Transcript Accounting in Crisis? - University of Alaska system

Accounting in Crisis?
Financial Reporting at a
Crossroads
Laws of Accounting

Trial Balances don’t

Bank reconciliations never do

Working capital does not

Return on investments never will
The “New” Pledge of Allegiance

One nation, under greed, with stock
options and tax shelters for all.

Proposed following a June 26, 2002 U.S.
court decision that the present version is
unconstitutional.
Consider Three Quotations
Quotation #1

Transparent accounting plays an
important role in maintaining the vibrancy
of our financial markets.

Alan Greenspan
Chairman, Board of Governors of
The Federal Reserve Board
Quotation #2

The single most important innovation
shaping the (American capital) market
was the idea of generally accepted
accounting principles. We need
something similar internationally.

Lawrence H. Summers
Former Secretary of the Treasury.
Quotation #3

The quality of information we now
receive from companies in the U.S. is
about the best we have ever seen and
exceeds that of almost any other nation.

Abby Joseph Cohen
Chair, Investment Policy Committee Goldman,
Sachs & Co.
What is the “purpose” of
Accounting?
Objective #1

Financial reporting should provide
information that is useful to present and
potential investors and creditors and
other users in making rational
investment, credit, and similar decisions.
Objective 1 continued

The information should be
comprehensible to those who have a
reasonable understanding of business
and economic activities and are willing to
study the information with reasonable
diligence.
Objective #2

Financial reporting should provide
information to help present and potential
investors and creditors and other users
in assessing the amounts, timing, and
uncertainty of prospective cash flows.
Objective #3

Financial reporting should provide
information about the economic
resources of an enterprise, the claims to
those resources (obligations of the
enterprise to transfer resources to other
entities and owners’ equity), and
Objective #3 continued

The effects of transactions, events, and
circumstances that change its resources
and claims to those resources.
First-Order Feedback System
Boundary
Environment
Inputs
Outputs
Process
Feedback Loop
Control
Sensor
The Accounting Process
Transaction
or event
Source
documents
Analysis
Reporting
Trial balance
Recording &
posting
Accounting Information System
Boundary
Ongoing events in
world
Recording
Data Bank
Information
Classifying
First . . . Consider this

Accounting is all about accuracy.

Accounting is all about hard numbers.

Accounting is all about accountability.

Accounting is a time-honored tool for
making hard decisions about dollars and
cents, about profits and losses.
First . . . Consider this

Accounting is the land of bean counters,
of number crunchers – men and women
with green eyeshades and calculators.

Accounting says Baruch Lev, Professor
of Accounting and Business at New York
University’s Stern School of Business is
increasingly irrelevant.
First . . . Consider this

The problem, says Lev, is that the
systems of accounting and financial
reporting that are being used today date
back more than 500 years.

These systems are not only part of the
old economy, they’re part of the old, old
economy.
First . . . Consider this

Luca Pacioli, an Italian mathematician
who lived in Venice in the 1400s
developed double-entry bookkeeping in
order to offer business people a simple
method for keeping track of their
transactions – and even more important,
for making sense of the way they did
business.
First . . . Consider this

“If you cannot be a good accountant,”
Pacioli wrote, “you will grope your way
forward like a blind man and may meet
great losses.”
The Evolution of the
Knowledge Professional
Robert K. Elliott and
Peter D. Jacobson
Accounting Horizons, March 2002
Introduction

Wealth creation depends on knowledge
work as never before, a change full of
implications for those who provide
information services.

We argue that a new economic model
has created a need for a new type of
information professional.
Four Economic Paradigms

Hunting and Gathering

Agriculture

Industry

The Information Economy
Your Questions

Is it possible that the role of the new
information professional will never be
fully defined? Since technology is now
advancing at such a rapid rate, could the
role of the new information technology
professional be a moving target?
Your Questions

Is the new paradigm really coming, or is
this simply a case of divergent
specialties resulting from an increasingly
complex world?
Your Questions

Is it possible for a profession to
consciously “reinvent” itself? If so, what
are some examples of professions who
have succeeded (or tried and failed)?
Your Questions

The author argues that the accounting
profession should take the initiative to
expand its role in the information
economy and serve as the foundation of
the new information professional. Are
there other professional disciplines that
might serve as well or better as a
foundation for the new information
professional?
Your Questions

In light of the scandals that occurred
after the commentary was written, do
accountants have an opportunity to fulfill
the role of the knowledge professional in
the new economy.

Aren’t there other professions that have
just as much claim to lead the
“information economy?”
Your Questions

As the “information economy” continues to
improve making information more easily and
readily available to each individual, will there
not be fewer positions for these trusted
knowledge professionals since their efficiency
will be greater than those of today?
Conversely, would each individual then
become responsible for being their own
knowledge professional?
Your Questions

Is it possible that the evolution of the
accountant/auditor profession will end in
a merger with the finance profession?
Or will software replace them both?
Your Questions

Is this field moving so fast that when
teaching new methods, they will be
outdated by the end of the semester?
Does the teaching professional need to
be revolutionized as well?
Financial Reporting at a
Crossroads
Michael H. Sutton
Accounting Horizons
December 2002
Some Challenging Questions

Can we believe in and rely on the
independent audit?

Can we believe that our accounting and
disclosure standards provide the
transparency that is essential to
investors and the public?
Some Challenging Questions

Can we rely on self-regulatory systems
to ensure audit quality and to root out
and discipline substandard
performance?

No one wants Congressional Required
Accounting Principles (CRAP makes a
pretty lousy acronym!)
Some Challenging Questions

Can we rely on corporate governance
processes – oversight by boards of
directors and audit committees – to ride
herd on management and to see to it
that auditors do their job?
Some Recommended
Changes
Regulatory Processes

Timely and thorough investigations of
circumstances that may involve
fraudulent financial reporting.

Objective and fair assessments of the
role and performance of auditors.

Timely and meaningful discipline of
auditors and firms that violate acceptable
norms of conduct.
Regulatory Processes

Regular oversight and periodic
examinations of the policies and
performance of independent auditors.

Timely and responsive changes in
professional standards and guidance
when a need for improvements is
identified.
Your Questions

The words “in a timely manner” were
used throughout the article in reference
to auditors reporting information. What
would be considered “timely” in the eyes
of the law.
Your Questions

How were auditors ever entrusted to
fulfill their duties when they reported to
top management of the firm they
audited?
Your Questions

The author points to information asymmetry
between insiders and the investing public as a
source of inefficiency in capital markets and
asserts that auditors can “balance the scales”
by providing accurate and trustworthy
information about business entities. How far
do you believe the auditing function can
reduce this asymmetry and level the playing
field between insiders and the investing
public?
Your Questions

Is there a way to redefine the accounting
system to ensure that a “single financial
reporting failure” is not a disaster that
wipes out “decades of hard work,
planning, and saving?”
Your Questions

How can the bonds between managers
and independent auditors be entirely
broken when large amounts of money
from corporations fund the independent
auditors?
Your Questions

Why did the Enron and WorldCom
failures demand meaningful reforms, but
past failures did not?
Your Questions

Were the financial reporting of Enron and
WorldCom legal or within the rules of
accounting authorities?
Your Questions

The FASB rules currently permit
distorting financial reporting of Special
Purpose Entities. Why?
So . . . What is “wrong” with
Accounting?
Accounting in the 21st Century
Testimonies Before the U.S. Senate
Banking Committee
The Traditional View of Accounting

“Transaction” oriented

Narrow focus on financial data

Reporting is periodic and not real-time

Limited accessibility of information

Too high a level of aggregation
The Traditional View of Accounting

Limited flexibility which prevents
answering queries that cross functional
boundaries.
The Fundamental Accounting
Problem
Fundamental Accounting Problem

We are using a 500-year-old system to
make decisions in a complex business
environment in which the essential
assets that create value have
fundamentally changed.

Baruch Lev Professor of Accounting
NYU Stern School of Business
New Math for a New Economy
www.fastcompany.com
Intangible Assets

Assets associated with product
innovation (R&D)

Assets associated with a company’s
brand

Structural assets – better, smarter,
different ways of doing business.

Monopolies (barriers to entry).
Intangible Assets

Expensive to acquire and to develop.

Extremely difficult to manage

Property rights are fuzzy
Violation of Matching Principle

Accounting is based on the matching
principle.

Good matching = good income number.

Knowledge assets = mismatch.
The Sarbanes-Oxley
Act of 2002
Public Companies Accounting
Reform and Investor Protection Act
of 2002
Sarbanes-Oxley Act of 2002

Directly impact these groups:

CPAs and CPA firms auditing public
companies.

Publicly traded companies, their employees,
officers, and owners. (Includes CPAs
employed by publicly traded companies as
CFOs or in their finance department)
Sarbanes-Oxley Act of 2002

Directly impact these groups:

Attorneys who work for or have as clients
publicly traded companies; and

Brokers, dealers, investment bankers and
financial analysts who work for these
companies.
PCAOB

Establishes a new Public Company
Accounting Oversight Board (PCAOB).

Board composition

Two must be or must have been CPAs

Three must not be and cannot have been
CPAs
PCAOB

Board composition – continued

Chair may be CPA, but must not have
practiced accounting during the five years
preceding appointment.

Appointed by the SEC.

Subject to SEC oversight
PCAOB - Funding

The Board will be funded by public
companies through mandatory fees.

Accounting firms that audit public
companies must register with the Board
and pay registration and annual fees.
PCAOB – Standard Setting

The Board will issue standards or adopt
standards set by other groups or
organizations, for audit firm quality
controls for the audits of public
companies.
PCAOB – Standard Setting

These standards include: auditing and
related attestation, quality control, ethics,
independence and “other standards
necessary to protect the public interest.”

The Board has the authority to set and
enforce audit and quality control
standards for public company audits.
PCAOB – Other Powers

Investigative and Disciplinary authority

International authority
The Sarbanes-Oxley
Act of 2002
New Roles for Audit Committees
and Auditors
Audit Committees & Auditors

Auditors report to audit committee

Audit committees must approve all
services

Auditor must report new information to
audit committee

Offering specified non-audit services
prohibited
Audit Committees & Auditors

Audit partner rotation

Employment implications.
The Sarbanes-Oxley
Act of 2002
Criminal penalties and protection
for whistleblowers.
Criminal penalties

Failure to maintain workpapers

Document destruction

Securities fraud

Fraud discovery

Protection for whistleblowers