings outstanding on a variety of subjects, but the OCC
spokesman wouldn't say how many, if any, were related to banks' reserve
releases.
Mr. Curry has been vocal on the issue for more than
a year. In September 2012, he called it a "matter of great concern," warning
banks that "too much of the increase in reported profits is being driven by
loan-loss-reserve releases."
Last month, Mr. Curry said in a speech that when
economic growth is slow, as it is now, banks might take more risks to
maximize their returns, and so it is "particularly important" they maintain
appropriate reserves. While some level of reserve releases is "certainly
warranted," he said, the ease of boosting earnings through the practice "has
proved habit-forming" at some banks, though he didn't single out any
specific institutions.
Mr. Curry said his previous concerns initially
seemed to get banks' attention, and reserve releases temporarily eased, but
that was "an anomaly." Since then, he said, the releases have increased
again, despite "loosening credit underwriting standards" that suggest banks
are facing higher risks.
The OCC isn't alone in its concern. Last year,
Federal Deposit Insurance Corp. Chairman Martin Gruenberg said the trend of
earnings driven by lower loan-loss provisions "cannot go on forever." An
FDIC spokesman said Friday, "We will continue to evaluate and confirm the
ongoing adequacy of reserves during our regular examinations."
Other banks are releasing reserves, as well, though
the amounts drop off drastically below the top four. In the second quarter,
the most-recent period for which industrywide figures are available, nearly
40% of all FDIC-insured banks released reserves, according to the FDIC. As
of June 30, the industry's bad-loan reserves had fallen to their lowest
level as a percentage of total loans since before the financial crisis
began, according to FDIC data.
J.P. Morgan released $1.8 billion in the third
quarter, including $1.6 billion from its consumer and community banking
unit, accounting for 19% of its pretax income after the bank's giant
litigation expenses in the quarter are excluded. That is higher than in
recent quarters, though the bank's nonperforming assets have declined 18%
over the past year, helping to justify a larger release.
Bank of America released $1.4 billion, comprising
29% of pretax income, and Wells released $900 million, or 11% of pretax
income, its biggest release in more than two years. Citigroup released $778
million, down slightly from the second quarter, and the release amounted to
18% of pretax income. At all three, the percentage of pretax income was up
from the second quarter, and nonperforming assets have fallen at all four
banks at least 18% compared with a year ago.
Continued in article
Jensen Comment
This teaching case will be very confusing to accounting students learning
from traditional textbooks. In those textbooks the Allowance for Doubtful
Accountants ledger account has nothing to do with cash in reserve funds,
cookie jar accounting, or profits smoothing funds. The Allowance for
Doubtful Accounts is simply a contra account to receivables assets in the
accrual system that forces companies to currently expense the portion of
receivables that is estimated will not be collected. It is a way to
anticipate bad debt losses that are anticipated will not be collected. Bad
debt losses are not to be estimated in advance only when there is no
reliable statistical basis for estimating them in advance such as when a
company has only a few customers (like Boeing) as opposed to millions of
customers (like Sears). Sears can statistically estimate with great accuracy
what portions of credit sales this year will not be collected in later
years.
The key issue that will be confusing to students is what triggers a
debit (reduction) in the Allowance for Doubtful Accounts ledger account.
Our USA textbooks teach that this Allowance for Doubtful Accounts ledger
account deibt (reduction) comes when an account is ultimately written off as
a bad debt. The expense for this was estimated in an earlier year of a sale
under the Matching Concept that tries to match expenses in the same year
that those expenses are associated with the revenues they helped generate.
Hence current revenues and profits are not reduced due to bad debt write
offs from sales made on account in prior years.
Cookie Jar Reserve Funds for Income Smoothing Rather Than Bad Debt
Accruals
One difference in the past between USA accounting and European accounting
(especially in Switzerland) was that USA GAAP discouraged having rainy day
"cookie jar" reserve accounts that were set up to smooth profits rather than
merely satisfy better matching of revenues and expenses under the matching
concept.
Bob Jensen's thread on Cookie Jar Accounting at
http://faculty.trinity.edu/rjensen/Theory01.htm#CookieJar
Question
What is cookie jar accounting and why is it generally a bad thing in
financial reporting?
Answer
Cookie jar is more formally known as earnings reserve accounting where
management manipulates the timings of earnings and expenses usually to
smooth reported earnings and prevent shocks up and down in the perceived
stability of the company. European companies in the past notoriously put
deferred earnings in "cookie jars" so as to picture themselves as solid
by covering bad times with deferrals out of the cookie jar that mitigate
the bad news and vice versa for good times. The problem with too much in
the way of a good time (in terms of financial reporting) is that
accelerated growth rates in one year cannot generally be maintained
every year and it may be a bad thing, in the eyes of management, to have
investors expecting high rates of growth in revenues and earnings every
year.
What's wrong with cookie jar reporting is that
it allows management wide latitude in discretionary reporting that is a
major concern to both investors and standard setters. Accounting reports
become obsolete when they mix stale cookies from the cookie jar with
fresh sweets and lemon balls of the current period.
You can read more about FAS 106 at
http://www.fasb.org/st/index.shtml
Scroll down to FAS 106 on "Employers' Accounting
for Postretirement Benefits Other Than Pensions"
Federal regulators have warned banks to be careful
about padding their profits with money set aside to cover bad loans.
But some of the nation's biggest banks did more of it in the third quarter
than earlier this year.
Jensen Comment
Firstly, in USA textbooks we teach that money (cash) is not usually set aside
for the Allowance for Doubtful Accounts. Presumably cash could be set aside that
is earmarked for future bad debts, but this result in the opportunity loss on
what that cash could earn when invested in more profitable operations rather
than being stored in a savings account.
J.P. Morgan Chase JPM -2.02% & Co., Wells Fargo WFC
-0.95% & Co., Bank of America Corp. BAC -1.41% and Citigroup Inc., C -2.21%
the nation's largest banks by assets, tapped a total of $4.9 billion in
loan-loss reserves in the third quarter, up by about a third from both the
second quarter and the year-ago quarter after adjustments. All the banks
except Citigroup showed significant increases compared with the second
quarter.
Accounting rules allow the money to flow directly
into profits. In all, it made up 18% of the banks' third-quarter pretax
income excluding special items, the highest percentage in a year, according
to an analysis by The Wall Street Journal.
Jensen Comment
In USA textbooks we teach that money does not flow directly into profits when
receivables are declared bad debts and written off against the Allowance for
Doubtful Accounts contra account. Firstly, there's usually no cash that's been
set aside for such purposes. Secondly, the bad debt expense was estimated and
written off earlier in the year that the loans were made so that profits were
not overstated in those earlier years.
It would be a violation of USA GAAP if a bank used the Allowance for Doubtful
Account reduction for anything other than a legitimate admission that a
receivable must be at last deemed as uncollectable. It is the uncollectablity of
the account that triggers the write down of the Alllowance for Doubtful
Accounts. This contra account should never be a cookie jar account for the
purpose of smoothing profits independently of actually writing off of
uncollectable accounts.
Either the banks are illegally using the Allowance for
Doubtful Accounts ledger inappropriately as cookie jar reserves or there is
something that I'm not aware of that allows USA banks to use cookie jar accounts
apart from accounting rules and regulations for other companies.
Didn't Fair Value Accounting for Financial Instruments Eliminate the
Matching Concept and the Allowance for Doubtful Accounts?
Yes and no.
If JP Morgan bought $10 million worth of Greek bonds, USA GAAP dictates that the
value of those bonds should be written up and down for their estimated value in
the financial markets. (Rules for this have recently changed, but I will not go
into all of that here.)
But if Sears has 25 million accounts receivable on the books, including the
account of Bob Jensen, it is beyond comprehension that Sears will will track the
current fair value of the $29.18 that Bob Jensen currently owes Sears or the
current fair value of each of the other tens of millions accounts receivable.
Instead Sears with set up an aging schedule for the millions of active
accounts and estimate what portions of all accounts in each age class will
eventually be written off as bad debts. Then in the year of sale those estimates
will be expensed and credited to an Allowance for Doubtful Accounts ledger
account under the Matching Concept just as literally all the USA accounting
textbooks have explained for decades.
Similarly, JP Morgan and other large banks will use fair value accounting for
large-account financial instruments but will not use fair value accounting for
33 million small loans of under $500 to customers. Thus even though fair value
theorists would like to kill and bury the Matching Concept, this concept is
alive and well due to the total impracticality of tracking fair values of
millions and millions of small accounts receivable and small loans by banks.
But the Allowance for Doubtful Accounts ledger accounts were never intended
to be cookie jar income smoothing accounts.
The bottom line is that I do not understand the article above by Michael
Rapaport.
Governments around the world are taking bold steps
to minimize the likelihood of another catastrophic financial crisis.
Regulators and financial institutions already have their hands full, so the
bar for adding anything to the agenda should be high.
However, one relatively simple but critically
important item should move to the top of the list: reforming the accounting
rules that inexplicably prevent banks from establishing reasonable loan-loss
reserves. If reserve rules had been written correctly before 2008, banks
could have absorbed bad loans more easily, and the financial crisis probably
would have been less severe. It is now time, before the next crisis, to
recognize that reality.
Loan-loss reserves get far less attention than
capital or liquidity requirements, which are subject to specific government
regulations. Nevertheless, the "Allowance for Loan and Lease Losses" should
be an essential part of assessing the safety and soundness of any bank. The
ALLL—not Tier 1 capital or even cash-on-hand—is the most direct way a bank
recognizes that lending, including necessary and constructive lending,
entails risk. Those risks should be recognized in both accounting and tax
practices as a reasonable cost of the banking business.
However, banks are now only allowed to build their
loan-loss reserves according to strict accounting conventions, enforced by
the Securities and Exchange Commission. Reserves have to be based on losses
that are strictly "incurred," in effect shortly before a bad loan is written
off. Bankers have been prohibited from establishing reserves based on their
own expectations of future losses.
The practical result is that in good times real
earnings are overrated. Conversely, the full impact of loan losses on
earnings and capital is concentrated in times of cyclical strain.
Why have accounting conventions created this
perverse result? Some accountants claim that giving banks flexibility with
their reserves is bad because it lets bankers "manage earnings"—that is, to
raise or lower results from quarter to quarter to look better in investors'
eyes. This is a weak argument, because the ALLL reflects a banking reality,
and the allowance itself is completely transparent.
No one is misled when sufficient disclosures exist.
The size of the bank's reserve cushion will be on the balance sheet, and it
would need to be recognized as reasonable by auditors, supervisors and tax
authorities. Importantly, from a financial policy point of view, reserves
will tend to be countercyclical, likely to discourage aggressive lending
into "bubbles" but helping to absorb losses in times of trouble.
Capital is vital to the safety and soundness of
banks. It is the ultimate and necessary protection against insolvency and
failure. However, permitting a more flexible allowance for loan-loss
reserve, an approach that gives banks and prudential regulators the right to
exercise reasonable discretion to build a more flexible cushion in case of
loss, is a must. Accounting rules need to change to permit this to happen.
Mr. Ludwig, the CEO of Promontory Financial Group, was Comptroller of
the Currency from 1993 to 1998. Mr. Volcker, former chairman of the Federal
Reserve System, is professor emeritus of international economic policy at
Princeton University.
JPMorgan Chase holds $3 billion of
“model-uncertainty reserves” to cover mishaps caused by quants who have
been too clever by half. If you can make provisions for bad loans, why
not bad maths too?
And in response to this revelation, Francine
McKenna wondered how the auditors could have signed-off on
the models:
If you need $3 billion of “model reserves” how
[does] PwC attest to [the] models underlying valuations, estimates and
reserves?
It’s worth noting that these model-uncertainty
reserves not only comply with GAAP, but are mandated by it. So in response
to Ms. McKenna’s concern, there is in fact a “GAAP for that.”
FAS 157 Par. C16: This Statement clarifies that
the measurements should be adjusted for risk, that is, the amount market
participants would demand because of the risk (uncertainty) inherent
in a particular valuation technique used to measure fair value (such as
a pricing model) and/or the risk inherent in the inputs to the
valuation technique (a risk premium notion). Accordingly, a measurement
(for example, a “mark-to-model” measurement) that does not include an
adjustment for risk would not represent a fair value measurement if
market participants would include one in pricing the related asset or
liability. [Emphasis mine.]
OK, so now we understand why banks have to
measure model risk, but how do you do it? Well, if you’re being
honest, you don’t. Model risk is impossible to measure. Here’s why.
Pricing Models as Interpolation
First, it’s important to understand what a pricing
model is and why they are used. Pricing models are used for two purposes:
valuation (that is, to come up with fair values for instruments that do not
have directly observed prices—e.g. OTC derivatives) and risk management
(that is, to measure the sensitivities of instruments to particular risks
for the purpose of managing an overall book). Let’s put aside for now the
risk management purpose and focus on the valuation.
The majority of OTC positions are not
“marked-to-model” in any meaningful sense of that term. Yes, there are
pricing models used to value them, but they’re not the scary kind of marks
that skeptics rightly call “mark-to-make-believe.” Most of the time, the
pricing model is simply a fancy (and sometimes expensive) tool to
interpolate between observed market prices.
Let’s say I have an interest rate swap. I can
observe the market prices (rates of various maturities) and as long as my
swap is within the range of my observations, then my pricing model is
calibrated to market. The only modeling I’ve done is to build a rate curve
based on observed inputs and used this curve to discount the contractual
cash flows of the swap. This is simply a robust way to interpolate the
value of my swap from observed quotes on similar instruments (i.e. other
swaps). Now this is obviously a very simple example, but this
model-as-interpolation view can also be said of more complicated, but
traded, instruments like synthetic index CDOs.
What’s this have to do with model risk? When models
are calibrated to observed market prices, and hence where the model is used
an interpolation tool, the model risk is (pretty much) already captured by
the model. This is true even if the model is “wrong”. If the model
calibrates to market, it already reflects the market’s view of the model
risk—at least with respect to the observed instruments to which it’s
calibrated. I should add that even if you’re interpolating between observed
prices, you might have residual model risk—how much residual risk (which
could be significant) depends on the granularity of observed data, among
other things.
True Mark-to-Model Positions and Why Model Risk
is Immeasurable
But wait. If most positions are marked to
prices interpolated between observed quotes, what about the rest? Here’s
where we get into the true mark-to-model issues, and where model risk is
most prevalent. Thankfully, these are easy enough to identify on a balance
sheet. They are anything noted as a “level 3” fair value measure—i.e.
instruments where the value significantly depends on the model itself and on
the unobservable inputs or parameters thereto. Think of a CDO-squared or a
bespoke synthetic CDO.
I promised I’d get to the point about the
impossibility of measuring model risk, so here it is:
<!--[if !supportLists]-->Model risk is the
risk that you’re using the wrong model.
<!--[if !supportLists]--><!--[endif]-->The
space of possible models is infinite. That is, there are an infinite
number of models to choose from, including those not yet discovered.
<!--[if !supportLists]-->No one knows what the
right model is. If you knew which model was the right one, you’d
already be using it. Even if most market participants agree on a model
today, they might discover a better model tomorrow, or simply decide
that no model is sufficient to assess the risks (this has happened).
<!--[if !supportLists]-->Judgments about the
amount of model risk are necessarily qualitative. The best I could hope
for would be to say that this model feels more certain than that
one.
<!--[if !supportLists]--><!--[endif]-->Model
risk is recursive. Even if I could quantify the level of model risk,
what model would I use to measure the impact of that model risk on fair
value? Where are the models of model risk? Even if they existed, those
model risk models have model risk, no?
That $3B Model-Uncertainty Reserve
If model risk is immeasurable, where did JPMorgan’s
$3B come from and what does it mean? As to where it came from, I don’t know
the specifics, but I suspect they’ve either: (a) shocked the unobservable
model inputs by some arbitrary amount and taken the worst of the lot or (b)
run some “shadow models” (i.e. run the same positions through multiple known
models) and taken the worst of the lot. Either way, the result is
arbitrary. So as to what it means: not much. At best, it gives us some
insight into the subjective judgments of JPMorgan management with respect to
the quality of their models. So yeah, not much at all.
Bob Jensen's threads on cookie jar accounting are at See below
As to the cookie jar question, I think it reduces to an issue of
whether the bad quant reserves are used primarily to smooth income in the
same sense as cookie jar reserves are traditionally used to smooth income.
Or are the bad quant reserves more like bad debt reserves that are used for
better matching under the matching concept where timing of cost write offs
better matches revenues with expenses incurred to generate those revenues.
To me, the Allowance for Bad Quants seems to me to be a bit more
like the Allowance for Bad Debts, but I’ve not really taken time to study
this question in detail.
A great example of cookie jar accounting, aside from the classic examples
allowed in Switzerland, is Tom Selling’s General Motors example --- See below
Note: This post was
published about 12 hours prior to
publication of Justin Hyde's
article on the same topic in the
Detroit Free Press. Justin was the one
who brought the topic to my attention,
and I made the decision to write this
post after a conversation with him. I
thank him for allowing me to go ahead
with publication, even though his own
article would be appearing later.
In an earlier
post,
I
expressed my strong suspicion that top
managers at General Motors were
utilizing big bath accounting. By 'big
bath', I mean a violation of GAAP that
permits delayed recognition of
relatively small losses over time, so as
to recognize the whole enchilada in some
later period. For some reason that
others may wish to ponder, managers
prefer the big bang to the accounting
equivalent of death by a thousand cuts.
In GM's case, they appear to have
improperly delayed as much as $11
billion in writedowns of their deferred
tax assets.
Now comes another enormous red flag out
of GM's public disclosures. In fact,
the numbers -- in the neighborhood of
$50 billion -- make the big bath look
like a glass of water. This new one is
of the 'cookie jar' variety: the
improper deferral of a gain so as to
spread its sweet goodness to the benefit
of many subsequent accounting periods.
But, sad to say, this tale has another
annoying twist: if GM doesn't get SEC
approval for the accounting they are
aiming for, they can -- for no other
good reason -- opt out of their
recent milestone agreement with the
United Auto Workers.
How this Opportunity for
Accounting Shenanigans Came to Be
Before I get into
the sordid details of the current
situation, some background information
may help. GM has an 'OPEB' ('Other
Post-Employment Benefit') liability on
its balance sheet that is somewhat north
of $50B. It represents the present
value of estimated future payments to
employees as reimbursement of health
care costs during their retirement
years. In all, the plans cover about
500,000 current and retired employees. I
have read that the expected future
payments add about $1,600 to GM's
per-vehicle cost, which is about eight
times the cost incurred by foreign
competitors (who benefit from more
generous state-sponsored health care
programs). Note 15 to the financial
statements in
GM's 2007 10-K
indicate that they spent in the
neighborhood of $6 billion on retiree
health care costs in that year.
Yuck. How did GM let itself get eaten
alive by an OPEB in the first place?
The story starts with accounting
standards -- or more accurately, the
appalling lack thereof. FAS 106, though
significantly flawed, filled a gap in
GAAP, but it was birthed only in 1990 --
long after the horses galloped through
the open barn door. My recollection
from reading the financial press in the
years just preceding is that corporate
America was already buried under
approximately $1trillion in off-balance
sheet liabilities relating to retiree
health care costs. Why did management
keep them off-balance sheet? Because
they could. Why did managers let the
liabilities get to be so humongous?
Because they were off-balance sheet.
Let me explain. When negotiating with
unions, companies could either grant
wage rate increases that would affect
the bottom line starting at Day 1, or provide deferred compensation
that would not hit the income statement
for decades. Such was the case with
retiree health care benefits prior to
FAS 106. The "generally accepted"
accounting prior to then was "pay as you
go." In other words, you expensed only
that portion paid out to employees and
their health care providers. Actual
payments (and thus, expenses) at the
outset were low because so few of the
employees to whom benefits were promised
were old enough to begin receiving
them. By the time FAS 106 came to
require accrual of benefits as the
employees earned them, the unionized
rust belt was already awash in unfunded,
gold-plated retiree health care plans.
To make matters worse, health care costs
looked like they might increase faster
than inflation forever.
Back to Now
Late last year, GM and the UAW entered
into a compromise ('Settlement
Agreement') whereby GM gave its
commitment (albeit with an escape clause
I shall address anon) to pre-fund, in
2010, its $50 billion accumulated
retiree health care obligation. In
exchange, GM would be relieved of any
future obligation to make payments, except for funding annual plan
shortfalls up to a paltry $165 million
per year for the next 20 years. (The
UAW thinks that GM's money should last
them 80 years, but that's another
story.)
$165 million? What's up with that? The
numbers I gave you earlier make it
abundantly clear that it's but a drop in
the bucket compared to the expected plan
costs and the number of employees in the
plan. If we assume that expenditures
are the current amounts paid by GM and
ignore inflation, $165 million amounts
to about 10 days worth of coverage. If
we further assume that there are about 1
million beneficiaries (retirees plus
spouses), that's a safety net of only
$165 per beneficiary. That would be like
a safety net made of thin-sliced swiss
cheese.
As to the real purpose of the $165
million, it's much akin to a fly on a
cow's hindquarter: maybe just enough to
get the 'right' accounting -- or to get
the cow toswish her tail. The 'right'
accounting for GM is "negative plan
amendment" treatment under FAS 106, or
else they're gonna pick up their marbles
and go home.
And just what is negative plan amendment
accounting? It's a cookie jar reserve.
Basically, the accounting treatment of
transactions of this ilk boil down to
three possibilities:
Settlement: The
liability would be taken off the
books, and a gain (around $50
billion) would be recorded in 2010
when the settlement occurs. The
GM-UAW agreement looks like a
settlement and quacks like a
settlement, but FAS 106 (para. 90)
defines a settlement as "...a
transaction that (a) is an
irrevocable action, (b) relieves the
employer ... of primary
responsibility ... and (c)
eliminates significant
[emphasis supplied] risks related to
the obligation and the assets used
to effect the settlement."
Thus, the result of settlement
accounting would be no cookie jar:
just a blob of earnings that can't
be used to juice any earnings-based
compensation of top management.
Negative plan amendment:
Even though a plan
amendment immediately affects the
calculation of the liability
recorded on the balance sheet, FAS
106 requires that it be deferred and
recognized over the time that
current employees become eligible
for retirement (para. 55). If
that amortization period is, say, 20
years, then negative plan amendment
accounting creates an earnings
cookie jar to be drawn on at the
rate of $2.5 billion per year.
Partial Settlement:GM
is insisting that the recognized
liability be written down to about
$1.5 billion, the present value of a
19-year annuity of $165 million per
year. It is conceivable that one
could find that GM is exposed to
more risk than that amount, and
that, therefore, the liability
should be higher.
Section 21 of the
Settlement Agreement (Exhibit 10(m) of
the 10-K), is where stated that GM can
hold up the agreement if they can't get
the liability on their balance sheet
down to $1.5 billion. Both settlement
and negative plan amendment accounting
will do that, and there is some chance
that the Settlement Agreement may
qualify for neither. That's the
scenario under which everybody has to
sit down and renegotiate. However, a
presentation
that GM gave to analysts reveals that
the brass ring is negative plan
amendment accounting. That's where the
measly $165 million comes in; it's
supposed to be just enough to be
considered "significant." They want the
SEC to say that because of it,
settlement accounting is not
appropriate, and that accounting as a
negative plan amendment is the result.
It's a ridiculous charade, well-hidden
by the following 10-K disclosure
appearing under the caption "Risk
Factors":
"We are relying on the
implementation of the Settlement
Agreement to make a significant
reduction in our OPEB liability.
Under certain circumstances,
however, it may not be possible to
implement the Settlement Agreement.
The implementation of the Settlement
Agreement is contingent on our
securing satisfactory accounting
treatment for our obligations to the
covered group for retiree medical
benefits, which we plan to discuss
with the staff of the SEC. If, based
on those discussions, we believe
that the accounting may be some
treatment other than settlement or a
substantive negative plan amendment
that would be reasonably
satisfactory to us, we will attempt
to restructure the Settlement
Agreement with the UAW to obtain
such accounting treatment, but if we
cannot accomplish such a
restructuring the Settlement
Agreement will terminate...."
I have a couple of things to say about
this disclosure:
First, the
possibility of not getting the
accounting treatment one wants is
not a risk factor. Risk factors
have to do with the possibility of
real losses; paper losses are just
that -- unless, perhaps, recognizing
a paper loss has an indirect real
effect like tripping a loan
covenant. In fact, the SEC has said
as much quite recently, and I wrote
about it
here.
I admit to not having read the 10-K
completely (I do have a life), but I
can't see that the accounting
treatment has any such indirect
effects. If there were any, that
surely is a substantive risk factor, and should have been
disclosed.
Second, what does Section 21 of the
Settlement Agreement and the risk
factor disclosure say to providers
of capital about the focus of GM's
management on the real business of
running a car company? Exactly
why is a particular accounting
result is so darn important that
they're willing to go back to the
table with the UAW in order to get
it? Everything else equal, you
gotta expect that in a renegotiation
GM will end up giving more to the
UAW; they will get nothing more in
return than a new "economic
substance" to run up the SEC's
flagpole.
When the ball is in the SEC's court,
what will they do with it? It
doesn't appear that anyone at the SEC
has lifted a finger to follow up on GM's
$11 billion big bath deferred tax asset
charge, and I don't expect they will.
My money says the fix is in for this
one, too. The only question is how
Chief Accountant Conrad Hewitt is going
to fall over himself to give GM the
negative plan amendment accounting they
crave, resulting in what may be the
largest legitimized accounting cookie
jar in history.
I've been blogging about financial
reporting for a little over six months
now, and so far I haven't had to overly
tax my brain to find something to write
about once or twice a week. For
whatever reason(s), there are many tales
of wealth destruction that begin with a
bad accounting rule. Vast destruction
of shareholder wealth ensues by the
deliberate actions of managers who
realize they can paper over their
self-serving behavior with rosy
short-term earnings reports. The
cases of retiree health care costs at
company's like GM are particularly
notable because it takes multiple
manager and employee turnovers spanning
decades to merely begin the process of
exterminating the termites eating away
at shareholder wealth and employee job
security.
The GM case is particularly emblematic
of corporate governance run amok because
the older generations of managers
skimmed accounting cream going into
questionable deals with unions when more
discipline was called for; now, the
latest generation is trying to do the
same on the back end. As they go about
their business of re-arranging the deck
chairs, current management seems to be
doing quite well for themselves. It is
even more certain that their scheming
progenitors have retired and shielded
themselves with ironclad contracts,
signed and sealed by board members who
effectively serve at the pleasure of the
CEO. Those managers became rich while
at the same time bequeathing their
legacy of unsustainable labor costs.
From The Wall Street Journal Accounting Weekly Review
on June 1, 2007
SUMMARY: FIN
48, entitled Accounting for Uncertainty in Income Taxes--An
Interpretation of FASB Statement No. 109, was issued in June
2006 with an effective date of fiscal years beginning after
December 15, 2006. As stated on the FASB's web site, "This
Interpretation prescribes a recognition threshold and
measurement attribute for the financial statement recognition
and measurement of a tax position taken or expected to be taken
in a tax return. This Interpretation also provides guidance on
derecognition, classification, interest and penalties,
accounting in interim periods, disclosure, and transition." See
the summary of this interpretation at
http://www.fasb.org/st/summary/finsum48.shtml As noted in
this article, "in the past, companies had to reveal little
information about transactions that could face some risk in an
audit by the IRS or other government entities." Further, some
concern about use of deferred tax liability accounts to create
so-called "cookie jar reserves" useful in smoothing income
contributed to development of this interpretation's recognition,
timing and disclosure requirements. The article highlights an
analysis of 361 companies by Credit Suisse Group to identify
those with the largest recorded liabilities as an indicator of
risk of future settlement with the IRS over disputed amounts.
One example given in this article is Merck's $2.3 billion
settlement with the IRS in February 2007 over a Bermuda tax
shelter; another is the same company's current dispute with
Canadian taxing authorities over transfer pricing. Financial
statement analysis procedures to compare the size of the
uncertain tax liability to other financial statement components
and follow up discussions with the companies showing the highest
uncertain tax positions also is described.
QUESTIONS:
1.) Summarize the requirements of Financial Interpretation No.
48, Accounting for Uncertainty in Income Taxes--An
Interpretation of FASB Statement No. 109 (FIN 48).
2.) In describing the FIN 48 requirements, the author of this
article states that "until now, there was generally no way to
know about" the accounting for reserves for uncertain tax
positions. Why is that the case?
3.) Some firms may develop "FIN 48 opinions" every time a tax
position is taken that could be questioned by the IRS or other
tax governing authority. Why might companies naturally want to
avoid having to document these positions very clearly in their
own records?
4.) Credit Suisse analysts note that the new FIN 48 disclosures
about unrecognized tax benefits provide investors with
information about risks companies are undertaking. Explain how
this information can be used for this purpose.
5.) How are the absolute amounts of unrecognized tax benefits
compared to other financial statement categories to provide a
better frame of reference for analysis? In your answer, propose
a financial statement ratio you feel is useful in assessing the
risk described in answer to question 4, and support your reasons
for calculating this amount.
6.) The amount of reserves recorded by Merck for unrecognized
tax benefits, tops the list from the analysis done by Credit
Suisse and the one done by Professors Blouin, Gleason, Mills and
Sikes. Based only on the descriptions given in the article, how
did the two analyses differ in their measurements? What do you
infer from the fact that Merck is at the top of both lists?
7.) Why are transfer prices among international operations
likely to develop into uncertain tax positions?
Reviewed By: Judy Beckman, University of Rhode Island
Another One from That Ketz Guy
"Deferred Income Taxes (Accounting) Should be Put to Rest," by J. Edward
Ketz , AccountingWeb, March 2010 ---
http://accounting.smartpros.com/x68912.xml
One of the silliest constructs in the world of
accounting happens to be deferred income taxes. I don't understand why we
bother with deferred tax liabilities and deferred tax assets because they
are neither liabilities nor assets. If the FASB and the IASB are serious
about principles-based accounting -- which I am becoming to believe is
rhetoric without referents -- then they would eliminate these bastard
accounts without delay.
Consider Procter & Gamble’s annual report for 2009,
for instance. They report deferred income tax assets (net) of $5.2 billion
and deferred income tax liabilities of $13.7 billion. But, are the former
really assets and the latter really debts?
The FASB defines liabilities as “probable future
sacrifices of economic benefits arising from present obligations of a
particular entity to transfer assets or provide services to other entities
in the future as a result of past transactions.” The IASB defines them
similarly as “a present obligation arising from a past event, the settlement
of which results in an outflow of resources embodying future economic
benefits.”
Suppose a business enterprise uses accelerated
depreciation for tax purposes and straight-line for financial reporting such
that depreciation for tax purposes amounts to $320,000 and for financial
purposes $200,000. There is a difference of $120,000 and, if we assume a tax
rate of 25%, this leads to an increase in deferred income taxes of $40,000.
But what is the nature of this $40,000?
This $40,000 is not a probable future sacrifice—the
sacrifice will be in the nature of future taxes paid to the U.S. and other
governments. At most, the $40,000 helps one better to predict future cash
flows for taxes. Yet that does not make this $40,000 a liability.
Even if it were a probable future sacrifice, there
is a bigger problem. This future sacrifice is not a present obligation of
the firm. The incremental tax becomes a “present obligation” only when the
next tax year rolls around. Taxes are statutory requirements that arise only
in the year they are imposed. Just because taxes are an unending penalty for
living in advanced societies doesn’t make any of them present obligations
today (the boulder pushed up the mountain by Sisyphus was actually his
income taxes).
Furthermore, these deferred income tax liabilities
are not a result of past transactions between the tax authority and the
taxpayer. We have the transaction when the taxpayer purchased the plant or
equipment and we have past tax transactions. But, it requires a lot of
imagination to think that any of these transactions give rise to some
present obligation.
If they were liabilities, one would expect them to
be discounted. All long-term obligations are measured at the present value
of their future cash flows, including mortgages and bonds and long-term
notes payable. I think the FASB does not require discounting of deferred tax
liabilities because it knows that fundamentally the numbers used in the
computation of deferred taxes are not cash flows. If they were, discounting
would be meaningful; as they aren’t cash flows, discounting only compounds
this monstrosity.
I view Procter & Gamble’s $13.7 billion of deferred
tax liabilities as not representing probable future sacrifices, nor present
obligations, and certainly not resulting from past transactions. Even if
they were, the number is vastly inflated because they are raw, undiscounted
numbers.
The FASB defines assets as “probable future
economic benefits obtained or controlled by a particular entity as a result
of past transactions or events.” The IASB’s definition is again quite
similar: an asset is “a resource controlled by the entity as a result of
past events and from which future economic benefits are expected to flow to
the entity.”
Suppose a firm has estimated warranty expense of $1
million but the tax expense is zero because nobody has filed a warranty
claim by year-end. The FASB asserts that there is a deferred tax asset of
$250,000 (assuming again the marginal tax rate is 25%) because these
represent future deductible amounts.
Note, however, they are not future economic
benefits yet if for no other reason, the government’s tax laws can change.
Even if they were, they are not the result of any past transactions or
event. Nobody has made a warranty claim; there has only been an adjusting
entry that the entity made within itself. It has not contracted or exchanged
anything involving these warranties. And not requiring any discounting is
again telling—there is no discounting because there is no event and no cash
flows.
A corporation must write down the supposed value of
the deferred tax asset if it is more likely than not that it will not
realize some of the asset. If this asset were real, where is the market
valuation (mark-to-model)? As firms cannot conduct such a valuation (even as
a Level 3 estimate per FAS 157), this valuation process is hollow.
I do not view Procter & Gamble’s deferred income
tax assets of $5.2 billion to be real. Just fluff and nonsense. And who
knows what P&G’s valuation allowance of $104 million means. It certainly
says nothing about valuation.
Probably the most illogical aspect of deferred
taxes occurs on the income statement. P&G determines for 2009 that earnings
from continuing operations before income taxes is $15.3 billion. Then it
records income tax expense of $4.0 billion. This close proximity gives the
reader the idea that there is a relationship between the two, but of course,
there is no association. The actual amounts owed to the IRS are computed on
taxable income, not on the financial reporting earnings before taxes.
Expenses are supposed to be sacrifices incurred
during the operating activities of the entity. Ok, the current portion of
the income tax expense is indeed a sacrifice. But, the deferred portion is
clearly not a sacrifice of any resources of the firm. That’s why firms
employ MACRS—they want to reduce their sacrifices to Uncle Sam.
P&G shows the current portion of income tax expense
in its tax footnote. The current portion is $3.4 billion and the deferred
portion is $0.6 billion.
I realize that academics have shown a statistical
association between market returns and deferred income taxes; however, they
usually overstate their conclusions. The correlation between market returns
and deferred income taxes merely indicates that market agents find the
disclosures useful in predicting future cash outflows to the IRS. This
statistical association doesn’t make these constructs assets or liabilities.
If the FASB wants to require these disclosures, it should require firms to
stick them in a footnote rather than contaminate the balance sheet with
their presence.
Analysts and researchers have an easy time dealing
with the problem of deferred income taxes, as the misinformation is in plain
view. We just eliminate the phony assets and liabilities from the balance
sheet and restate income tax expense to the current portion. Nevertheless,
the FASB and the IASB still should eliminate these deferred accounts and
clean up the balance sheet, especially if they are serious about
principles-based accounting. It makes the financial statements more
representationally faithful and thus more reliable.
This essay reflects the opinion of the author and not necessarily the
opinion of The Pennsylvania State University.
I have always found these discussions highly
superficial because they don't get down to the actual accounting involved.
"Cookie jar" reserves most commonly come from overly pessimistic valuation
judgments that management must make under GAAP. The classics are the
valuation reserves accounts receivable (allowance for doubtful accounts),
inventories (under the lower of cost of market rule), tax assets, and
warrantees. On other side are decisions when to recognize or defer revenues.
However, GAAP has guidelines for all these issues and auditors also have
guidelines they follow. Thus, the idea that managers have unlimited
discretion to put "cookies" in a "jar" is pure fiction. Also, if you want to
complain about "cookie jar reserves," then you should be talking about the
specific GAAP feature that allows them. These "hand waivy" discussions
accomplish nothing and indicate to me that the people writing them have
never actually thought deeply about the sources of these reserves and the
possible "fixes."
When I wrote my blog post on GM, I made a
distinction in my mind between "cookie jar reserves" and "rainy day
reserves." I realize that this is not the way that Arthur Levitt used the
term in his famous “Numbers Game” speech, but these are mere euphemisms, and
I thought the distinction was useful for the purpose of my post.
As to “unlimited discretion”, I don’t see how that
is a necessary condition for earnings management – it’s more a matter of
degree. As to the auditor’s role, let’s get real here; how much is D&T going
to push back against GM? I was at the SEC, and I actually do know how the
accounting can happen. Just like when ATT needed the SEC to bless their
pooling of interests accounting when they acquired NCR, even though it
couldn’t be shoe-horned into APB 16, D&T will be more than happy to let the
SEC decide whether GM can get the accounting they want.
As to tax and other reasons -- as I stated in my
post, if those were considerations they should have been disclosed in the
10-K as part of the relatively new Item 1A. (See Reg. S-K, Item 503(c)).
Your main objection to "cookie jar" (I prefer to
call it "piggy bank" accounting) seems to be that one can "manipulate"
income. Unfortunately, accounting period "income" is a fiction created by
accounting and economists.
Don't we, in our personal lives, put away something
for a rainy day and then dip into such "reserves" when the rainy day
arrives? What is wrong with it when the companies do the same thing, so long
as they are required to fund such reserves?
When reserve accounting is permitted, the income
reported is likely to reflect the long term prospects for the company, or a
sort of moving average of incomes over the planning horizon. In my humble
opinion that would be a far more accurate number for "income".
We accountants often think that the world exists to
satisfy our fetish for encapsulating all that happened during an "accounting
period" into one fictional number we call "income".
The deadly combination of the concepts of
"accounting period" and a fictional "income" that we have created will
expose the corporate world to incalculable hazards by way of manipulation of
financial statements.
At the risk of sounding like a broken record, I'll
repeat what I have said many times. In the early days of the SEC there was a
"battle" between the accountants and the attorneys as to the importance of
disclosures as opposed to measurement. We accountants won the battle in
favour of measurement. With all that has happened since the early thirties,
we may have won the battle, but we may be on the brink of losing the war
(fair reporting).
With warm regards,
Jagdish
Reply from Bob Jensen
Hi Jagdish,
I wonder if a company could keep dipping into its cookie jar to report
earnings for years after it's dead and buried. Existing shareholders could
thereby recoup some of their losses long after the company ceased producing
goods and services.
The cookie
jar might be a disaster for income tax reporting because it allows for
interest free deferrals of taxes for many years or at least until the GOP
gets on its feet again.
Or put another way the New England Patriots could've won the 2008 Super
Bowl if their unused reserves in points exceeded the reserves of the NY
Giants. Or John Kerry might be able to win the Democratic Nomination in 2008
if he has enough reserve delegates from Year 2004.
The problem with reserve accounting is that it can distort current
performance with ancient history. To some extent we do that already with
accruals like depreciation, but at least sophisticated investors and
analysts know the rules (standards) that apply to all companies.
Cookie jar accounting is generally associated with customized (for one
company only) secret reserves that allow management to do their own
scorekeeping. If we allow cookie jar accounting with full faith in
management to provide its own customized scores why use accounting scores at
all? Why not just let management tell us that this year performance relative
to last year was 27 points to 24 points. Each company can thereby devise its
own point system and secret rules for assigning points.
Obviously I'm exaggerating, and I do understand your position on this
Jagdish. However, I for one lose all faith in accounting if management
can reserve ancient history points to fudge current performance scores. But
I would like the Patriots to be declared Super Bowl winners on the basis of
accumulated reserve points from prior seasons. They might not even have to
play the game.
I think my thinking on this topic were partially
expressed by Jim.
Reserves are fine so long as they are funded and
are not secret. When reserves are funded and not secretive, they are not in
a cookie jar but in a piggy bank. It is only when they are secretive that
they become cookies.
A good example is a dividend equalisation reserve
or asset replacement reserves, where you appropriate retained earnings and
put the amount in a fund by seggregating the associated assets. I don;t
think they are very popular now.
A short article (http://ezinearticles.com/?Secret-Reserves&id=616062)
describes some examples of secret reserves. In fact they should be the
staples of Auditing courses except that since they do not fit into the
textbook risk models of auditing, are often ignored in classes. For example,
in auditing we always teach that the risk is in overvaluation of assets and
therefore the most important assertion tested is 'existence, and that since
the primary risk in case of liabilities is one of understatement, the most
important assertion to be tested is 'completeness. Textbooks rarely mention
the risk at the other tail, namely, the risk of secret reserves created by
lack of support for the opposite assertions -- completeness for assets and
existence for liabilities.
The only risk of such secret reserves are that they
violate SEC rules and existing GAAP. I do not know of a single company in
history that went under because they had secret reserves.
It is just that they do not fit our fixation with a
single indicator of income which we have failed to define objectively (the
idea of income is incorrigible in the sense of Art Thomas).
The examples are,
1. By under valuation of assets much below their
cost or market value, such as investment, stock in trade, etc.
2. By not writing up the value of an asset, the
price of which has permanently gone up.
3. By creating excessive reserve for bad and
doubtful debts or discount on sundry debtors.
4. By providing, excessive depreciation on fixed
assets.
5. By writing down goodwill to a nominal value.
6. By omitting some of the assets altogether from
balance sheet.
7. By changing capital expenditure to revenue
account and thus showing the value of assets to be less than their actual
value.
8. By overvaluing the liabilities.
9. By the inclusion of fictitious liabilities.
10. By showing contingent liabilities as actual
liabilities.
I think Jim was saying that there are protections
against the above by way of GAAP and GAAS. Jim, let me know if I am right.
Regards to both,
Jagdish
May 16, 2008 reply from
I took a quick look at the "secret reserve' article
and most of them aren't secret at all. You just have to teach analysts and
accountants how to read footnotes. I taught a financial statement analysis
class for years at the U. of Maryland in their MBA program and did just
that. Annectodally, I was repeated told by my students who work as analysts
for major firms that analysts never read footnotes. I guess my basic point
about all these reserves is that most can be detected easily if you know how
to read financial statements and footnotes.
By the way, if you want to cover a classic example,
check out Lucent Technology's use of their tax asset valuation allowance
beginning in 2001. I hope the following table comes out in the e-mail, but
it shows that they incurred a sharp increase in their tax assets in 2001 and
then wrote substantially all of them off in 2002, only one year later. The
numbers are in millions so we are talking billions. The vast majority of
their tax assets were NOL's carryforwards that won't expire for 20 years.
So, do you think they won't make enough taxable income over the next 20
years to recover at least some, if not all, of these NOL's? You can see the
valuation allowance steadily dropping from 2003 on when they started making
money and cashing in the NOL's. The get a boost of nearly $1 billion in
earnings from this, which, for them, was nearly 50% of their net income in
2004 and 2005. Their "hidden reserves" are very obvious by doing this simple
side calculation based on their footnote disclosures.
Valuation account as % of gross tax assets
98.6% 99.8%
89.8% 93.0%
8.8% 5.2%
8.8% 7.3%
6.6%
Gross tax asset as a % of total assets
45.1% 47.4%
70.2% 60.3%
25.0% 7.7%
5.7% 13.4%
14.9%
Tax asset valuation as a % of revenues
77.3% 88.7%
117.3% 81.1%
3.5% 0.7%
0.6% 1.1%
0.9%
I guess that is my main point. In my opinion,
analysts that complain about hidden researves are just lazy and won't take
the time to really analyze a firm's financial statements, including
footnotes. Of course, managers know that analysts are lazy and so they will
pull this sort of "stuff." Also, it is fair to ask "where were the
auditors?" First, I think auditors are too fixated on increasing assets and
revenues and decreasing liabilities and expenses, which, of course, is the
opposite of setting up reserves. I also teach auditing and have never seen
an auditing text refer to settting up these sorts of reserves as an audit
issue. Second, I do think auditors will never be truly independent as long
as they audit the hand that feeds them and I have publically advocated
nationalizing auditing by having a Federal agency, structured similarly to
the Federal Reserve or GAO whose directors are appointed for 15 years, take
over hiring, monitoring, and firing the auditors and just have the firms pay
for them. However, I get called a communist a lot for that suggestion.
By the way, if you want to cover a classic example,
check out Lucent Technology's use of their tax asset valuation allowance
beginning in 2001. I hope the following table comes out in the e-mail, but
it shows that they incurred a sharp increase in their tax assets in 2001 and
then wrote substantially all of them off in 2002, only one year later. The
numbers are in millions so we are talking billions. The vast majority of
their tax assets were NOL's carryforwards that won't expire for 20 years.
So, do you think they won't make enough taxable income over the next 20
years to recover at least some, if not all, of these NOL's? You can see the
valuation allowance steadily dropping from 2003 on when they started making
money and cashing in the NOL's. The get a boost of nearly $1 billion in
earnings from this, which, for them, was nearly 50% of their net income in
2004 and 2005. Their "hidden reserves" are very obvious by doing this simple
side calculation based on their footnote disclosures.
---
For someone who says "I have always found these
discussions highly superficial because they don't get down to the actual
accounting involved" and "These "hand waivy (sic)" discussions accomplish
nothing and indicate to me that the people writing them have never actually
thought deeply about the sources of these reserves",
over $1.7 billion of Lucent's deferred tax asset
arises from credit carryovers and state & foreign loss carryovers, some of
which expire as early as 2007. Second, the provisions that lead to these
carryovers (net operating loss carryovers, foreign tax credit carryovers,
alternative minimum tax considerations, section 382 limitations, etc.)
interact in complicated ways. For all their federal NOL carryovers, for
example, Lucent had a positive current tax expense for federal, state, and
foreign purposes in 2006. This suggests that their ability to use these
carryovers is more constrained than you suggest. Third, the ability to
recover "some" of their NOLs in the future does not mean a firm can avoid
recording a valuation allowance for the full deferred tax asset. Suppose a
firm has a $1 billion deferred tax asset, and believes that 48% of the time
it will use all of it in the future and 52% of the time it will use none of
it in the future. Even though its expected future tax benefit is $480
million, GAAP requires the firm to record a $1 billion valuation allowance
under the "more likely than not" criterion.
I have no opinion as to whether Lucent's valuation
allowance is too high, too low, or just right. Sensible people understand
that strong claims require strong evidence. What evidence--not conjecture,
not speculation, evidence--which requires a detailed understanding of
Lucent's federal, state, and foreign tax situations, and the interactions
among them, as well as expectations about Lucent's performance well into the
future--can you present to support your claims that their valuation
allowance for 2006 or any prior year is inconsistent with GAAP?
Richard C. Sansing
Professor of Accounting
Tuck School of Business at Dartmouth
100 Tuck Hall Hanover, NH 03755
March 17, 2008 reply from Bob Jensen
Hi Jim and Jagdish,
When is a cookie jar reserve secret? I would
contend that manipulation of bad debt reserves is sometimes a secret and
devious practice even though the reserve itself is not secret. A great
example of the secrecy employed is provided in "iMergent Practicing 'Cookie
Jar Accounting'?" November 6, 2006 ---
http://seekingalpha.com/article/19914-imergent-practicing-cookie-jar-accounting
In our
last comments on iMergent, we
promised further discussion of the company’s accounting
vulnerabilities. When a short seller calls “accounting
irregularities” on a company, they might just be accused
of pounding the table on their own position. Yet, when
the company in question is currently the subject of
numerous Attorney General Investigations, a Formal SEC
Investigation, and a business that Forbes Magazine
singled out this month as a
paradigm for dirty companies
on the AMEX, a warning of accounting irregularities begs
to be given additional weight.
Stocklemon believes that
iMergent is guilty of using cookie jar accounting to pad
current earnings. This “voodoo” accounting
employed by iMergent could be the reason why the company
has lost all coverage from major brokerage houses and is
now reports numbers to the public without independent
scrutiny.
In
2005, iMergent confessed a huge restatement of prior
earnings, and rolled up a mass of prior years’
unreported losses. The losses were due to overestimating
collectability of receivables from its installment
contract sales to its typically poor quality credit risk
customers.
Hidden by these massive adjustments were their repeated
acts of “cookie jar” accounting, where they shuttled
dollars in and out of receivables, reserves, and net
profit, as necessary to massage their earnings for the
benefit of shareholders.
As
the stock tanked from 25 to 4 last year, iMergent issued
these multi-year restatements under the cover of late
filing and the absence of a conference call to discuss
them.
For a
“normal” company, a massive confession/restatement like
this one would be an opportunity to “clean house”, to
sweep out the closets, dump out all the bad news and
take a fresh start.
Not
iMergent. They simply used the revision of their entire
accounting policy and all the confusion created by a set
of massive one-time adjustments (which obstruct
investors’ ability to draw meaningful comps to prior
periods) to start a whole new cookie jar.
Most
cookie jar accounting serves to “smooth earnings” and,
although subtle, is banned corporate behavior. But
cookie jars also have a more sinister use – misleading
investors to believe there is a pattern of increasing
earnings when actually the business is stagnant or
declining. With the amount of complaints online and
government regulation along with dissatisfied customers,
it does not take Warren Buffet to figure out this is a
terminal business model.
And
now, the other hand… This strategy only works until the
cookie jar runs out… and the jar at iMergent is running
low.
In a
call with First Albany (before they dropped coverage),
management of iMergent was astoundingly candid about the
company’s reserve policy. They implied that the company
was at times over-reserving against bad debt, which
could, in future periods improve earnings.
SEC files show
the agency was curious
enough about this to inquire further as to its validity.
In
the company's reply to SEC questions, they clarified how
exactly the reserves are figured out and also supplied
statistics for defaults. This Rosetta Stone, posted on
the SEC website not more than 2 weeks ago. The company
explained the issue to the SEC with facts it had never
previously disclosed to investors.
Their
better credits (the "A"s) defaulted at a 26% rate and
the lower quality credits (the "B"s) defaulted at a 53%
rate. The company also stated that they didn't make a
determination of reserves when finance receivables were
perfected (created), rather they would look at the pool
of receivables at quarter-end and then determine what
reserve level was appropriate. The result was that when
the prior reserve was deemed higher than necessary, the
recently added reserves would get a lower reserve
allocated -- which has the direct result of improving
non-GAAP earnings!
Hidden under the massive restatements of June 2005, an
anomaly appears which raises serious questions about
IIG's use of reserves to benefit future earnings. Buried
in the restatement, and not explicitly disclosed, IIG
reserved an astounding 79% of revenues for bad debt
reserves, dropping their new contracts written (from
which the reserve has been deducted) to a historic low
$14.6 million. This made their loss for the quarter even
worse (because of the restatement it was already
gigantic, so nobody noticed).
It
also created a brand new cookie jar to pad future
quarters. Strangely, at the same time, the company,
explaining why their sales conversion rate had dropped,
stated that new policy changes were resulting in
increased credit quality. This is contradictory to a
reserve rate nearly double its historical levels.
Stocklemon believes iMergent’s current results have been
benefiting from the new cookie jar.
As
recently as March 2005 the company stated that the
eventual default rate for finance receivables was 47%,
which begs the question as to why higher reserves were
ever materially above that. The company refuses to
update the overall default rate, as they say it won't
impact GAAP earnings. True enough, but it directly
impacts non-GAAP earnings. Since the September 2005
quarter with a 57.5% reserve ratio, the company has
grown gross receivables by $14.8 million, yet reserves
have only grown by $1.2 million for an 8% suggested
reserve ratio. While the company will suggest that that
is mainly due to losing the lower quality credits (which
we showed may have been artificially created last year)
it suggests very strongly that the company was using
those higher reserves to benefit current earnings.
In
fact, were the ending June 2006 reserve materially
higher, it would have had a dramatic impact on non-GAAP
earnings as demonstrated by this table: Most companies
would report non-GAAP so as to give a clear picture of
profitability without options expenses or goodwill.
iMergent wants you to focus on non- GAAP so you do not
factor in their customer with a 550 FICO Score who may
or may not pay 18% interest on his “software loan”.
Therefore, it is the opinion of Stocklemon that if this
company reserved properly, their NON-GAAP would be 24%
lower than their GAAP earnings.
Receivables still not visible
Imergent’s receivables and reserves
accounting can only be relied upon if the company’s cash
is indeed “unrestricted” and the receivables are real.
Considering
the company
they sold their receivables to:
1) was set up with a Storesonline Website
2) doesn’t seem to have any factoring business
beyond iMergent
3) runs out of a 2000 sq ft house in Incline Village
NV
4) bought the receivables on a “non-recourse” basis,
but still periodically puts bad contracts back to
iMergent for “replacement”
...this transaction fails to dispel the questions
looming over the quality of iMergent’s receivables.
History repeats?
Imergent bears very strong resemblance to
former Stocklemon subject Housevalues.com
(SOLD).
At the heart of
both is an accounting model that systematically leaves
out certain key metrics needed by the investing public
to determine the true health of the company. Add to that
an unending litany of consumer complaints, and you have
the reason for the reporting omissions – an
unsustainable business model – the last thing management
wants to admit.
When
Stocklemon reported on Housevalues.com, the stock was
$15 a share and Avondale and Piper both had lofty price
targets on the stock. Today it is $5.65, trading not far
above its cash.
In
contrast to Housevalues.com, iMergent has no analyst
coverage. There’s no independent scrutiny holding
management to a standard of reporting sufficient to shed
light on their real business operations.
Continued in article
The history
of cookie jar accounting is rooted so deeply in “secret reserves” that I
generally think of secret reserves as part and parcel to cookie jar
accounting as I learned about it. Newer standards have made it more
difficult to hide reserves, especially standards making it more difficult
not to consolidate subsidiary companies.
Some
references on this history of secret reserves include the following:
Financial Statement Analysis in Europe, by J.M. Samuels, R.E. Brayshaw and
J.M. Craner (Chapman & Hall, London, 1995) These authors discuss how common it was and still is in Europe to manage
earnings with secret reserves, especially in Germany and Switzerland.
The
Applied Theory of Accounts, by Paul-Joseph Esquerre ---
Click Here
Secret
Accounting in New Zealand: P&O and the Union Steam Ship Company,
1917-1936, by Christopher J. Napier ---
Click Here
Proceedings of the Fourth International Congress on
Accounting Author(s) of Review: A. C. Littleton The Accounting Review,
Vol. 9, No. 1 (Mar., 1934), pp. 102-103 ---
Click Here
Bob Jensen
From the CFO Journal's Morning Ledger on July 22, 2013
(Congratulations Tony)
The dark side of non-GAAP metrics Over
on the Grumpy Old Accountants blog, Villanova
University Prof. Anthony Catanach takes aim at the growing use of non-GAAP
metrics—noting
a recent article by CFOJ’s Emily Chasan
highlighting the trend. Prof. Catanach argues that in
most cases, companies using nontraditional metrics actually mask real
operating performance. “I am so hot about this that I’m calling out today’s
CFOs, as well as the Securities and Exchange Commission (SEC) to stop this
nonsense once and for all. I propose scrapping the SEC’s current Regulation
G, which governs the use of non-GAAP measures. Let’s replace it with a
requirement that companies disclose real operating data and metrics, not
just financial measures,” he writes.
It’s been over
a decade, 12 years to be exact, since Isaac C. Hunt, Jr. then Commissioner
of the SEC, delivered his seminal "Accountants
as Gatekeepers" speech. Those of you with gray
hair (or no hair) will recall this speech for Hunt’s attack on managed
earnings and “pro forma” financials.” In venting his frustration with non-GAAP
metrics (today’s descriptor for bad financial metrics), he reminded
securities issuers of their responsibilities to “make full and fair
disclosure of all material information.” Hunt’s speech is particularly
noteworthy as it points out that “federal securities laws, to a significant
extent, make accountants the ‘gatekeepers’ to the public securities markets.
Recently, several articles have appeared in the
popular press highlighting “new” ways that companies are reporting
performance. In one, “New
Benchmarks Crop Up in Companies Financial Reports,”
Emily Chasan discusses how some firms are
complementing financial reports with nontraditional performance benchmarks.
What’s my beef you ask? Well, my objections this time are consistent with
my recent rants about Black Box’s
new
metrics, and Citigroup’s
new performance measurement system. Simply put,
these supposedly innovative and insightful performance measures are neither!
In fact, in most cases, they are quite the opposite, and actually mask real operating performance.
My grumpiness on this “new” disclosure business has
reached the boiling point. I am so hot about this that I’m calling out
today’s CFOs, as well as the Securities and Exchange Commission (SEC) to
stop this nonsense once and for all. I propose scrapping the SEC’s current
Regulation G, which governs the use of non-GAAP
measures. Let’s replace it with a requirement that companies disclose real
operating data and metrics, not just financial measures. But there is one
hitch: none of the operating metrics I have in mind can use, or be based in
any way on any financial statement data, or any combination of numbers that
come from the general ledger system! Let me explain further.
As Ms. Chasan reports, some companies are beginning
to disclose relevant operating data, particularly as it relates to customers
(e.g., paid membership rates, active users, cumulative customers, etc.).
Unfortunately, many more CFOs continue to try to sell us the same old
“snake oil,” namely, “innovative” metrics that are nothing more than
repackaged financial statement-based illusions. You know them well,
EBITDA,
adjusted EBITDA, and the like. And this deception has continued unabated
for years…some of us even remember a wonderful piece by Jonathan Weil titled
“Companies
Pollute Earnings Reports, Leaving P/E Ratios Hard to Calculate.”
Nevertheless, the result is the same:
financially-based, non-GAAP performance measures that have less to do with
the nuts and bolts of daily operating processes, and more to do with today’s
troubled accounting “standards.”
Why do so many
CFOs promote the use of these non-GAAP metrics?
They maintain that these metrics are needed because financial statements
prepared in accordance with generally accepted accounting principles (GAAP),
particularly the income statement, don’t provide a complete and accurate
picture of a company’s performance. But are CFOs really being driven to more
non-GAAP metrics so as to present a clearer picture of the future direction
of a business as
recently suggested by Professors Paul Bahnson of
Boise State and Paul Miller of UC – Colorado Springs?
Continued in article
Once Again:
The Controversy of Neutrality in the Setting of Accounting Standards
In
Concepts Statement No. 2, the FASB
asserts it should not issue a standard for the purpose of achieving some
particular economic behavior. Among other things, this statement implies that
the board should not set accounting standards in an attempt to bolster the
economy or some industry sector. Ideally, scorekeeping should not affect how the
game is played. But this is an impossible ideal since changes in rules for
keeping score almost always change player behavior. Hence, accounting standards
cannot be ideally neutral. The FASB, however, actively attempts not to not take
political sides on changing behavior that favors certain political segments of
society. In other words, the FASB still operates on the basis that fairness and
transparency in the spirit of neutrality override politics. However, there is a
huge gray zone that, in large measure, involves how companies, analysts,
investors, creditors, and even the media react to new accounting rules.
Sometimes they react in ways that are not anticipated by the FASB
Over the next 30 years,
Nassau County expects to spend $3.6 billion paying health care bills for its
retired workers. Already this year, it spent more for retirees' health care
than it did for their pensions, according to financial statements it plans
to publish Wednesday.
Suffolk County faces an even
higher liability, according to its latest accounting -- $4.1 billion over 30
years, according to county comptroller Joseph Sawicki.
Free health care for life is
a prized benefit of public employment, but its rapidly rising cost to
taxpayers is looming into view like the iceberg that sank the Titanic,
thanks to the phasing in of a national accounting rule known as GASB-45.
That rule, issued in 2004,
also applies Go towns, villages, school districts and public authorities. It
requires the 30-year cost of retiree health benefits to be listed on their
annual financial reports. This year, for the first time, governments with as
little as $10 million in revenue will begin reporting those costs in their
financial statements, filed at the end of this month. But they are not
required to set aside money to cover those costs.
"While we're facing
difficult times, now is not the time to ignore this issue and push it
aside," said state Comptroller Tom DiNapoli Tuesday, calling the expense
"staggering."
New York State has the
highest costs in the nation for retired employees' medical care -- an
estimated $55 billion over the next 30 years. It, too, paid more last year
for retirees' health benefits than their pension costs. Those health costs
are only going to go up, warns DiNapoli, who has proposed creating a trust
fund governments can use to save for their retirees' health costs. That will
reduce the long-term expense, he argues.
But at the moment, county
officials seem more interested in finding ways to reduce the obligations
than set aside extra money to meet them.
"Knowledge of this figure
does not change the pressure on our hard-pressed county taxpayers since we
only pay one year's health care bill at a time," said Nassau Comptroller
Howard Weitzman, who last year worked with the county legislature on a new
benefits package for nonunion employees that increased the number of years
required for them to vest lifetime benefits. But his office acknowledged
that nonunion employees make up only a small share of the county workforce.
In Suffolk, County Executive
Steve Levy is also looking to trim benefits, and blamed the current
predicament on a series of nine government downsizings approved by the
legislature in eight years that were followed by new hires into many of the
same positions.
"Those early retirement
incentives of the 1990s are coming home to roost," he said.
Levy has required nonunion
employees to contribute at least 10 percent of their health benefits, and
said the issue will figure prominently in future contract talks.
"New rules have to be
written for new employees coming into the game," he said.
Neutrality is the
quality that distinguishes technical decision-making from political
decision-making. Neutrality is defined in FASB Concepts Statement 2 as the
absence of bias that is intended to attain a predetermined result. Professor
Paul B. W. Miller, who has held fellowships at both the FASB and the SEC,
has written a paper titled: "Neutrality--The Forgotten Concept in Accounting
Standards Setting." It is an excellent paper, but I take exception to his
title. The FASB has not forgotten neutrality, even though some of its
constituents may appear to have. Neutrality is written into our mission
statement as a primary consideration. And the neutrality concept dominates
every Board meeting discussion, every informal conversation, and every
memorandum that is written at the FASB. As I have indicated, not even those
who have a mandate to consider public policy matters have a firm grasp on
the macroeconomic or the social consequences of their actions. The FASB has
no mandate to consider public policy matters. It has said repeatedly that it
is not qualified to adjudicate such matters and therefore does not seek such
a mandate. Decisions on such matters properly reside in the United States
Congress and with public agencies.
The only mandate
the FASB has, or wants, is to formulate unbiased standards that advance the
art of financial reporting for the benefit of investors, creditors, and all
other users of financial information. This means standards that result in
information on which economic decisions can be based with a reasonable
degree of confidence.
A fear of information
Unfortunately, there
is sometimes a fear that reliable, relevant financial information may bring
about damaging consequences.
But damaging to whom? Our democracy is based on free dissemination of
reliable information. Yes, at times that kind of information has had
temporarily damaging consequences for certain parties. But on balance,
considering all interests, and the future as well as the present, society
has concluded in favor of freedom of information. Why should we fear it in
financial reporting?
Your post on
'neutrality' is very thought provoking and I am especially appreciative of
the link to Denny Beresford's article published in 1989 in Financial
Executive Magazine, which I had not recalled reading for some time if
ever; it is a great article.
I was fortunate
to have Dr. David Solomons as my accounting theory professor at Penn in
1982, and I have always been fascinated by the accounting standard-setting
process and Con. 2's qualitative characteristics of financial reporting, in
particular neutrality and representational faithfulness, as well as the
subject of accounting standard-setting vis-a-vis public policy.
One of my favorite quotes from the term paper I
wrote in Dr. Solomons' class on the subject of 'Standard-Setting and Social
Choice" was by Dale Gerboth,
in which Gerboth said:
“The public accounting
profession has acquired a unique quasi-legislative power that, in
important respects, is self-conferred. Furthermore, its accounting
‘legislation’ affects the economic well-being of thousands of business
enterprises and millions of individuals, few of whom had anything to do
with giving the profession its power or have a significant say in its
use. By any standard, that is a remarkable accomplishment.”
[Gerboth, Dale L., "Research, Intuition, and Politics in Accounting
Inquiry" The Accounting Review, Vol. 48, No. 3 (July 1973), pp. 475-482,
published by the American Accounting Association (cite is on pg 481).]
Returning to Denny's 1989
article, I find it significant that he wrote:
"The only mandate the FASB
has, or wants, is to formulate unbiased standards that advance the art
of financial reporting for the benefit of investors, creditors, and all
other users of financial information. This means standards that result
in information on which economic decisions can be based with a
reasonable degree of confidence. ... Unfortunately, there is
sometimes a fear that reliable, relevant financial
information may bring about damaging consequences."
I believe the above statement
makes sense, and extending it further, the point I'd make (let me note now
these are my personal views) is that: it's one thing if people want to
'throw caution to the wind' so to speak by saying 'ignore public policy (or
economic) consequences' - but it's another thing to say that when the
proposed accounting treatment would not necessarily 'result in information
on which economic decisions can be based with a reasonable degree of
confidence" or when 'reliability' has been overly sacrificed for perceived
'relevance.'
Another consideration should be
- 'relevance' for whom and by whom, e.g. relevance for some who base their
own business or consulting service on, e.g. fire-sale or liquidation prices,
vs. e.g. going concern models of valuation?
Said another way, I think it's
one thing to risk economic upheaval for high quality standards, vs. risk
economic upheaval for accounting standards of questionable relevance,
reliability or representational faithfulness.
Maybe the concept of 'first, do
no harm' is another way of saying this, i.e., do not inflict unnecessary
harm, particularly without exploring the reasonableness of alternatives, and
exploring motivations of all parties involved, and the ability for investors
to truly 'understand' what's behind numbers reported in accordance with the
accounting standards, and the reliability of those numbers.
The interaction of moral sentiments and self-interest
"Does the Invisible Hand Need a Helping Hand? A behavioral economist
explores the interaction of moral sentiments and self-interest," by Ronald
Bailey, Reason Magazine, June 24, 2008 ---
http://www.reason.com/news/show/127130.html
Remember how you reacted to your micromanaging boss
in a past job? He was forever looking over your shoulder, constantly
kibitzing and threatening you. In return, you worked as little as you could
get away with. On the other hand, perhaps you've had bosses who inspired
you—pulling all-nighters in order to finish up a project so that you
wouldn't disappoint her. You kept the first job only because you couldn't
get another and because you needed the money; you stayed with the second one
even though you might have earned more somewhere else.
In the June 20 issue of Science, Samuel Bowles,
director of the Behavioral Sciences Program at the Santa Fe Institute, looks
at how market interactions can fail to optimize the rewards of
participants—e.g., the micromanager who gets less than he wants from his
employees. For Bowles, the key is that policies designed for self-interested
citizens may undermine "the moral sentiments." His citation of the "moral
sentiments" obviously references Adam Smith's theory of Moral Sentiments
(1759), in which Smith argued that people have an innate moral sense. This
natural feeling of conscience and sympathy enables human beings to live and
work together in mutually beneficial ways.
To explore the interaction of moral sentiments and
self-interest, Bowles begins with a case where six day care centers in
Haifa, Israel imposed a fine on parents who picked their kids up late. The
fine aimed to encourage parents to be more prompt. Instead, parents reacted
to the fine by coming even later. Why? According to Bowles: "The fine seems
to have undermined the parents' sense of ethical obligation to avoid
inconveniencing the teachers and led them to think of lateness as just
another commodity they could purchase."
Bowles argues that conventional economics assumes
that "policies that appeal to economic self-interest do not affect the
salience of ethical, altruistic, and other social preferences."
Consequently, material interests and ethics generally pull in the same
direction, reinforcing one another. If that is the case, then how can one
explain the experience of the day care centers and the micromanager?
Bowles reviews 41 behavioral economics experiments
to see when and how material and moral incentives diverge. For example,
researchers set up an experiment involving rural Colombians who depend on
commonly held forest resources. In the first experiment, the Colombians were
asked to decide how much to anonymously withdraw from a beneficial common
pool analogous to the forest. After eight rounds of play, the Colombians
withdrew an amount that was halfway between individually self-interested and
group-beneficial levels. Then experimenters allowed them to talk, thus
boosting cooperation. Finally, the experimenters set up a condition
analogous to "government regulation," one where players were fined for
self-interestedly overexploiting the common resource. The result? The
players looked at the fine as a cost and pursued their short-term interests
at the expense of maximizing long-term gains. In this case, players
apparently believed that they had satisfied their moral obligations by
paying the fine.
While this experiment illuminates how bad
institutional designs can yield bad social results, I am puzzled about why
Bowles thinks this experiment is so telling. What would have happened if the
Colombians in the experiment were allocated exclusive rights to a portion of
the common pool resources—e.g., private property? Oddly, Bowles himself
recognizes this solution when he discusses how the incentives of
sharecropping produced suboptimal results. He recommends either giving the
sharecropper ownership or setting a fixed rent.
In fact, Bowles recognizes that markets do not
leave us selfish calculators. He cites the results of a 2002 study that
looked at how members of 15 small-scale societies played various
experimental economics games. In one game, a player split a day's pay with
another player. If the second player didn't like the amount that the first
player offered, he could reject it and both would get nothing.
The findings would warm the hearts of market
proponents. As Bowles notes, "[I]ndividuals from the more market-oriented
societies were also more fair-minded in that they made more generous offers
to their experimental partners and more often chose to receive nothing
rather than accept an unfair offer. A plausible explanation is that this
kind of fair-mindedness is essential to the exchange process and that in
market-oriented societies individuals engaging in mutually beneficial
exchanges with strangers represent models of successful behavior who are
then copied by others." In other words, as people gain more experience with
markets, morals and material incentives pull together.
Interestingly, neuro-economics is also beginning to
delve deeper into how we respond to various institutions. In one experiment
done by Oregon University researchers, MRIs scanned the brains of students
as they chose to give—or were required to give—some portion of $100 to a
food bank. The first was a charitable act and the second analogous to a tax.
In both cases, their reward centers "lit up," but much less so under the tax
condition. As Oregon economist William Harbaugh told the New York Times,
"We're showing that paying taxes does produce a neural reward. But we're
showing that the neural reward is even higher when you have voluntary
giving."
Bowles, with some evident regret, observes, "Before
the advent of economics in the 18th century, it was more common to appeal to
civic virtues." Bowles does recognize that such appeals "are hardly adequate
to avoid market failures." How to resolve these market failures was the
subject of Smith's second great book, The Wealth of Nations (1776), where he
explained: "By pursuing his own interest (the individual) frequently
promotes that of society more effectually than when he really intends to
promote it."
Question
Did Clemson hide a cookie jar in order to increase revenue?
A former executive secretary to Clemson
University’s Board of Trustees alleges in a lawsuit that top officials of
the public university hid $80-million in cash reserves from legislators
while requesting more money from the state and increasing tuition, The
State, a newspaper in Columbia, S.C., reported today.
The board’s chairman, Leon J. (Bill) Hendrix Jr.,
denied the allegations in the lawsuit, which was filed by Chalmers Eugene
Troutman III, and described Mr. Troutman as a “disgruntled former employee.”
Mr. Troutman says in the lawsuit that he was fired last August after he
encouraged the trustees to spend down the cash reserves.
The university’s chief public-affairs officer,
Catherine T. Sams, declined to comment on the suit but told the newspaper
that Clemson’s financial practices were open and were audited annually. As
of last June, she said, the university had $79.1-million in unrestricted
funds, adding that “unrestricted does not mean uncommitted.” The money is
available to “cover expenditures and plans that extend beyond the end of a
fiscal year,” she said.
Mr. Troutman is seeking lost pay, actual and
punitive damages, and reinstatement as executive secretary. A hearing on his
lawsuit is scheduled this week before Judge Matthew J. Perry Jr. in the U.S.
District Court in Columbia. Since 2001, in-state tuition at Clemson has
risen from $5,090 to $9,870, the newspaper reported.
Accounting program news items
for colleges are posted athttp://www.accountingweb.com/news/college_news.html
Sometimes the news items provide links to teaching resources for accounting
educators.
Any college may post a news item.