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An Economic Basis for Honest Financial Accounting

An Honest Financial Accounting: Draft of Introduction to Preliminary Edition – Part II

Draft Table of Contents

It so happens that around the time Beaver published his recommendations for the FASB, Harvard philosophy professor John Rawls took on the larger question – in which financial accounting surely plays a part – of fairness in politics and economics. His first major book, A Theory of Justice,[14] is regarded by many as the most influential work of political philosophy of the 20th century.[15]  He was awarded the National Humanities Medal in 1999 for “his argument that a society in which the most fortunate help the least fortunate is not only a moral society but a logical one.”[16]

Rawls’ philosophy is derived from a novel thought experiment:  How would “social justice” be formulated by a convention of economically “rational” individuals who otherwise knew nothing about themselves?  From behind this “veil of ignorance,” these individuals wouldn’t, among every other thing, know the color of their own skin, their innate capabilities, or to whom and where they were born.

Very broadly speaking, Rawls derives from his thought experiment standards of moral behavior that should be presumed to be just, given that they were derived by society’s members before they knew how the standards would affect them individually.  Of particular relevance, he reasoned that since the convention members cannot know whether they are on the giving or receiving end of any particular action, they should agree that anything less than honesty is a prerequisite to just outcomes.

To illustrate from the tale of Jack Welch, let’s consider whether individuals from behind a veil of ignorance would agree that Welch should be allowed to manipulate the earnings of General Electric. Even though they can be proponents of their own personal interests with impunity, they will rationally expect that earnings management is highly unlikely to add to their own well-being.  For a very few would attain the enviable position of CEO of a public company. Thus, presuming that earnings management does not otherwise contribute to social good, the convention must conclude that permitting earnings management puts practically everyone – except for the Jack Welch’s of the world – on the short end of the stick.

This book will show, among other things, that a simple honesty constraint imposed on financial accounting rules would produce a vast improvement over extant US GAAP.  For there are a great many examples of US GAAP that fall short of an honesty standard in a great many ways.  Notwithstanding, not all of US GAAP violates an honesty constraint.  There are also many examples where a choice could be made between two or more honest accounting treatments.  For those, this book is intended to be an example of a good-faith attempt to weight those relative costs and benefits from behind a veil of ignorance.

Accordingly, this preliminary first edition is the product of an iterative process to develop An Honest Financial Accounting (AHFA).  Initial chapter drafts were exposed for comment in my blog The Accounting Onion.  Subject to constraints on civility and relevance, all readers’ comments made through the blog have been considered and published.  A ‘final’ first edition will follow that adds extensive examples of the application of AHFA, and a tabular presentation of the differences and similarities between AHFA and US GAAP.

Next section is here.

Draft Table of Contents

[14] John Rawles, A Theory of Justice, Harvard University Press, 1971 (revised 1999).


[16] Insert footnote.   Weinstein, Michael M. (December 1, 2002). “The Nation; Bringing Logic To Bear on Liberal Dogma”. The New York Times. ISSN 0362-4331. Retrieved September 7, 2021 [emphasis supplied]


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