Summarize Baker and Burland (August 2015) “The Historical Evolution of from Accounting Theory to the Conceptual Framework’ The CPA Journal.

S

ummarize the attached reading.

In
Focus
60s
The Hist
from Accounting Theory to
50s
In Brief
40s
30s
54
During the first half of the 20th century, few official
bodies were dedicated to the promulgation of financial
accounting standards, and accounting theory provided
the primary basis for accounting education. Since the
second half of the 20th century, however, the guidance
issued by national accounting standards setting bodies
has formed the primary basis for the practice and
teaching of accounting. At present, the role of accounting theory and of national accounting standards setting
bodies is beginning to diminish in the wake of the movement toward uniform international accounting standards.
However developed and implemented, accounting
standards can shape the behavior of businesses,
governments, and individuals. This article traces the historical evolution of standards setting from accounting
theory to conceptual framework, and explores some consequences of this evolution.
AUGUST 2015 / THE CPA JOURNAL
orical Evolution
Conceptual Framework in Financial Standards Setting
70s
A
ccounting theory in Europe and
the United States has often been
based on debates related to the
resolution of practical issues,
such as the proper way to measure assets
and liabilities, the proper way to measure
business performance, the determination of
allowable dividend payments, the protection
of creditors in the event of bankruptcy, and
the taxation of corporations. The ways in
which these issues have been addressed have
differed among accounting theorists, and
even among countries.
Accounting standards can significantly
influence the behavior of enterprises, governments, and individuals, but the wider
spectrum of stakeholders (i.e., employees,
consumer groups, environmental groups,
and the public) generally do not actively
participate in the standards-setting process,
and their interests are often not represented. Thus, an understanding of the evolution of the standards setting process is
important for understanding its economic
and societal consequences.
AUGUST 2015 / THE CPA JOURNAL
80s
By C. Richard Baker and Alain Burlaud
The Development of Accounting Theory
and Doctrine
Germany played a prominent role in the
development of accounting theory in the late
19th and early 20th centuries (R. Mattessich,
H. Kupper, “Accounting Research in the
German Language Area: First Half of the
20th Century,” Review of Accounting and
Finance, 2003, vol. 2, no. 3, pp. 106–137).
The creation of uniform German accounting
law dates to 1861, when the German Code
of Commerce (ADHGB) required all companies to keep accounts and to prepare an
annual balance sheet. This law did not, however, specify recognition and measurement
criteria for financial statements, and disputes
arose around the meaning of a particular section of the ADHGB explaining that assets
and liabilities were to be measured at the
“value” they had at the time the inventory
was drawn up (J. Richard, “The Concept of
Fair Value in French and German
Accounting Regulations from 1673 to 1914
and Its Consequences for the Interpretation
of the Stages of Development of Capitalist
00s
Accounting,” Critical
Perspectives on Accounting,
2005, vol. 16, pp. 825-850). Some
legal scholars interpreted this phrase to mean
that assets should be measured at market values that would allow the payment of dividends out of unrealized holding gains. In the
event of bankruptcy, this might mean that
creditors would be disadvantaged with
respect to shareholders. To correct this problem, an 1870 law specified recognition and
measurement rules to protect creditors by
limiting dividend payments to the amount of
realized profits (M. Hommel, S. Schmitz,
“Insights on German Accounting Theory,”
in Y. Biondi, S. Zambon, Accounting and
Business Economics: Insights from National
Traditions, Routledge, 2014, p. 333).
Static and Dynamic Accounting
Debates concerning the protection of
creditors and determination of dividend
payments, which directly affect the measurement of assets and liabilities as well as
profits, were crystalized in the “static”
55
In
Focus
(asset/liability) versus “dynamic” (revenue/expense) views of accounting theory
that emerged in the early years of the
20th century. According to Richard (2005,
2013), conflicts between capitalist
entrepreneurs and providers of capital
occurred pursuant to the development of
the static view of accounting theory in the
19th century. The basic assumption underlying the static view was that every human
enterprise has a definite life; therefore, it
is necessary to consider the potential failure of a company, and then proceed as if
the company would be put into liquidation.
This concept of “fictional liquidation”
required the valuation of assets at their market values at the binnerce sheet date in
order to determine the amount necessary
to pay the liabilities in case of bankruptcy
(J. Richard, “The Three Main Schools of
the French Financial Accounting Doctrine:
A Historical Survey,” in Y. Biondi and S.
Zambon, Accounting and Business
Economics: Insights from National
Traditions, London: Routledge, 2013,
pp. 249–271).
The transition to the dynamic approach to
accounting theory occurred in the late 19th
century as a response to pressure from
shareholders who wanted regular dividend
payments. This desire was not compatible
with fluctuations in the market value of assets
and liabilities. In contrast to the static view,
the dynamic view is based on recognizing
assets and liabilities at historical cost with
depreciation of these assets and amortization
of deferred charges where appropriate. Income
is then determined by matching expenses
against revenues. This dynamic view became
the primary basis of accounting theory in the
United States for most of the 20th century.
The dynamic view had been elaborated in the
work of the German accounting academic theorist Eugen Schmalenbach, whose theories
are well known in Germany and continue to
be taught in German universities (Hommel,
Schmitz, 2014).
Accounting Theory in the United States
The development of accounting theory
in the United States was largely due to
the work of William Paton and John
Canning. In his 1922 book, Accounting
Theory, Paton presented a set of “assumptions” underlying financial accounting. In
his 1928 book, The Economics of
Accountancy, Canning was the first to
develop a theoretical framework for the
valuation of assets and the determination
56
of accounting profit similar to that of the
static approach. These works significantly
influenced the development of accounting
theory in the United States (S. A. Zeff,
“The Evolution of the Conceptual
Framework for Business Enterprises in the
United States,” Accounting Historians
Journal, 1999, vol. 26, no. 2, pp. 89–131).
A. C. Littleton was another scholar with a
significant influence on American accounting
theory. Littleton, who was fluent in German,
was particularly familiar with the German
dynamic approach to accounting theory (Y.
Biondi, “Accounting, Economics, and the
The dynamic view
became the primary basis
of accounting theory in
the United States for most
of the 20th century.
Law of the Enterprise Entity: A. C. Littleton
and the German-American Connection,” in
Y. Biondi, S. Zambon, Accounting and
Business Economics: Insights from National
Traditions, 2013, Routledge, pp. 363-386).
Littleton argued that the primary objective of accounting is to render an account
(accountability), and that this objective
would be difficult to achieve if market values were used in accounting measurements.
Littleton rejected market values because he
believed that value is a subjective concept
that cannot be measured reliably. He also
dismissed the idea that labor cost determines value (A. C. Littleton, “Price and
Value in Accounting,” Accounting Review,
vol. 4, 1929, pp. 149-159). He argued
that an object’s worth depends solely on
future prices:
Value is a subjective estimate of an article’s relative importance; price, however, is a compromise between subjective
estimates and is measured by the quantity of money for which an article can
be exchanged. Value exists in one’s mind
alone and therefore is not objectively
measureable. … Much of the use of
the term “value” in accounting may be
due to the view that value in business
has a cost basis, that Price = Cost +
Profit. As a matter of fact: Price –
Cost = Profit. … If cost is a proper basis
for the inventory of a stock of unsold
goods, it must be for other reasons than
that it expresses the value of the goods.
As an expression of the investment in
goods, cost is quite acceptable, but not
as an expression of their value. Cost is
a record of recoverable outlay, and not
recorded value. … What something is
worth will depend upon future prices.
(Littleton, 1929)
Paton and Littleton participated in the
preparation of “A Tentative Statement of
Accounting Principles Affecting Corporate
Reports,” published in 1936 by the executive committee of the American
Accounting Association (AAA) in the
Accounting Review in order to assist the
SEC, which had been created in 1934
(“A Tentative Statement of Accounting
Principles Underlying Corporate Reports,”
The Accounting Review, 1936, vol. 11,
no. 20, pp. 187-191).
The subsequent Paton and Littleton
monograph, An Introduction to Corporate
Accounting Standards, was based on the
tentative statement (W. A. Paton, A. C.
Littleton, An Introduction to Corporate
Accounting Standards, American
Accounting Association, 1940).
The Paton and Littleton monograph
advocated the dynamic approach to
accounting theory, involving the use of historical cost principle for asset and liability measurement and recognition; and using
the matching principle (i.e., revenue and
expense) as the basis for calculating profit. The SEC adopted the monograph as the
primary theoretical basis underlying U.S.
Generally Accepted Accounting Principles
(GAAP), and it was also used for many
years to teach accounting in the United
States. More than any other accounting
publication, this monograph was responsible for the maintenance of the historical
cost principle in the United States.
Historians note that the Paton and Littleton
monograph was an exception to the general rule that academic theory has had little impact on accounting practice (R. K.
Storey, “Conditions Necessary for
Developing a Conceptual Framework,”
AUGUST 2015 / THE CPA JOURNAL
From Accounting Theory to Conceptual Framework
FOR FURTHER READING
AAA Executive Committee, “A Tentative Statement of Accounting Principles Underlying Corporate Reports,” The Accounting Review, vol. 11, no. 20, 1936, pp. 187-191
C.R. Baker, Y. Biondi, Q. Zhang, “Disharmony in International Accounting Standards Setting: The Chinese Approach to Accounting for Business Combinations,”
Critical Perspectives on Accounting, vol. 21, 2010, pp. 107-117
C.R. Baker, “The Curious Change in Leadership at the IASB,” The CPA Journal, vol. 81, no. 11, 2011, pp. 6-8
E. Bengtsson, “Repoliticalization of Accounting Standard Setting—The IASB, the EU and the Global Financial Crisis,” Critical Perspectives on Accounting, 2011,
vol. 22, no. 6, 2011, pp. 567–580
G.P. Benston, M. Bromwich, A. Wagenhofer, “Principles- Versus Rules- Based Accounting Standards: The FASB’s Standard Setting Strategy,” Abacus, vol. 42, no.
2, 2006, pp. 165–188
Y. Biondi, “Accounting, Economics, and the Law of the Enterprise Entity: A.C. Littleton and the German-American Connection,” in Biondi, Y. and S. Zambon,
Accounting and Business Economics: Insights from National Traditions, London: Routledge, 2013, pp. 363-386
A. Burlaud, “Les Comptes Doivent-Ils Dire le « Vrai » ou le « Bon »? A Propos du Cadre Conceptuel de l’IASC/IASB,” Revue Française de Comptabilité.
2013, vol. 467, pp. 17-20; vol. 468, pp. 38-41; vol. 470, pp. 27-31
A. Burlaud, B. Colasse, “International Accounting Standardization: Is Politics Back?,” Accounting in Europe, vol. 8, no. 1, 2010, pp. 23-47
A. Burlaud, R. Pérez, “La Comptabilité Est-Elle un “Bien Commun?,” in N. Nikitin, C. Richard, Comptabilité, Société, Politique: Mélanges en L’honneur du
Professeur Bernard Colasse, 2012, Paris: Economica”
J. Canning, The Economics of Accountancy: A Critical Analysis of Accounting Theory, 1929, New York: The Ronald Press Company
S. Carmona, M. Trombetta, “On the Global Acceptance of IAS/IFRS Accounting Standards: The Logic and Implications of the Principles-Based System,” Journal of
Accounting and Public Policy, 2008, vol. 27, no. 6, pp. 455–461
W.F. Chua, S. Taylor, “The Rise and Rise of IFRS: An Examination of IFRS Diffusion,” Journal of Accounting and Public Policy, 2008, vol. 27, no. 6, pp. 462–473
B. Colasse,,“La Comptabilité : Un Savoir d’Action en Quête de Theories,” in B. Colasse, Savoirs, Théoriques et Savoirs d’Action, 1996, PUF: pp. 73-89
B. Colasse (ed.), Les Grands Auteurs en Comptabilité, Paris, EMS, 2005
C.J. Deegan, J. Unerman, Financial Accounting Theory, 2006, London: McGraw-Hill Education
P.J. DiMaggio, W.W. Powell, “The Iron Cage Revisited: Institutional Isomorphism and Collective Rationality in Organizational Fields,” American Sociological Review,
vol. 48,1983, pp. 147-160
European Union, On the Application of International Accounting Standards, Regulation (EC) No. 1606/2002 of The European Parliament and of The Council, July 19, 2002.
Financial Accounting Standards Board (FASB), Scope and Implications of the Conceptual Framework Project, Norwalk, Conn., 1976
E. Hendriksen, Accounting Theory, 1970, Homewood, Ill.: R.D. Irwin
R.D. Hines, “Financial Accounting: In Communicating Reality, We Construct Reality,” Accounting, Organizations and Society, vol. 13, no. 3, 1988, pp. 251-261
J-M Hitz, “The Decision Usefulness of Fair Value Accounting: A Theoretical Perspective,” European Accounting Review, vol. 16, no. 2, 2007, pp. 323-362
IASB, The Conceptual Framework for Financial Reporting. London: International Accounting Standards Board, 2010 http://eifrs.ifrs.org/eifrs/bnstandards/en/2014/
conceptual_framework_unaccompanied
IASB, “IFRS Application Around the World,” London: International Accounting Standards Board, 2014, http://www.ifrs.org/Use-around-the-world/Pages/
Jurisdiction-profiles.aspx
Institute of Chartered Accountants in Scotland (ICAS), The International Federation of Accountants (IFAC), “Do We Need a Roadmap for Financial Reporting?
Developing the IASB’s Conceptual Framework,” 2014, Edinburgh, UK
W.A. Paton, A.C. Littleton, An Introduction to Corporate Accounting Standards, 1940, Urbana, Ill.: American Accounting Association
R. Macve, “Trading places: A UK (and IFRS) Perspective,” Accounting, Economics and Law: A Convivium, vol. 4, no. 1, 2014, pp. 27-40
M. Moonitz, The Basic Postulates of Accounting, Accounting Research Study No. 1, New York: American Institute of Certified Public Accountants, 1922
W.A. Paton, Accounting Theory: With Special Reference to the Corporate Enterprise, 1961, New York: The Ronald Press Company
Revue Française de Comptabilité (RFC), “Création du Comité International pour les Principes Comptables (IASC),” Revue Française de Comptabilité, Oct. 31, 1973.
E. Schmalenbach, “Grundlagen der Dynamischen Bilanztheorie (Foundations of Dynamic Accounting),” Zeitschrift für handelswissenschaftliche Forschung, vol. 13,
pp. 1-101, 1919
E. Schmalenbach, “Der Kontenrahmen (The Master Chart of Accounts),” 1927, Leipzig, Germany: G.A. Gloeckner
SEC, “Study Pursuant to Section 108(d) of the Sarbanes-Oxley Act of 2002 on the Adoption by the United States Financial Reporting System of a PrinciplesBased Accounting System,” 2003 Washington, D.C.: United States Securities and Exchange Commission (SEC)
R.T. Sprouse, M. Moonitz, “A Tentative Set of Broad Accounting Principles for Business Enterprises,” 1962, New York: American Institute of Certified Public
Accountants.
R.K. Storey, “Conditions Necessary for Developing a Conceptual Framework,” Journal of Accountancy, vol. 151, no. 6, 1981, pp. 84-96
Trueblood Report. “Objectives of Financial Statements: Report of the Study Group on the Objectives of Financial Statements,” New York: American Institute of
Certified Public Accountants (AICPA), Study Group on the Objectives of Financial Statements, 1973
G. Whittington, “Harmonization or Discord? The Critical Role of the IASB Conceptual Framework Review,” Journal of Accounting and Public Policy, vol. 27, no. 6,
2008, pp. 495–502
S.A. Zeff, “Some Junctures in the Evolution of the Process of Establishing Accounting Principles in the U.S.A.: 1917-1972,” The Accounting Review, vol. 59,
no. 3, 1984, pp. 447-468
S.A. Zeff, “The Evolution of the Conceptual Framework for Business Enterprises in the United States,” The Accounting Historians Journal, vol. 26, no. 2, 1999, pp. 89-131
AUGUST 2015 / THE CPA JOURNAL
57
In
Focus
Journal of Accountancy, vol. 151, no. 6,
1981, pp. 84–96). Generations of accounting practitioners learned accounting theory through the Paton and Littleton
monograph (S.A. Zeff, “The Evolution
Of The Conceptual Framework for
Business Enterprises in the United States,”
Accounting Historians Journal, vol. 26,
no. 2, 1999, pp. 89-131).
Moreover, major accounting standardssetting bodies, including the AICPA’s
Committee on Accounting Procedure
(CAP), the AICPA’s Accounting Principles
Board (APB), and FASB, took positions
that were consistent with those in Paton
and Littleton’s monograph. In fact, when
the AICPA created the CAP in 1939 as the
first accounting standards setter in the
United States, one of its early decisions
was to reject the idea of creating a new
set of accounting theory or principles on
the grounds that it would take too long and
the Paton and Littleton monograph could
serve the same purpose. Thus, the CAP
began publishing Accounting Research
Bulletins (ARB) to address immediate
accounting practice issues, rather than basing its ARBs on a full statement of
accounting theory or a conceptual framework (Zeff 1999).
In summary, accounting theory enunciated by academic scholars began to play
an important role in the accounting standards setting process in the United States
during the first half of the 20th century.
Subsequently, the development of accounting standards was largely based on the
influence of professional accounting bodies, such the AICPA, acting in tandem with
regulatory authorities such as the SEC
and the largest public accounting firms.
This transition is discussed below.
The Transition to
Standards-Setting Bodies
Accounting theory initially had an
important influence on the development of
accounting practice and teaching, but it
could not lead to the standardization of
accounting practices. The government (i.e.,
the SEC) and professional associations (i.e.,
the AICPA) believed that in order to standardize accounting practices, and provide
financial information intended for society
as a whole, recognized accounting standards setting bodies were needed to provide legitimacy and support for the
enforcement of accounting standards.
58
Development of U.S. standards setting
bodies. The enactment of the Securities
Acts of 1933 and 1934 required publicly
listed companies to prepare audited financial statements in accordance with
GAAP—although there was no document
or source specifying what GAAP consisted of prior to that time. To resolve this
problem, the AICPA and the SEC created
Accounting theory initially
had an important influence
on the development of
accounting practice and
teaching, but could not lead
to the standardization of
accounting practices.
the Committee on Accounting Procedure
(CAP) in 1938. From 1938 until 1959,
the CAP issued 51 ARBs that came to
define GAAP in the United States. In 1959,
the AICPA revised the standards-setting
structure by creating the Accounting
Principles Board (APB), which was intended to have greater authority to promulgate
accounting standards. From 1959 until
1973, the APB published 31 Opinions.
Thus, between 1938 and 1973, accounting standards in the United States consisted primarily of ARBs and APB Opinions
issued by the CAP and APB, whose members were mostly representatives of public
accounting firms, along with a few academics (Zeff, 1984).
In the 1940s and 1950s, the SEC, the
leaders of the large public accounting firms,
and academics discussed whether accounting standards setting should be based on a
comprehensive set of accounting principles,
and what these principles should be (S.
A. Zeff, “Some Junctures in the Evolution
of the Process of Establishing Accounting
Principles in the U.S.A.: 1917-1972,” The
Accounting Review, vol. 59, no. 3, 1984,
pp. 447–468). The leaders of the major
firms had differing opinions over the choice
between a uniformity of accounting or flexibility in the selection of methods (Zeff,
1984, pp. 458–459). In order to resolve
these conflicts, the AICPA created the
Special Committee on Research Programs,
composed of preparers of financial statements, auditors, academics and the chief
accountant of the SEC. In a report published in 1958, the Special Committee proposed the creation of the APB to replace
the CAP, and the creation of a Research
Division to support the APB.
In its report, the Special Committee identified three main levels of accounting theory: postulates (used by Paton in 1922),
principles, and rules. Postulates were to
be derived from the economic and political environment in which businesses operate. The report indicated that postulates
should be few in number and should logically lead to the principles and the rules.
The purpose of the Research Division
was to determine the postulates and principles to be used in the promulgation of
accounting standards (Zeff 1999).
Three levels of postulates. When the
APB and the Research Division were created in 1959, Maurice Moonitz, professor
of accounting at the University of
California, Berkeley, was named director
of accounting research. In this role, he
authored Accounting Research Study 1,
“The Basic Postulates of Accounting”
(M. Moonitz, “The Basic Postulates
of Accounting,” Accounting Research
Study 1, AICPA, 1961). This document
describes three levels of postulates:
n Group A: Economic and political environmental postulates. This group of postulates is based upon the economic and
political environment in which accounting exists. They represent descriptions of
the aspects of the environment that are relevant for accounting. These postulates
included quantification, exchange, entities,
time period, and unit of measure.
n Group B: Accounting postulates. This
group focuses on the field of accounting.
These postulates form the basis for the construction of accounting principles. These
postulates included financial statements,
market prices, entities, and tentativeness.
AUGUST 2015 / THE CPA JOURNAL
From Accounting Theory to Conceptual Framework
Group C: Imperative postulates. The
third group differs fundamentally from
the first two groups. These postulates are
not descriptive statements. Instead, they
represent a set of normative statements concerning what ought to be rather than what
is. These postulates included continuity,
objectivity, consistency, stable unit, and
disclosure.
Following Accounting Research Study 1,
Robert Sprouse, professor of accounting at
Stanford University, joined Moonitz in coauthoring Accounting Research Study 3, “A
Tentative Statement of Broad Accounting
Principles for Business Enterprises.” This document recommended that the realization principle be de-emphasized and that the use of
market values should be expanded (R. T.
Sprouse, M. Moonitz, “A Tentative Set of
Broad Accounting Principles for Business
Enterprises,” AICPA, 1962, p. 15).
Given the SEC’s hostility to the abandonment of historical cost, the document
immediately created controversy. Thus, the
APB devoted itself to the issuance of opinions that responded to practice issues, rather
than basing its opinions on a comprehensive
set of accounting theory or principles.
Trueblood Committee. A new attempt
to create a complete set of accounting theory began in 1973 with the publication of
the report of the AICPA’s Trueblood
Committee, “Objectives of Financial
Statements” (Trueblood Report, “Objectives
of Financial Statements: Report of the Study
Group on the Objectives of Financial
Statements,” AICPA, Study Group on the
Objectives of Financial Statements, 1973).
This document supported the views of
a 1966 report issued by the AAA, “A
Statement of Basic Accounting Theory
(ASOBAT),” which argued that the primary objective of financial reporting should
be usefulness for decision making (AAA,
1996, p. 1). This emphasis on decision usefulness—and in particular usefulness for
decision making by investors and creditors—was the basis of Statement of
Financial Accounting Concepts (SFAC) 1,
Objectives of Financial Reporting by
Business Enterprises, issued in 1978, which
became the first element in FASB’s
Conceptual Framework. Since that time,
SFAC 1 has been used in the development
of FASB standards and in the development
of additional elements in the Conceptual
Framework of both the FASB and the
IASB (Zeff 1999).
n
AUGUST 2015 / THE CPA JOURNAL
The Conceptual Framework. In the latter
part of the 20th century, FASB’s Conceptual
Framework essentially replaced accounting
theory as the basis for the development of
accounting standards in the United States.
The Conceptual Framework was developed
primarily by FASB and its professional
staff rather than by academic theorists; there
was also little input from the general public
in its creation. Possibly due to the failure of
Accounting Research Study 3, which was
FASB’s Conceptual
Framework essentially
replaced accounting theory
as the basis for the
development of accounting
standards in the U.S.
authored by two academics and firmly based
in accounting theory, the development of
accounting standards has evolved so that it
is now the work of an independent professional technocracy without representation
from a broad spectrum of stakeholders. It
would take a specific change in the
accounting standards setting process in
order for accounting theory to broadly represent stakeholders.
The following section examines some of
the challenges associated with this evolution
away from accounting theory, and towards
a greater reliance on conceptual frameworks
and the institutional convergence of the
standards setting process in a way that diminishes debate about alternatives.
Consequences of the Standards–Setting
Process and Conceptual Framework
The 2008 global financial crisis has led to
renewed reflections regarding the consequences of accounting standards setting and
the purposes of a conceptual framework for
financial reporting (A. Burlaud, B. Colasse,
“International Accounting Standardization:
Is Politics Back?,” Accounting in Europe,
vol. 8, no. 1, 2010, pp. 23–47).
It has been argued, for example, that the
measurement of financial assets at market values has had a pro-cyclical, macroeconomic
effect that exacerbates the impact of economic
crises (A. Burlaud, “Les Comptes Doivent-ils
Dire le «Vrai» ou le «Bon»? A Propos du
Cadre Conceptuel de l’IASC/IASB,” Revue
Française de Comptabilité, vol. 467, 2013, p.
17). It is necessary to reconsider the
accounting standards-setting process and its
consequences.
One difference between the operating structures of the IASB and FASB is the relative
degree of government supervision over the
two boards. FASB’s standards are subject to
review by the SEC, as well as the U.S. government’s legal authority, even though the
board’s operating structure facilitates its functioning in the private sector. The IASB’s operating structure is different, because there is no
external governmental authority supervising
its actions, and its standards may be issued
without any significant public debate. For
example, the use of “fair value” in the measurement of agricultural assets was introduced
without major input from countries that could
be negatively affected by fair value measurements (e.g., agriculturally based
economies in Africa and Asia; see C. Elad,
“Fair Value Accounting in the Agricultural
Sector: Some Implications for International
Accounting Harmonization,” European
Accounting Review, vol. 13, no. 4, 2004,
pp. 621–641).
Accounting standards can affect the
functioning of financial markets, as well as
the decisions of companies, governments
and individuals, and yet there is little democratic input into the standards-setting process (E. Chiapello, K. Medjad, “An
Unprecedented Privatisation of Mandatory
Standard-Setting: The Case of European
Accounting Policy,” Critical Perspectives
on Accounting, vol. 20, no. 4, 2009,
pp. 448–468). Thus, the question of legitimacy for the IASB and its standards-setting process remains an unresolved issue
(Burlaud and Colasse, 2010).
Despite questions about the legitimacy
of the IASB, many standards-setting bodies are becoming more similar in their operating structures and procedures (P.J.
DiMaggio, W.W. Powell, “The Iron Cage
Revisited: Institutional Isomorphism and
Collective Rationality in Organizational
59
In
Focus
Fields,” American Sociological Review,
vol. 48, 1983, pp. 147-160; R. Ball,
“International Financial Reporting
Standards: Pros and Cons for Investors,”
Accounting and Business Research,
vol. 36, supplement 1, 2006, pp. 5-27).
This type of institutional isomorphism
has led to a paradoxical situation in
which the operating structure of the IASB
has mimicked that of the FASB, while
the convergence between the IASB and
FASB’s standards appears to have been
postponed indefinitely (Burlaud and
Colasse, 2009).
Political Influence on Standards Setting
In 2002, the European Union issued
Regulation EC 1606/2002, which defined the
use of international accounting standards within the EU in an effort to obtain more influence over the IASB standards setting process.
This regulation did three things: 1) It defined
international accounting standards as those
promulgated by the IASB; 2) it specified
that for each financial year starting on or after
January 1, 2005, companies governed by the
law of a EU member state must prepare
their consolidated accounts in conformity with
international accounting standards, if their
securities are traded on a regulated market; 3)
the European Commission retained the authority to determine the applicability of specific
standards within the EU. In pursuing this third
point, the European Commission created an
Accounting Regulatory Committee (ARC)
composed of representatives of governmental authorities from each of the member states.
The ARC can recommend approval or disapproval of IFRS standards for use by companies in the EU.
The EU’s efforts to gain more influence
over the standards-setting process intensified
in 2004 with the debate over IAS 39,
Financial Instruments: Recognition and
Measurement. IAS 39 has provisions similar
to SFAS 115. Financial instruments are
required to be recognized when an entity
becomes a party to the contractual provisions,
and they must be classified into trading, available for sale, loans and receivables, or held
to maturity. The classification determines the
subsequent measurement of the instrument
(typically amortized cost or fair value).
The provisions of IAS 39 prompted a reaction on the part of European banks, which
pressured government authorities to overrule the standard (J. House, “IAS 39
Adoption Faces French Resistance,
60
Accountancy, vol. 132, 2003, pp. 9–12). At
the end of 2004, the ARC and European
Commission recommended partial approval
of IAS 39, with the exception of certain
provisions pertaining to hedging and fair
value measurement of financial instruments.
In response to political pressures brought to
bear on the IASB by various European governments, in June 2005, the IASB amended
IAS 39 with provisions to reduce volatility
in the financial statements of banks and other
financial institutions.
Further exacerbating the political problems
associated with IAS 39, in 2008, banks around
the world faced substantial write-offs of their
trading and available for sale securities portfolios. The accounting treatment of these losses differed substantially between U.S. GAAP
and IFRS. Under U.S. GAAP, FASB interpreted the problems posed by the financial
crisis to be one of the circumstances contemplated in SFAS 115, which provided an
option to transfer securities from the trading
or available for sale category into the held to
maturity category (i.e., to suspend fair value
measurement of the respective assets).
Prominent U.S. banks made use of this opportunity (C. Laux, C. Leuz, “The Crisis of
Fair-Value Accounting: Making Sense of
the Recent Debate,” Accounting,
Organizations, & Society, vol. 34, no. 7/8,
2009, pp. 826–834). But European banks
could not avoid reporting the losses, because
IAS 39 required that “an entity shall not
reclassify a financial instrument into or out
of the fair value through profit or loss category while it is held or issued.”
As a result, at the peak of the financial
crisis in October 2008, the IASB decided to
suspend its normal due process in order to
issue an amendment to IAS 39 (P. André,
A. Cazavan-Jeny, W. Dick, C. Richard, P.
Walton, “Fair Value Accounting and the
Banking Crisis in 2008: Shooting the
Messenger,” Accounting in Europe, vol. 6,
2009, pp. 3–24).
The IASB decision was preceded by
intense lobbying efforts on the part of
European politicians and banking regulators,
which culminated in the European
Commission threatening to prevent the
application of IAS 39. The amendment to IAS
39 allowed companies to retroactively
reclassify financial assets previously recognized at fair value into categories that permitted recognition at amortized cost, and avoid
significant write-downs in the carrying value
of financial assets (J. Bischof, U. Brüggemann,
H. Daske, “Fair Value Reclassifications of
Financial Assets During the Financial Crisis,”
2014, http://ssrn.com/abstract=1628843).
External political pressures can bear down
on the accounting standards setting process,
and the legitimacy of this process remains
an unresolved issue. The political interventions surrounding the implementation of IAS
39 also illustrate the weakness of the IASB
Conceptual Framework, because the principle of fair value measurement of financial
instruments was not effectively maintained in
the face of a severe financial crisis.
How Standards Shape the Future
Accounting theory influenced the development of accounting standards during the
first half of the 20th century, but it diminished during the second half of the 20th
century in response to the rise of national
standards-setting bodies. In the 21st century, the role of national standards setters
has subsequently diminished with the creation of the IASB and the movement
towards uniform international accounting
standards. The primary influences on
accounting standards setting currently come
from international capital markets and global business enterprises. Since Jan. 1,
2005, IFRS is compulsorily applicable to
consolidated accounts of all European
listed companies. Apart from the purely
technical aspects of this change, and its difficulties in implementation, there is a questionable lack of consideration of the
consequences of accounting standards
and the standards-setting process.
Accounting standards—far from being neutral—contribute to shaping economic practices and social relations. Management
practices can be fundamentally altered,
induced into a short-term perspective in
order to meet market expectations regarding profitability as defined under the standards. It appears to this author that the
principles of reliability, stewardship and
prudence—present decades ago in early
accounting theory—have been replaced in
favor of relevance.
q
C. Richard Baker, PhD, CPA, is a professor of accounting at Adelphi University,
Garden City, N.Y. He is a member of The
CPA Journal Editorial Board. Alain Burlaud
is a professor emeritus at the Conservatoire
National des Arts et Métiers, Paris, France.
He is a designated auditor and accountant.
AUGUST 2015 / THE CPA JOURNAL
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