March 31, 2008

Bob Jensen's New Bookmarks on March 31, 2008
Bob Jensen at Trinity University 

For earlier editions of Tidbits go to http://www.trinity.edu/rjensen/TidbitsDirectory.htm
For earlier editions of New Bookmarks go to http://www.trinity.edu/rjensen/bookurl.htm 

Click here to search Bob Jensen's web site if you have key words to enter --- Search Site.
For example if you want to know what Jensen documents have the term "Enron" enter the phrase Jensen AND Enron. Another search engine that covers Trinity and other universities is at http://www.searchedu.com/.

Bob Jensen's Blogs --- http://www.trinity.edu/rjensen/JensenBlogs.htm
Current and past editions of my newsletter called New Bookmarks --- http://www.trinity.edu/rjensen/bookurl.htm
Current and past editions of my newsletter called Tidbits --- http://www.trinity.edu/rjensen/TidbitsDirectory.htm
Current and past editions of my newsletter called Fraud Updates --- http://www.trinity.edu/rjensen/FraudUpdates.htm
 

Bob Jensen's past presentations and lectures --- http://www.trinity.edu/rjensen/resume.htm#Presentations   
 

Bob Jensen's various threads --- http://www.trinity.edu/rjensen/threads.htm
       (Also scroll down to the table at http://www.trinity.edu/rjensen/ )

Roles of a ListServ --- http://www.trinity.edu/rjensen/ListServRoles.htm

Click here to search this Website if you have key words to enter --- Search Site.
For example if you want to know what Jensen documents have the term "Enron" enter the phrase Jensen AND Enron. Another search engine that covers Trinity and other universities is at http://www.searchedu.com/

Bob Jensen's Home Page is at http://www.trinity.edu/rjensen/

CPA Examination --- http://en.wikipedia.org/wiki/Cpa_examination

Wikipedia has a rather nice summary of accounting software at http://en.wikipedia.org/wiki/Accounting_software

Bob Jensen's accounting history summary --- http://www.trinity.edu/rjensen/Theory01.htm#AccountingHistory

Bob Jensen's accounting theory summary --- http://www.trinity.edu/rjensen/Theory.htm

Tom Selling's blog The Accounting Onion (great on theory and practice) --- http://accountingonion.typepad.com/

XBRL Networking --- http://xbrlnetwork.ning.com/

Accountancy Discussion ListServs:

For an elaboration on the reasons you should join a ListServ (usually for free) go to   http://www.trinity.edu/rjensen/ListServRoles.htm

AECM (Educators)  http://pacioli.loyola.edu/aecm/  AECM is an email Listserv list which provides a forum for discussions of all hardware and software which can be useful in any way for accounting education at the college/university level. Hardware includes all platforms and peripherals. Software includes spreadsheets, practice sets, multimedia authoring and presentation packages, data base programs, tax packages, World Wide Web applications, etc Roles of a ListServ --- http://www.trinity.edu/rjensen/ListServRoles.htm

CPAS-L (Practitioners) http://pacioli.loyola.edu/cpas-l/  CPAS-L provides a forum for discussions of all aspects of the practice of accounting. It provides an unmoderated environment where issues, questions, comments, ideas, etc. related to accounting can be freely discussed. Members are welcome to take an active role by posting to CPAS-L or an inactive role by just monitoring the list. You qualify for a free subscription if you are either a CPA or a professional accountant in public accounting, private industry, government or education. Others will be denied access.

Yahoo (Practitioners)  http://groups.yahoo.com/group/xyztalk This forum is for CPAs to discuss the activities of the AICPA. This can be anything  from the CPA2BIZ portal to the XYZ initiative or anything else that relates to the AICPA.

AccountantsWorld  http://accountantsworld.com/forums/default.asp?scope=1  This site hosts various discussion groups on such topics as accounting software, consulting, financial planning, fixed assets, payroll, human resources, profit on the Internet, and taxation.

Business Valuation Group BusValGroup-subscribe@topica.com  This discussion group is headed by Randy Schostag [RSchostag@BUSVALGROUP.COM]

Tidbits Directory for Earlier Months and Years --- http://www.trinity.edu/rjensen/TidbitsDirectory.htm

New Bookmarks Directory for Earlier Months and Years --- http://www.trinity.edu/rjensen/Bookurl.htm

Fraud Updates is now available at http://www.trinity.edu/rjensen/FraudUpdates.htm

Links to my other fraud modules can be found at http://www.trinity.edu/rjensen/Fraud.htm

Bob Jensen's Threads --- http://www.trinity.edu/rjensen/Threads.htm

Humor Between March 1 and March 31, 2008 --- http://www.trinity.edu/rjensen/book08q1.htm#Humor033108

Humor Between February 1 and February 29, 2008 --- http://www.trinity.edu/rjensen/book08q1.htm#Humor022908   

Humor Between January 1 and January 31, 2008 --- http://www.trinity.edu/rjensen/book08q1.htm#Humor013108  

Links to Documents on Fraud --- http://www.trinity.edu/rjensen/Fraud.htm

Bob Jensen's complete set of Enron Updates are at http://www.trinity.edu/rjensen/FraudEnron.htm#EnronUpdates

Bob Jensen's threads on the Enron scandal are at http://www.trinity.edu/rjensen/FraudEnron.htm

Large International Accounting Firm History --- http://en.wikipedia.org/wiki/Big_Four_auditors

Global Perspectives on Accounting Education --- http://gpae.bryant.edu/%7Egpae/content.htm

Economic Stimulus Payments Information Center
Starting in May, the Treasury will begin sending economic stimulus payments to more than 130 million households. To receive a payment, taxpayers must have a valid Social Security number, $3,000 of income and file a 2007 federal tax return. IRS will take care of the rest. Eligible taxpayers will receive between $300 to $600 if single or $600 to $1,200 if married filing jointly. Millions of retires, disabled veterans and low-wage earners who usually are exempt from filing a tax return must do so this year in order to receive a stimulus payment. But there are more details to know about. Find out more here and visit this page regularly for the latest updates.
From the IRS:  Economic Stimulus Payments Information Center --- http://www.irs.gov/irs/article/0,,id=177937,00.html
Jensen Comment
Although I think this is a horrible Keynesian tinkering with the economy by a deficit-bound government that cannot afford this election-year give away, there are some important things to know about the latest economic stimulus program. For example, not everyone or every family is eligible for a check. For those who don't normally file, a tax return (Form 1040A) must be filed on or before April 15, 2008 to get a check

Taxpayers in my viewpoint should opt for the electronic payments option to avoid mix ups or theft in mail delivery. Also beware of scam artists who phone or write claiming to be from the IRS. The IRS anticipates an explosion of scams trying to get at your stimulus payment. The good news from a business standpoint is that the scam artists will spend the money. The bad news is that it’s your money that might get scammed.

Index --- http://www.irs.gov/irs/article/0,,id=177937,00.html
|The Basics | Scenarios | Frequently Asked Questions Social Security | Veterans Benefits | Low Income |
| Scam Alert News Releases, Audio, Fact Sheets and Legal Guidance |

Troubling Student Reports on Revenue Recognition

March 1, 2008 message from Dennis Beresford [dberesfo@TERRY.UGA.EDU]

March 2, 2008 reply from Bob Jensen

Hi Denny,

My threads on the revenue recognition mess are at http://www.trinity.edu/rjensen/ecommerce/eitf01.htm 

In particular I find Bill and Hold issues vexing since they so often arise to deceive about revenue --- http://www.trinity.edu/rjensen/ecommerce/eitf01.htm#BillAndHold 

My threads on the AIG mess are at http://www.trinity.edu/rjensen/FraudRotten.htm#MutualFunds 
There's some useful source material here for student assignments and papers.

"Research on Accounting Should Learn From the Past," by Michael H. Granof and Stephen A. Zeff, Chronicle of Higher Education, March 21, 2008 --- http://chronicle.com/weekly/v54/i28/28a03401.htm?utm_source=cr&utm_medium=en

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.

March 18, 2008 reply from Paul Williams [Paul_Williams@NCSU.EDU]

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.

Paul Williams
paul_williams@ncsu.edu 
(919)515-4436

Bob Jensen's threads on these matters are at the following links:

http://www.trinity.edu/rjensen/Theory01.htm#AcademicsVersusProfession

http://www.trinity.edu/rjensen/Theory01.htm#DoctoralPrograms

http://www.trinity.edu/rjensen/Theory01.htm#Replication

“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.

This citation was forwarded by Don Ramsey
"Why business ignores the (research of) 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.

March 17, 2008 reply from David Fordham, James Madison University [fordhadr@JMU.EDU]

In response to Don Ramsay's quote from the Skapinker article: "The reason that real-life lawyers, doctors and engineers have no problem with their [respective academics'] research is not because they are smarter than business people, but because their research assists them in what they do" ---

So the problem is that business professors are not publishing studies that are relevant to what the business practitioners need? Our research doesn't assist our practitioners in what they do? Hmmmm.

Question: could the problem (IF it's a problem) be traced back, beyond the business professors, to the "gatekeepers" (read: reviewers and editors) who control the publishing arm of the field? Could it be that professors really are interested in engaging in relevant and applicable research, but this stuff never gets publishined in the "journals that count" because the *criteria* used by reviewers (to judge whether the work is acceptable for publication) is fatally flawed?

This is in the front of my mind because I am revising one more time a paper in which the reviewers say the paper is "interesting", "intriguing", "applicable", "enlightening","revelant to practice", "could materially improve" accounting education, and even "is well-written", ... but they then condemn the paper to rejection or revision saying "it needs more thorough development of theoretical underpinnings", in other words, more Greek letters and diagrams with arrows. The ideas in this paper won a national award in a practitioner journal, but academic reviewers repeatedly reject it, even when it's explained in a way designed to directly assist educators.

My post here isn't the sour grapes it sounds like... I don't mind playing the game now and then (and although I'm at the point where one more pub isn't worth too much effort anymore, I honestly enjoy the exercise). But I figured that perhaps flawed publication criteria might indeed be responsible for the observed effect of business practitioners (and accountants in particular) ignoring academic publishing. Just another thought.

This begs the next question: what SHOULD be the criteria used for academic publishing? (criteria is plural, by the way...)

Another paper tiger from...

David Fordham
James Madison University

March 20, 2008 reply from Ramsey, Donald [dramsey@UDC.EDU]

It would probably by too simplistic to suggest that faculty at research institutions should publish primarily in academic journals, and those at "teaching" institutions in practitioner journals.

Also, too naive to hope that university tenure committees of any institutions, faced with limited budgets and various forms of campus politics, would agree with any deans' recommendations based on practitioner journals.

Do non-practice fields, let's say History or English, have any such thing as practitioner journals? Second-tier and lower academic journals, I suppose. So maybe academics is the only game in town at the university level. But what about tenure based on music performance, for example? Or medicine or law, as the original article implied? Is it the endowments of medical or law schools that may give them some independence in tenure decisions?

If assessment of student outcomes is the present crest of the wave, will the next wave be assessment of the value of academic peer-reviewed journals compared to appropriate publishing objectives?

Donald D. Ramsey
University of the District of Columbia

March 20, 2008 reply from Bob Jensen

Hi Don,

The paradox is that good research (defined as new knowledge) for practitioners is actually much more difficult than accountics research published in academic journals.

Accountics research takes many more years of preparation (math, statistics, econometrics, psychometrics) to prepare to do accountics research. But the actual research itself is ploddingly methodical rather than Eureka! The contribution to knowledge is often described by the accountics researchers themselves as epsilon (asymptotically speaking).

But practitioner research (defined as new knowledge) requires much more creativity and discovery happenstance, serendipity, luck, or what have you. Professors do publish quite often in practitioner journals, but their contribution is generally in terms of scholarship rather than new knowledge.

The one exception is survey research that technically speaking often is new knowledge. But the majority of surveys published by professors in practitioner journals is not all that exciting (at least not to me).

Bob Jensen

You can read about accountics research at http://www.trinity.edu/rjensen/395wpTAR/Web/TAR395wp.htm

"The Rap on Accounting Education: 
Are colleges focused too much on preparing students for public accounting and not enough for their later corporate careers?" by David McCann, CFO Magazine, March 19, 2008 --- http://cfo.com/article.cfm/10875359/c_10879801
Link forwarded by Glen Gray

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://www.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?" AccountingWeb's U.K. Site, March 11, 2008 ---
http://www.accountingweb.com/cgi-bin/item.cgi?id=104768

"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.

March 12, 2008 reply from Ed Scribner [escribne@NMSU.EDU]

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).)

Ed

March 12, 2008 reply from J. S. Gangolly [gangolly@CSC.ALBANY.EDU]

Ed,

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://www.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.

Other revenue inflation scams and questions raised in the following issues resolved by by various EITF pronouncements --- http://www.trinity.edu/rjensen/ecommerce/eitf01.htm

Revenue Issue: Gross versus Net

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.

Bob Jensen's threads on e-Commerce and e-Business accounting issues are at http://www.trinity.edu/rjensen/ecommerce/000start.htm

Especially note the revenue recognition issues at http://www.trinity.edu/rjensen/ecommerce/eitf01.htm 

Microsoft's Shiny New Toy Photosynth is an application that's still a work in progress.
It is dazzling, but what is it for?
Jeffrey McIntyre, MIT's Technology Review, March/April 2008 --- http://www.technologyreview.com/Infotech/20203/?nlid=915&a=f
Watch Photosynth stitch photos together
View the images and see how it works

Jensen Comment
It struck me that if a company's financial report could be visualized in a photograph then Photosynth might be used to stitch various financial reports together.

Bob Jensen's threads on visualization of multivariate data are at http://www.trinity.edu/rjensen/352wpvisual/000datavisualization.htm

Bankers bet with their bank's capital, not their own. If the bet goes right, they get a huge bonus; if it misfires, that's the shareholders' problem.
Sebastian Mallaby. Council on Foreign Relations, as quoted by Avital Louria Hahn, "Missing:  How Poor Risk-Management Techniques Contributed to the Subprime Mess," CFO Magazine, March 2008, Page 53 --- http://www.cfo.com/article.cfm/10755469/c_10788146?f=magazine_featured
Now that the Fed is going to bail out these crooks with taxpayer funds makes it all the worse.
Bob Jensen's "Rotten to the Core" threads are at http://www.trinity.edu/rjensen/FraudRotten.htm

That some bankers have ended up in prison is not a matter of scandal, but what is outrageous is the fact that all the others are free.
Honoré de Balzac

Question
When is the purpose of reclassifying loans as "Held-to-Maturity" for purposes of stabilizing earnings rather than a true strategy to hold those notes to maturity, especially when the value of those notes is plunging daily? "Even analysts think so. "If you thought the accounting for investments in debt and equity securities was unnecessarily complex, the accounting for loans will make your head spin,"

"Is Fair-Value Accounting Always Fair?" Matt A. Greenberg, The Wall Street Journal, March 5, 2008; Page A15 --- http://online.wsj.com/article/SB120468197325912303.html?mod=todays_us_page_one

Is Fair-Value Accounting Always Fair? March 5, 2008; Page A15 Regarding "Wave of Write-Offs Rattles Market" by David Reilly (page one, March 1): Thirty years ago, no accounting principle was more accepted than that assets are worth what they cost, absent proof of a permanent impairment of value. When such impairment was understood and confirmed, the carrying value was adjusted.

Today, I see the overzealous accounting profession calling for long-term assets, those which the owners do not intend to sell, nor have need to sell, being forced to mark such assets to market on a regular basis. While this may make sense for equities, where market values tend to reflect economic reality or assets which may need to be sold in the normal course of operating the business, it makes no sense for assets intended to be held to maturity. The marking of long-term complex financial instruments where market values are temporarily depressed and meaningless for the longer term is terribly destructive. In many cases, the only market prices available are distressed sellers or some thin index which is regularly shorted by investment professionals.

These are not real values, and marking to these prices causes unnecessary volatility and contractions in capital which restrict the ability of financial institutions to operate and grow. Perhaps the accounting profession is trying to overcompensate for its failures in the Enron fiasco and other similar cases, and to prevent lawsuits. Fair-value accounting, particularly for long-term complex instruments that do not trade in liquid markets, is illogical and destructive and should be re-examined immediately.

Jensen Comment
One problem here is bank's want it both ways. The want to classify investments and loans as "held-to-maturity" (HTM) so that they can avoid having to carry them at fair value such as allowed in FAS 115. However, bands want to classify them as HTM but want to sell them when fair value hits trigger points. Hence a lot of those "HTM" securities are not HTM after all.

From The Wall Street Journal Accounting Weekly Review on February 29, 2008

Banks Use Quirk as Leverage Over Brokers in Loan Fallout by David Reilly The Wall Street Journal Feb 27, 2008 Page: C1 Click here to view the full article on WSJ.com --- http://online.wsj.com/article/SB120407667879295385.html?mod=djem_jiewr_AC   TOPICS: Accounting, Advanced Financial Accounting, Banking, Fair Value Accounting, Investment Banking, Investments, Loan Loss Allowance SUMMARY: "Leveraged loans for buyouts were originally made with the idea that banks and brokers would quickly sell them to investors." That approach proved impossible when markets froze in August 2007. "Among banks, Citigroup and J.P. Morgan have the most at stake, with $43 billion and $26.4 billion in exposures, respectively....among brokers, Goldman has the biggest leveraged-loan exposure, at $26 billion, followed by Lehman Brothers...with $23.8 billion....By reclassifying (to held-to-maturity) some of the loans they hold, banks can avoid marking these loans to market, unlike brokerages which have to price these assets" at current market value at each balance sheet date. "J.P. Morgan...Chief Executive James Dimon said during a January conference call...[that] the bank reclassified loans...because it believed that at current depressed prices, some of its leveraged loans 'may be terrific long-term assets to hold.' That said, the more favorable accounting treatment doesn't hurt, either." CLASSROOM APPLICATION: Accounting for investments versus loans is the main topic in the article. The article refers to market value (fair value) measurement, lower or cost-or-market and the cost method as applied to held-to-maturity investments. QUESTIONS:  1.) Three methods of valuing loans and investments -- fair value, lower of cost or market and cost basis -- are described in the article, without using these terms. Summarize how each of these methods is described in the article. 2.) Why do banks and investment brokerage houses face different requirements in accounting for loans they have offered in leveraged buyout transactions? 3.) How might a bank face fewer reported losses by using the cost method of valuing loans than the fair value method? In your answer, comment on the possibility that the bank may have to report allowances for uncollectibility of these loans. 4.) What is the significance of J.P. Morgan Chief executive James Dimon's statement that "at current depressed prices, some of its leveraged loans 'may be terrific long-term assets to hold'?"   Reviewed By: Judy Beckman, University of Rhode Island

"Banks Use Quirk as Leverage Over Brokers in Loan Fallout," by David Reilly, The Wall Street Journal, February 27, 2008; Page C1 --- http://online.wsj.com/article/SB120407667879295385.html?mod=djem_jiewr_AC 

When it comes to losses on "leveraged loans" -- a big source of worry for investors in financial firms -- banks may have an advantage over their brokerage-house rivals in weathering the storm.

Thanks to a quirk in accounting rules, banks such as J.P. Morgan Chase & Co. don't always have to book losses immediately on those loans even as brokers like Goldman Sachs Group Inc. are forced to take hits right away.

Leveraged loans -- used by companies, usually with low credit ratings, and often to fund buyouts -- were originally made with the idea that banks and brokers would quickly sell them to investors. When markets froze in August, institutions found themselves stuck with billions of these loans that they couldn't unload.

That led to losses last fall as financial firms were forced in many cases to mark these loans down by about 5%. The market for these loans is again struggling, and prices are falling further -- in some cases to about, or even less than, 90 cents on the dollar -- which will likely lead to another round of losses at financial firms.

This makes it more likely some banks will look to shield at least part of their holdings from the swings in market prices. By reclassifying some of the loans they hold, banks can avoid marking these loans to market, unlike brokerages, which have to price these assets at whatever investors say they are worth.

This isn't to say that banks will be able to entirely sidestep losses stemming from leveraged loans issued to fund huge corporate buyouts. But any kind of shock absorber would be welcome, given the depressed market conditions now.

Still, while the accounting peculiarity may give banks an edge, it could also pose a danger to their investors, analysts warn. That is because investors could be lulled into complacency when it comes to the size and scope of the hits that the banks may face.

Banks and brokers have nearly $200 billion in leveraged-loan exposure. Given recent falls in market prices of these loans, that could lead to $10 billion to $14 billion in write-downs, Oppenheimer analyst Meredith Whitney estimated in a recent note.

Among banks, Citigroup and J.P. Morgan have the most at stake, with $43 billion and $26.4 billion in exposures, respectively, as of the end of last year. Among brokers, Goldman has the biggest leveraged-loan exposure, at $26 billion, followed by Lehman Brothers Holdings Inc. with $23.8 billion.

The fact that a bank and a broker holding the same kind of loan could see very different effects highlights what some analysts feel is a major flaw in the accounting for leveraged loans. Brokers for years have argued that banks should also be required to assess the values of all their financial assets using market prices.

The differing approaches also underscore that even as the use of so-called market values cause some firms to quickly recognize big losses -- even if there are growing questions about the reliability of these values in frozen markets -- not every financial player always has to measure up against this same yardstick.

Seem strange? Even analysts think so. "If you thought the accounting for investments in debt and equity securities was unnecessarily complex, the accounting for loans will make your head spin," Credit Suisse accounting analyst David Zion wrote in a recent research note looking at issues surrounding loans.

J.P. Morgan, for example, said last month that it had reclassified about $5 billion of $26 billion in leveraged loans it holds. J.P. Morgan declined to comment beyond what Chief Executive James Dimon said during a January conference call. At that time, he said the bank reclassified the loans this way because it believed that at current depressed prices, some of its leveraged loans "may be terrific long-term assets to hold."

That said, the more favorable accounting treatment doesn't hurt, either. Here is how it works: Companies either classify loans as being "held for sale" or as investments, sometimes referred to as "holding to maturity." Loans held for sale are carried at whichever is lower: the original cost or the current market value. That is similar to "marking to market prices." Any losses are taken in the current period.

But the value of loans held for investment doesn't change with every uptick or downtick in the market. Instead, such loans are said to be held at their cost, although they are initially marked to market prices if a firm is reclassifying them from held for sale.

The big benefit is that holding loans for investment reduces volatility. Brokers like Goldman, Lehman, Morgan Stanley or Merrill Lynch & Co., on the other hand, have to mark just about everything they hold to market prices. So the firms -- which together have about $91 billion in leveraged-loan exposure, according to Oppenheimer -- take losses right away.

This isn't to say banks completely avoid losses on loans held for investment. Mr. Dimon said in the bank's conference call that while it wouldn't mark the reclassified loans to market prices, it would "have to build up proper loan-loss reserves against those, and we would fully disclose that so there's no issue about what that did to the company."

But in checking to see whether the value of a held-for-investment loan is impaired, a bank would look to see if there has been a change in the credit rating of an issuer, if the issuer has fallen behind in interest payments or if it looks like a delinquency could be looming.

A bank wouldn't necessarily have to consider what the loan would fetch if sold in the market today, analysts say. That view, which reflects market perceptions, is what is causing big losses at many firms today. So looking only to credit quality could prove to be advantageous.

Three Articles from the American Bankers Association on Fair Value Accounting (as of the end of 2007) --- http://www.cs.trinity.edu/~rjensen/Calgary/CD/FairValue/AmericanBankersAssn/

Bob Jensen's threads on fair value accounting are at http://www.trinity.edu/rjensen/Theory01.htm#FairValue

Question
Since the Enron and Worldcom scandals and the meltdown of their auditing firm (Anderson), audit fees have sky rocketed.
What has this money really bought in the way of improved quality of audits?

"Watching the detectives:  The subprime crisis should teach us to keep a much closer eye on company auditors from now on." by Prem Sikka, The Guardian, March 14, 2008 --- http://commentisfree.guardian.co.uk/prem_sikka_/2008/03/watching_the_detectives.html

Company auditors, the private police force of capitalism, make millions of pounds in fees from company audits. And company audits are used to get easy access to senior management and sell a variety of consultancy services.

But fee dependence, weak laws and self-interest inevitably compromise impulses for penetrating audits. The inevitable outcome is worthless audit reports.

Carlyle Capital Corporation, a Guernsey-registered hedge fund with debts of £11bn, has become the latest casualty of the deepening credit crisis - and the effects will ripple throughout the financial world.

Questions are now being asked about the financial health of its parent company, the Carlyle Group, which has more than $75bn (£37bn) under its management.

But as the crisis spreads, questions also need to be asked about auditors, who are the eyes and ears of regulators and markets. For the Carlyle episode once again draws attention to duff audit reports.

. . .

On February 27 2008, Carlyle Capital Corporation published its annual accounts for the year to December 31 2007. These accounts were audited by the Guernsey office of PricewaterhouseCoopers, the world's biggest accounting firm, which boasts revenues of $25bn.

Amid one of the biggest credit crises, the accounts claimed on page five), that the directors were "satisfied that the Group has adequate resources to continue to operate as a going concern for the foreseeable future".

The auditors were satisfied, too, and on 27 February 2008 gave the company a clean bill of health (page 6).

Less than two weeks later, on March 9 2008, Carlyle announced that it was discussing its precarious financial position with its lenders. And on March 12, the company announced that it "has not been able to reach a mutually beneficial agreement to stabilize its financing".

The company says (page 24) that it paid $2.5m in fees "principally ... to our independent auditors, our external legal counsel, and our internal audit service provider".

Yet In less than two weeks, the mirage of assurance offered by auditors vanished.

And the case of Carlyle Capital Corporation is surpassed by Thornburg Mortgage, America's second-largest independent mortgage provider. Its accounts for the year to December 31 2007 were audited by KPMG, another giant accounting firm, with global revenues of nearly $20bn. On February 27 2008, KPMG gave the accounts a clean bill of health; barely six days later, the company explained that it was experiencing financial turbulence and renegotiating its financial position. Auditors decided to retract their opinion.

On March 7, a press release from Thornburg said it had "received a letter, dated March 4 2008, from its independent auditor, KPMG LLP, stating that their audit report, dated February 27 2008, on the company's consolidated financial statements as of December 31 2007, and 2006, and for the two-year period ended December 31 2007, which is included in the company's Annual Report on Form 10-K for 2007, should no longer be relied upon."

These episodes raise serious questions about the quality of audit work. Why are we paying auditors millions of pounds in fees, especially as audit reports seem to have a shelf life of less than two weeks, and even auditors themselves apparently lack confidence in their own work?

Despite the rising financial gloom, auditors were silent on the subprime crisis. Now, in the middle of the credit crunch, they are found to have issued audit reports of little value.

Auditors can be kept on the straight and narrow by the threat of lawsuits for shoddy work. But that threat has been diluted by a series of liability concessions in the US, the UK and elsewhere. These have eroded economic incentives to deliver penetrating audits. The erosion of liability pressures has made it extremely difficult to sue negligent auditors, and they are now a law unto themselves. The inevitable result is the publication of worthless audit reports.

The auditing industry continues to fail. Yet that is of little comfort to people who may lose their savings, jobs, pensions and investments. This private police force of capitalism has failed again and again to police financial institutions, and that task must now fall upon the regulators.

Continued in article

Andy Bailey has some interesting comments about audit professionalism at http://www.trinity.edu/rjensen/Bailey2008.htm 

Bob Jensen's threads on audit professionalism are at http://www.trinity.edu/rjensen/fraud001.htm#Professionalism

From McGraw-Hill in 2008
Architect's Square Foot Costbook --- https://www.bnibooks.com/botw/archSqFt08orderForm.asp?kcode=204W

From The Wall Street Journal Accounting Weekly Review, March 7, 2008

Wave of Write-Offs Rattles Market by David Reilly The Wall Street Journal Mar 01, 2008 Page: A1 Click here to view the full article on WSJ.com --- http://online.wsj.com/article/SB120432957846104273.html?mod=djem_jiewr_AC   TOPICS: Accounting, Financial Accounting, Financial Accounting Standards Board, Financial Analysis, Financial Reporting, Financial Statement Analysis, Standard Setting SUMMARY: "The massive write-downs that financial firms are posting have begun to spur a backlash among some investors and executives, who are blaming accounting rules for exaggerating the losses and are seeking new, more forgiving ways to value investments." The article quotes comments by Ben Bernancke to the Senate banking committee saying that he doesn't know how to "fix" this accounting issue and that accountants must "make the best judgment they can." Also quoted are comments by FASB Chairman, Bob Herz. CLASSROOM APPLICATION: Use the article to discuss the various influences on accounting standards setting: Economic consequences of accounting choices, the political pressures that can arise, and the desire to uphold qualitative characteristics in financial reporting. The related article is a 'Letter to the Editor' written by a Westport, CT, investment advisor with approximately $230 million in assets under management. QUESTIONS:  1.) Define the concept of "valuation" in accounting, the historical cost basis, and fair-value accounting. Provide examples in which each of these bases of reporting is used in financial statements. 2.) How is fair value accounting potentially contributing to the effects of losses reported by financial institutions? 3.) In responding to questions by the Senate banking committee, Federal Reserve Chairman Ben Bernanke says he does not know how to fix accounting issues arising from reporting on a fair-value basis and that "..accountants need to make the best judgment they can." What accountants are responsible for making judgments about whether to use the historical cost basis or fair-value basis for accounting valuations? 4.) On what basis do accountants decide which is the appropriate model for valuation in financial statements? In your answer, define the conceptual framework in financial accounting and reporting and it's associated qualitative characteristics. 5.) What are the economic consequences of accounting policy choice? List one argument made in the main article or the related one which exemplifies this concern with the economic consequences of accounting policy choice. 6.) FASB Chairman Bob Herz acknowledges "the difficulty investors and companies are facing" but also argues that the alternative to fair-value reporting is to pretend "...that things aren't decreasing in value" and that company managements at times like these would "... say they think it's going to recover." Do you think that historical cost reporting works in this fashion?   Reviewed By: Judy Beckman, University of Rhode Island

"Wave of Write-Offs Rattles Market:  Accounting Rules Blasted as Dow Falls; A $600 Billion Toll?" by David Reilly, The Wall Street Journal, March 1, 2008; Page A1 --- http://online.wsj.com/article/SB120432957846104273.html?mod=djem_jiewr_AC

The massive write-downs that financial firms are posting have begun to spur a backlash among some investors and executives, who are blaming accounting rules for exaggerating the losses and are seeking new, more forgiving ways to value investments.

The rules -- which last made headlines back in the Enron era -- require companies to value many of the securities they hold at whatever price prevails in the market, no matter how sharply those prices swing.

Some analysts and executives argue this triggers a domino effect. The market falls, forcing banks to take write-offs, pushing the market lower, causing more write-offs.

The rules' supporters, however, make a stark counter-argument: They can help prevent the U.S. from suffering the kind of malaise that gripped Japan in the 1990s -- as banks there sat on mountains of dud loans for years without writing them down.

This debate gained new urgency Friday as the Dow Jones Industrial Average fell 315 points, or 2.5%. Driving stocks lower was insurance giant American International Group Inc.'s announcement of an $11.1 billion write-down that led the firm to post a $5.3 billion loss for the fourth quarter, the biggest loss in the firm's 89-year history.

Also rattling investors was a report by UBS that said losses among financial institutions could top $600 billion as the turmoil in global credit markets continues to unfold.

No one, including the chairman of the Federal Reserve, Ben Bernanke, knows with certainty what would be a better approach than using market prices for valuing holdings like these. "I don't know how to fix it," Mr. Bernanke said during testimony Thursday before the Senate banking committee. "I don't know what to do about it."

Mr. Bernanke added that "I think the accountants need to make the best judgment they can."

Despite the grim developments, many investors actually doubt that firms like AIG will suffer the full force of the losses they are now booking. Instead, these investors argue that the market has overreacted and will recover once the current panic subsides.

Indeed, Martin Sullivan, AIG's chief executive, said Friday on the firm's conference call that he doesn't expect the losses to be permanent. "We are obviously witnessing and living through extraordinary market conditions," he said. "We are trying, as are many others, to value very complex instruments."

Tumult also spread further in the normally staid market for municipal bonds -- debt issued by states and municipalities -- which is suffering one of its biggest crises in its history. Several hedge funds were hit with big losses after betting wrong on the direction of muni-bond prices, and as traders rushed to sell and exit their positions, portions of the market effectively froze.

On Friday, muni-bond-prices fell for a 13th straight day, pushing yields significantly higher. (Bond yields move in the opposite direction as price.)

For hundreds of muni-bond issuers, ranging from New York's Port Authority to the North Texas Tollway Authority, this tumult could cause borrowing costs to soar. That's a particular problem at a time when tax revenues are coming under strain from a slowing economy.

AIG's argument that its write-downs were "unrealized" -- in other words, they may never actually result in a true charge to the company -- echoes points made by a number of other major financial firms. It's a sore point because companies feel they are being forced to take big financial hits on holdings that they have no intention of actually selling at current prices.

The firms argue they are strong enough to simply keep the holdings in their portfolios until the crisis passes. Forcing companies to value securities based on what they would fetch if sold today "is an attempt to apply liquidation accounting to a going concern," said Charles Thayer of Chartwell Capital, a financial advisory.

The market-value accounting approach is "exaggerating" the market turmoil, leading to write-downs that are "excessive," said Neal Soss, chief economist at Credit Suisse. "Many people would take the view that price and ultimately value have disconnected."

Even analysts who are generally supportive of the market-value approach acknowledge it can make things tougher for investors in the current environment. It "increases the volatility of the accounts and it makes comparisons from quarter to quarter difficult," said Jeremy Perler of RiskMetrics Group, a research and strategy firm. "It certainly turns the world on end a little bit.

Alternative accounting strategies don't offer much for markets to cling to. One alternative is to value a security based on what the buyer originally paid for it. However, that risks giving investors outdated information.

The use of pricing models that don't pay heed to market values was discredited after Enron Corp. used them to book phantom profits earlier this decade.

Enron, for example, would book a profit on a contract to buy or sell energy years in the future based on its own expectations of how much the contract would be worth over time. But Enron never tried to gauge what others in the market might think the contracts were worth.

As the Fed chairman acknowledged in his recent Senate testimony, a move away from market values could in fact worsen current market turmoil. "The risk on other side is that if you do too much forbearance, or delay mark-to-market, that the suspicion will arise among investors that you're hiding something," Mr. Bernanke said.

Buyers are already lacking trust and that has been a reason they have balked at buying securities that were typically seen as safe havens.

But these market seizures are what have made market values so contentious. Robert Herz, chairman of the body that sets the accounting rules governing the use of market values, the Financial Accounting Standards Board, acknowledged the difficulty investors and companies are facing.

"But you tell me what a better answer is," he said. "Is just pretending that things aren't decreasing in value a better answer? Should you just let everybody say they think it's going to recover?"

Others who favor the use of market values say that for all its imperfections, it also imposes discipline on companies. "It forces you to realistically confront what's happening to you much quicker, so it plays a useful purpose," said Sen. Jack Reed (D., R.I.), a member of the Senate banking committee.

Japan stands out as an example of how ignoring problems can lead to years-long stagnation. "Look at Japan, where they ignored write-downs at all their financial institutions when loans went bad," said Jeff Mahoney, general counsel at the Council for Institutional Investors.

In addition, companies don't always have the luxury of waiting out a storm until assets recover the long-term value that executives believe exists. Sometimes market crises force their hands. Freddie Mac, for instance, sold $45 billion of assets last fall to help the company meet regulatory capital requirements.

Investors can no longer take a firm's survival for granted in today's environment. Fed Chairman Bernanke in his testimony noted that it wouldn't be surprising if there were some bank failures due to the current market crisis.

Bob Jensen's threads on fair value accounting are at http://www.trinity.edu/rjensen/Theory01.htm#FairValue

"Among Different Classes of Equity:  Valuation models can be tailored to unique financing structures." by Andrew C. Smith and Jason C. Laurent, Journal of Accouintancy, March 2008 --- http://www.aicpa.org/pubs/jofa/mar2008/allocating_value.htm 

EXECUTIVE SUMMARY
It is essential for board members, executive officers, CFOs, auditors and private equity investors to comprehend option-pricing models used to determine the per-share values of common and preferred shares.

The AICPA Practice Aid, Valuation of Privately-Held-Company Equity Securities Issued as Compensation, describes three methods of allocating value between preferred and common equity, which include:

Current Value Method (“CVM”) Probability Weighted Expected Return Method (“PWERM”) Option-Pricing Method (“OPM”)

OPM, which is based on the Black-Scholes model, is a common method for allocating equity value between common and preferred shares.

Valuation models must be tailored to the specific facts and circumstances of the equity in the company being valued.

Bob Jensen's threads on valuation are at http://www.trinity.edu/rjensen/roi.htm

Bob Jensen's threads on fair value accounting are at http://www.trinity.edu/rjensen/Theory01.htm#FairValue

"CHECKLIST Implementing Enterprise Risk Management," Journal of Accountancy, March 2008 --- http://www.aicpa.org/pubs/jofa/mar2008/chklist.htm

"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.

March 19, 2008 reply from Zane Swanson [zswanson@EMPORIA.EDU]

We discussed attributes of principles vs. rules based standards in my accounting theory class at the beginning of the semester. Upon reflection of the students' discussion and writing, the one thing that I would emphasize to the discussion is that accountants need to consider the issue from a perspective that the firms present the information to the statement users. Users definitely need comparability and they need understandability. With respect to the average firm in an specific industry, most accounting professionals will formulate statements and render opinions in a manner consistent with relevant reports for the users. As with our students, 1% of them cause 95% of our problems. In this standards' situation, the "Enron" exceptions cause the trouble. Those are the firms that slant the presentation by circumventing the transparent disclosure intention of the rule-based system. In my opinion of a principle-based system, the accounting professional's judgment of "exceptions" becomes more critical than in rules-based system. The "exceptions from the norm" in principle-based situations appear to me to have increased audit risk for the user to appreciate the accounting professionals judgment (even assuming the professionals exercise due diligence in the principles standard system).

Zane Swanson

Professor Zane Swanson
Department of ACIS
Emporia State University
1200 Commercial St.
Emporia, KS 66801
(620)-341-5087

March 19, 2008 reply from Bob Jensen

Hi Zane,

Even today it’s hard for firms to go toe-to-toe with their clients, especially the biggest clients of any local office.

What a relief it must be for auditors to point to bright lines in FASB and SEC rules that make some disputes non-negotiable and free of worry that the client will get better deal from a “less principled” local office competitor of the audit firm.

And when there are bright lines auditors cannot weasel out of some mistakes or hanky pank in auditing. For example, Andersen’s Carl Bass and Enron’s whistle blowing Sherron Watkins knew a bright line had been crossed by not having the requisite three percent (it was only three percent in those days) outside equity ownership in some of Andy Fastow’s SPEs. Without such a bright line, Andersen auditors could simply fudge their “principles.” As it turned out Duncan did fudge and Andersen brass caved in to Duncan’s request to have Carl Bass removed from the Enron audit. But down deep they all knew they’d crossed over the bright lines. You can read more about this by taking the quiz at http://www.trinity.edu/rjensen/FraudEnronQuiz.htm 

Auditors and their clients can make a lot more “fudge” with principles-based standards!

Bob Jensen

March 20, 2008 reply from Zane Swanson [zswanson@EMPORIA.EDU]

Hi Bob,

I also agree bright lines are a good idea to address the normal easily identifiable concerns of auditor/client relations (your three percent example is right on target). From a financial statement user perspective, I am still concerned about situations where professional judgement is involved in firm situations which are quite different from their industry norms. For example, there has been great discussion about FIN48 with respect to the more-likely-than-not deferred tax asset amounts. In particular, these "estimates' will present challenging principles-type judgements when the circumstances are complex beyond "normal" firm/industry situations. I wonder how many users will understand the judgements in those situations and how "bright line" measures will identify effective the professional accounting treatments when judgement is a key issue.

Regards,

Zane

 

Bob Jensen's threads on rules-based versus principles-based standards are at http://www.trinity.edu/rjensen/Theory01.htm#Principles-Based

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.

Also see http://en.wikipedia.org/wiki/Cookie_jar_accounting

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"
 

"FAS 106: Will the SEC Allow GM to Have the Largest Earnings Cookie Jar in History?" by Tom Selling, The Accounting Onion, March 13, 2008 --