Peeling away financial reporting issues one layer at a time

It’s Nice to Win Something, Even if it’s the “Losing Cause Man of the Year”

No one likes to be told they are irrelevant, but that was my first reaction to Bob Jensen's AECM post, in which he dubbed me the "Losing Cause Man of the Year." I am certain that Bob meant it as a compliment, and I've gotten over the unintentional slight. Now, I am ready to reflect on how I came to merit such a dubious distinction.

I'll begin by restating Bob's remarks. I am using much of his own words, but without quotation marks (the full text of his remarks are here).

Losing Cause 1 — Fending Off the Takeover (Convergence) of US GAAP by the International Accounting Standards Board

Tom has never accepted that international standards will replace domestic accounting standards in the United States. But, the takeover of US GAAP by the IASB is a fait accompli because all the people that count applaud such a takeover. Domestic corporations like the idea of softer principles-based international standards replacing the thousands of bright line hard rules in present U.S. GAAP. Multinational corporations really like the idea of only having one set of accounting standards to deal with year after year. Large auditing firms and the AICPA are salivating over being able to bill companies for IFRS training programs and materials and software.

The only serious, albeit ineffectual, resistance to IASB takeover of U.S. GAAP has been perpetrated by a few powerless academics like Tom Selling, Shyam Sunder, Ray Ball, David Albrecht, and Bob Jensen. Among these protesters, Tom Selling is our persistent champion.

Losing Cause 2 — Mandatory Rotation (Term Limits) of Audit Firms

In 2011 the PCAOB put mandatory audit firm rotation out for discussion. The response from the business community and auditing firms has been overwhelmingly negative to the idea.

The academic community remains largely silent on the issue, but when push comes to shove I suspect that most accounting professors, like me, see more costs than benefits of audit firm rotation even though rotation of the auditor partners themselves on audits is a current practice supported by almost all academics.

Tom Selling remains the lone voice in favor of mandatory audit firm rotation – click here. He proposes something like seven-year term limits before a corporation has to change its audit firm.

Losing Cause 3 — Financial Statements Entirely Based on Replacement Costs

For nearly 100 years leading academics have advocated some type of current cost or value replacement of the historical cost basis of accounting. Historical cost never pretended, as repeatedly noted by AC Littleton, to be valuation accounting. In 1929, John Canning started the ball rolling for current (replacement) cost accounting, which is sometimes called "entry value" accounting. In 1939, Kenneth McNeal commenced the ball rolling for exit value accounting where buildings, vehicles, and factory machinery are valued at what they can sell for, rather than amortized historical costs.

From an academic standpoint the literature on value accounting has probably been more focused upon the bad features (e.g., goodwill accounting) of historical cost accounting rather than on convincing research that some type of "value" accounting justifies the costs of preparation. The sermons on the evils of historical cost accounting became less convincing as research emerged in the 1990s showing that historical cost accounting really did have value for both earnings and stock price forecasting.

John Canning's current (replacement) cost baton has now been passed to Tom Selling. Like John Canning, Tom advocates that business firms spend tens of billions of dollars annually shifting from traditional historical cost reporting of operating assets to replacement costs. The problem is that replacement cost advocates can point to zero research convincing us that the benefits of such drastic changes in financial statements justify the costs.

My Response to Bob

Bob, I appreciate the compliment, especially coming from you. I covet your erudition, and you are the lifeblood of the AECM listserv. We both have strong opinions, and we disagree on some pretty important matters. But, I am proud to say that we both willingly wear our hearts on our sleeves.

I wish I could say the same about most other academics – You state that the academic community remains largely silent on the issue of mandatory audit firm rotation, but I say that the academic community has largely remained silent on all of these issues – IFRS, auditor rotation and independence, and crappy accounting standards (despite the boat loads of narrowly-focused research produced by academics on the information value of GAAP-based financial statements). I believe I am your Losing Cause Many of the Year because academics as a group have proven themselves milquetoasts at this critical juncture for the accounting profession, on which we claim to have a unique and valuable perspective.

I can't know what I would have been writing and saying if I were still a faculty member somewhere, but I would like to think that my training and upbringing would not have permitted me to stifle strongly-held points of view that directly affect my teaching and/or research activities. The accounting professor who denies having strong opinions on at least one of these "lost cause" topics should be asking themselves: what the heck do they spend their time thinking about; whether what they actually are thinking about matters very much to society; and whether they have an ethical obligation to participate in the conversation.

Costs and benefits of change — Bob, you seem to focus on incremental costs (like amounts paid for experts to make various estimations); and I focus on avoidable costs, because I believe they are many times larger:

  • The vast amounts spent on auditors and accountants need only be a small fraction of what they are today. Auditors do perform many valuable services; but, some of the services performed require highly subjective judgments and consequently have little value. Those low-value services seem to cost the most, and they challenge the ability of an auditor to be objective.


  • The amounts of shareholder value destroyed because of "earnings management" and similar games that executives are permitted to play can be stupefying just by recalling the role that financial reporting played in Enron, Worldcom, GM, Lehman, S&Ls in the 1990s, financial institutions over the last few years, just to name a few. If auditor rotation could have prevented just one of these debacles, then your own cost-benefit calculus would be flipped on its head.


  • There is plenty more value waiting to be destroyed because the system of accounting rules actually encourages it. Bob, you may not agree that replacement cost accounting is the answer, but surely you recognize that financial reporting has many more and far more unsightly warts than simply goodwill accounting! The patchwork of rules we call US GAAP or IFRS is not analogous to the result of some Darwinian evolutionary process of natural selection, as you once said. It is — in spite of (or perhaps even because of) all of the research confirming its predictive value to which you allude — a "garbage truck." (That's not my term; it belongs to David Mosso, a former FASB member no less.)

The end of a tumultuous 2011 may be an appropriate time to recognize a champion of lost causes. But looking ahead to 2012, I see all of these issues in play. Audit rotation may fizzle in the U.S., but it is more alive in Europe; the voices against IFRS adoption are getting louder (even though academics are still sitting on their hands); and once the U.S. escapes from the clutches of the IASB, perhaps we can have a real discussion of value accounting.

2012 is just getting started, and so am I.

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