Adverse effects of uniform written reporting standards on accounting practice, education, and research

When transactions have multiple attributes, achieving uniformity in their classification depends on whether similarities or dissimilarities are of interest; uniformity with respect to both is not possible. The pursuit of uniform written standards at the expense of social norms diminishes the effectiveness of financial reporting in stewardship and governance, and in keeping the security markets informed. A shift to written standards discourages thoughtful classroom discourse on alternatives which develop professional judgment. It also engenders ‘‘by the book” attitudes and drives talent away from accounting programs and, ultimately, from the accounting profession. Judgment and personal responsibility being the hallmarks of a learned profession, the dominance of uniform written standards weakens the claim that accounting programs belong in universities alongside architecture, dentistry, engineering, law, and medicine. Uniformity discourages research and debate in academic and practice forums and promotes increasingly detailed rule-making. It shuts the door on learning through experimentation, making it difficult to discover better ways of financial reporting through practice and comparison of alternatives. Improved financial reporting calls for a careful balance between written standards and unwritten social norms. 2009 Elsevier Inc. All rights reserved. c. All rights reserved. s the Emanuel Saxe Distinguished Lecture, Baruch College, City University of audience, two referees, and Manjula Shyam for comments and suggestions. dverse effects of uniform written reporting standards on accounting Public Policy (2009), doi:10.1016/j.jaccpubpol.2009.10.011 2 S. Sunder / J. Account. Public Policy xxx (2009) xxx–xxx ARTICLE IN PRESS Samuel Johnson published his dictionary (Johnson, 1755) not as the conqueror of the language but as the person who knew best how unconquerable it really is. Verlyn Klinkenborg (2005) The rules of accounting, even more than those of law, are the product of experience rather than logic. George O. May (1943) Common global standards, if read to mean identical, is an illusory and unobtainable goal. However, seeking to achieve similar objectives and to address in an effective way similar problems is a realistic goal. Richard Breeden (1992), Former Chairman, SEC The pursuit of uniformity in accounting practice through written standards and their enforcement by authority has been a prominent theme in financial reporting during the past half-century. In the current decade, the convergence of accounting standards and the harmonization of accounting practice have been the policy of the Financial Accounting Standards Board (FASB) and the International Accounting Standards Board (IASB). If the current trends continue, the US, the EU, andmany other parts of the world may claim to have reached this long-sought goal of uniformity in the foreseeable future. The pursuit of uniform financial reporting through the official enforcement of standards written by organized boards enjoys broad support from government, business, the accounting profession, and academia. For evidence of this broad support, we can look at (1) practice: all four major firms have significant campaigns to promote IFRS for the sake of uniformity, (2) textbooks: the space given to written standards of financial reporting, (3) research: the number of papers in our journals concerning written standards, and (4) professional meetings: the number of sessions in the AAA’s professional meetings – the Anaheim meeting in 2008 had more than a dozen sessions on written standards. Further, noteworthy by its rarity in our discourse is mention of the role of social norms in accounting. The label of ‘‘generally accepted” in accounting and auditing is now claimed for ‘‘what is required at the threat of penalties.” It is widely believed that uniform written standards will result in improved financial reporting; better governance and stewardship of business, not-for-profit, and governmental organizations; and better informed and more efficient financial markets directing capital toward productive deployment. When accounting problems arise, we look to written standards to address them. This paper presents a contrarian case: when transactions have multiple attributes whose similarities as well as dissimilarities are of interest, a uniform scheme of classification is not feasible. The pursuit of uniform written standards at the expense of social norms diminishes the effectiveness of financial reporting in stewardship and governance, and in keeping the security markets informed. Before the enactment of federal securities laws in the 1930s, social norms played an important role in accounting which has gradually diminished during recent decades. Accounting has dispensed with its equivalent of common law, discouraging thoughtful classroom discourse on alternatives that would help develop professional judgment, and inducing ‘‘by the book” attitudes that drive talent away from accounting programs and, ultimately, from the accounting profession. Judgment and personal responsibility being the hallmarks of a learned profession, the dominance of uniform written standards weakens the claim that accounting degree programs belong in universities alongside architecture, dentistry, engineering, law, and medicine. Uniformity discourages research and debate in academic and practice forums, and promotes increasingly detailed rule-making. It shuts the door on learning through experimentation, making it difficult to discover better ways of financial reporting through practice and the comparison of alternatives. Better financial reporting calls for a careful balance between written standards and unwritten social norms. Allowing several standard-setting bodies to compete, under regulatory supervision, for royalties from those who follow their standards may help achieve such a balance. The enthusiasm for the pursuit for uniformity to the exclusion of social norms should be tempered by the recognition of unintended consequences arising from the path regulators of financial reporting Please cite this article in press as: Sunder, S. Adverse effects of uniform written reporting standards on accounting practice, education, and research. J. Account. Public Policy (2009), doi:10.1016/j.jaccpubpol.2009.10.011 S. Sunder / J. Account. Public Policy xxx (2009) xxx–xxx 3 ARTICLE IN PRESS have chosen. Perhaps it is not too late to adjust our goals so we can improve financial reporting by seeking to balance written standards with the unwritten social norms of the accounting and business community. I address the nature of uniformity and the role of social norms, institutions, and law in accounting theory, practice, education, and research before turning to reforms that might help pave the way for better financial reporting. 1. Uniformity and classification Uniformity has long been the holy grail of rule-making in accounting. Diversity in accounting practices invites criticism rooted in an intuitively appealing idea that if the accountants would treat similar transactions similarly, and different ones differently, financial statements would be more useful. Unfortunately, this is not true. The problem is that two events or transactions are rarely exactly identical or totally different. Close examination nearly always reveals some similarities as well as some differences between any pair. Transactions come in limitless variety, and the accountant must classify and aggregate them into a manageably small number of categories. We can use one of the following two principles to classify any set of transactions into a smaller set of categories: (1) Treat any two transactions that have any differences differently. (2) Treat any two transactions that have any similarities similarly. Superficially, the two criteria may appear to be the same, but they yield quite different results. By choosing one, one necessarily violates the other, giving rise to a fundamental difficulty in defining and attaining uniformity and comparability in accounting (Sunder, 1983, 1997, pp. 143–144). In applying the first criterion, each transaction, being different from all others in some respect, must be treated differently. This yields an unmanageably thick accounting rule book, with each rule being used for only one transaction. In effect, there is no categorization and no aggregation. Some may call this a system without rules or uniformity because no two transactions are treated alike. Others can, with equal justification, refer to the system as the ultimate in uniformity in the sense that two transactions must be exactly identical in all respects in order to qualify for the same treatment. In a world where transactions have multiple attributes of substantive interest, pursuit of uniformity carried far enough leads to complete diversity. Paradoxically, applying the second criterion does not help. If every pair of transactions that have anything in common between them are treated alike, then all transactions are covered by a few categories, or even a single one. In accounting, this is not of much use. This problem is common to all systems of rules and laws, as well as to other schemes of classification. The point can be graphically illustrated by a simple example of four objects which differ in, say, size and color – two large, two small, two black and two white (see Panel A of Fig. 1). Applying the first uniformity criterion to size (objects with any differences should be treated differently) we get the classification shown in Panel B. However, this classification would leave dissatisfied those who consider color to be the important criterion. Applying the first uniformity criterion to color, we get the classi1 Uniformity ‘‘overall sameness, homogeneity, or regularity” (Random House Dictionary); ‘‘freedom from variation or difference, . . .consistency, sameness” (Webster’s Revised Unabridged Dictionary); ‘‘a condition in which everything is regular and unvarying” WordNet 3.0; ‘‘adherence to an imposed regulation or established rule or custom” (Kohler’s Dictionary for Accountants, 1983). Further, Kohler’s Dictionary has an entry that anticipates the difficulties of attaining uniformity:uniform accounting system A system of accounts common to similar organizations, such as those developed or promoted by associations and those promulgated by federal and state regulatory bodies such as public utility commissions.Attempts to establish uniform accounting for an industry or for all forms of human endeavor have been unsuccessful, at least in the United States, because the principal objective has been the development of elaborate, categorical classifications of accounts designed to aid in making comparisons, or to facilitate the construction of macro statistics, whereas the aim in micro accounting has been to provide information peculiar to the selfcontained, self-concerned organization or individual; information not readily adaptable, without substantial adjustment, to a macro buildup. In the so-called ‘‘Norwalk Agreement” the FASB and the IASB committed themselves ‘‘to the development of highquality, compatible accounting standards” without defining either ‘‘compatible” or ‘‘high-quality” (http://72.3.243.42/news/