THE NEED FOR AN ACCOUNTING COURT
by Leonard Spacek
Partner, Arthur Andersen & Company
The Accounting Review
1958, Pages 368-379
I am highly honored by the privilege of appearing before you today--especially to discuss* the particular subject assigned to me.
For you to understand my comments, I must explain the premises from which I speak. As most of you know, I am a practicing accountant--I speak from that point of view. My views are influenced by the hard everyday practical realities of my function in saying to the layman who reads financial statements that such statements can be relied upon. I find no satisfaction at this level of service to the public in any high-sounding theory of economic controls or regulation, or that an overstatement of income today may be atoned for by an understatement some time in the future. Our work in reporting income to owners of businesses is so practical that it is equivalent to food and rent to the people we report to. What we, as a firm of accountants, say about the financial statements of a company must be said in a brief paragraph. We do not generally meet our reader face to face to answer questions or discuss the financial statements of the company involved. While the statements are the company's and we examine them and express our opinion about them, we can and in most instances, we do influence the financial presentation, including foot-note explanations.
* This paper was presented at the Annual Meeting of the American Accounting Association at the University of Wisconsin, August 27, 1957.
Our Responsibilities to the Public
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.
In reporting to the shareholders, corporate managements generally feel that they must present the financial position of their companies in the most favorable light. In fact, they have no alternative in our competitive system. Shareholders want the facts abut their investment, but they also want these facts presented in the best light in comparison with other companies so that a favorable effect on market value will result. This is natural because they want the best price possible for their investments if they desire or are required to sell, or even if they have no intention of selling. They want the financial statements prepared on a basis comparable with other companies in the same industry or in other industries. Thus, the idea that accounting principles meet the test of public needs even though they are not consistently applied among companies, violates the very purpose for which the statements are used. A high-sounding contrary theory that this is impracticable may be presented as an excuse for inconsistency, but it is no justification.
We in the profession must be able to give reasons for the accounting we believe a client should follow. These reasons must have real meaning in the everyday economics of life. We often hear that the authority for proper accounting is the "utilitarian concept," or the utility of the statements. That concept, however, means nothing unless the utility sought is specifically defined. Even erroneous accounting is "utilitarian" to the unscrupulous. So the word "utilitarian" is not used in everyday accounting work because it is meaningless.
Nevertheless, the practicing accountant should, in fact must, have a definite explanation of the utility of every accounting principle to the observed if he is to serve a professional purpose today. My associates and I have given considerable thought to this subject, and we have arrived at very deep convictions. Yet there is no place where these basic criteria of accounting principles can be brought to issue. This is the reason we need an accounting court. In some of these views we may be wrong; if so, errors in our reasoning can be demonstrated if the profession will but establish the basis of its accounting principles.
How Can We Secure the Basic Criteria Under Today's Conditions?
Today there is no place where agreement on basic premises or purposes can be argued. Without agreement on these fundamentals it is useless to talk of bringing the profession together in the function it is supposed to serve. Agreement as to a lot of rules on accounting principles does not meet our needs if we have no agreement on the objectives of such rules and no criteria on which to base them.
We have, for instance, ample evidence that the public accountant's primary responsibility is to express his opinion on the fairness of the results of the operation of a corporation and its related financial position. But nowhere do we find the criteria or even an attempt to set criteria as to what constitutes fair presentation of income. Look through the bulletins issued by the accounting organizations and you will find very few, if any, criteria consistently present. Instead of standards of measurement, attention is focused on techniques. Most documents are overburdened with procedural comment on how to handle certain transactions, but little is said about the effect sought, and still more important--why. The profession should describe the criteria for the end results sought. The medical and legal professions' objectives are easily defined--ours are not. There is no need as a profession to describe the journal entries and the accounting procedures to be followed; that should be left to the practitioner. Discussions of methodology are secondary from a professional viewpoint; they fall into the same category as the discussion of the best form for an invoice or for a flow chart of accounts payable procedures.
Our problems in accounting principles are so constantly overshadowed by methodology that we fail to clearly express the principles involved. We, who are engaged in the practice of accounting, feel that we have made great progress in our profession. How do we know and how is it measured? Just recently the President of the American Institute stated:
"Of major concern in financial reporting is the determination of profits. It seems hardly necessary to remind this audience why the methods of determining business profits are important. But to set the stage for questions I want to discuss, let me restate briefly some of the situations in which statements of net income of business enterprises have significant influence on important decisions."
I agree that this statement should be true. That too often it is not true seems to me self-evident. Here, for example, is what one of the foremost financial men of our country said about his company just thirty days earlier:
"Now yesterday's witness...suggested that somehow these (accounting) systems have one more important use--that they are valuable for managerial decision making. This isn't so. I cannot think of a single major decision that we make by going back to the books of account. We certainly didn't rush to the books to find out what they dividend rate...should be."
Unfortunately, this is not an isolated view. So when we talk of progress in "accounting," we must measure our steps forward against the increased needs that have developed for accounting. If we had met those needs as they developed, we could feel that our progress had been satisfactory. The public certainly gets enough accounting statements--in fact too many. But has the quality of these statements improved as rapidly as the needs have advanced? On that score I believe we are losing ground.
The Annual Reports of Corporations Are Not Prepared for the Ways They Are Used
In my opinion our greatest deficiencies exist in the regular annual reports to stockholders. These reports, whether we want to believe it or not, are not just reports to stockholders--they are also annual reports to the public, to labor, and to the consumer. With such widespread use, the idea that annual reports should be read only by those who understand accounting cannot be supported. If annual reports are to be issued only for those who can understand accounting procedures, then many stockholders are receiving reports which they are not expected to be able to understand. The man on the street, whether he is a shareholder or a member of the public, has a right to assume that he can accept as accurate the fundamental end results shown by the financial statements in annual reports, without knowing all the underlying theory on which those statements are based, the same as he accepts conclusions from a doctor or lawyer without knowing the intricacies of medical or legal theory upon which his conclusions are based.
The readers should not have to, and most of them could not, evaluate the effect of alternative accounting principles or conventions simply on the basis of disclosure. A reader should, and has a right to, assume that the correct method of recording a transaction was followed, and that corresponding transactions are handled the same way by all companies. Thus, he has the right to make comparisons among companies without having to assume the difficult, if not impossible, responsibility of making mental pro forma adjustment to make the figures comparable.
We cannot assume, simply because men have achieved success in one field, that they must know and can decipher accounting procedure and its end result. Witness this statement by the columnist Sydney J. Harris of a few weeks ago:
"Moreover, I have neither the talent nor the patience to study the reports and analyses, the averages, and the trends, that are requisite for intelligent participation in the investment field."
And then at a recent press conference President Eisenhower, on the subject of price level depreciation, made this statement which clearly shows a woefully inadequate understanding of the subject. He said:
"One side gives you a list of statistics and shows you what this means. For example, the manufacturer who is putting 500 million dollars into a factory to make new jobs and greater prosperity in this country will show you that his write-off of taxes, extending over 25 years, will finally be in dollars that are much cheaper than he had to put in to build the thing, because the dollar tends to inch up on him all the time. Therefore, he thinks he should have a faster write-off or he should have his write-off on the basis of what it is going to cost him to replace these facilities, rather than what the original cost is."
"The other side comes in and shows you all of the privileges exercised by the board of directors, and how much wages, what stipends, they get and so on, and it is very difficult, at least for me, to find out where justice lies on this point."
If our accounting principles do not produce results which the President can understand, surely we are not properly serving the man on the street.
Continued in the following reference:
THE NEED FOR AN ACCOUNTING COURT
by Leonard Spacek
Partner, Arthur Andersen & Company
The Accounting Review
1958, Pages 368-379
The Accounting Hall of Fame Citation for Leonard Spacek --- http://fisher.osu.edu/acctmis/hof/spacek.html
Updates following the Enron Scandal
Bob Jensen's Threads on Accounting Fraud, Forensic Accounting, Securities Fraud, and White Collar Crime
http://www.trinity.edu/rjensen/fraud.htm
Bob Jensen's Commentary on the Above Messages From the CEO of Andersen
(The Most Difficult Message That I Have Perhaps Ever Written!)
http://www.trinity.edu/rjensen/fraud.htm#Andersen120401
My paper on "Damages" at http://www.trinity.edu/rjensen/damages.htm